4/1/2015: Eurasian Economic Union: Extra "E" & Less of "U"

In other 'Russia et al' news, Eurasian Economic Union came into force this week. This includes original founders (2010): Russia, Belarus and Kazakhstan, plus Armenia which joined in October 2014. In May, Kyrgyzstan is expected to join, having signed formal agreement last month.

Here's a summary of the EEU economic position, based on IMF data and forecasts.

The EEU objective is to increase economic integration and coordination within the sub-set of CIS states. Like the EU, it also sets a target of achieving integrated energy and capital markets.

In 2012, the EEU founding states agreed to implement free mobility of labour and capital, as well as free movement of goods and services. While there were transitionary periods set, integration to-date has been relatively limited and in recent months it came under increasing pressure, primarily driven by Belarus, but also, to a lesser extent, by tougher-talking Kazakhstan.

Ruble crisis certainly not making things easier. In recent weeks, there have been renewed border inspections between Russia and Belarus, and the latter demanded that trade with Russia be settled in foreign currency, not Ruble.

4/1/2015: Russian Economy Update

As I noted earlier, Russian economy posted an estimated decline in real GDP of 0.5% in November for the first time since 2009, while Russian inflation accelerated to 11.4% y/y in December, up from 9.1% in November. Latest guesses for economic growth in 2015: -4.0% at average crude prices of USD60 bbl via Finance Minister, Siluanov. Previous estimate by CBR consistent with this oil price level was 4.5-4.7% contraction.

To reduce inflationary pressures and to alleviate 'precautionary demand' (stockpiling) of some core goods, the Government is considering imposing a freeze on some food prices, according to Andrei Tsiganov, deputy head of the Federal Anti-Monopoly Service.

Still, according to CBR First Deputy Governor Ksenia Yudaeva, long term inflation target remains in place at 4% by the end of 2017. Good luck to that…

Largest driver for inflation was mid-December Ruble crisis (December 16-17). While Ruble posted some recovery in subsequent days, it came at a hefty price tag for the Russian foreign exchange reserves and Ruble resumed slide last week as CBR refrained from intervening in the markets from December 22nd.

Key driver for the upside of the Ruble has been, in addition to aggressive interventions by the CBR, the decision on December 17th to mandate five largest Russian state-owned enterprises: Gazprom, Rosneft, Alrosa, Zarubezhneft, and Kristall to reduce their foreign exchange holdings to the levels of October 2014. The deadline for this is March 2015. The companies will report their forex levels on a weekly basis. Behind the scenes, President Putin started discussions with larger private enterprises to also reduce their forex deposits.

Talking about deposits, to reduce pressure on retail banks, Duma passed the legislation to raise deposit insurance coverage from RUB700,000 to RUB1.4 million on December 19th. Russian Finance Ministry supported the bill, having previously resisted smaller increase. On corporate funding side, CBR announced, on December 23rd, new forex credit lines of 28-days and 365-days basis.

4/1/2015: "Betting on Ukraine" - Project Syndicate

I have been trying to reduce my commentary on Ukraine to a minimum for a number of reasons, including the viciousness of the 'Maidan lobby' and the fact that Ukraine is not a part of my specialisation.

However, occasionally, I do come across good and interesting commentary on the subject. Here is one example: http://www.project-syndicate.org/commentary/european-union-ukraine-reform-by-andres-velasco-2014-12.

To add to the above: the USD15 billion additional funding required, as reported to be estimated by the IMF, will also not be sufficient. Ukraine will require double that to address investment gap. USD15 billion estimate only covers the short-term fiscal gap.

Note: I called from the very start of the crisis for a Marshall Plan for the Ukraine, and suggested that for it to be more effective it should include Russian participation in funding and economic engagement. Funding Ukraine via standard IMF loans (shorter maturity instruments designed to address immediate liquidity crises) is simply useless. The country needs decade-long reforms and these reforms will have to be accompanied by investment and growth for them to be acceptable politically and socially. Such funding can only be supplied by a structured long-term lending programme. One additional caveat to this is that funding sources must be distinguished from funding administration. Given extreme politicisation of Ukrainian situation, neither Russia, nor the EU or the US can be left to administer actual funding programme. Hence, the task should be given to an World Bank or IMF-run administration mechanism that includes direct presence at the Board level of funders.

4/1/2015: Greek Crisis 4.0: Politics 1 : Reality 0

With hundreds of billions stuffed into various alphabet soup funds and programmes, the EU now thinks that Greece has been isolated, walled-in, that contagion from the volatile South to the sleepy North is no more (http://www.reuters.com/article/2015/01/03/us-eurozone-greece-germany-idUSKBN0KC0HZ20150103). Backing these beliefs, the EU and core European states have gone on the offensive defensive when it comes to Greek latest iteration of the political mess.

Yet, for all the 'measures' developed - from European Banking Union, to 'Genuine' Monetary Union, to EFSF, EFSM, ESM and ECB's OMT, LTROs, TLTROs, ABS, etc etc - the EU still lacks any clarity on what can be done to either facilitate or force exit of a member state from the EMU.

The state of the art analysis of the dilemma still remains December 2009 ECB Working Paper on the subject, available here: http://www.ecb.europa.eu/pub/pdf/scplps/ecblwp10.pdf which is, frankly put, a fine mess. Key conclusion, however, is that "a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that, while perhaps feasible through indirect means, a Member State’s expulsion from the EU or EMU, would be legally next to impossible."

So much for all the reforms, then - lack of clarity on member states' ability to exit the euro, whilst lots of clarity on measures compelling and incentivising a member state to submit to the euro area demand (e.g. bail-ins, access to Central Bank funding etc) - all the evidence indicates that the entire objective of 2009-2014 reforms of the common currency space has been singular: an attempt to simply lock-in member states' into the euro system even further. Disregarding any monetary or fiscal or financial or economic or social realities on the ground.

Which brings us back to the starting point: at 175% debt/GDP ratio, Greece cannot remain within the euro area (for domestic and international financial, economic and social reasons). Yet, it cannot exit the euro area (for domestic and international political reasons). Politics 1 : Reality 0, again.

4/1/2015: Homeownership, House Prices and Entrepreneurship

Two papers on related topics, the link between enterprise formation and homeownership/mortgages. In the past, I wrote quite a bit about various studies covering these, especially within the context of negative equity impact of reducing entrepreneurship and funding for start ups.

In the first paper, Bracke, Philippe and Hilber, Christian A. L. and Silva, Olmo, "study the link between homeownership, mortgage debt, and entrepreneurship using a model of occupational choice and housing tenure where homeowners commit to mortgage payments."

The paper, titled "Homeownership and Entrepreneurship: The Role of Mortgage Debt and Commitment" (CESifo Working Paper Series No. 5048: http://ssrn.com/abstract=2519463) finds that, from theoretical model perspective, "as long as mortgage rates exceed the rate of interest on liquid wealth [short-term bonds, deposits etc - and this usually is the case in all markets]:

1. mortgage debt, by amplifying risk aversion, diminishes the likelihood that homeowners start a business; 
2. the negative relation between mortgage debt and entrepreneurship is more pronounced when income volatility is higher; and
3. the relation between housing wealth and entrepreneurship is ambiguously signed because of competing portfolio and hedging considerations. 

Empirical analysis by the authors "confirm these predictions. A one standard deviation increase in leverage makes a homeowner 10-12 percent less likely to become an entrepreneur."

So back to negative equity. Negative equity is significantly increasing leverage taken on by the borrower. For example: original mortgage with LTV of 75% set against property price decline of 10% generates leverage increase of 8.3 percentage points. In Irish case, same mortgage (in Dublin case) brought back to current valuations of the property from the peak prices pre-crisis implies a leverage increase of, roughly, 50 percentage points, which is, roughly an increase of 12 standard deviations.


The second study is by Jensen, Thais Laerkholm and Leth‐Petersen, Søren and Nanda, Ramana, titled "Housing Collateral, Credit Constraints and Entrepreneurship - Evidence from a Mortgage Reform" (CEPR Discussion Paper No. DP10260: http://ssrn.com/abstract=2529930). The paper looks at "how a mortgage reform that exogenously increased access to credit had an impact on entrepreneurship, using individual-level micro data from Denmark."

The authors find that "a $30,000 increase in credit availability led to a 12 basis point increase in entrepreneurship, equivalent to a 4% increase in the number of entrepreneurs. New entrants were more likely to start businesses in sectors where they had no prior experience, and were more likely to fail than those who did not benefit from the reform."

What does this mean? "Our results provide evidence that credit constraints do affect entrepreneurship, but that the overall magnitudes are small. Moreover, the marginal individuals selecting into entrepreneurship when constraints are relaxed may well be starting businesses that are of lower quality than the average existing businesses, leading to an increase in churning entry that does not translate into a sustained increase in the overall level of entrepreneurship."

So the study basically shows that mortgage credit constraints in Denmark are not highly important in determining the rate of successful entrepreneurship. But the study covers only intensive margin constraints - in other words it covers credit availability increases over and above normal operating credit markets. This does not help our understanding of what happens in the markets where credit constraints are severe. 

3/1/2015: Greek Crisis 4.0: Timeline

Neat timeline of the Greek Crisis 4.0 forward, via @zerohedge

Click on the chart to enlarge

The above shows key points of uncertainty and pressure, with all of these hanging in the balance based on January 25th national elections.

Prepare for loads of politically-induced volatility.

Meanwhile, Greek manufacturing PMI remain in contraction territory:

3/1/2015: Can LTV Cap Policies Stabilise Housing Markets?

The Central Bank of Ireland late last year unveiled a set of proposals aimed at cooling Irish property markets, including the controversial caps on LTV ratios on new mortgages. And this generated loads of controversy, shrill cries about the cooling effect of caps on property development and even speculations that the caps will put a boot into rapidly rising (Dublin) property prices. In response, our heroic property agents unleashed a torrent of arguments about supply, demand, sparrows and larks - all propelling the property prices to new levels, 'despite' the CBI measures announced (see for example here:  http://www.independent.ie/business/personal-finance/property-mortgages/property-prices-set-to-rise-despite-lending-cap-plan-30879087.html for a sample of property marketers exhortations on matters econometric).

But never, mind the above. Truth is, the measures announced by the CBI are genuinely, for good economic reasons, have low probability of actually having a serious impact on property prices. At least all real (as opposed to property agents' economists') evidence provides for such a conclusion.

A recent paper by Kuttner, Kenneth N. and Shim, Ilhyock, titled "Can Non-Interest Rate Policies Stabilise Housing Markets? Evidence from a Panel of 57 Economies" (BIS Working Paper No. 433: http://ssrn.com/abstract=2397680) used data from 57 countries over the period spanning more than three decades, to investigatee "the effectiveness of nine non-interest rate policy tools, including macro-prudential measures, in stabilising house prices and housing credit."

The authors found that "in conventional panel regressions, housing credit growth is significantly affected by changes in the maximum debt-service-to-income (DSTI) ratio, the maximum loan-to-value ratio, limits on exposure to the housing sector and housing-related taxes. But only the DSTI ratio limit has a significant effect on housing credit growth when we use mean group and panel event study methods. Among the policies considered, a change in housing-related taxes is the only policy tool with a discernible impact on house price appreciation."

On DSTI finding, the authors estimate that setting a maximum DSTI ratio as the policy tool allows for a typical policy-related tightening, "slowing housing credit growth by roughly 4 to 7 percentage points over the following four quarters." In addition, on tax effectiveness, the authors found that while "an increase in housing-related taxes can slow the growth of house prices", this result is "sensitive to the choice of econometric method" used in model estimation.

Finally, on CBI-favoured LTV limits: "Of the two policies targeted at the demand side of the market, the evidence indicates that reductions in the maximum LTV ratio do less to slow credit growth than lowering the maximum DSTI ratio does. This may be because during housing booms, rising prices increase the amount that can be borrowed, partially or wholly offsetting any tightening of the LTV ratio."

In other words, once prices are rising, LTV caps are not terribly effective in controlling house price inflation.

3/1/2015: Trade Protectionism Since the Global Financial Crisis

A year ago, ECB paper by Georgiadis, Georgios and Gräb, Johannes, titled "Growth, Real Exchange Rates and Trade Protectionism Since the Financial Crisis" (ECB Working Paper No. 1618. http://ssrn.com/abstract=2358483) looked at whether the current evidence does indeed support the thesis that "…the historically well-documented relationship between growth, real exchange rates and trade protectionism has broken down."

Looking at the evidence from 2009, the authors found that "the specter of protectionism has not been banished: Countries continue to pursue more trade-restrictive policies when they experience recessions and/or when their competitiveness deteriorates through an appreciation of the real exchange rate; and this finding holds for a wide array of contemporary trade policies, including “murky” measures. We also find differences in the recourse to trade protectionism across countries: trade policies of G20 advanced economies respond more strongly to changes in domestic growth and real exchange rates than those of G20 emerging market economies. Moreover, G20 economies’ trade policies vis-à-vis other G20 economies are less responsive to changes in real exchange rates than those pursued vis-à-vis non-G20 economies. Our results suggest that — especially in light of the sluggish recovery — the global economy continues to be exposed to the risk of a creeping return of trade protectionism."

One thing to add: the above does not deal with trade-restrictive policies relating directly to financial repression, such as outright regulatory protectionism of incumbent domestic banks and asset managers, or direct and indirect subsidies pumped into the incumbent banking system.

2/1/2015: Irish Banking System: Still Reliant on Non-Deposits Funding

A handy chart from Deutsche Bank Research on sources of funding - focusing on deposits - for euro area banks.

Irish banks are an outlier in the chart, with domestic household and Non-Financial Companies deposits forming second lowest percentage of banks' funding in the entire euro area. As of Q3 2014, Irish banking system remains less deposits-focused and more funded by a combination of other sources, such as the Central Banks, Government deposits and foreign/non-resident deposits.

And the dynamics, post-crisis, are not impressive either: since the onset of the Global Financial Crisis, there has been lots of talk about increasing reliance on deposits for funding banking activities. Ireland's extremely weak banking sector should have been leading this trend. Alas, it does not:

2/1/2015: Credit and Growth after Financial Crises

Generally, we think of private sector deleveraging as being associated with lower investment by households and enterprises, lower consumption and lower output growth, leading to reduced rates of economic growth. However, one recent study (amongst a number of others) disputes this link.

Takats, Elod and Upper, Christian, "Credit and Growth after Financial Crises" (BIS Working Paper No. 416: http://ssrn.com/abstract=2375674) finds that "declining bank credit to the private sector will not necessarily constrain the economic recovery after output has bottomed out following a financial crisis. To obtain this result, we examine data from 39 financial crises, which -- as the current one -- were preceded by credit booms. In these crises the change in bank credit, either in real terms or relative to GDP, consistently did not correlate with growth during the first two years of the recovery. In the third and fourth year, the correlation becomes statistically significant but remains small in economic terms. The lack of association between deleveraging and the speed of recovery does not seem to arise due to limited data. In fact, our data shows that increasing competitiveness, via exchange rate depreciations, is statistically and economically significantly associated with faster recoveries. Our results contradict the current consensus that private sector deleveraging is necessarily harmful for growth."

Which, of course, begs a question: how sound is banking sector 'return to normalcy at any cost' strategy for recovery? The question is non-trivial. Much of the ECB and EU-supported policies in the euro area periphery stressed the need for normalising credit operations in the economy. This thinking underpinned both the bailouts of the banks and the bailouts of their funders (bondholders and other lenders). It also underwrote the idea that although austerity triggered by banks bailouts was painful, restoration of credit flows is imperative to generating the recovery.

2/1/2015: Monetary Policy and Property Bubbles

Returning again to the issue of lender/funder liability in triggering asset price bubbles (see more on this here: http://trueeconomics.blogspot.ie/2015/01/112015-share-liability-debtor-and-lender.html), CEPR Discussion Paper "Betting the House" (see
http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10305) by Òscar Jordà, Moritz Schularick, Alan M. Taylor asks a question if there is "a link between loose monetary conditions, credit growth, house price booms, and financial instability?"

The authors look into "the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. We exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions."

Do note: Ireland and the rest of euro periphery are the prime examples of this specific case.

The authors find that "…loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era."

So let's give the ECB a call… 

2/1/2015: Negative Deposit Rates: Swiss Method

The best explanation of the Swiss negative deposit rates intervention I've read so far is here: http://perspectives.pictet.com/2014/12/19/switzerland-the-snb-introduces-negative-interest-rates/ via Pictet Perspectives.