20/2/15: Russian Perception of the West: Hitting Historical Lows

Levada Center report from earlier this month points to a rising anti-Western sentiment in Russian public opinion. Based on the (gated) article covering Levada findings (see http://www.vedomosti.ru/newspaper/article/840171/plohoj-mir):

• 44% of Russians held a negative perception of the U.S. in early 2014. This rose to 81% at the end of 2014.
• 4% of Russians saw US-Russian relations as hostile, this rose to 42% in late 2014.
• 71% of Russian hold a negative view of the EU
• 1% of Russians saw EU-Russian relations as hostile in early 2014, and this increased to 24% by the end of 2014.
• 40% of Russians still believe that Russia needs to improve its relations with the West, with 36% saying Russia should further distance itself from the West.
• Proportion of those who believe that Russia is now on par with the world's most powerful nations fell from 45% in 2008 to 27% at the end of 2014.

Levada Center comment on the results of the latest surveys points to the fact that end-2014 data marks the worst public perception of the West and the US in Russia over the last 25 years.

18/2/15: IMF Package for Ukraine: Some Pesky Macros

Ukraine package of funding from the IMF and other lenders remains still largely unspecified, but it is worth recapping what we do know and what we don't.

Total package is USD40 billion. Of which, USD17.5 billion will come from the IMF and USD22.5 billion will come from the EU. The US seemed to have avoided being drawn into the financial singularity they helped (directly or not) to create.

We have no idea as to the distribution of the USD22.5 billion across the individual EU states, but it is pretty safe to assume that countries like Greece won't be too keen contributing. Cyprus probably as well. Ireland, Portugal, Spain, Italy - all struggling with debts of their own also need this new 'commitment' like a hole in the head. Belgium might cheerfully pony up (with distinctly Belgian cheer that is genuinely overwhelming to those in Belgium). But what about the countries like the Baltics and those of the Southern EU? Does Bulgaria have spare hundreds of million floating around? Hungary clearly can't expect much of good will from Kiev, given its tango with Moscow, so it is not exactly likely to cheer on the funding plans… Who will? Austria and Germany and France, though France is never too keen on parting with cash, unless it gets more cash in return through some other doors. In Poland, farmers are protesting about EUR100 million that the country lent to Ukraine. Wait till they get the bill for their share of the USD22.5 billion coming due.

Recall that in April 2014, IMF has already provided USD17 billion to Ukraine and has paid up USD4.5 billion to-date. In addition, Ukraine received USD2 billion in credit guarantees (not even funds) from the US, EUR1.8 billion in funding from the EU and another EUR1.6 billion in pre-April loans from the same source. Germany sent bilateral EUR500 million and Poland sent EUR100 million, with Japan lending USD300 million.

Here's a kicker. With all this 'help' Ukrainian debt/GDP ratio is racing beyond sustainability bounds. Under pre-February 'deal' scenario, IMF expected Ukrainian debt to peak at USD109 billion in 2017. Now, with the new 'deal' we are looking at debt (assuming no write down in a major restructuring) reaching for USD149 billion through 2018 and continuing to head North from there.

An added problem is the exchange rate which determines both the debt/GDP ratio and the debt burden.

Charts below show the absolute level of external debt (in current USD billions) and the debt/GDP ratios under the new 'deal' as opposed to previous programme. The second chart also shows the effects of further devaluation in Hryvna against the USD on debt/GDP ratios. It is worth noting that the IMF current assumption on Hryvna/USD is for 2014 rate of 11.30 and for 2015 of 12.91. Both are utterly unrealistic, given where Hryvna is trading now - at close to 26 to USD. (Note, just for comparative purposes, if Ruble were to hit the rates of decline that Hryvna has experienced between January 2014 and now, it would be trading at RUB/USD87, not RUB/USD61.20. Yet, all of us heard in the mainstream media about Ruble crisis, but there is virtually no reporting of the Hryvna crisis).

Now, keep in mind the latest macro figures from Ukraine are horrific.

Q3 2014 final GDP print came in at a y/y drop of 5.3%, accelerating final GDP decline of 5.1% in Q2 2014. Now, we know that things went even worse in Q4 2014, with some analysts (e.g. Danske) forecasting a decline in GDP of 14% y/y in Q4 2014. 2015 is expected to be a 'walk in the park' compared to that with FY projected GDP drop of around 8.5% for a third straight year!

Country Forex ratings are down at CCC- with negative outlook (S&P). These are a couple of months old. Still, no one in the rantings agencies is rushing to deal with any new data to revise these. Russia, for comparison, is rated BB+ with negative outlook and has been hammered by downgrades by the agencies seemingly racing to join that coveted 'Get Vlad!' club. Is kicking the Russian economy just a plat du jour when the agencies are trying to prove objectivity in analysis after all those ABS/MBS misfires of the last 15 years?

Also, note, the above debt figures, bad as they might be, are assuming that Ukraine's USD3 billion debt to Russia is repaid when it matures in September 2015. So far, Russia showed no indication it is willing to restructure this debt. But this debt alone is now (coupon attached) ca 50% of the entire Forex reserves held by Ukraine that amount to USD6.5 billion. Which means it will possibly have to be extended - raising the above debt profiles even higher. Or IMF dosh will have to go to pay it down. Assuming there is IMF dosh… September is a far, far away.

Meanwhile, you never hear much about Ukrainian external debt redemptions (aside from Government ones), while Russian debt redemptions (backed by ca USD370 billion worth of reserves) are at the forefront of the 'default' rumour mill. Ukrainian official forex reserves shrunk by roughly 62% in 14 months from January 2014. Russian ones are down 28.3% over the same period. But, you read of a reserves crisis in Russia, whilst you never hear much about the reserves crisis in Ukraine.

Inflation is now hitting 28.5% in January - double the Russian rate. And that is before full increases in energy prices are factored in per IMF 'reforms'. Ukraine, so far has gone through roughly 1/5 to 1/4 of these in 2014. More to come.

The point of the above comparatives between Russian and Ukrainian economies is not to argue that Russia is in an easy spot (it is not - there are structural and crisis-linked problems all over the shop), nor to argue that Ukrainian situation is somehow altering the geopolitical crisis developments in favour of Russia (it does not: Ukraine needs peace and respect for its territorial integrity and democracy, with or without economic reforms). The point is that the situation in the Ukrainian economy is so grave, that lending Kiev money cannot be an answer to the problems of stabilising the economy and getting economic recovery on a sustainable footing.

With all of this, the IMF 'plan' begs two questions:

1. Least important: Where's the European money coming from?
2. More important: Why would anyone lend funds to a country with fundamentals that make Greece look like Norway?
3. Most important: How on earth can this be a sustainable package for the country that really needs at least 50% of the total funding in the form of grants, not loans? That needs real investment, not debt? That needs serious reconstruction and such deep reforms, it should reasonably be given a decade to put them in place, not 4 years that IMF is prepared to hold off on repayment of debts owed to it under the new programme?

Note: here is the debt/GDP chart adjusting for the latest current and forward (12 months) exchange rates under the same scenarios as above, as opposed to the IMF dreamt up 2014 and 2015 estimates from back October 2014:

Do note in the above - declines in debt/GDP ratio in 2016-2018 are simply a technical carry over from the IMF assumptions on growth and exchange rates. Not a 'hard' forecast.

20/2/15: Russian Public Perceptions of 2014 Events

A small snippet of an insight into Russian public opinion about big themed 2014 events via Levada Center: http://www.levada.ru/eng/most-memorable-events-1

The obvious conclusion: the overall dominance of Ukraine and economic crisis in public perceptions of the most important events of 2014.

Another obvious conclusion, absolute lack of interest in the fate of Russian opposition: the Navalny case being remembered by only 2%, despite the case entering headlines once again in December 2014 - January 2015. These, of course should be seen in line with "Protests after the verdict of the Navalny brothers’ trial" (3%), pushing joint significance of the case to more respectful 5%.

Third point: whilst the Western sanctions against Russia are clearly at the forefront of public attention, the counter-sanctions (often reported in the Western press as inducing hardship on ordinary Russians) are less important than the death of opera singer Yelena Obraztsova.

Fourth point: proximately linked events are showing some interesting results: for example, "Terrorist attack in Paris" (18%) and "Solidarity marches after the terrorist attack in Paris" (10%) jointly signify singular event and by importance rival "American and Western European sanctions against Russia".

Fifth point: "The creation of the European Economic Union" (5%) is about as important to Russians as "The World Economic Forum in Davos" and probably less significant than "Power outages in Crimea due to the Ukrainian blockade" (6%).

18/2/15: Inflation Expectations and Consumers' Readiness to Spend

In an earlier post I provided a rough snapshot of the evolving relationship between inflation and consumer demand. But here is a fresh academic paper covering the same subject:

Bachmann, Rüdiger, Tim O. Berg, and Eric R. Sims. 2015. "Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence." American Economic Journal: Economic Policy, 7(1): 1-35. https://www.aeaweb.org/articles.php?doi=10.1257/pol.20130292 (h/t to @CHCEmsden for this link)

From the abstract: the authors examined "the relationship between expected inflation and spending attitudes using the microdata from the Michigan Survey of Consumers. The impact of higher inflation expectations on the reported readiness to spend on durables is generally small, outside the zero lower bound, often statistically insignificant, and inside of it typically significantly negative. In our baseline specification, a one percentage point increase in expected inflation during the recent zero lower bound period reduces households' probability of having a positive attitude towards spending by about 0.5 percentage points."

In other words, when interest rates are not close to zero, consumers expecting higher inflation do lead to a weak, statistically frequently zero, uplift in readiness to increase durable consumption (type of consumption that is more sensitive to price variation, and thus should see a significant positive increase in consumption when consumers anticipate higher inflation).

But when interest rates are at their zero 'bound', consumers expecting higher inflation in the future tend to actually cut their readiness to spend on durables. Not increase it! And this negative effect of future inflation on spending plans is "significantly negative".

Now, give it a thought: the ECB is saying they need to lift inflation to close to 2% from current near zero (stripping out energy and food). Based on the US data estimates, this should depress "households' probability of having a positive attitude towards spending" by some 1 percentage point or so. In simple terms, there appears to be absolutely no logic to the ECB concerns with deflation from consumer demand perspective.


Update: a delightful take on deflation from Colm O'Regan: http://www.bbc.com/news/blogs-magazine-monitor-31489786. And a brilliant vignette on prices, markets, consumers and ... thought for deflation too: http://www.eastonline.eu/en/opinions/hobgoblin/economics-elsewhere-three-tales-that-may-rock-the-boat by @CHCEmsden h/t above.

18/2/15: A Tale of Two Capitalisms & Economics Education

A recent paper by Bennett, Daniel L., titled "A Tale of Two Capitalisms: Perilous Misperceptions About Capitalism, Entrepreneurship, Government, and Inequality" (December 11, 2014, http://ssrn.com/abstract=2537118) examined "two widely held perceptions about capitalism, challenging the popular view that capitalism is a villainous perpetuator and government a saintly corrector of cronyism and inequality".

Much of this erroneous view has been driven by the fallout from the Global Financial Crisis, the Great Recession and the Euro Debt Crisis, although those of us who lived through it face-to-face would note the obvious error in this paradigm when it comes to expectations about the Government role.

As authors note, "this characterization is largely driven by misperceptions. Capitalism is viewed as a system that favors the elite at the expense of everyone else (crony capitalism), rather than one that promotes economic liberty and opportunity for all (free market capitalism). The state is meanwhile viewed as a benevolent and omniscient corrector of market failures and provider of public goods (romantic view of politics), rather than a political system operated by agents whose actions may reflect their own self-interest and not the welfare of the general public (public choice view). These misperceptions result in not only a distorted understanding of the institutional structure that underlies capitalism and the mechanism in which income is distributed, but also lead to perilous reform prescriptions that undermine free market capitalism and generate unintended consequences that act to reduce individual and societal well-being."

The paper shows how "institutions that constrain the discretionary authority of government incentivize productive entrepreneurship and facilitate free market capitalism, giving rise to a natural or market determined income distribution and opportunity for economic mobility." In other words, markets do work, when markets are allowed to work. On the other hand, "institutions that do not sufficiently constrain the authority of government incentivize unproductive entrepreneurship and facilitate the development of crony capitalism, resulting in structural inequality and little opportunity for economic mobility." In other words, markets don't work when they are prevented from working.

As per empirical evidence, the author concludes that:

"This tale of two capitalisms provides insights about the connection between institutions, entrepreneurship, and the desirability of income inequality. Empirical evidence suggests that sound monetary institutions and legal institutions that protect private property rights and enforce the rule of law provide an environment favorable for free market capitalism and productive entrepreneurship, as well as promote greater economic development and less income inequality. This tends to support
Milton Friedman’s (1980) famous proclamation: ““A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both.”"

"A growing body of evidence and the theory advanced here suggests that the development and preservation of institutions supportive of free market capitalism is the best way to facilitate productive entrepreneurship, economic development, economic mobility, and a distribution of income that, while unequal, is determined by merit rather than political ties, and is lower than that which exists in less capitalistic economies."

As per sources of the public misconceptions about capitalism in its various forms, "The scarcity of public choice and institutional analysis in mainstream economics education has contributes to widely held misperceptions about capitalism, entrepreneurship, government, and inequality. An analysis by FIke and Gwartney (2014) finds that only half of the 23 most common economic principles textbooks provide any coverage of public choice topics and that the coverage of market failure is sextuple that of government failure. The economics profession must do a better job of educating students and the public about the nuanced but vital distinction between the varieties of capitalism, and the important role of institutions in constraining the Hobbesian propensity of man to “rape, pillage, and plunder” and enabling the Smithian proclivity of man to “truck, barter, and exchange”
(Boettke, 2013)."

18/2/15: Digital Disruption and Traditional Banks: More Value Uncertainty

My recent post for Learn Signal blog on effects of Digital Technologies disruption on the traditional banking models: http://blog.learnsignal.com/?p=156

18/2/15: Deflation and Consumer Demand: Euro Area Evidence

The key premise behind the risk of deflation is the argument that faced with a prospect of declining prices, consumers will withhold current consumption in favour of the future consumption and producers will delay current investment in favour of lower cost future investment.

The problem, of course, with this theory is two-fold:

1. It ignores the entirety of the evidence from the modern sectors (e.g. ICT services, ICT manufacturing and pharma) where deflation (falling prices of comparable services and goods, adjusted for quality and efficacy) has been ongoing for decades and the demand and investment grew, not fallen.
2. It ignores the totality of fundamentals that drive both demand and prices, and in particular the role of the after-tax disposable incomes available to support consumption and investment.

But never mind, the Euro area, griped by the fears of deflation is itself proving the meme of the deflation = bad, inflation = good as consumers continue to buy, because of falling prices, not despite of them.

Here's a telling slide from BBVA assessment of the European situation:

Thus, we have a question: why, then, do European policymaker fear deflation? The answer is a simple one: deflation hurts tax intake. So the real concern here is not for the wellbeing of the economy or consumers or society at large, but for the fiscal position of already over-stretched (and in some cases insolvent) sovereigns. 

17/2/15: Of Debt, Equity and the Wake Up Calls for the Financial Markets

My post for Learn Signal blog on the issues of debt v equity composition of the global financial markets: http://blog.learnsignal.com/?p=157

16/2/15: Euro v 'Sustainable Growth': Mythology of Brussels Economics

Euro existence has been invariably linked to the promise of a 'sustainable' prosperity. From days when it was just a dream of a handful of European integrationists through today.  Which means that we can have a simple and effective test for the raison d'être of common currency union: how did GDP per capita fare since the euro introduction.

So let's take a simple change in GDP per capita, expressed in constant prices (controlling, therefore, for inflation) across the advanced economies around the world. Chart below details annualised rates of growth achieved between the end of 1999 and the end of 2014.

Excluding the most recent addition to the euro area, let's consider the original EU12. Across all advanced economies (34 of them), average annualised rate of real GDP per capita growth was 1.57%. Across the euro area 12 it was 0.727% - less than 1/2 of the average. Average for non-euro area 12 states was 2.126% or almost 3 times the euro area 12 average.

All of this translates into a massive gap between the euro area 12 (euro 'growthology' states that supported from the start the idea of 'sustainable' growth based on the EMU) and the rest of the advanced economies. In cumulative terms - over 2000-2014, EA12 states clocked growth of 11.674% in terms of their real GDP per capita. Over the same period of time, ex-EA12 advanced economies managed to grow on average by 40.01%.

Oh dear... even if you are not Italy or Cyprus (the latter made utterly insolvent by the EU inept 'resolution' of the Greek crisis and then promptly accused of causing this disaster upon itself - just to ad an insult to an injury), even if you are the 'best in the class' Ireland... within the euro, you are screwed.

So the key question is: where is the evidence that having a common currency results in better economic outcomes? Key answer is: nowhere. 

16/2/15: Current Account, Growth and 'Exports-led Recovery': 1999-2014

There is one European economic policy/theory fetishism that stresses the importance of external balance in 'underpinning sustainable' growth. The theory works the following way: countries with external imbalances (e.g. current account deficits) need to enact 'reforms' that would put their economies onto a path of external surpluses. More commonly, this is known as achieving an 'exports-led recovery'.

Set aside the Cartesian logic suggesting that if someone runs a current account surplus, someone else must run a current account deficit. Or in other words, if someone achieves 'sustainable' growth, someone else must be running an 'unsustainable' one.

Look at the actual historical relationship between current account position and growth in income per capita, measured in real (inflation-adjusted terms).

Take the sample of all advanced economies (34 in total, excluding those that we do not have full data for: San Marino and Malta). Take total growth achieved in GDP per capita from the end of 1999 through 2014. And set this against the average current account surplus/deficit achieved over the same period of time.

Chart below illustrates:

Note: there is no point, given the sample size, to deal with non-linear relationship here.

Per chart above, there is, statistically-speaking no relationship between two metrics. Multi-annual growth GDP per capita (in real terms) has basically zero (+0.019) correlation with multi-annual average current account balance. The coefficient of determination is a miserly 0.00036.

Now, cut off the 'outliers' - four countries with lowest GDP per capita: Estonia, Latvia, Slovak Republic and Slovenia. Chart below shows new relationship:

Per chart above, there is a very tenuous relationship between multi-annual growth GDP per capita (in real terms) and multi-annual average current account balance, highlighted by a rather weak, but positive correlation of +0.41 between two metrics. The coefficient of determination is around 0.17, which is relatively low for the longer-term averages relationship across the periods that capture both - a slowdown in growth in the 2002, a boom-time performance for both the advanced economies and the global economy during the 2000s and the global crises since 2008.

I tested the same relationship for GDP per capita adjusted for Purchasing Power Parity and the results were exactly identical. Furthermore, removing the three Asia-Pacific growth centres: Taiwan, Korea and Singapore from the sample leads to a complete breakdown of the stronger relationship attained by excluding the Eastern European outliers, with coefficient of determination falling to ca 0.05. Removing these three economies from the sample with Eastern European outliers present results in a negative (but statistically insignificant) relationship between the current account dynamics and growth.

Lastly, it is worth noting that the sample is most likely biased due to policy direction: during economic slowdowns and in poorer performing European economies in general, there is a strong policy bias to actively pursue exports-led growth strategies, while in non-euro area economies this is further reinforced by the pressure to devalue domestic currencies. Which, of course, suggests that the above correlation links are over-stating the true extent of the current account links to growth.

The conclusion from this exercise is simple: there is only a weak evidence to support the idea that for highly advanced economies, rebalancing their economic growth over the longer term toward persistent current account surpluses is associated with sustainable economic growth. And if we are to consider a simple fact that many euro area 'peripheral' economies (e.g. Greece, Cyprus, Portugal and Spain, as well as Slovenia) require higher upfront investments in physical and human capital to deliver future growth, the proposition of desirability of an 'exports-led' recovery model comes into serious questioning.

15/2/15: European Federalism: Principles for Designing New Federal Institutions

This week, I was honoured to have been invited to participate in a discussion panel of the Future of Europe at the Trinity Economic Forum 2015.

Here are my extended speaking notes on the subject of European Federalism and the challenges of building future European institutions: http://trueeconomicslr.blogspot.ie/2015/02/15215-european-federalism-principles.html

14/2/15: Russian Banks: Some New Stats

A very interesting interview with Jim Rogers, reprinted by Russia Insider: http://russia-insider.com/en/politics_opinion/2015/02/12/3390?utm_source=dlvr.it&utm_medium=twitter

Note the points on the threat of SWIFT sanctions against Russia and the position of China in the US-led sanctions. Both themes have been highlighted on this blog before and both remain very important to the current situation.

And on a SWIFT-related note, few fresh stats on Russian banks situation, reported by BOFIT. Latest data shows Russian banking system assets at RUB77.66 trillion at the end of 2014, up 18% y/y, and this fully accounting for Ruble devaluation. Surprisingly (or not, depending on which fundamentals you consider core drivers for assets growth forward), growth in banking assets accelerated in Q4 2014. The reason was increase in CBR funding for the banks unlocking some liquidity tightness present in Q2-Q3 2014. As the result, CBR-funded share of assets rose from 9% in Q3 2014 to 12% in Q4 2014.

In January 2015, total assets fell RUB24 billion, down 2.6% m/m, thus accelerating the decline registered in December.

Loans to non-financial private sector rose ca 13% in 2014 y/y, similar to 2013 for non-financial companies but lower for the households. In December, outstanding loans to households declined. Non-performing household loans rose ca 6% and non-performing corporate loans were up roughly 30%. Corporate lending fell 0.5% m/m in January, while household lending fell 1.3%, although these figures do not reflect changes in Ruble valuations (Ruble lost 22% vis-a-vis the USD in January after falling 14% in December).

Meanwhile, household deposits fell 2.5% y/y as dollarisation of deposits drove more household savings into 'mattress' savings. In December alone this resulted in a 1% m/m decline in household deposits - a rate, though substantial, still well below what anyone could have expected given the Ruble crisis peak around December 16-18. In part, Government doubling the deposit insurance coverage to RUB1.4 million helped reduce deposits outflows, along with a massive hike in deposit rates that in December hit ca 14% on average, with some banks offering Ruble deposit rates in excess of 20%. Dollarisation also led to a massive, near doubling, of forex deposits held by the households. Share of forex deposits rose from just under 10% at the start of 2014 to 26% at the end of last year.

Drain of household deposits was more than offset by a rise in corporate deposits as companies aggressively built up cash reserves and forex reserves to provide contingency funding for possible acceleration in liquidity squeeze in the markets. Corporate deposits were up 24% y/y and this growth was dominated by larger enterprises.

All of this means that T1 banks capital ratio fell from 13.5% to just under 12% in 11 months through November 2014. November 2014 injection of RUB1 trillion in Government-approved capital for 27 banks via the Deposit Insurance Agency will inject additional 15% of T1 capital into the banking sector.

BOFIT comment on the situation is quite informative: "Russia’s banking sector is in different shape than during the 2008–2009 financial crisis. Banks are struggling with larger portfolios of non-performing loans and capitalisation is weaker. Economic sanctions and higher interest rates have cut off the access of banks to affordable credit and hurt their ability to intermediate credit to the wider economy. The banking sector is also more concentrated than in 2008, when the five largest banks held 43 % of total assets. Today they hold 54 %. All five banks are state-controlled, so the state’s role in the banking sector has grown further. Stricter supervision has caused over 100 small and mid-sized banks to lose their licences since summer 2013, and more banks are expected to lose their licences this year. Some 835 banks operated in Russia at the end of 2014."

Still, take a comparative to Ukraine, where Non-Performing Loans amount to close to 22% of the bank's loans. At the start of 2015, based on CBR data, non-financial corporate's NPLs in Russian banking system amounted to 4.2%. The forecast is for NPLs across the entire private sector to rise to 5.3-5.5% in 2015. NPLs rose 14.4% in January for corporate loans and by 6% for household loans.

Another telling source on the state of Russian banks is Fitch's latest report on 3 banks: http://www.businesswire.com/news/home/20150213005819/en/Fitch-Downgrades-Russian-Alfa-Bank-Lowers-Sberbanks#.VN8VyLCsVic

One thing is for sure: the banking crisis is still on-going and is likely to worsen this year, leading to accelerated consolidation in the sector.