20/12/2014: ECB, Inflation Expectations and Oil

There is much hype about the ECB not actively gunning for re-inflating the economy around. Which is understandable... as the fears of deflation are real. But it is also partially misplaced, as deflationary causes are a bit more complex and changing over time.

The main cause of the longer-term deflation is stagnant demand. This provides support for low level inflation base off which any negative shock to prices risks triggering a deflation. Here, in my opinion, ECB can do some helping, but not much.

The second cause, the shock to the downside, is oil price. And here ECB should do absolutely nothing, simply because lower cost of energy is neither caused by the monetary drivers, nor is hugely detrimental to the economy. If anything, lower cost of energy helps business margins and household budget, partially offsetting the stagnant demand.

Here's the link between Euro area inflation expectations and oil prices, courtesy of @ReutersJamie:

Yes, ECB is way off-target on its monetary policy: http://trueeconomics.blogspot.ie/2014/12/19122014-lots-of-talk-more-plans-little.html although the above begs a question if we really do want to see ECB balancesheet expanding so dramatically once again. Yes, ECB off-target on inflation. But no, ECB balancesheet growing is not a solution to the core problem holding European demand under water. Debt is, followed by lack of investment. And ECB can't help much with either. At least it cannot help by expanding it balancesheet.

19/12/2014: Lots of Talk, More Plans, Little Action: ECB Balancesheet Expansion

Couple of interesting charts, courtesy of @Schuldensuehner on the ECB balancesheet expansion:

First the target to be reached over 2015-2016:

Do notice the flat-lining of the balancesheet from the start of H2 2014 on, despite the deflationary pressures building up and ECB rhetoric pushing forward balancesheet expansion as being the 'silver bullet' rising proportionally.

Next, Nomura's estimates on how the target of leveraging up ECB balancesheet can be reached:

 (click on image to enlarge)

19/12/2014: Some links on Russian Crisis

Several interesting news this week on Russian corporate front.

One of the longer-running deal, the swap of assets between German BASF and Russian Gazprom was finally killed off on foot of sanctions. The deal collapse is one of the first spillovers to Europe from the Ruble crisis and the overall deterioration in Russian markets. Details here: http://www.bloomberg.com/news/print/2014-12-18/gazprom-deal-to-swap-assets-with-basf-ends-as-relations-sour.html. Key quote from the point of macro analysis: "BASF attributed the breakdown in the agreement to “the currently difficult political environment.” “We will continue our joint ventures in Europe and Russia,” the company said in a statement. “The facts clearly show: Europe and Russia need each other also in the future.”"

Russian Duma approved the bill to recapitalise the banks, injecting some USD16.5 billion worth of funding into the banking system. Details: http://www.reuters.com/article/2014/12/19/russia-crisis-banks-capital-idUSL6N0U318520141219?feedType=RSS&feedName=bondsNews.

This, amidst the already rolling contagion from Russian financial services to Europe's: http://www.reuters.com/article/2014/12/18/russia-crisis-raiffeisen-idUSL6N0U23AT20141218 as Ruble devaluations help drive Raiffeisen Bank International's overall capital ratio one percentage point down. Austria has the largest exposure of to Russian banks - see http://trueeconomics.blogspot.ie/2014/12/19122014-russian-banks-contagion.html.

And for the last bit, here is the latest polling from Russia:

19/12/2014: Russian Banks: Contagion exposures for Europe

From a different Deutsche Bank note, a handy chart plotting exposures of various Western banking systems to Russia.

Do keep in mind, same banks' exposure to Ireland was probably of a magnitude of 1/5th of their exposures to Russia, yet Irish banking system was deemed to be systemically important when it came to assessing the potential contagion from Anglo failure back in 2008.

19/12/2014: The Plight of Russian Banks Overhype?

Deutsche Bank note from earlier this month covering Russian banks is telling as to the nature of the problems.

Per DB: "A tighter funding situation and weak economic growth will dampen credit expansion, although Russian banks’ dependence on external funding is not strong. Rising NPLs will negatively impact profitability, but the government’s capacity to provide support to systemically important banks remains strong."

So in summary, few illustrations of the above.

There is a weak credit impulse in Russia through Q2 2014 (this is likely accelerated in Q3-Q4), especially on foot of hikes in CBR rates:

But credit growth remains elevated, albeit it is subdued relative to historical averages:

DB conclusion on growth potential is cautious: "Russian banks are facing several challenges. As economic growth is projected to remain weak and the banks’ external funding situation has tightened given EU and US sanctions, real credit growth is expected to slow down from the current 11% yoy (October data referring to total domestic credit)."

Still, "overall asset quality remains adequate (NPLs at 6.7% of total loans as of September), but it is likely to deteriorate over the coming months as the economy is close to recession and consumer indebtedness is growing. Moreover, rising loan loss provisions (with provisioning levels currently at 70% of total NPLs) and higher funding costs will have a negative impact on profitability over the next few quarters.

Capitalisation levels are moderate, with the ratio of core capital to risk-weighted assets standing at 9.4% in September. The Central Bank has started preparing Russian banks to meet Basel III capital requirements. But it recently delayed the implementation of the Basel III liquidity requirement by six months to July 2015, taking into account difficulties in obtaining long-term funding."

Worth noting that the delay is no longer: Russia introduced new bank recaps this week: http://www.reuters.com/article/2014/12/19/us-russia-crisis-banks-capital-idUSKBN0JX0R620141219

Amazingly, Russian banks overall are not as reliant on foreign funding as one would have expected: "…a closer look at the funding structure of Russian banks shows that they are not overly dependent on external funding, which accounts for less than 20% of total debt liabilities. The share of the potentially most volatile funding sources (foreign interbank funding, syndicated loans, Eurobonds) has decreased since the financial crisis in 2008/2009. Non-resident deposits account for half of the USD 209 bn external bank debt outstanding. Moreover, only USD 44 bn of external bank debt will fall due within the next 14 months (see figure 5), with the largest 30 financial institutions holding an FX buffer of USD 32 bn (difference between FX liquid assets and FX liabilities maturing in the next five quarters)."

Two charts to illustrate:

Few caveats: "…when assessing the external debt of Russian banks, two contrasting data specification aspects have to be kept in mind. On the one hand, part of banks’ external borrowing is inter-company lending, which tends to be rolled over and thus mitigates external funding risks (figure 6 shows a proxy for this lending). On the other hand, bank external debt might be underestimated by the CBR using the “residency” and not the “nationality” concept of the borrower. Figure 7 shows that banks’ international debt securities falling due are significantly higher when using the nationality rather than the residency concept (USD 16.4 bn vs. USD 1.3 bn)."

But the key, so far, is the non-performing loans:

Clearly, Russian banking pressures from NPLs are, for now, benign. DB warns: "we expect NPLs to increase in Russia and Ukraine given the bleak economic outlook and currency weakness (against the background of relatively high levels of FX- denominated loans, especially in Ukraine)." Question is: what about provisioning cushions? Well, Russian banks seem to be fine here too:

On the net, DB warns that tough times are still ahead for Russian banks. I would agree. This week's changes in mark-to-market accounting rules and repo collateral quality requirements, as well as recpaitalisation of the banks are strengthening the system buffers to deal with shorter term aspects of the crisis. Higher policy rates (17% for key rate) are net positive for deposits, but negative for mortgages and credit. So where the balance of these changes lies is anyone's guess at this point in time.

17/12/2014: Russia: Running Out of Euros and Ikea Kitchens?

While Russians are converting dollars into rubles to buy Ikea furniture to store cabbage, shortages of which are imminent... or maybe converting Ikea kitchens into dollars to buy spare parts for Ladas door handles... there's a panic... allegedly.

In one city, some banks have run out of dollar kitchens and euro handles... even at the rate of 110 RUB/1EUR, though the main banks remained fully stocked with hard currency:

Funny enough, the reporter spotted a queue for currency only in one branch of one bank, where EUR was selling for 92 Rubles instead of 110... There is a rich behavioural economics paper sitting somewhere between the Russian retail currency exchanges margins...

Another behavioural adjustment was made today - by the Central Bank of Russia which suspended mark-to-market valuations of its own portfolio:  http://www.forexlive.com/blog/2014/12/17/russian-central-bank-imposes-temporary-moratorium-on-portfolio-revaluation/ The CBR also suspended mark-to-market valuations of credit institutions and banks. To offset asset base volatility, or in plain terms, to reduce impact of volatile exchange rates on assets and liabilities valuations.

And more households' behavioural 'antics': despite rapid rise in interest rates, demand for credit has sky-rocketed: http://www.interfax.ru/russia/413783 Households seem to be stocking up on short term credit while interest rates are still creeping up.

17/12/2014: Winners and Losers in Russian Crisis

My effort at explaining some of my thinking on Russian crisis in an interview with Expresso (in Portuguese and paywalled) here: http://expresso.sapo.pt/o-vencedor-da-crise-no-leste-europeu-e-a-china=f902733
and in English here: http://janelanaweb.com/trends/the-greatest-winner-of-the-2014-geopolitical-crisis-in-eastern-europe-has-been-china-constantin-gurdgiev/

17/12/2014: Russian Industrial Production & Investment

Russia's industrial output fell 0.4% in November after two months of relatively strong growth, expanding 2.9% and 2.8% in October and September. Core drivers were:

• Manufacturing sector contracted at 3% in November, having expanded 3.6% in October. The latest change, if confirmed over the next few months, might signal wearing off of the imports substitution effects from Russian counter-sanctions.
• Natural resources exploration sector expanded output by 2.5% in November
• Production of heat and electricity rose 7% in November
• Pipeline production grew by 30% in October, gas turbines manufacturing rose 91%. The $400 billion gas contract with China, signed in May was the reason, as Russia started construction of the 4,000 km Power of Siberia pipeline in September.

Note: November Manufacturing PMIs were up http://trueeconomics.blogspot.ie/2014/12/1122014-russia-manufacturing-pmi.html signalling that things might improve in December data.

On a no-surprise side, fixed capital investment was down in the first nine months of 2014 and in Q3 2014 - declining by around 2% or well below expectations. SMEs investments declined, while investment by larger companies rose. Oil refining investments remain the largest contributor to manufacturing sector investments, per BOFIT. Food sector investments also were robust. Q3 also saw reversal of negative growth in total investments in machinery & equipment by large and medium-sized firms.

BOFIT: "Growth in investments of large firms reflects the government’s goal, reinforced at the start of this year, of getting large state-owned enterprises to increase investments
despite the hard times. The economy ministry indicated in November that investments of so-called natural monopolies, which represent some of the biggest state-owned enterprises, will grow even more notably next year."

Another handy chart via BOFIT:

17/12/2014: Some Ruble-Heavy Reading: Contagion, Reserves & Fundamentals

Some interesting set of articles on the topic I mentioned earlier on Irish radio and in the post here: http://trueeconomics.blogspot.ie/2014/12/16122014-russian-inflation-hot-but.html  - the topic of contagion from the run on Russian ruble to the global economy:

• First off, the Guardian on the destabilising effects of playing brinksmanship with Russia (not to excuse the equally destabilising effects of Russia playing its own brinksmanship): http://www.theguardian.com/commentisfree/2014/dec/16/russia-economy-west-vladimir-putin?CMP=twt_gu
• Second, RT article on subject of spillovers: http://rt.com/op-edge/215031-russian-ruble-crisis-aftershocks/ Note: the article quotes myself on the topic
• Third, FT Alphaville piece - tongue-in-cheek - on Russian external liabilities http://ftalphaville.ft.com/2014/12/16/2074181/russian-foreign-liabilities-in-perspective/ Give that a thought - these are owed to someone in the West (mostly in Europe).
• Fourth, Bloomberg View piece on spillovers: http://www.bloombergview.com/articles/2014-12-16/russias-problems-are-everyones-problems - not much in the way of factual, but on the money in general
• Fifth, a bit over-the-top, but important question of potential geopolitical response from Moscow here: http://www.businessinsider.com/what-will-happen-next-2014-12?IR=T
• Sixth, factual report on PIMCO effect from the Russian crisis: http://www.bloomberg.com/news/2014-12-16/russia-crisis-hits-pimco-fund-wipes-out-options-as-ruble-sinks.html
• Seven (update): WSJ on Ruble spillover to European companies: http://www.wsj.com/articles/rubles-decline-deepens-concerns-for-european-companies-1418760793

As an aside to the menu of options available to Russian Government, here is one of a 'limited capital control': http://www.nakedcapitalism.com/2014/12/how-putins-fealty-to-the-washington-consensus-made-his-currency-crisis-worse.html aka de-dollarisation of the retail deposits. Surely, that would just amplify pain for ordinary savers.

And another aside: in-depth analysis of the reserves position and demand for debt redemptions for Russia here: http://www.nakedcapitalism.com/2014/12/oil-ruble-ideology.html. Key quote from the article:

"We notice that the strong depreciation of the Rouble corresponds to a peak in repayments, but that the situation will loosen up in early 2015. It is sure therefore that the exchange rate will reverse its tendency in the first semester of 2015. The question is, up to what point? If the Rouble stabilizes around 50 roubles for 1 USD, inflation will be strong next year and could reach 12%. If we witness a rise in oil prices and the Rouble stabilizes around 40-42 roubles for 1 USD, the inflation rate could amount to merely 10%. Still, this implies that the Central Bank of Russia keep an eye on such establishments which could be tempted to speculate on the exchange rate, dragging it farther down than it should normally be. Explicit threats were made by President Putin at the occasion of his declaration of general policies before the chambers of parliament on December 4th. However spectacular it has been, the depreciation of the Rouble by no means puts into question the financial stability of Russia. The trade balance remains in excess, with an amount outstanding of 10 billion dollars a month. This is largely sufficient to face up to coming payments. The budget is actually profiting from this depreciation, which should allow the government to spend a little bit more in 2015. Russia will therefore remain one of the least indebted countries in the world, which is not necessarily an advantage and goes to show that, provided it takes up debts internally, the country wields over a strong potential for investment and development."

Another update: a must-read from Bloomberg's @Bershidsky on why sanctions are at best secondary when it comes to the run on the Ruble:  http://www.bloombergview.com/articles/2014-12-17/lift-sanctions-now-to-humiliate-putin

16/12/2014: Russian Inflation: Hot, but Hardly a Meltdown, yet...

While everyone is chasing tails of Ruble (or Rouble / Rubel / Roubel and any other toungue-twisting permutation), here is one fact on the Russian economy:

Russian 12-month inflation was running above 9% at the end of November. 

Sounds a lot. In fact, as I am typing this, one UK news report is referencing Russian inflation and telling us that if the UK were to experience such, there would have been panic. Right...

Truth is, Russia is accustomed to inflation at 7% - whether it is a positive marker or not, it is simply a fact - so 9% is a bit less of a drama than one might expect. However, end-November food price inflation is 12.6% y/y and non-food inflation is at 6%. The latter is benign, but likely to rise more. The former is a bit of concern, as Russian crops hit nearly historical records this year. Admittedly, it takes time for field-to-table route to be completed, but… According to the economy minister Alexei Ulyukayev, roughly 4% of the above inflation is down to Ruble depreciation (so expect more pressure here when December CPI is out), but 2.5% is down to imports bans under Russian counter-sanctions. Slightly confusing the message, Ulyukayev's deputy estimated that around 2.4% of full year inflation will come courtesy of Ruble devaluations (again, this will have to be revised up now). 

Expectations forward are not rosy. I expect inflation to hit 10% before year-end and roll over that number in Q1 2015. CBR, meanwhile, expects it to be close to, but below 10% mark in Q1 2015. Many analysts and the CBR expect inflation to moderate in Q2 2015. I doubt that. It will be sticky to the upside, likely North of 12%. 

And the crucial marker for the entire 2015 will be the 2015 crop, not estimates, but actual output, which - judging by cyclicality - is not going to be as good as this year's one.

Here's a neat chart plotting Russian CPI from 2005 on, courtesy of BOFIT. 

Source: BOFIT

Do tell me again that the current inflation rates are a 'meltdown'… though one still has to recognise they are a concern.

Meanwhile, last week revised economic forecasts by Russian Economy Ministry were factoring in USD80 bbl Ural's price of oil for 2015. Sounds outrageously high? Not really: Brent consensus forecast by IEA-polled economists produces the expectation slightly above that. With this price assumed, Russian economy is forecast to shrink by 0.8% in 2015. Again, you might think that the world is collapsing, if you are to read current headlines related to the run on the Ruble, but let me remind you that euro area economy shrunk by 1.08% in 2012-2013 and last time I checked, Frankfurt is still around.

Russia desperately needs some breathing space on the funding markets side. And it needs to stop capital flight. If it finds solutions to these twin problems, it can weather the storm.

Note: I was asked today on Irish radio to comment on the effects of the Russian crisis on Europe and Ireland. Here is a summary of my view:

Continued currency crisis in Russia presents risks to the European economy hard to estimate.

Russian imports of goods and services are likely to contract by between 12 and 15 percent in 2015, with much of this effect being driven by decline in capital goods and consumer goods imported traditionally from Europe. Second order effect is ongoing substitution of Russian imports away from Europe and in favour of Asia Pacific as a source of goods. This means that the impact on Russian demand for exports from Europe is likely to be even stronger.

In addition, financial exposures to Russia run high in Austria, Italy, France and the UK. While the European banks have strengthened of their balancesheets in recent months, another adverse shock to their assets base is not something they would like to contemplate. While it will not be a sector-defining event, continued deterioration in Russian assets valuations will not be helping.

The big unknown - Russian response to current pressures - is yet another risk factor no one in Europe needs. If Russia opts for capital controls and/or imposes a holiday on repayment of larger debt tranches coming due in H1 2015, European financial system will receive another shock as much of Russian banks and corporate funding was underwritten in Europe.

In simple economic terms, everyone around the world would benefit from Russia stepping off the financial precipice line as soon as possible.

16/12/2014: Next Stop... for Parabolic Ruble...

Ruble down below USD70 and EUR87.40, with 109.20 against Sterling. The CBR move last night (http://trueeconomics.blogspot.ie/2014/12/15122014-dont-blink-or-russian-data.html) is nothing more than a blip on the FX trading screen and a massive hit on the economy.

credit @TheStalwart

There is an emergency meeting scheduled by Medvedev and the next stop is either capital controls or EUR100 marker... or maybe both. The point is that no one is in control anymore, not because they are not trying, but because they are unable...so... smile, as you prepare to ride the RUB/USD chart...

16/12/2014: The Surreal Takes Hold of Kiev and Moscow...

While all of us are watching the Ruble crash, there is an ongoing collapse in Ukraine: http://www.nakedcapitalism.com/2014/12/imf-world-bank-halt-lending-ukraine-franklin-templeton-4-billion-ukraine-bet-goes-bad.html.

I posted IMF 'note' on the emergency visit to Kiev last week http://trueeconomics.blogspot.ie/2014/12/14122014-imf-emergency-mission-to-kiev.html which, in simple terms, amounted to nothing... as in nada... or no new lending.

And to note a simple fact: yesterday's Moscow dramas were nothing compared to Kiev dramas: http://trueeconomics.blogspot.ie/2014/12/15122014-russia-ukraine-cds-hitting.html and

Note: Russia's CDS rose, but didn't even make it into top under-performers group, while Ukraine did... and at an eye watering 77.36% probability of default (cumulative at 5 years). In other words, unless the IMF stamps out some USD15+ billion in new 'loans', Ukraine is done for.

The Russia/Ukrainian 'Arc':

It shows that Ukraine is getting worse faster than Russia is getting worse...

But back to Russia for now, as West's newest 'ally' East of Dniper is out of criticism or questioning... Ruble is tanking, still, as predicted in the first link above:

Credit to: @Schuldensuehner 

The reason is that when you have a 1am Governing Council meeting, you signal to the domestic economy that things are out of control (and they are), which prompts:

• Companies facing upcoming debt redemptions or holding Ruble deposits to run for FX cover and demand dollars or euros or pounds or Mongolian tugriks; and
• Households facing actual inflation (in PPP terms, not CPI) to run for FX deposits and demand same dollars or euros, less so unfashionable pounds and certainly not Mongolian tugriks...

The only way to stop this is... capital controls. All of which has little to do with the actual economy as a cause of the malaise, but all of which will cause actual economy to contract.

Oh, Happy Birthday, Wassily Kandinsky... your Composition VII aptly illustrates the whole mess: