23/2/15: Ukraine CDS-implied Default Rate Shoots Above 97%

As noted by @Schuldensuehner Ukraine's probability of default is now just shy of 97.1%:

Which is spectacular in its own right. But one has to consider what this market pricing really implies.

As we know, Ukraine will receive super-senior debt injections courtesy of the IMF. This will alleviate the immediate crunch on Government liquidity (Ukraine FX reserves are now below scheduled debt redemptions for March-September). So the above risk spike cannot be attributed to the risk of liquidity crisis.

As I explain here: http://trueeconomics.blogspot.ie/2015/02/18215-imf-package-for-ukraine-some.html , this liquidity support comes at a hefty cost: the debt burden that will result from the international lenders intervention will be non-sustainable and it can exacerbate popular discontent with current Government.

Now, the latest news from the Eastern ATO are pretty disastrous, and, arguably, also unlikely to go well with the Ukrainians.

This is of course speculative, but given lack of the risk around future liquidity crunch, the latest spike in the CDS spreads suggests that the markets see serious political risks ahead soon.

23/2/15: Russian Policy Uncertainty Environment Moderated in January

January 2015 saw some easing in the overall policy uncertainty environment in Russia, based on the Policy Uncertainty Index that fell to 197.8 in January 2015 from 305.7 in December and down 22.6% y/y. The index is down 12.3% on the current crisis period average (January 2014-present)

You can see index methodology and get data here: http://www.policyuncertainty.com/russia_monthly.html

23/2/15: Russian Sanctions: Round 4 Looming?..

Big change in EU official language marks a major departure from the past diplomatic practice: https://euobserver.com/foreign/127667. Let's see if this continues, but at the very least, it lays foundations for renewed pressure on Moscow in relation to Ukrainian conflict.

Both the U.S. (see https://euobserver.com/foreign/127754) and the EU (see here: https://euobserver.com/foreign/127703) have stepped up pressure for new sanctions.

Here is my take on the prospect of the latter.

Rumours of the U.S. (and by proxy EU) sanctions extension include, once again:

• Cutting Russian bank's access to SWIFT system (spearheaded in EU by the UK and Poland back in August 2014 and backed by the EU Parliament resolution from September 2014);
• Widening sanctions against imports of Russian goods and services across broader categories and applying more pressure on the emerging markets (traditionally more important to Russian exporters of industrial machinery and capital goods) to abstain from dealing with Russian suppliers (though it is hard to see what can be added to the current list); and
• Expanding the lists of Russians banned from travel to the U.S. and Europe (which would be a weak form of response, unless it starts explicitly impacting travel for ordinary Russians - a suggestion that was floated in late 2014 by a number of former U.S. high ranking officials and analysts, with some going as far as suggesting the U.S. should ban all travel for Russian citizens, regardless of circumstances or their residency). In addition, expanding the list of sanctioned individuals to cover members of their families (to allow arrests of their property abroad, especially in those cases where such property ownership is de facto linked to the originally sanctioned officials and business leaders).

All of these proposals, at their extreme, will be firstly painful, but secondly non-reversible in the short- and medium- run.

The latter would signify that any restoration of normal relations between the U.S. (and Europe) and Russia will no longer be feasible even in the medium term and will demonstrably fail President Obama's own test of sanctions as being a tool for influencing short term policies' outcomes without directly adversely impacting ordinary Russians or sacrificing the objective of long-term normalisation.

In financial terms, cutting Russian banks off SWIFT will compound the already significant pressures on Russian corporates and banks, leading to retaliatory measures that will likely see Russian banks and companies suspending repayment and servicing of forex loans to non-affiliated entities based in the U.S. and the EU. This, financially-speaking 'nuclear' retaliation, is feasible given the downgrades of the Russian sovereign debt by Moody's and S&P: the lower the ratings go, the lower is the cost of counter-measures.

In return for this, Western lenders are likely to ask for (and easily receive) court orders to cease Russian assets abroad.

In effect, the worst case scenario here will be an all-out unwinding of Russian economic integration into the Western European and U.S. economies - a process that will make all sanctions irreversible in the medium term. The tail end of this risk is that a more isolated Moscow will face even lower future costs from taking a more aggressive stance in Ukraine or elsewhere. Economic escalation, at this stage, will most likely result in a political escalation along the lines of 'cornering Russia' into retaliation.

But beyond the Russian-U.S./EU theatre of confrontation, there looms another shadow.

In explicitly deploying economic agents and institutions in a geopolitical conflict against a significant global economic player, the U.S. is risking undermining the very foundation of its own economic power and with it, the power of the West. A long-term economic conflict with Russia is putting all emerging markets and non-Western economies on notice: the U.S. markets and institutions can be a high risk counter-parties, controlled and driven by the political considerations. Until now, targeted nature of sanctions has avoided this risk. And until now, SWIFT and its backers in Europe have made a cogent argument that excluding Russia from the system of banks payments clearance risks undermining the system itself. If Russia, in partnership with China, were forced to develop own system of parallel clearance to rival SWIFT, the West will lose control over the financial transactions pipeline that can be monitored and used to combat illicit trade, financing of terrorism and tax evasion. With time, we will also risk losing major transactions flows between other emerging markets and the West, with resultant de-internationalisation of the global financial flows and a reduction in the West's ability to tap emerging markets surplus savings and liquidity to underwrite long-term Western pensions and investment needs.

Similarly, tax evasion has been put on the declining trend by enhanced international cooperation - a process that is now driving the likes of the OECD reforms efforts in corporate taxation. This too will become more difficult to deliver if the global economic systems, largely based on Western institutions, revert toward regionalisation.

As I said, these are tail risks, but they are risks nonetheless.

Furthermore, broadening of sanctions to target explicitly Russian entities and citizens regardless of their affiliation or position vis-a-vis Moscow political regime will have another hefty long-term risk premium. The West is hoping for the sanctions to drive significant economic decline across Russia to effect a regime change, if not in terms of the physical head of Russian state, then in terms of his core policies. However, broadly anti-Russian (as opposed to counter-Kremlin) sanctions are likely to trigger more nationalist revival in Russia and any regime change in such circumstances is likely to lead to an even more bellicose stance from Moscow. Current political opposition within Russia, even theoretically capable of asserting control over power systems in the political and executive systems, is simply much more nationalistic and anti-Western than we, in Europe and the U.S., would like to believe.


None of this should override the consideration of the urgent need to restore peace in and territorial integrity of Ukraine, first and foremost. And, as I said on numerous occasions before, the onus is on Russia to act decisively to make this possible: by forcing the Eastern Ukrainian separatists to implement Minsk accord pro-actively, ahead of the Ukrainian counterparts and with fully verifiable results.

But, in the game of sanctions escalation, longer term losses for both, Russia and the West, will be significant.


It is worth noting that even Mikhail Khodorkovsky - hardly a supporter of the current regime in Moscow - has repeatedly warned against sanctions being deployed as a tool against the ordinary Russians and the Russian economy at large. See here: http://www.bbc.com/news/world-europe-27513321 and here: http://www.enpi-info.eu/eastportal/news/latest/39323/EU-needs-to-differentiate-sanctions-against-Russia,-Mikhail-Khodorkovsky-tells-MEPs.

Another prominent - and actually more important in terms of his popularity and position in Russia - opponent of the current Government, Alexey Navalny also called for strongly targeted sanctions that avoid damaging the economy and, thus, increasing nationalist axis power within the country: http://www.nytimes.com/2014/03/20/opinion/how-to-punish-putin.html although Navalny did contradict himself in some later statements (see for example a report here: http://joinfo.com/world/1001120_Alexei-Navalny-if-not-for-sanctions-Putins-army.html).

Beyond that, there has been significant enough analysts' coverage of the sanctions trap risks - the adverse impact of sanctions on the West's own objectives: the more effective the sanctions are in destabilising Russia, the more they reduce Western capacity to effect change in Russia in the longer run (see here: http://www.ecfr.eu/page/-/ECFR117_TheNewEuropeanDisorder_ESSAY.pdf).

22/2/15: Ifo on Eurogroup Conclusions

Ifo's Hans-Werner Sinn on Eurogroup deal for Greece:

I failed to spot where the Eurogroup allows for any 'additional cash' for Greece. 

The core point that Greece "has to become cheaper to regain competitiveness. This can only happen if Greece exits the Eurozone and devalues the drachma." On this, Sinn is probably correct. Unless, of course, there is a large scale writedown of Greek debts accompanied by a massive round of reforms. Both of these conditions will be required and not one of them is on the cards.

21/2/15: Russian Sovereign Wealth Funds: 2015 drawdowns

In the previous note I covered Moody's downgrade of Russian sovereign debt rating (see http://trueeconomics.blogspot.ie/2015/02/21215-moodys-downgrade-russia-risks-and.html). Now, as promised, a quick note on Russian use of sovereign fund cash reserves (also referenced in the Moody's decision, although Moody's references are somewhat more dated, having been formulated around the end of January).

Back at the end of January, Russia’s sovereign wealth funds amounted to USD160 billion, with the Government primarily taking a historically-set approach (from 2003 onwards) of arms-length interactions with the Funds management. This relative non-interference marked 2014 and is now set to be changed, with the Government looking at using SWFs to provide some support for the investment that has been falling in 2013-2014 period and is likely to fall even further this year.

Fixed investment in Russia fell 2.0% y/y in 2013, and by another 3.7% in 2014. Private investment is likely to fall by double digits in 2015, based on the cost of funding, lack of access to international funding and general recession in the economy. It is likely to stay in negative growth territory through 2016.

Thus, last week, Prime Minister Medvedev signed an executive order deploying up to RUB500 billion from the Reserve Fund. The money will be used, notionally, to cover this year deficits (expected to hit 2% of GDP), thus protecting the state from the need to borrow from the markets. The Fund was originally set up precisely for this purpose - to finance deficits arising during recessionary periods. In other words, this is stabilisation-targeted use of stabilisation funds. The fund is fully accounted for in the total Forex reserves reported by the Central Bank. Latest figures for end of January 2015 showed the fund to have USD85 billion or RUB5,900 billion in its reserves, so this year allocation is a tiny, 8.5% fraction of the total fund. All funds are allocated into liquid, foreign currency-denominated assets.

The second use of SWFs is via the economic support programme that will draw up to RUB550 billion worth of funds in 2015 from the second SWF - the National Welfare Fund (NWF). Part of this funding is earmarked for banks capitalisation, ring fenced explicitly for banks providing funding to large infrastructure investments and lending for the enterprises. The use of the NWF funds is more controversial, because the Fund was set up to provide backing for future pensions liabilities, including statutory old-age pensions. However, the NWF has been used for the economic stimulus purposes before, namely in the 2009 crisis. Currently, NWF holds USD74 billion or RUB5,100 billion worth of assets. Liquid share of these assets, denominated in foreign currencies, is also included in the Central Bank-reported Forex reserves, but long-term allocated illiquid share and ruble-denominated assets are excluded from the CBR reported figures.

Now, per Moody's note issued last night, "The second driver for the downgrade of Russia's government bond rating to Ba1 is the expected further erosion of Russia's fiscal strength and foreign exchange buffers. …Taking at face value the government's plans to proceed with its planned fiscal consolidation for 2015, Moody's expects a consolidated government deficit of approximately RUB1.6 trillion (2% of GDP) as well as a widening of the non-oil deficit. The deficit would likely be financed by drawing on the Reserve Fund, which is specifically designed for circumstances when oil prices fall below budgeted levels. …Moreover, under the stress exerted by a shrinking economy, wider budget deficits and continued capital flight -- in part reflecting the impact of the Ukraine crisis on investor and depositor confidence -- and restricted access to international capital markets, Moody's expects that the central bank's and government's FX assets will likely decrease significantly again this year, cutting the sovereign's reserves by more than half compared to their year-end 2014 level of approximately USD330 billion. In a more adverse but not unimaginable scenario, which assumes smaller current account surpluses and substantially larger capital outflows than in Moody's baseline forecast, FX reserves including both government savings funds would be further depleted. While the government might choose to mobilise some form of capital controls to impede the outflow of capital and reserves, such tools are not without consequences. Capital controls, which might include a rationing of retail deposit withdrawals and/or prohibition upon repatriation of foreign investment capital, would weaken the investment climate further and undermine confidence in the banking system."

21/2/15: Moody's Downgrade: Russia Risks and Politics

Moody's downgraded Russian sovereign debt last night from Baa3 to Ba1 with negative outlook. Moody's put Russian ratings on a review back on January 16.

The bases for the downgrade were (quotes from Moody's statement):

1. "The continuing crisis in Ukraine and the recent oil price and exchange rate shocks will further undermine Russia's economic strength and medium-term growth prospects, despite the fiscal and monetary policy responses". In more specific terms, "Russia is expected to experience a deep recession in 2015 and a continued contraction in 2016. The decline in confidence is likely to constrain domestic demand and exacerbate the Russian economy's already chronic underinvestment. It is unlikely that the impact of recent events will be transitory. The crisis in Ukraine continues. While the fall in the oil price and the exchange rate have reversed somewhat since the start of the year, the impact on inflation, confidence and growth is likely to be sustained." As I noted on numerous occasions before, monetary policy environment remains highly challenging. Per Moody's "The monetary authorities face the conflicting objectives of keeping interest rates high enough to restrain the exchange rate and bring down inflation and keeping rates low enough to reinvigorate economic growth and bank solvency."
2. "The government's financial strength will diminish materially as a result of fiscal pressures and the continued erosion of Russia's foreign exchange (FX) reserves in light of ongoing capital outflows and restricted access to international capital markets." I will post a quick note on this matter later today, so stay tuned. Here's Moody's view: "Taking at face value the government's plans to proceed with its planned fiscal consolidation for 2015, Moody's expects a consolidated government deficit of approximately RUB1.6 trillion (2% of GDP) as well as a widening of the non-oil deficit. The deficit would likely be financed by drawing on the Reserve Fund, which is specifically designed for circumstances when oil prices fall below budgeted levels. Moody's also expects that widespread demands for fiscal easing are likely to emerge if, as the rating agency projects, the recession persists into 2016. In a scenario in which the government would turn to borrowing in the domestic market to finance at least a share of these deficits, higher spending could result in an increase of the debt-to-GDP ratio to 20% or more."
3. "The risk is rising, although still very low, that the international response to the military conflict in Ukraine triggers a decision by the Russian authorities that directly or indirectly undermines timely payments on external debt service." In other words, we are facing a political risk. Capital controls and debt repayment stops are two key risks here and these were visible for some time now, especially if you have followed my writing on the Russian crisis.

What's the driver for the negative outlook? Uncertainty. Per Moody's: "The negative outlook on the Ba1 rating reflects Moody's view that the balance of economic, financial and political risks in Russia is slanted to the downside, with scenarios incorporating either an escalation of the Ukraine crisis and/or damage caused by recent shocks being greater than in Moody's baseline scenario. Essentially, the probabilities associated with the downside scenarios are higher than those associated with an upside scenario in which the recession is shorter and shallower than Moody's baseline."


Conclusion: an ugly, but predictable move by Moody's. One can say part of it is down to rating agencies activism in trying to establish some sense of credibility post-Global Financial Crisis, whereby getting tougher on ratings is a major objective, and it is well-served by getting tougher on politically softer targets, like Russia. But one can equally argue that the ratings downgrade is consistent with economic environment and some longer-run fundamentals. My view would be is that we are seeing both, with the balance of impetus tilted toward the latter argument.

20/2/15: Troika 3 : Greece 1. Rematch on Monday.

Eurogroup agreement on Greece 'achieved' tonight is a classic can kicking exercise in which Eurogroup and the Troika have won, Greece lost, but no one has moved an inch in real actionable terms.

Why?

• This is not an agreement to end the current programme that Greece is in, nor an agreement on a new programme to replace the current one. Instead, this is an agreement on the methodology for future negotiations over the replacement agreement. The current Master Financial Assistance Facility Agreement (MFAFA) is extended by four months. Hence, the current 'austerity programme' is still in place and has not been replaced by anything new. The extension is to allow time for developing a new agreement to bridge the current programme. This does not guarantee any of the conditions of the new agreement (e.g. 'easing of austerity' or 'reducing debt burden' or anything whatsoever) that will have to follow the current programme after June.
• Over the next two months (at the longest) here will be a review of the current programme and Greek Government proposals for amending the programme. The review will be conducted "on the basis of the conditions in the current arrangement" (see full agreement here: http://www.consilium.europa.eu/en/press/press-releases/2015/02/150220-eurogroup-statement-greece/). So no deviations from the 'basis of the conditions in the current' agreement will be allowed even in the review stage, although they might be allowed in the future agreement.
• However, the agreement also states that this review will make "best use of the given flexibility which will be considered jointly with the Greek authorities and the institutions." In other words, the new agreement will still be required to run within the parameters allowed by the current agreement. You can read this as 'Greece has won recognition from the Eurogroup that current austerity programme needs revision'. Or you can equally read it as: within current austerity programme, there can be some flexibility, like for example, delaying austerity today, but loading more austerity risk into the future, should current delay fail to produce substantial improvement in underlying conditions.

To sum up the above: the old austerity (MOU and MFAFA) are now extended by 4 months. In exchange, Greece gets a promise that the Eurogroup and the institutions (aka Troika) will take a look at its proposals, as long as these proposals adhere to the basis of the current austerity MOU.

• Greece originally requested a 6-month extension, which would have allowed it to cover redemptions of some EUR6.7 billion worth of ECB bonds maturing in July and August, using the funds from the existent programme. They failed - the agreement extends current access to funds until June and puts Greece on the hook negotiating new bailout while staring into the double barrel of massive debt redemptions coming up. (see http://www.zerohedge.com/news/2015-02-20/why-4-and-not-6-months)

To sum up: Greece will be back to square one, but in a weaker financial position in June, unless it really plays ball before the end of the current extension. This is a major win for the Eurogroup.

• Greece committed to complete the current bailout. Worse, if it does not follow on through with the planned austerity, Greece will not receive the last tranche of funds. "Only approval of the conclusion of the review of the extended arrangement by the institutions in turn will allow for any disbursement of the outstanding tranche of the current EFSF programme and the transfer of the 2014 SMP profits. Both are again subject to approval by the Eurogroup." So Troika is still there today as it was there yesterday and the Greeks have failed to end the current bailout. If you are inclined to say Eurogroup is not Troika, good luck: today's Eurogroup included IMF, ECB and ESM chiefs. And the Eurogroup clearly stated: "we welcome the commitment by the Greek authorities to work in close agreement with European and international institutions and partners. Against this background we recall the independence of the European Central Bank. We also agreed that the IMF would continue to play its role." So both ECB and IMF are in place and Troika has simply been renamed into Institutions. 

To sum up: Troika is here, still. 

• On top of that, the Greeks have lost control of bank recapitalisation funds. "In view of the assessment of the institutions the Eurogroup agrees that the funds, so far available in the HFSF buffer, should be held by the EFSF, free of third party rights for the duration of the MFFA extension. The funds continue to be available for the duration of the MFFA extension and can only be used for bank recapitalisation and resolution costs. They will only be released on request by the ECB/SSM." Until now, these funds were to be handled by the Hellenic Financial Stabilisation Fund (HFSF). These funds were also targeted by the Greek Government for use outside bank recapitalisations. Both are now lost positions for Greece: the funds move to EFSF, Greek Government has no say on their disbursement and they can only be used for banks recaps. 

To sum up: Greeks did not gain control over banks recapitalisation funds and did not gain access to these funds for the purpose of easing austerity.

• In return for the above concessions, Greece got a very wooly commitment from the Eurogroup that the New Troika "will, for the 2015 primary surplus target, take the economic circumstances in 2015 into account". In other words, the primary surplus required for 2015 can (and probably will) be adjusted down. The problem, of course, is that this is only for 2015 and not beyond and that it is of a magnitude that will make absolutely no difference to Greece - we are talking about something of the order of 1-2 percent of GDP in just one year. 
• Reminder, Greek debt to GDP stands at around 175%. No amount of tinkering on the margins will deliver sustainability of this debt and no amount of tinkering on the margins can deliver a buffer of defense from the risk of future increase in the cost of funding the Greek debt.

To sum up: Presenting a primary deficit adjustment as a victory for the Greeks is equivalent to prescribing a course of homeopathy for the stroke patient.


Key point of the whole agreement is that it entails nothing in terms of what follows after the current bailout is completed. This - in all its principles and details - remains subject to future agreement, outside the scope of this Eurogroup meeting. In other words, Greece bought itself time to bargain about the future, Eurogroup bought itself time to get Greeks into even less comfortable financial position. And the Troika is still there.


In words of Wolfgang Schäuble: “The Greeks certainly will have a difficult time to explain the deal to their voters. As long as the programme isn’t successfully completed, there will be no payout."

In words of the Agreement: "The Greek authorities reiterate their unequivocal commitment to honour their financial obligations to all their creditors fully and timely."

In words of the WSJ: "Greece’s ...government backed down from its plans to throw out the bailout program..., striking a tenuous deal with the rest of the eurozone to extend the program by four months."

In words of FT: "The decision to request an extension of the current programme is a significant U-turn for Alexis Tsipras, …who had promised in his election campaign to kill the existing bailout. …it includes no reduction of Greece’s sovereign debt levels, another campaign promise. Discussions on debt restructuring are likely as part of follow-on talks ahead of another bailout programme, which must now be agreed before June…Critically, the agreement commits Athens to the “successful completion” of the current bailout review, although it allows for Greece to negotiate its economic reform agenda."

Troika 3 : Greece 1

20/2/15: January Russian CPI hit 15%. Food Inflation at 21%

Russian consumer prices data for January posted CPI of 15% y/y, with food inflation at 21% and non-food inflation at 11%. Per Economy Ministry estimates, more than 4 percentage points in inflation came from Ruble devaluation, while Russian July 2014 counter-sanctions (food imports bans) accounted for just over 1 percentage points.

As predicted in this blog, most of the price increases due to counter-sanctions will have an impact this year, rather than in 2014, in part due to lags in contracts and supplies storage, but also due to crop outruns - 2014 crops were at near historical record, and simple arithmetic on this suggests that 2015 is likely to post lower production figures. Additional break on prices was provided by some larger retail stores committing to freezing prices on foodstuffs - a measure that is unlikely to hold in the longer run. To mitigate this, the Government imposed export duties on wheat, in force from February 2015 set at a minimum rate of EUR35 per ton. This is set to run through June 2015 and my expectation is that it will rise there after. Indirect (non-tariff) measures to cut exports of foodstuffs are operating across the food sector, primarily manifesting themselves via slower issuance of exports documentation and limiting availability of transport capacity.

This came at the time when the Federal Anti-Monopoly Service were carrying out inspections of Russian retailers to determine if there were cases of price gouging. The Service was instructed to carry out monitoring of prices in an attempt to cut back inflation. At the same time, many regional authorities have been issuing regulatory caps on profit margins for retailers, also aimed at cutting back prices, while falling short of direct price controls. Note: price controls do operate - for years now - in the Northern regions.

As reported by BOFIT, Prime Minister Medvedev singled out specific concerns about the cost of drugs and medical supplies, warning "last week that medicine prices could rise as much as 20%" in 2015. Also per BOFIT, "Health ministry price monitoring found that in January regulated prices of life-saving medicines were up 4% and other drugs 15%". In this area - a note to exporters to Russia - the Government is continuing to expand the list of drugs covered by direct price controls and is currently preparing a draft regulation to control prices for medical equipment.

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.