6/2/15: Two Tax Inversions Islands

Remember Tax Inversions Islands? Ireland ≠ Bermuda?

Bloomberg have a neat reminder:

Source: http://www.bloomberg.com/infographics/2014-09-18/tax-runaways-tracking-inversions.html

6/2/15: Cyprus AWOL on Troika 'Reforms'

Yes, at some point, Troika won't be able to handle all the bad news flying its way... for now, however, a new alarm at the barbwire fence of European Reformism: Cyprus is heading off the Troika Reservation:

Whatever might have made Cyprus rush for the AWOL, I'll let you discover, but judging by the foreclosure and insolvency framework reforms approved by the Troika in Ireland, one can't be too much surprised if any country would have much of faith in Troika expectations on that front. Then again, Cypriots would probably remember how EU regulators first encouraged accumulation of Greek sovereign debt in Cypriot banks, then haircut that debt, causing instant insolvency crisis across the Cypriot banks. Why would anyone listen to the same people giving advice on 'structural' reforms next, puzzles me.

5/2/15: IMF and Ukraine: 'Scaling Back' Risk Is Real

Generally, I rarely comment directly on Ukrainian economy as was explained before on this blog. But the latest set of news is certainly falling into the category of 'big time news'.

As I noted before, IMF were in Kiev since mid-January and were going over the Ukrainian Government request for switching lending to Ukraine into a different facility (see http://trueeconomics.blogspot.ie/2015/01/2112015-ukraine-requests-extended-fund.html). In January, IMF head, Christine Lagarde gave an interview to Le Monde, saying that no partner of the IMF can participate in a funding programme when some 20% of the Ukrainian economy remains impacted by the conflict in the East.

So far, under stand by arrangements, IMF committed USD17 billion in funding for Ukraine, of which Kiev already received disbursements of USD3.2 billion in May 2014 and USD1.4 billion in September. Under stand-by arrangements, funding is provided for up to two years, so in 2015, Ukraine must redeem USD1.42 billion in IMF funding and some USD9.6 billion more in maturing government debt. Of this, more than USD4 billion is due in Q1 2015. Meanwhile, currency and gold reserves of Ukraine are down to USD7.5 billion - below debt maturity levels for 2015.

Now, IMF is reportedly (see here: http://www.bloomberg.com/news/articles/2015-02-05/ukraine-allows-hryvnia-free-float-raises-key-rate-to-19-5-) "is seeking to limit its share of the aid burden in discussions on an expanded bailout for Ukraine, according to two people with knowledge of the institution’s stance, as a military conflict pushes the sovereign closer to default."

Note: IMF limiting new funding share to 2/3rds will mean that of USD15 billion that Ukraine wants to get over the next 2 years, USD5 billion will have to come from 'other' sources. If IMF were to restrict its total share to 2/3rds of all bailout money, then in the new funding, the non-IMF share will be USD4 billion. One might think that the funds can be provided by the EU - keen on partnership with Kiev. But EU talks a lot, yet delivers little. In 2014, EU Commission President, Barroso stated that the EU is willing to commit EUR11 billion to fund Ukraine over 2 years. So far, EU delivered only EUR1.4 billion in 2014 and committed to provide EUR1.8 billion in 2015. EBRD and EIB promised Ukraine EUR6.5-8 billion in funding, but delivered only EUR2.2 billion so far. Germany promised and delivered EUR1.6 billion to Ukraine in 2014 and in January this year committed to provide further EUR500 million.

The point is that absent IMF funding an entirely new programme, it is impossible to see how Ukraine can continue servicing and redeeming existent debts and cover current deficit that is expected to hit double digits in 2015. On the other hand, IMF is aware of this reality as well as of the lack of will in Europe and the US to fund Ukraine. Worse, stung by the 'partnership' with EU in funding euro area crisis-hit countries, the IMF is itching to cut back its engagements with difficult partners. Meanwhile, Ukraine has - completely understandable - difficulties pushing through IMF-mandated reforms. And to add to the complexity of the situation, the EU and US are nursing major differences in their respective objectives when it comes to what the two players want to see emerging from the current crisis.

In my view, Ukraine is now being played in the game of geopolitical chess by all sides, with the IMF struggling to remain independent (even pro-forma). The tragedy of all of this is that Ukraine is being prevented, by a combination of poor funders cooperation and ongoing conflict in the East, from actually engaging in reforming its economy, politics and society. My sympathies on this mess are with Ukraine and President Poroshenko - they got the short ends of all sticks.

Note: In my opinion, Ukraine needs a much more structured package of supports, including larger loans, on more benign terms, and grants, and over a longer horizon. In effect, it needs a Marshall Plan.

5/2/15: Maan... it's like... Structural Reforms, like... maaan!

You know that slightly odd person who sits on a park bench repeating to anyone who bothers to ask him the same story over and over again? Well, now try imagining one that is doing so unburdened by a request.

And you have ECB...

At least Frankfurt did not mention its (and IMF's) favourite made up dream: the labour market reforms... presumably because in China, labour markets are already 'efficient' enough, why with all the factory dorms and campuses and the rest.

H/T for the ECB blurb to @LorcanRK.

5/2/15: Where the Models Are Wanting: Banks Networks, Risks & Modern Investment Theory

My post for Learn Signal blog: "Where the Models Are Wanting Part 2: Banks Networks, Risks and Modern Investment Theory" covering networks effects on risk propagation in the financial services sector and the impact of these networks on equity pricing models is now available here: http://blog.learnsignal.com/?p=153.

5/2/15: Gazprom's Nord and South Streams: Lessons Learned, Strategy Changed

I just published a long note on the trials and tribulations of the ill-fated South Stream gas pipeline project that was designed to deliver Russian gas to Bulgaria and Southern Europe. Here is the link: http://trueeconomicslr.blogspot.ie/2015/02/5215-gazproms-nord-and-south-streams.html

4/2/15: Debt Overhang and Sluggish Growth

Debt overhang and its impact on growth has been a rather controversial topic over the recent years. One of the key contributors to the debate is Kenneth Rogoff. Rogoff has a new paper out on the topic, together with Stephanie Lo, titled "Secular stagnation, debt overhang and other rationales for sluggish growth, six years on" published by the Bank for International Settlements (http://www.bis.org/publ/work482.pdf).

In the paper, Rogoff and Lo state that "there is considerable controversy over why sluggish economic growth persists across many advanced economies six years after the onset of the financial crisis. Theories include a secular deficiency in aggregate demand, slowing innovation, adverse demographics, lingering policy uncertainty, post-crisis political fractionalisation, debt overhang, insufficient fiscal stimulus, excessive financial regulation, and some mix of all of the above." Rogoff and Lo survey "the alternative viewpoints" on the causes of slow growth. The authors argue that "until significant pockets of private, external and public debt overhang further abate, the potential role of other headwinds to economic growth will be difficult to quantify."

Rogoff and Lo focus strongly on the effects of debt overhang on growth. "In our view, the leading candidate as an explanation for why growth has taken so long to normalise is that pockets of the global economy are still experiencing the typical sluggish aftermath of a financial crisis… The experience in advanced countries is certainly consistent with a great deal of evidence on leverage cycles, for example the empirical work of Schularick and Taylor (2012), who examine data for a cross-section of advanced countries going back to the late 1800s and find that the last half-century has brought an unprecedented era of financial vulnerability and potentially destabilising leverage cycles. Moreover, focusing on more recent events, Mian and Sufi’s (2014) estimates suggest that the effects of US household leverage might be large enough to explain the entire decline in both house prices and durable consumption."

Still, their conclusion is very cautious. Instead of assigning direct causality from debt to growth, they suggest increased indeterminacy of the relationship between other variables and growth in the presence of high debt overhangs. They do reinforce the point that the argument about debt overhang relates to the total real economic debt (governments, households and non-financial corporations), not solely to government debt alone.

4/2/15: Russian Services & Composite PMIs: January

Russian manufacturing PMI slipped deeper into contractionary territory posting 47.6 in January compared to 48.9 in December, as covered here: http://trueeconomics.blogspot.ie/2015/02/2215-irish-manufacturing-pmi-january.html

Today's release of the Services PMI adds to the gloom. Services PMI posted its fourth consecutive monthly reading below 50.0, coming in at abysmal 43.9 in January, down from an already disastrous 45.8 in December. 3mo MA through January is now at 44.7 - a deep contraction, deepest since 2009 recession. This compares to the already contractionary 49.4 3mo MA through October 2014. 3mo average through January 2014 was benign 52.2. So we have a full swing of 7.5 points year on year on a 3mo MA basis.

Things are bad over both sectors of the economy, implying that the Composite PMI should be performing poorly as well. No surprise there, hence, with Composite PMI falling to 45.6 the lowest monthly reading since May 2009 and the fourth consecutive monthly reading sub-50. 3mo average through January 2015 is at 46.8, marking significant contraction that accelerated from October 2014 through January 2015. This compares to 3mo average of 50.4 for the 3 months period through October 2014 and with 51.5 3mo average through January 2014. Year on year, 3mo average reading is now down 4.7 points.

In summary, January m/m decline in PMIs was second steepest over 12 months period for Manufacturing, fourth steepest for Services and third steepest for Composite PMI.

The downward trend across all series is being reinforced since Q3 2014.

3/2/2015: Japanification of Europe?

One of the main narratives for understanding European economy's longer term growth outlook has been the risk of Japanification: a long-term stagnation punctuated by recessionary periods and accompanied by low inflation and or deflationary episodes and pressures. I posted on the topic before (see for example here: http://trueeconomics.blogspot.ie/2014/10/19102014-chart-of-week-japanising-europe.html) and generally think we are witnessing some worrying similarities with Japan, driven primarily by longer-term trends: debt overhangs across real economy, nature of debt allocations (concentrated in less productive legacy assets, such as property in some countries, physical capital in others) and, crucially, demographics-impacted political and institutional paralysis.

One recent paper, titled "The Macroeconomic Policy Challenges of Balance Sheet Recession: Lessons from Japan for the European Crisis" by Gunther Schnabl (CESIFO WORKING PAPER NO. 4249 CATEGORY 7:MONETARY POLICY AND INTERNATIONAL FINANCE, MAY 2013) sets out the stage for looking into the direct comparatives between Japan's experience and that of the EU.

Per Schnabl, "Japan has not only moved through a boom-and-bust cycle …almost 20 years earlier than Europe but has also made important experiences with a crisis management in form of monetary expansion, unconventional monetary policy making, fiscal expansion and recapitalization of banks. Although Japan has reached the (close to) zero interest rate environment more than a decade earlier than Europe and gross general government debt (in terms of GDP) has gone far beyond the levels, which are today prevalent in Europe, growth continues to stagger."

In other words, as we know all too well, Japan presents a 'curious' case of an economy where neither monetary, nor fiscal policies appear to work, even when applied on truly epic scale.

What Schnabl finds is very intriguing. "The comparison between the boom-and-bust cycles in Japan and Europe with respect to the origins of exuberant booms, the crisis patterns, the crisis therapies, and the (possible) effects of the crisis therapies shows that despite significant differences important similarities exist. With the growing socialisation of risk Europe follows the Japanese economic policy decision making pattern, with – possibly – a similar outcome for European growth and welfare perspectives. The gradual decline in real income in Japan should be incentive enough for a turnaround in economic policy making in both Europe and Japan."

The key to the above is in the phrase "With the growing socialisation of risk Europe follows the Japanese economic policy decision making pattern" which of course has several implications:

• Mutualisation / Socialisation of risk is actually mutualisation and, thus, socialisation of debt - clearly suggesting that the path toward debt deleveraging is not the one we should be taking. The alternative path to debt deleveraging via mutualisation / socialisation is debt restructuring.
• To date, no European leader or organisation has come up with a viable alternative to the non-viable idea of 'internal devaluation'. In other words, to-date we face with a false dichotomous choice: either mutualise debt or deflate debt. Neither is promising when one looks at the Japanese experience. And neither is promising when it comes to European experience either. See more on this here: http://trueeconomics.blogspot.ie/2014/08/1082014-can-eu-rely-on-large-primary.html and http://trueeconomics.blogspot.it/2014/08/1082014-inflating-away-public-debt-not.html.
• ECB policies activism - the alphabet soup of various programmes launched by Frankfurt - is still treating the symptom (liquidity or credit supply to the real economy) instead of the disease (debt overhang). And the outcome of this activism is likely to be no different from Japan: debt overhang growing, economy stagnating, asset prices and valuations actively concealing the problem, data detaching from reality.

Here are some slides from Schnabl's November 2014 presentation on the topic:

So here's the infamous monetary bubble / illusion:

And the associated public sector balloon (do ignore some of the peaks that were down to banks rescue measures and you still have an upward trend):

And an interesting perspective on the Japanification scenario for Europe:

Happy demanding more Government involvement in the economy, folks... for this time, all the monetary, fiscal, regulatory, institutional, propagandistic etc 'easing' will be, surely, different... very different... radically different...

3/2/15: Global Trade Growth: More Compression, Whatever About Hope...

As I noted just a couple of days ago, global trade growth is falling off the cliff (see: http://trueeconomics.blogspot.ie/2015/02/1215-world-trade-growthnow-scariest.html). And euro area's trade growth is leading to the downside:

So no surprise there that the Baltic Dry Index is tumbling. As noted by @moved_average, the index is now down 577 - the level below the crisis peak lows and consistent with those observed back in 1985-1986 lows.

Ugly gets uglier... but you won't spot this in PMIs...

As an aside, in the chart above, perhaps a telling bit is the lack of any positive uplift in euro area trade growth from the introduction of the euro. 

2/2/15: Greek Primary Surplus: A Steep Hill to Climb

My comment for Expresso (January 31, 2015, pages 8-9) on Greece:

Greece has undertaken an unprecedented level of budgetary adjustments as reflected in the rate of debt accumulation on the Government balance sheet and the size of the primary surplus. Stripping out the banking resolution measures, Greek Governments have managed to deliver general government deficit consolidation of some 13.8 percentage points based on forecast for 2015, compared to the peak crisis, with Irish Government coming in a distant second with roughly 9 percentage points and Portuguese authorities in the third place with 7.7 percentage points. These figures are confirmed by the reference to the structural deficits and primary deficits. 

Given the level of austerity carried by the Greek economy over the recent years, and taking into the account a significant (Euro16 billion) call on debt redemptions due this year, it is hard to see how the Greek Government can deliver doubling of a primary surplus from IMF-estimated 1.5% of GDP in 2014 to forecast 3% of GDP in 2015 and 4.5% in 2016. Even assuming no adverse shocks to the Greek economy, these levels of surpluses appear to be inconsistent with the structural position of the Greek economy and I would have very severe doubts as to whether even the 2-2.5% range of surpluses can be sustained over the medium term (2015-2020) horizon.

2/2/15: Russian External Debt: Falling & So Far Sustainable

BOFIT published an update on Russian external debt as of the end of December 2014. The update shows the extent of debt deleveraging forced onto Russian banks and companies by the sanctions.

In H2 2014, repayments of external debt accelerated.

Banks cut their external debt by USD43 billion to USD171 billion over the year, with much of the reduction coming on foot of two factors: repayment of maturing debt and ruble devaluations. Ruble devaluations - yes, the ones that supposed to topple Kremlin regime - actually contribute to reducing Russian external debt. Some 15% of banks' external debts are denominated in Rubles.

Corproate external debt fell by USD60 billion to USD376 billion, with Ruble devaluation accounting for the largest share of debt decline, as about 25% of all external corporate debt is denominated in Rubles.

So do the maths: Ruble devaluations accounted for some USD16 billion drop in banks debts, and some USD54 billion in corporate debt in 2014 (rough figures as these ignore maturity of debt composition and timing).

Additional point, raised on a number of occasions on this blog, is that about 1/3 of corporate debt consists of debt cross-held within corporate groups (loans from foreign-registered parent companies to their subsidiaries and vice versa).

All in, end-2014 external debt of Russian Government, banks and corporates stood at USD548 billion, or just below 30% of GDP - a number that, under normal circumstances would make Russian economy one of the least indebted economies in the world. Accounting for cross-firm holdings of debt, actual Russian external debt is around USD420 billion, or closer to 23% of GDP.


CBR latest data (October 2014) puts debt maturity schedule at USD108 billion in principal and USD20 billion in interest over 2015 for banks and corporates alone. Of this, USD37 billion in principal is due from the banks, and USD71 billion due from the corporates. Taking into the account corporates cross-holdings of debt within the enterprise groups, corporate external debt maturing in 2015 will amount to around USD48 billion. Against this, short-term banks' and corporate deposits in foreign currency stand at around USD120 billion (figures from October 2014).

In other words, Russian banks and companies have sufficient cover to offset maturing liabilities in 2015, once we take into the account the large share of external debts that are cross-held by enterprise groups (these debts can be easily rolled over). Of course, the composition of deposits holdings is not identical to composition of liabilities, so this is an aggregate case, with some enterprises and banks likely to face the need for borrowing from the CBR / State to cover this year's liabilities.

BOFIT chart summarising: