18/10/2014: Latest news on Russian economy

In the week this was, much of my attention was on Irish economy (given the Budget 2015 shower of news), so here's a quick catch up on Russian economy news.

Fresh off the printing press, Moody's downgraded Russia credit ratings from Baa1 to Baa2. Per Moody's moody grumblings: "The first driver for the downgrade ...relates to the longer term damage the already weak Russian economy is likely to incur as a result of the ongoing crisis in Ukraine and, relatedly, the additional sanctions imposed against Russia." More bad news: the agency is maintaining Russia's outlook at "negative".

Let's face the music: so far in October, Russian Central Bank spent some USD13.5 billion in a futile attempt to hold ruble from sliding against USD and the euro. This is not good news as it signals three things:

1. Flood of capital out of Russia continues and seems to have resumed with renewed strength in last 30-45 days after a brief slowdown in May-August.
2. The combined effects of (a) general outflow of funds from Emerging Markets, (b) falling exports revenues on foot of collapsing prices of oil, © building of arrears against some importers of Russian gas (actually that would be Ukraine alone), (d) general volatility in the global markets, and (e) rumours of capital controls and deteriorating business climate in Russia, including in the shadow of the Russian banks facing pressures from the EU and US funding markets shutdown and talks of SWIFT disconnection, all are now acting to reinforce the adverse effects of the geopolitical mess in the Ukraine. [Note: here's the latest on SWIFT saga: http://www.themoscowtimes.com/business/article/sanctioned-russian-banks-seek-alternative-to-swift/509345.html]
3. There is now political economy kicking into high gear when it comes to ruble valuations: after  continued depreciation of the ruble against all major currencies stretching over some 12 months, we are starting to see some serious concerns in both the Central Bank and the Kremlin that more devaluations will be translating into serious pain on the ground for ordinary consumers.

Chart below (via Bofit) to illustrate the degree of interventions and associated exchange rates:

On the above point (2): Bofit reports that "Russian banks repatriated a record high amount of their assets from abroad in order to balance their forex positions as Russian firms and households reduced their domestic forex deposit accounts with Russian banks. ...Russia’s large state banks repatriated assets from abroad also in case there was an as-set freeze. Net borrowing of banks from abroad was strongly, and to an unusual degree, negative." In other words, banks were repaying foreign loans much more aggressively than rolling them over. Corporate capital outflows rose big time in Q3. This was driven by liabilities flows, which became negative in Q3 as companies aggressively paid down foreign debt and received virtually no new debt from abroad. It is worth noting that official capital outflows include not only funds expatriated abroad, but also private (corporate and household) funds converted into foreign currency, even if these funds never leave Russia.

And on the above point (2)(d), two weeks ago the rumours were so strong that the Central Bank of Russia had to issue a note denying the capital controls were under consideration.

The general sentiment in the EM asset markets is that of a heavy risk-reweighting in the mature economies pushing massive outflows of funds from the EMs. Risk-off sentiment is certainly on this week across global markets. Ongoing volatility is high and rising and signals general nervousness in the global markets. This is fuelling a strong sell-off in risky assets, especially in the EMs. Addicted to endless increases in liquidity supply, the markets are clearly waiting for the Central Banks to open the taps once again. Absent such action, there is no fundamental reason for current asset valuations in any region in the world.

Ruble is getting hammered, with the largest catalyst for change being oil prices. Currently RUB/EUR is at 52.3 and RUB/USD is at 40.8. Two weeks ago, we had RUB/EUR at 50.5 and RUB/USD at 39.6. Month ago: RUB/EUR at 48.4 and RUB/USD at 36.8. Ugly!

In the short run, I can see both rates rise by around 5 percent (3mo outlook) and at 12 months horizon, my expectation would be for RUB/EUR is at 54.0-55.0 and RUB/USD is at 43.0-44.2.

With ruble plunging, imports are also falling off the cliff. Latest data from the Central Bank show Q3 2014 current account surplus hitting another 2 year high. Over 12 months through September 2014, Russian current account surplus averaged almost 3% of GDP. Goods trade surplus has been running at nearly 10% of GDP. This is despite a small decline in exports of goods and services in Q1 and Q3 2014 and virtually zero growth in exports in over 2 years. In contrast, imports fell 6-7% y/y in the first 9 months of 2014 and in Q3 2014. Goods imports declined 8%. Chart below (courtesy of Bofit) illustrates:

On the net, current account position is still strong, but trending around post-crisis levels. Lower oil prices should significantly harm this, especially as supports from imports declines start to wear out over time.

16/10/2014: Euro Area Industrial Production Losing Momentum... What Momentum?..

A nice chart from Pictet, graphing industrial production in the US against the Euro area:

Everyone is talking about 'fading momentum' in euro area industrial production... my view: what 'fading momentum'? Euro area industrial output has been on a declining trend for more than 36 months now. The 'recovery' from Q1 2013 through Q1 2014 was a blip - so weak in any 'momentum' it is not worth mentioning.

The chart basically shows no gains on output in the sector for the euro area since 2000-2003 averages. If there was any 'momentum' in the series before the last couple of months, would anyone please point it out?

16/10/2014: Ireland's Real Recovery Metrics: Try Avoiding that Over-Confidence Trap

So 7 years into the crisis, and Ireland is 'securing' the 'robust recovery' according to the Government. Securing? Well, here's the chart based on IMF latest projections for real GDP growth in 2014 (never mind, GDP is not that great metric for Ireland, but that's all we have to compare across the economies as of now).  The data is on per-capita basis and the index reflects 100=value of real GDP per capita in the year of pre-crisis peak.

So how is Ireland faring?

Ah, as of 2014, with 'robust recovery' being 'secured' we are the third worst-off economy in the Euro area, with GDP per capita in real terms down 11.9 percent on pre-crisis peak and 7 years (longer-tail of the range) duration of the crisis. Two economies worse off than our 'robustly recovering' one are: Greece and Cyprus. And of these, only Greece is as long into the crisis as Ireland.

But, I hear you say, things are improving in Ireland faster than anywhere else... Shall we take a look?

The rate of improvement is measured by the slope of the line. By this measure, Ireland in 2014 is indeed improving faster than anyone else, except the recovery is close to or on par with Latvia, Slovakia and Malta. But here's a kicker: 2014 rate of improvement in Ireland is similar to the rates of improvement attained in the past during this crisis by:

• Latvia in 2011, 2012, 2013 and 2014
• Finland in 2009 and 2010
• Malta in 2010, 2013 and 2014
• Slovakia in 2009, 2010 and 2014
• Germany in 2010 and 2011
• Austria in 2011

So our 'unique today' is not as unique as we would like it to be, both today and historically over the crisis period.

Time to be a bit more humble, perhaps? Just to avoid falling into over-confidence fallacy?

16/10/2014: Stating the Obvious, yet the Un-mentionable

With all the talk about 'inflation is too low' in Europe, let me put it to you succinctly: It is not the inflation, stupid! It is income, aka consumers capacity to sustain demand...

In real terms, and with illicit drugs and prostitution factored in, whilst counting in addition bogus R&D reclassifications and other 'bells and whistles' of national accounts, only TWO of the Euro Area 12 'rich' economies have managed to regain their pre-crisis real GDP per capita peak: Germany and Austria. One of them - Germany - has no demographic driver for increased demand. So go figure: price inflation is low because incomes are low! Not because monetary authorities are not doing something. Nor because Germany is dragging Europe down. May be, because, in part, fiscal authorities have taxed the daylights out of people. And may be because banks have shoved so much credit into households prior to the crisis than few can borrow much more to sustain unsustainable (judging by income growth) consumption growth.

So again: It is not the inflation that is too low, stupid! It is income, aka consumers capacity to sustain demand, that is too low...

15/10/2014: Changing Nature of Financial Diversification

My new blog post on Learn Signal Blog covering the changing nature of diversification in financial markets: http://blog.learnsignal.com/?p=83

Certainly of use to our MSc in Finance class!

14/10/2014: Budget 2015: Of Double Irish and Tax Non-Reforms

This Budget was supposed to be about giving working families something back. In the end, it was not.

The core asymmetry in Irish tax system has been, since the onset of the crisis, increasing burden of State on ordinary incomes. This remains.

2014 projected income tax take is EUR17.18 billion out of total tax take of EUR41.04 billion. 2015 projected income tax at EUR17.98 billion against total tax take of EUR42.3 billion.

Corporation tax: 2014 projection for EUR4.525 billion and 2015 at EUR4.575 billion.

So as a share of total tax take, income tax continues to rise, corporation tax continues to fall.

There is no re-balancing of tax system. Households pay. Full stop.

Of core measures, announced, corporate tax reforms are the biggest. As predicted, 12.5% headline rate is here to stay. Minister Noonan sounded like a politician cornered by someone with a bit more power (Germany? US? EU? UK? all of the above?) on the topic. And he stayed his ground (absent visible opponents).

But the 'non-tax-haven' tax loophole of the Double Irish was abolished, as predicted. For new companies coming into Ireland - starting with 2015 - all companies resident here will be resident here for tax purposes too. For existent companies, the new provision comes into force at the end of 2020. Transition period will see more tax optimised activity being booked through Ireland as corporates embark on building up cash reserves. This firmly puts any risk of economic activity falloff after the full abolition of the Double Irish out into next Government, so should FF or SF or both win next elections, they will bear the weight of any disruptions. Before then, however, more will flow through Ireland on the way to real tax havens.

It is worth reminding that in October 2012, Minister Noonan steadfastly claimed that abolishing Double Irish provision was not within his remit.

Minister Noonan also set out some sketch of the forthcoming tax reforms. These will:

1) Remove completely any base year consideration in application of R&D tax credits. The measure will take hold from January 1, 2015 and will create more incentives to book R&D spending into Ireland. Whether this will tangibly increase actual R&D activity here remains to be seen, since R&D investment is even harder to price than transfer pricing in the services sector. Suppose a lab located in, say, New Hampshire develops a formula for new drug. But final preparation is registered into Ireland. All R&D investment, save minor expenditure on lab operations, can be billed into Ireland, in exchange for having a 'token' small lab of formula preparation team here. make a key scientist fly into Dublin for a couple of meetings and you have magic R&D activity here that can easily exceed activity in the actual lab. The “knowledge box” will, presumably, tax corporate profits generated as a result of patented innovations in a way similar to so-called 'patent box' structures already in place in the Netherlands and the UK. UK 'box' has a tax of 10% , Netherlands' one has 5%, and Minister Noonan promised Irish equivalent will be 'the best in class', so it will need to undercut the already existent ones. Which means that the above-mentioned example of an 'investment' will book profits into Ireland as payments on R&D-generated IP and these will be taxed at a reduced rate.

2) Aim to deliver even more 'competitive' environment for 'intangible assets' domiciling in Ireland. In other words, the fabled IP pushed through the fabled 'Knowledge Development Box', aka black box tax system that leaves IP outside tax net. This should sweeten the removal of the Double Irish for MNCs, especially in the IP-intensive ICT services sector. But it will also mean preciously little in terms of incentivising real activity on the ground here. Instead of shifting profits to Bahamas to get them off the tax hook, MNCs can just book payments into Ireland as payments on IP, making them basically tax free too.

3) To facilitate internationally trading sector, Budget 2015 enhances Special Assignee Relief Programme

4) To address future criticisms of the new system as being unfair to our trading partners, the Revenue will get additional resources to act as a 'competent authority' in enforcement and monitoring of corporation tax matters.

Gas bit is: the EU Commission is already investigating if 'patent-knowledge' box schemes constitute illegal state aid.

One simply cannot assess the full impact of the new changes on the economy. We have no data on specific activities by MNCs here. We have no data on operating tax structures. We have no data on how MNCs can re-arrange their activities here to address the challenge. It is, however, safe to assume that none of existent MNCs will be rushing to do much before 2020. And it is also safe to assume that by 2020, when the Double Irish fully bites the dust, the OECD-led BEPS reforms will be already known.

This, in effect, will mean that Ireland's Double Irish abolition today is a preemptive move that preempts nothing but bad PR. Reputational gain. Opportunity of real reforms for now remains a distant hope.

14/10/2014: Budget 2015: Economic Forecasts a Bit Optimistic

Here's my take on economic side of the Budget 2015 projections:

Gross current expenditure for 2015 will be just over €50 billion. This figure represents an increase of €429 million over the 2014 Revised Estimates. Note: in H1 2014, Government spent EUR35.567 billion which is EUR1.255 billion more than in the same period 2013. As unemployment fell, social benefits rose from EUR13.823 billion to EUR14.016 billion. General Government Deficit has fallen only EUR307 million y/y in H1 2014. These numbers are not consistent with strong economy or strong fiscal performance. Meanwhile, the state took out of the economy EUR1.893 billion more in taxes and social contributions in H1 2014 compared to H1 2013. Where did this increase of funding go?

Government deficit target for 2015 is 2.7% of GDP under ESA 2010 classification. Which means that going back to Troika programmes-comparable measure (ESA 1995 classification), the target deficit is closer to 3.2% of GDP. This is ahead of 3% target and shows how much debt we owe not to smart management of resources, but to accounting rules changes.

Here's a set of economic puzzles courtesy of the Department of Finance:

Real growth is slowing down from 2014 levels, but employment generation is rising. A puzzle. Especially as domestic demand is expected to grow at same rate in 2015 and growth rate is expected to fall in years after.

As compared against other organisations forecasts:

Added puzzle: IMF projections for Irish economy real GDP growth are: 2015 3.045% - full 0.85 percentage points lower than DofF, 2016: 2.538% which is full 0.87 percentage points below DofF, in 2017 : 2.649% or 0.75 percentage points below DofF… and so on.

And another kicker in the teeth… the promise of fiscal rectitude and 'no going back to boom-and-bust cycles':

All of the above is rather academic, since the Department of Finance refuses to forecast Gross Voted Current expenditure of the Exchequer beyond 2015, setting all of it at EUR50.075 billion for each year 2015-2018. Which means the estimated effects on deficit and on borrowing are based on assuming zero growth in spending and continued growth in tax revenues. Happy times roll, even though Haddington Road agreement is about to expire.

Still, as you can see, debt/GDP ratio is expected to fall, courtesy of higher GDP, including the new classification effects that came into force this year. But debt itself is not expected to fall. Instead, from EUR 203.2 billion, Government debt is expected to rise to EUR 215 billion in 2017 and basically stay there in 2018.

So on the balance: a bit too much optimism, especially past 2015. Not enough risk cushion. May the numbers turn out this well in reality...

14/10/2014: One Chart to Keep in Mind when Watching Budget 2015

When you are listening to the Budget 2015, remember this chart:

Corporate activity has been booming (per National Accounts), Households' tax burden has been booming too...

14/10/2014: Expect the Expected: pre-Budget 2015

Pre-Budget Budget... what to expect based on leaks so far:

Big Items:

1) Corporate Tax Regime changes: we can expect some phasing out to be announced for the notorious Double-Irish Tax Scheme.

This is one of the most criticized parts of the Irish tax code. Double Irish a complex corporate structure whereby a multinational can channel revenues to an Irish subsidiary, which then pays royalties on Intellectual Property to another company resident in Ireland, but tax resident in a tax haven, e.g. Bermuda.

To close the loophole, we can expect the Government will announce that all companies registered in Ireland will be automatically deemed tax resident in Ireland. Such a change will make Irish tax law fully aligned with the US and UK systems.

Since MNCs employ around 160,000 in this country, or roughly 8.6 percent of our workforce, the impact can potentially be significant. Which means Minister Noonan will have to be careful in closing the loophole. It is expected he will off-set the impact by expanding the R&D and Intellectual Property taxation benefits.

It is worth remembering that in October 2012, Michael Noonan solemnly declared that changing the Double Irish 'situation' was not within his remit. Direct quote: "Mu understanding of the "double Irish" is that while it exists, it cannot be remediated by changes in Irish tax law".

2) Households: Budgets 2009-2014 have lifted tax (direct and indirect) take by EUR11.7 billion. Meanwhile, on spending side, all years of austerity have basically meant that our Government spending (excluding banks measures) stayed relatively flat on pre-crisis levels.

There has been re-allocation of some spending from services to paying interest on our massive debt, which or course means there were cuts to some specific services. But we had no significant improvements in public sector efficiencies and we had no significant changes in how the State does business:

• Semi-state companies continue to inflate their books by charging higher and higher prices, blessed by captive regulators;
• State employment, pay and promotion policies remain detached from productivity;
• State pensions remain unfunded, private pensions becoming de-funded;
• State health system continues to crumble, while private subsidy to this system is being eroded;
• Management in public services remains excessively bloated and inefficient, compared to front-office staff which is getting worked harder.

All of which means that 'austerity' years have shifted the burden of state even more directly onto ordinary income earners.

Now, with the economy expected to grow by 4.7 percent in 2014 and deficit expected to fall thanks to the national accounts reclassifications and booming MNCs tax arbitrage, Minister Noonan has some room for minor giveaways.

We can expect that he will cut income tax burden, possibly by lowering the top 52 percent tax rate or raising the income threshold for that rate. Another possible target is much despised USC which currently hits workers on earnings from €10,036.

Keep in mind, whilst the Government will claim credit for any tax reductions and austerity easing, these were made possible, primarily, by the EU-mandated changes in our National Accounts. On the other hand, keep also in mind that the Troika-demanded water charging is introduced as double-taxation measure on foot of Government-own design.

To appease trade unions and other 'Social Partners' pivotal to the Labor Party electoral base, he could also announce the hiring of more teachers and increase some benefits. One point he will probably address is the kick backs to taxpayers and vocal interest groups in terms of reduced cost of water provision. Rumour has it, he will:

• Create additional EUR100 credit for the elderly for water services; and
• Announce tax relief on water charges.

Net outcomes: We are some 18 months away from elections and the Government desperately needs to test waters to see what response from electorate they can get if they start 'McCreeviasing' their Budgets. Over months to come, the Government will be closely watching changes in opinion polls as a function of Budget 2015 'easing' of the austerity. Which is all about one thing: instead of 'stimulating the economy', the Government is attempting to gauge the extent of the Budget easing stimulus on electorate.

Still, keep in mind: Budget 2015 is likely to cut spending and raise revenues by some EUR800-900 million. So small giveaways will mask still substantial austerity. Which means that Budget 2015 is going to be about reallocating once again the burden on budgetary adjustments. Pensioners (already massive winners during deflationary period in the economy and low on debt burden courtesy of the previous property boom) are going to gain. Special interest groups are going to gain. General economy, ordinary working households are going to lose.

'McCreevization' by one half, then...

Little pesky details: Budget 2015 is, in part, going to be based on some non-trivial economic assumptions. In best practice terms, these should be conservative, rather than optimistic. But in Irish reality, the champagne of big 7.7% headline GDP print in Q2 2014 is starting to hit some heads in the Department of Finance. Government's forecast for 2015 Budget is for 3.6% GDP and 3.3% GNP growth. Seems conservative compared to H1 2014 figures, but is it conservative enough? Underlying these, there is a forecast for exports growth of 5% y/y in 2015. Again, might be a tad optimistic. And we also have forecast for accelerated jobs creation over 2015 +2.2% growth) compared to 2014 (+1.8% growth), despite the fact that the Government is forecasting slower economic growth in 2015 (3.6% GDP and 3.3% GNP) than in 2014 (4.7% GDP and 3.1% GNP).  Interestingly, in SPU 2014 (April 2014), the Government estimated employment growth to be 2.2% in 2014 and 2.0% in 2015. This is now revised down to 1.8% for 2014 and up to 2.2% in 2015. Labour force growth was penciled in at 0.5% in 2014 and 0.8% in 2015, but by Budget 2015 it was revised down to -0.1% in 2014 and up to 0.9% for 2015.

Past optimism is being reloaded forward? Or did someone miss their cup of milk before going to bed?

13/10/2014: Germany: Too Old to Read Paul Krugman or Rescue Europe

You want to know WHY Germany ain't 'saving Europe' in a fashion favoured by Paul Krugman? Read this:

Key point, of course, is demographics. Germany already experiencing shrinking working age population pool. And this process is only going to accelerate.

Here are 2009 projections for worker/retired ratios in economies:

Source: http://www.ncpa.org/pdfs/st319.pdf

This shows Germany as second worst-off economy to Italy. And here (from the above source) estimates of pensions and health liabilities:

In 2012, Germany already had second lowest income replacement ratio for new entrants into workforce, meaning its capacity to fund future cost increases without hitting directly the retirees is now pretty much exhausted:

Source: http://www.oecd-ilibrary.org/finance-and-investment/oecd-pensions-at-a-glance_19991363

And here's a table of projections for public spending on pensions, showing Germany accelerating spending as share of GDP earlier than other comparable economies:

All of which means that Germany is not in a position to ramp up leveraged fiscal expenditure or investment. It has no fuel to move itself, let alone the Euro area. So stop calling on Germany 'to do the right thing'. It is too old to read Paul Krugman.

11/10/2014: WLASze: Weekend Links on Arts, Sciences & zero economics

One of my by-now rather irregular WLASze posts: Weekend links of Arts, Sciences and zero economics. Enjoy!

In the week of Nobel prizes, it is worth taking a look at some awards.

Chemistry: a well-deserved award for empirical work on improving our ability to observe sub-cellular activities http://www.nytimes.com/2014/10/09/science/nobel-prize-chemistry.html?partner=rss&emc=rss&smid=tw-nytimes&_r=0 And a lovely story of a scientist leaving a big mark on his field and then leaving the field…

Meanwhile, in Physics, the Prize went for an invention that is rather more about engineering than science: the LED (and a sub-component of that, to boot): http://www.nytimes.com/2014/10/08/science/isamu-akasaki-hiroshi-amano-and-shuji-nakamura-awarded-the-nobel-prize-in-physics.html?rref=science&module=Ribbon&version=context&region=Header&action=click&contentCollection=Science&pgtype=article In my view, nothing earth-shattering as far as knowledge goes, but big item as far as practical applications are concerned.

Physiology (or popularisingly: Medicine): an exciting choice covering the discovery of the structure of the brain responsible for spatial positioning: http://www.nytimes.com/2014/10/07/science/nobel-prize-medicine.html?rref=science&module=Ribbon&version=origin&region=Header&action=click&contentCollection=Science&pgtype=article

And a priceless account by 2011 Nobel Physics Prize winner of his attempt at smuggling the Nobel medal to fargo, North Dakota… http://blogs.scientificamerican.com/observations/2014/10/10/nobel-prize-airport-security/

Stories are the stuff Literature is made of. And Modiano - this year's winner - is no stranger to them. http://www.theguardian.com/books/2014/oct/09/patrick-modiano-wins-nobel-prize-for-literature. Another take on same: http://moreintelligentlife.com/blog/simon-willis/my-first-patrick-modiano.
Let my literary professionals friends take this one over…

While you were on the pages of Scientific American, did you spot this gem? "Is Kindness Physically Attractive": http://blogs.scientificamerican.com/beautiful-minds/2014/10/09/is-kindness-physically-attractive/ . Clearly, there's no end to social 'sciences' experimentation… at which point it is probably worth shouting: "Stop! Leave at least something undiscovered, will you?" To break my own chain of thinking - here's a link I blogged on before, covering the Mathematics of Beauty: http://www.boston.com/ae/theater_arts/articles/2009/02/22/beauty/?page=full

But no, never, reply social 'scientists', deploying a total buzz-killer: the Social Machines to Tackle Twitter http://socialmachines.media.mit.edu/ At least, for now, the machines are chasing us… for now… Half-ironically, earlier today I tweeted:

which relates to the MIT Media Lab's latest Lab nicely and, of course, confirms the self-referential nature of social 'science'. At one point we will get fed up with all this trawling of the  www and start thinking once again.

Meanwhile, for those who still marvel at art and science and thought, a nice essay on one of my favourite artists of all times, Anselm Keifer: http://www.prospectmagazine.co.uk/arts-and-books/anselm-kiefer-inside-a-black-hole

Here are some of the links to his works:
http://www.saatchigallery.com/aipe/anselm_kiefer.htm

https://theartstack.com/artists/anselm-keifer
http://www.tate.org.uk/art/artists/anselm-kiefer-1406
Maybe it's German psyche exposed. Or human one. Or both... just kidding...

And to marvel at something entirely different, a wonderful essay on the Killogram: http://moreintelligentlife.com/content/ideas/tom-whipple/weight-almost-over via The Economist's Intelligent Life supplement.

9/11/2014: New WP on Tsallis Entropy application to FTSE & AIM

Just got a new Working Paper over the line (submission ready over the weekend): "Tsallis Entropy: Do the Market Size and Liquidity Matter?" (October 2014). Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2507977