23/1/2015: Russian Economy Growth Downgrades

On top of downgrades by the rating agencies, Russia also got downgraded by the host of international agencies - in terms of country growth prospects for 2015-2016. The IMF downgrade took 2015-2016 forecast for growth of 0.5% and 1.5% for 2015 and 2016 respectively published in October 2014 down to a contraction of -3.0% in 2015 and -1.0% in 2016. The Fund estimates 2014 GDP growth of 0.6% for the full year and Q4 2014 growth of zero percent compared to Q4 2013. Not bad for the economy going though a massive, multi-dimensional crisis. But a poor outlook for 2015-2016. IMF estimates are based on assumed oil price (full-year average weighted of 3 spot prices) at below USD60 but above USD55 (see http://blog-imfdirect.imf.org/2014/12/22/seven-questions-about-the-recent-oil-price-slump/), so closer to USD57.

The World Bank outlook, released on January 14th is a bit less gloomy when it comes to 2016. Per World Bank, "sustained low oil prices will weaken activity in exporting countries. For example, the Russian economy is projected to contract by 2.9 percent in 2015, getting barely back into positive territory in 2016 with growth expected at 0.1 percent." World Bank oil price assumption is USD66 per bbl.

EBRD notes that "Geopolitical risks from the Ukraine/Russia crisis remain significant, although they are contained for the time being." According to the bank, "Russia is projected to slip into recession, with GDP contracting by close to 5 per cent."  On more detailed assessment, EBRD says that: "In Russia, lower oil prices have compounded the effect of deep-seated structural problems, increased uncertainty and low investor confidence, along with the increasing impact of economic sanctions imposed since March 2014. In the first three quarters of 2014 investment continued to decline, consumption growth decelerated to below 1 per cent, and imports dropped by 6 per cent in real terms. Capital outflows more than doubled to an estimated US$ 151 billion in 2014. As a result, the rouble has lost almost half of its value in 2014 vis-à-vis the US dollar and Russia lost about a quarter of its international reserves, ending the year at around US$ 380 billion (including the less liquid National Welfare Fund). Markets were particularly shaken in late November/early December 2014, and the central bank had to raise its policy rate to 17 per cent to stem pressure on the currency. The government provided additional capital to a number of banks, temporarily relaxed certain prudential requirements for banks, and introduced measures to increase the supply on the foreign exchange markets by state-owned companies and put in place additional incentives for de-offshorisation."

An interesting footnote to the analysis is covering remittances from Russia. "Remittances from Russia to Central Asia and the EEC continued to decline (see Chart below). Partial data for the fourth quarter in 2014 suggest that the decline is likely to have accelerated in recent months, entering two-digit percentage rate territory, as the Russian economy weakened and the sharp drop in the value of the rouble reduced the US dollar (and also local currency) value of the remitted earnings. Lower remittances inflows will affect consumption adversely and likely add to downward pressures on a number of currencies in EEC and Central Asia, which also face reduced export demand and investment flows from Russia."

Crucially, EBRD forecasts also reflect downgrades on September 2014 outlook. EBRD now estimates 2014 growth to be at 0.4% (more gloomy than IMF estimate and down on 9.6% estimate at the end of Q3 2014), with a contraction of 4.8% in 2015, which represents a downgrade of 4.6 percentage points from September forecast. EBRD oil price assumption is around USD57-59 per bbl.

Chart below summarises unemployment trend 2013-2014:

23/1/2015: A Liquidity Fix for the Euro? What for?...

So Euro area needs liquidity... sovereign liquidity, right?

Take a look at the latest Eurostat data:

Even after all statistical 'methodology' re-jigging and re-juggling, Q1-Q3 2014 saw Government spending accounting for 49.5% of GDP and deficit averaged 2.43% of GDP. Meanwhile, debt/GDP ratio stood at 92.1% of GDP excluding inter-governmental loans (2.4% of GDP):

Yields on Government bonds are hitting all-time lows, including for 'rude health' exemplars such as Spain and Italy:

(credit @Schuldensuehner )

Clearly, liquidity is not  a problem for European sovereigns. But pumping in more liquidity into the euro system might just become a problem: the lower the yields go, the higher the debt climbs. With this, the lower will be the incentives for structural reforms, and the higher will be the debt overhang. All the while, without doing a ditch to repair the actual crisis causes: excessive legacy debts in the households' and corporates' systems.

Meanwhile, the press is lavishing praise on the ECB's Mario Draghi for... well I am not quite sure what is being praised: Mr Draghi is planning on doing in March 2015 what the Fed, BofE, and BoJ have been doing since (on average) 2009, albeit he is facing German (and others') opposition.

Being 6 years too-late into the game, Mr Draghi, therefore, is equivalent to a lazy and tardy student who finally showed up for the class after all other students have left, but bearing an elaborate excuse for not doing his homework.

22/1/2015: Don't Put Too Much Dosh on ECB's QE Dark Horse...

Today's ECB announcement of EUR60 billion per month from march 2015 through September 2016 QE aiming to take the ECB balance sheet up to EUR1.14-1.26 trillion (estimated, based on starting timing and treatment of 12% share of European institutions securities) has been dubbed a massive boost to the euro area, a watershed, a drastic measure and so on.

Official details are here: http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html

In truth, it is neither.

Quantum of Asset Purchases and Types of Assets

• Monthly EUR60 billion. This is lower (at current EUR valuations) than 'tapering' levels of Fed purchases (USD75 billion) and is lower than BofE interventions in 2009 which run at STG25 billion / month because EUR60bn ECB intervention is ca 7% of Euro area GDP, while BofE intervention was ca 20% of GDP.
• Monthly purchases will combine public and private sector securities. Which means the QE is really an add-on to ABS. Purchases will start in the secondary markets and will cover investment grade securities issued by the euro area governments and agencies and European institutions in the secondary market. The key objective is to 'inject new liquidity' to improve liquidity supply. Problem is: with majority of Government bonds in negative yields territory already, where is the targeted shortage of liquidity in the system? I can't find one.
• Limitation to investment grade cuts out Cyprus and Greece, but the ECB promised to include them into the programme under extended rules.
• Government and euro area agencies securities will be purchased on the basis of risk-sharing. Quantum of purchases will be proportional to Eurosystem shares of each National Central Bank (NCB). 
• For European institutions-issued securities,amounting to 12% of total purchases, 80% of purchased quantum to be held on NCB balance sheet, 20% on ECB balance sheet. The latter measure prompted some analysts to conclude that risks can be amplified for the already indebted sovereigns. But this is nonsensical for two reasons: 1) NCBs are part of the Eurosystem, and 2) NCBs will purchase liabilities of the state, so only risk attached to these liabilities is carried through. In simple terms, there cannot be any double liability, just in the same way as one cannot eat the same slice of cake twice. More fundamentally, liabilities of the NCBs do not have to match the NCBs assets, nor do they constitute a claim on NCBs assets. Here is an informative primer on the topic: http://www.bruegel.org/nc/blog/detail/article/1546-qe-and-central-bank-solvency/?utm_content=buffer25d2c&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer+(bruegel
• For National securities, there will be no risk sharing. So risk sharing only applies to Agencies-issued debt.
• As a part of QE announcement, the ECB has also altered the set up of the TLTROs (there are six more tranches of these forthcoming). TLTROs will now be priced at MRO set at the time of each TLTRO tranche. This will lower the cost of future TLTRO tranches by some 10 bps. Net result - TLTROs are now marginally more attractive.
• The ECB can cut short the asset purchasing programme if there is a signal of 'sustained improvement in inflation'.

Impact Assessment:

The measures are sign of desperation and frustration on ECB behalf. And not with the persistence of deflationary risks.

Instead, QE announcement was accompanied by another round of 'fighting' rhetoric from Draghi, who clearly continues to push member states and the European Commission to aggressively pursue structural markets reforms.

Draghi downplayed expectations for QE by stressing that QE only provides conditions to support growth. In his own words: "Monetary policy can create basis for growth but it's up to governments and Commission to make sure growth actually takes place". In so far as absent growth there won't be inflation, we, therefore, have a perfect excuse ex ante for any QE failure.

The key, however, is that we are now into the unchartered territory of watching the emergence of the second round effects of QE announcement.

The reason for this is that the direct impact - lowering Government borrowing costs - is effectively useless - the euro area as a whole is already enjoying record low yields. Meanwhile, market expectations of inflationary pressure over the longer horizon (e.g. 5yr/5yr spreads) are starting to price higher inflation, albeit modestly so.

Mr Draghi's claim that the measure is aimed at supplying liquidity is a red herring - a token nod to the German hawks. In reality, most likely, the QE will not unleash a wave of new credit creation.

More likely, we shall see some easing of deflationary risks, with inflation picking up in the medium term on foot of both QE and oil prices reversion back toward fundamentals-justified levels. Euro devaluation will also help to cover up underlying structural drivers for deflationary risks.

The real causes of deflationary risks in the euro area is weak demand. The latter is driven by collapse in after-tax household incomes and savings, and by the ongoing deleveraging of the households and firms. None of these can be helped by the QE.

Meanwhile, the QE is likely to provide some easier conditions for issuance of new Government debt. Currently, just under 50% of the euro area economy is accounted for by the Government spending. Pumping more spending into this economy is unlikely to do much for future growth and is hardly going to trickle down to the ordinary households. Which means that the entire QE exercise is dubious in nature. It will, however, significantly pads the pockets of bonds dealers and stock markets, and banks that hold these securities.

One caveat few noticed is that the ABS segment of the QE programme now falls under the remit of the NCBs. Which means that national authorities can select assets for purchases from the private sector. How this mechanism can prevent selection biases to, say, potentially favour so-called National Champions (larger state-owned entities and private monopolies) or corrupt selection of politically-connected enterprises and other similar behaviour is anyone's guess.

The circus surrounding the ECB announcement was (and remains) quite bizarre. The ECB announced effectively new (as in unknown to us before) measures to the quantum of roughly EUR114-260 billion, since it already previously set a target of ca EUR1 trillion balance sheet expansion.

Even more bizarrely, we know many details of the QE mechanism, but we have no idea as to the split between the sovereign bonds purchases and private asset purchases. We have no defined limit to the balancesheet expansion and we do not have a defined process for ending the programme (sudden stop or tapering).


Alternatives:

As I tweeted today, a viable alternative to the largely dubious QE would have been supporting household incomes and companies investment. This can be done more effectively via targeted and structured tax policies that are medium-term revenue neutral. One example, coincidentally, provided today in FT by Martin Feldstein: http://blogs.ft.com/the-exchange/2015/01/16/martin-feldstein-beyond-quantitative-easing-in-the-eurozone/

In the medium term, the key should be using monetary policy and fiscal policy to deleverage the economies: households, companies and governments. This is not being helped by the QE. Here is an interesting recent paper on the subject: http://www.bis.org/publ/work482.pdf.

In the long run, the key is finding real new catalysts for growth in the euro area that can compensate for the structural and demographic declines the EMU economies are suffering from. This too is not being helped by the QE.


Update 1: Here is the proportion by which ECB will allocate purchasing allowances for each NCB:

Update 2: And here is yet another reason why ECB's QE might not be the 'big bazooka' that will end markets fragmentation (aka increase credit supply to the real economy) - read bottom tweet first:

Courtesy of @Lee_Adler

22/1/2015: Some recent stats on Russian economy

Couple of recent stats for Russian economy:

• Federal Budget Deficit for 2014 full year was 0.5% of GDP or RUB328 billion (ca USD 5 billion). Meanwhile, the Cabinet prepared a new Budgetary plan for dealing with the crisis which includes RUB 1.375 trillion (USD21 billion) worth of new measures. Amongst reported changes: RUB 250 billion worth of state banks recaps funds via the National Wealth Fund; RUB 86 billion of new subsidies for agriculture, industry and health, plus some regional tax breaks for SMEs.
• As reported by the Russia Insider (http://russia-insider.com/en/2015/01/22/2624) Russian banks dramatically increased bad loans provisions in 2014, up 42.2% y/y compared to 16.8% growth in 2013. Based on Sberbank estimates, if oil averaged USD40/pbl over 2015, Russian banks provisions will have to rise some USD46 billion. Meanwhile, banks profits run some 40% below 2013 levels. In 2012, Russian banks profits stood at RUB 1 trillion (USD15.3 billion), and in 2013 profits were RUB 994 billion (USD15.2 billion). In 2014 banks profits fell to RUB 589 billion (USD9 billion). Ugly numbers.
• Rental values for Moscow apartments were all over the shop in Q4 2014: Economy Class average rental rate in Rubles rose 1.1% q/q despite reports of falling demand from the migrants, while Comfort Class average rentals were down 1% q/q. Business Class rental values were up 0.71% q/q, but Elite Class rentals were down massive 11.5% q/q. So mixed signals from the rental markets overall. 

21/1/2015: Ukraine Requests Extended Fund Facility from the IMF

So Ukraine made a (formal?) request for change in the IMF lending programme:

Of all places... in Davos. And Ms Lagarde is dead-pan sure that an agreement to proceed will follow from the IMF Executive Board... not that anyone could doubt that it will, but it might be a better tone not to jump ahead.

The quantum of funding requested is not known, but we already know that Ukraine's own estimates were USD15 billion back in November 2014. Since then, things did not improve, so the same figure is probably closer to USD18 billion. And I suspect that Ukraine will need at least USD20-25 billion over 2015-2017, even under rather positive assumptions.

I do hope they get a good rate on all this borrowing, as loans do require interest payments and principal repayments.

21/1/2015: ECB QE: Risk-Sharing or Risk-Dumping?

My comment for Expresso (January 17, print edition page 12) on what to expect from ECB next.


Given the deflationary dynamics, including the 5y/5y swap at below 1.50 and the first negative reading since 2009, there is a strong pressure on ECB to act. Crucially, this pressure is directly link to the ECB mandate. Additional momentum pointing toward ECB adopting a much more pro-active stance this month comes from the euro area leading growth indicators. Ifo's Economic Climate for the Euro Area continued to deteriorate in the Q4 2014 and January Eurozone Economic Outlook points to effectively no improvement in growth prospects in Q1 2015 compared to Q4 2014. Eurocoin indicator showed similar dynamics for December 2014.

At this stage, even the ECB hawks are in agreement that some monetary easing action is required and most recent comments from the ECB Governing Council members strongly suggest that there is strong momentum toward adopting a sovereign bonds purchasing programme.

The question, therefore, has now shifted toward what form will such a programme take.

Indications are, the ECB will opt for a programme that will attempt to separate risk of default from market risks. Under such a programme, the risk of sovereign default will be vested with the National Central Bank (NCB) of the bonds-issuing country, while the ECB will carry the market pricing risks.

The problem is that such a programme will directly spread the risk of fragmentation from the private sector financial system to the Eurosystem as a whole. If the NCBs carry direct risks (in full or in part) relating to sovereign default, the entire Eurosystem will no longer act as a risk-sharing mechanism and will undermine the ECB position as a joint and several institution.

Another problem is that if risks are explicitly shared across the ECB and NCBs, the ECB will become a de facto preferred lender, with rights in excess of NCBs and, thus, above the markets participants. Any other arrangement will most likely constitute a fiscal financing and will violate the restrictions that prevent non-monetary financing.

These twin problems imply that, unless the ECB fully participates in risk sharing with the NCBs, the QE programme will risk inducing much greater risk of repricing in the 'peripheral' euro states and thus can lead to greater fragmentation in the markets.

21/1/2015: Global Trade Indicators Flashing Red

Two very interesting charts reflecting upon the same macroeconomic reality: world trade is slowing down. Big time…

First, IMF revisions of the global trade growth rates forecasts for 2015 - now at their lowest in 12 months (chart courtesy of the @zerohedge):

And next, Baltic Dry Index series printing 753,000 currently, a level consistent with depths of 2009 crisis and 2012-2013 slump (chart courtesy of @Schuldensuehner) :

All in, the above highlights the powerless nature of large scale advanced economies' QE measures when it comes to reigniting global demand.

20/1/2015: IMF Global Growth Outlook 2015-2016: Europe Slips, U.S. Powers Away

My analysis of the IMF update to the World Economic Outlook is now available on Learn Signal blog: http://blog.learnsignal.com/?p=148

17/1/2015: Is QE permanent and do we need a Government debt 'deletion'?

In a far-reaching comment on the QE and its true nature, published back in 2013 (see here: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9970294/Helicopter-QE-will-never-be-reversed.html),  Ambrose Evans-Pritchard took the arguments of several economists and drew, with them, a very far reaching set of conclusions.

To summarise these:
1) QE is permanent - it cannot be undone. I agree.
2) Better than that, QE should be used to cancel legacy Government debts, providing deficit financing ex post facto. I agree only partially.
3) QE should be expanded to a stand by facility to fund aggregate demand via funding future deficits. I disagree.

Why would I disagree with the 2 latter points?

Reason 1: Government debt is not the biggest problem shared by all economies today. In some economies, such as Greece, Italy and US, for example, it is the main problem. But in other economies, such as Ireland and Spain, for example, it is secondary to household and corporate debts. This means that even if economic growth restarts on foot of the above 3-points plan, the reversion to 'normalcy' in interest rates will simply crash legacy debt-holders. No amount of fiscal stimulus will be able to undo this damage.

Reason 2: Government deficits and debts did not arise from purely automatic stabilisers (or in simple terms solely from the disruptions caused by the Global Financial Crisis) in all economies. In some countries they did, as, for example in Italy and France. In others, they came about as the result of imbalances in the economy that drove large asset bubbles, e.g. Ireland and Spain. In yet other countries they were systemic, e.g. Greece and Italy. The 3-points plan can help the first set of countries. Can do damage to the second set of countries (via interest rates channel and/or by generating another bubble) and will provide no incentives for change for the last set of countries.

There are other arguments as to the fallacious or partially fallacious nature of points 2 and 3. These include the arguments that public spending creates own bubbles - those in wages and salaries, employment and practices in the public sector, or those in rates of return for politically connected businesses or those in public infrastructures that will have to be maintained and serviced over decades to come, irrespective of the economic returns they might generate. They also include the arguments that public spending and investment can crowd out private spending and investment. As well as arguments that in a number of countries, especially within the euro area, public spending as already hefty enough and priming it up using monetary financing today is setting us up for creating a permanent future liability to continue funding the same out of tax revenues into perpetuity after the QE funding is completed.

The key, however, is the problem of total debt distribution, not just of Government debt volumes. A 'delete' button must be pushed, I agree. But what we will be deleting has to be much more complex than just the Government debt. In some countries it will have to also include private debts. And for that, we have not had a QE devised, yet...

17/1/2015: Russian Capital Flight: What Western 'Analysts' Forget

Central Bank of Russia released full-year 2014 capital outflows figures, prompting cheerful chatter from the US officials and academics gleefully loading the demise of the Russian economy. 

The figures are ugly: official net outflows of capital stood at USD151.5 billion - roughly 2.5 times the rate of outflows in 2013 - USD61 billion. Q1 outflows were USD48.2 billion, Q2 outflows declined to USD22.4 billion, Q3 2014 outflows netted USD 7.7 billion and Q4 2014 outflows rose to USD72.9 billion. Thus, Q4 2014 outflows - on the face of it - were larger than full-year 2013 outflows.

There are, however, few caveats to these figures that Western analysts of the Russian economy tend to ignore. These are:

• USD 19.8 billion of outflows in Q4 2014 were down to new liquidity supply measures by the CB of Russia which extended new currency credit lines to Russian banks. In other words, these are loans. One can assume the banks will default on these, or one can assume that they will repay these loans. In the former case, outflows will not be reversible, in the latter case they will be.
• In Q1-Q3 2014 net outflows of capital that were accounted for by the banks repayment of foreign funding lines (remember the sanctions on banks came in Q2-Q3 2014) amounted to USD16.1 billion. You can call this outflow of funds or you can call it paying down debt. The former sounds ominous, the latter sounds less so - repaying debts improves balance sheets. But, hey, it would't be so apocalyptic, thus. We do not have aggregated data on this for Q4 2014 yet, but on monthly basis, same outflows for the banking sector amounted to at least USD11.8 billion. So that's USD 27.9 billion in forced banks deleveraging in 2014. Again, may be that is bad, or may be it is good. Or may be it is simply more nuanced than screaming headline numbers suggest.
• Deleveraging - debt repayments - in non-banking sector was even bigger. In Q4 2014 alone planned debt redemptions amounted to USD 34.8 billion. Beyond that, we have no idea is there were forced (or unplanned) redemptions.

So in Q3-Q4 2014 alone, banks redemptions were scheduled to run at USD45.321 billion and corporate sector redemptions were scheduled at USD72.684 billion. In simple terms, then, USD 118 billion or 78 percent of the catastrophic capital flight out of Russia in 2014 was down to debt redemptions in banking and corporate sectors. Not 'investors fleeing' or depositors 'taking a run', but partially forced debt repayments. 

Let's put this into a slightly different perspective. Whatever your view of the European and US policies during the Global Financial Crisis and the subsequent Great Recession might be, one corner stone of all such policies was banks' deleveraging - aka 'pay down of debt'. Russia did not adopt such a policy on its own, but was forced to do so by the sanctions that shut off Russian banks and companies (including those not directly listed in the sanctions) from the Western credit markets. But if you think the above process is a catastrophe for the Russian economy induced by Kremlin, you really should be asking yourself a question or two about the US and European deleveraging policies at home.

And after you do, give another thought to the remaining USD 33 billion of outflows. These include dollarisation of Russian households' accounts (conversion of rubles into dollars and other currencies), the forex effects of holding currencies other than US dollars, the valuations changes on gold reserves etc.

As some might say, look at Greece… Yes, things are ugly in Russia. Yes, deleveraging is forced, and painful. Yes, capital outflows are massive. But, a bit of silver lining there: most of the capital flight that Western analysts decry goes to improve Russian balancesheets and reduce Russian external debt. That can't be too bad, right? Because if it was so bad, then... Greece, Cyprus, Spain, Italy, Ireland, Portugal, France, and so on... spring to mind with their 'deleveraging' drives...

17/1/2015: Russia is not Greece...

On foot of sovereign downgrade of Russian debt back on January 10, Fitch cut ratings for some Russian regions and banks last night.

Here's Interfax link to banks downgrades: http://www.interfax.ru/business/418387 and regional ratings downgrades: http://www.interfax.ru/business/418377.

Note: Moody's also issued a sovereigns bet downgrade for Russia - details here: http://trueeconomics.blogspot.ie/2015/01/1612015-moodys-get-double-moody-on.html

Meanwhile, another downgrade is coming - S&P said yesterday that it will review Russian ratings before the end of January. Interfax report here: http://www.interfax.ru/business/418357

The season of 'Get Russia' continues. With uninterrupted success… oh yes, the dim sum markets will be fun in 2015.

Note: I must say I have not seen such rapid fire downgrading any time in my memory, with exception of Greece and Cyprus where, in both cases, the ratings agencies were literally racing each other and themselves to catch up with the reality.

16/1/2015: Moody's Get Double Moody on Russia

As I predicted at a briefing earlier today, Moody's downgraded Russia's sovereign debt (expect downgrades of banks and corporates to follow in due course). This was inevitable given the outlook for growth 'dropped down' on us by the agency in their note on Armenia (see here).

Full release on downgrade is here: https://www.moodys.com/research/Moodys-downgrades-Russias-government-bond-rating-to-Baa3-on-review--PR_316487.

The point is - if you believe Moody's outlook for the risks faced by the economy - you should expect full, open (as opposed to partial and 'voluntary') capital controls and debt repayments holidays (for corporate and banks' debts for entities directly covered by sanctions) before the end of the year.

And, you should still expect a good 75%+ chance of a further downgrade upon the review as Moody's struggle to push ahead with projecting a more 'robust ratings' stance to the markets.

Even the best case scenario is for another downgrade and 12-18 months window of no positive reviews.

The impact of these downgrades is narrow, however. Russian Government is unlikely to become heavily dependent on new debt issuance and thus is relatively well insulated against the fall out from the secondary bond market yields spikes. Russian banks can withstand paper losses on sovereign bonds they hold. At any rate they have much greater headaches than these - if oil prices follow Moody's chartered course, who cares what sovereign ratings are assigned. The impact of sovereign ratings and yields on private debt issuance is a bit more painful, as it will hit those entities issuing new debt in dim sum markets, but again, the overall impact is secondary to the bigger issues of sanctions and the freezing of the debt markets for Russian entities.

On the other hand, were the downgrades and markets reaction to push Russians over the line into direct capital controls and suspension of debt redemptions and servicing for entities affected by the sanctions, the impact on Western debt holders will be painful. And the sovereign deficits and debt positions will be fully covered by sovereign reserves.

So the more real the Moody's risks prognosis becomes, the more pain will be exported from Russia our way.