21/315: Russia Forex Reserves: Down Another Week

Based on weekly data for the week of March 13, 2015, Russian Central Bank forex reserves fell to USD351.7 billion, down USD5 billion on previous week. The reserves are now down 28.7% (USD141.5 billion) y/y. Compared to the same week a month ago, the reserves are down 4.5% (USD16.6 billion).

The rate of weekly changes in reserves (USD5 billion) is slower than in the week of March 6th (USD6.3 billion) but well ahead the 3mo average weekly decline (USD4.61 billion) and 6mo average (USD3.57 billion).

Two charts to provide some historical comparatives in terms of period averages relative to both levels and rates of change.

It is worth noting that there have been virtually no Forex interventions (Ruble rate defence: http://www.cbr.ru/Eng/hd_base/Default.aspx?Prtid=valint_day and http://trueeconomics.blogspot.ie/2015/03/20315-central-bank-interventions-in.html) from CBR in February and March and there have been ongoing de-dollarisation of the household funds in February (http://trueeconomics.blogspot.ie/2015/03/18315-russian-deposits-dollarisation.html) that is likely continued in March (reducing forex deposits and cash holdings), which implies that declines in reserves are down to the following drivers:

1. changes in euro and other currencies, as well as gold and non-dollar denominated assets, valuations for assets held by the CBR - in other words the potential adverse effects of dollar exchange rates against other currencies, and changes in asset values due to changes in US bonds markets;
2. demand for Forex from corporates and banks (all of which would be in the form of loans from the CBR to these entities) all of which is associated with deleveraging the external debt; and
3. potential fiscal demand for forex.

20/3/15: Central Bank Interventions in Ruble Markets down to Zero in February

Don't hear much of "Panic at the Central Bank of Russia" reports as of late in the Western media - the ones that whipped into frenzy Russia 'analysts' back in November-December? Why, no surprise:

Per latest data, CBR interventions in forex markets defending the Ruble have shrunk in February 2015 to zero for USD and zero for EUR. Yep, zero.

Oh, and the table above shows, the panic of November-December 2014 Ruble crisis - real as it was - was not as bad as CBR supporting Ruble prior to the free float and during the peak of Crimean crisis.

So was the decision to let Ruble float wise? You decide. On the trend, it saved CBR some USD8.5 billion and EUR1.2 billion, even counting in December 2014 crisis.

20/3/15: Russia: Agri-food Sector and Falling Real Household Incomes

As BOFIT reported last week, 2014 marked the first year since 1999 crisis when Russian households experienced a decline in real household income. In 12 months through December 2014, real (inflation-adjusted) incomes declined by around 1% y/y, with the rate of decline accelerating to 5% y/y in November-December 2014, at the peak of the Ruble crisis. Even at the depths of 2008-2009 crisis, Russian real household incomes stayed in positive growth territory, as chart below illustrates:

One area of severe squeeze on actual (nominal) incomes has been in the public sector. As BOFIT noted: "As recently as 2013, public sector wages were rising nearly 20% a year. By the end of 2014, however, on-year nominal wage growth had fallen to zero, while inflation was running at 11.4%. Hence, real wages in the public sector fell substantially." Private sector wages shrunk by around 2% in dealt terms, y/y. Pensions rose by about 10% y/y in 2014, still below inflation increases.

As BOFIT reported: "The average 2014 wage (excluding grey-sector wages) was about €650 a month. In January this year, due to a massive drop in the value of the ruble, the average monthly wage was only about €450. The average pension last year was €220 a month, but in January, that amount had fallen to just €150."

Going forward, both public and private sectors are facing tough times in terms of wages growth. Meanwhile, composition of inflation - especially rapid inflation in food and other staples prices - is more significantly impacting retirees. As the result of inflation in food sector, Rosstat has revised its formula for the cost of consumer goods and services basket, increasing the relative weight of food by almost 1 percentage point to 37.3% of the total household spending. This means that going forward, higher inflation in food sector will have greater impact on CPI. And we can probably expect that higher inflation. 2014 was near-record crop year that is unlikely to repeat. Meanwhile, Russian agriculture is suffering from dire need of modernisation capes that is nowhere to be seen. There is some room for imports substitution via increased domestic production and via alternative supplies from outside the EU, US and other economies that imposed sanctions and suffered Russian counter-sanctions, but that substitution is severely limited by:

1. Bottlenecks in supply expansion in Russia; and
2. Lower exports revenues due to high oil prices.

Neither has much to do with sanctions: in the current oil price environment, lending to Russian corporates, even if it were available outside sanctions, would have been very subdued and expensive.

To lift production in the sector, the Government needs to simultaneously:

1. Increase capital investment supports to the producers;
2. Open and incentivise markets for agri-food production and supply sectors in Russia to foreign investment (lifting sanctions on imports of food will do absolutely nothing to food prices, as imports pricing will be linked to forex rates and cost of capital);
3. Set up long-term targeted incentives for Russian producers to increase output quality and volumes (preferably via tax system and streamlined land ownership, as well as improved access to markets). Less arbitrary enforcement of regulations would also help; and
4. In distribution and retailing, local authorities in a number of larger urban centres have tightened and consolidated control over retail markets, resulting in higher margins for retailers, lower margins for producers and cutting off producers' access to direct sales to consumers, especially for smaller producers. This should be reversed. 

Hedge Funds Returns: Part 4: To higher moments and beyond

My latest post for LearnSignal Blog on the topic of measuring hedge funds' returns: http://blog.learnsignal.com/?p=165

18/3/15: Russian Deposits Dollarisation and Capital Flight

I have written before about the nature of capital outflows from Russia. One aspect of capital outflows is how the aggregate reflects deposits shifts into forex, known as 'dollarisation' of deposits. When Russian residents withdraw foreign currency from the banks (either via drawing down existent currency deposits or by converting their Ruble deposits into forex), the transaction is registered as capital outflow from Russia, even if they park this currency in safety deposit boxes and in their coffee tins. In other words, capital outflow out of Russia is registered even if cash remains in Russia.

Based on the latest data from the Institute for Foreign Trade, The Gaidar Institute for Economic Policy and the Russian Presidential Academy of National Economy and Public Administration, as of February 1, 2015, share of forex deposits in Russian banks rose to 35.7% of total monetary base excluding cash, up on 19.4% a year ago. The degree of 'dollarisation' (conversion to forex) was higher in 2014 than during the 2009 crisis, when the share of forex deposits stood at 35.3% and is second highest after 1998 crisis peak.

In 2014, Russian residents directly withdrew USD28.6 billion in forex from the banks. A large figure, but significantly less than in 2008 when this figure stood at USD51.4 billion. Over 2014, Russian banking system lost, in total, USD40 billion of forex to cash conversions and deposits withdrawals - all of which was registered as capital outflow from Russia.

The research note can be accessed (in Russian) here: http://www.ranepa.ru/news/item/6869-monitoring-4.html.

Interestingly, it tells the story of banks running out of deposit boxes storage capacity around November-December 2014 as households rushed to convert to forex holdings (mistrusting the Ruble) and switched to holding this forex in cash (mistrusting the banks).

February data showed significant moderation in dollarisation. Forex deposits held by the Russian banks fell 10.7% to RUB5.1 trillion, while Ruble denominated deposits those 2.7% to RUB13.8 trillion, with changes driven predominantly by the strengthening of the Ruble (in February, Ruble gained 14% relative to the basket of USD and EUR).

Over the last 12 months, corporate forex deposits rose substantially, with 41.3% of all corporate sector deposits now held in forex - a sign that Russian companies are continuing to build forex reserves to counter existent and potential future sanctions. In effect, Russian companies are cutting back on exporting forex out of Russia in fear of losing control over these funds in the future. At the same time, household forex deposits fell by USD5 billion and Ruble-denominated deposits rose on improved Ruble exchange rate.

17/3/15: IMF Cries Wolf as Emerging Markets Currencies Plunge

Remember the Russian Ruble Melt of 2014? Now get ready for the Emerging Markets Currencies Shake-n-Bake of 2015:

H/T: @Schuldensuehner

It is a miracle that the Fed can do in the IMF-sponsored mercantilist world of Exports-led Recoveries...  And guess who is now crying wolf? Why, IMF, of course: http://www.imf.org/external/np/speeches/2015/031715.htm. Except they don't dare call it a wolf, just 'lessons to be learned'.

17/3/2015: Russian Banks Latest Stats: January-February 2015

Some interesting banking sector stats were reported this week by the deputy head of the Central Bank of Russia, Mikhail Suhov during the Russian Economic Forum in Geneva.  Here is a compendium of the latest banking stats reported by the CBR and in the Russian media.


Non-Financial Sector Credit

Russian retail banking lending to households fell 1.5% in February, down RUB165.4 billion with CBR expecting the trend to continue, stabilising at around 4-5% decline in household credit for the full year 2015. As of March 1, household credit outstanding stood at RUB11,060 billion.

According to Sukhov, household credit arrears rose 0.8 percentage points in the first two months of 2015 from 5.8% at the start of January to 6.6% by the end of February.

In January-February 2015, household credit declined by 2.1%, down RUB243.8 billion with RUB-denominated credit standing at RUB10,756 trillion against forex denominated credit of RUB304.4 billion.

Non-financial corporate sector credit fell 4.7% in dollar terms and 1.1% in Ruble terms. The figures do not reflect the latest CBR that lowered benchmark rate to 14% on March 13 from 15% previous. The CBR expects effects of the latest rate reduction to show in the aggregate data around May 2015.

Overall lending to the real sectors (excluding Government and financial sectors) fell 1.5% in February. Much of credit contraction is concentrated in a small number of banks, acceding to CBR deputy head.

Based on data from Finmarket, total real sector arrears stood at RUB730.4 billion, up RUB24.7 billion or 3.5% m/m. In January-February 2015, arrears rose RUB64.2 billion or +9.6%. As percentage of total banking assets, as of March 1st, real sector credit arrears were 6.6%, up 0.3 percentage points in February compared to January.

Sukhov also noted that current rate of increases in non-financial sector credit arrears is likely to continue, resulting in total arrears stabilising at around 7.5% for outstanding credit and 7% taking into the account new credit. CBR estimated 2015 total arrears increases of roughly RUB900 billion.


Bail-in Mechanism

Meanwhile, under the Financial Stability Board arrangement (FSB, set up in 2009 by the G20 group), the CBR is currently looking into establishing formal bail-in rules for the Russian banking sector and the system of bridging banks (licensed entities that act as bridging institutions temporarily holding banking assets in the case of bank shutdown). Bridge banks are supposed to take over assets of insolvent mankind institutions and hold these assets during the period of liquidation, allowing to extend the process of assets disposals to minimise the risk of fire sales. The bail-in mechanism proposed by the FSB includes automatic conversion of unsecured creditors (into equity and subordinated loans) to allow direct bail-in. However, the CBR has already stated that the automatic bail-in mechanism is not necessary for the Russian banking system at this point in time.


Forex Mortgages

Another interesting point raised by Sukhov in Geneva relates to the much-discussed in the recent past risk of forex-denominated mortgages held by the Russian banks. As a reminder, in December 2014, the CBR started a consultation with the banks on creating a mechanism for converting existent forex-denominated mortgages into RUB-denominated loans based on the exchange rate as of October 1, 2014. At the time, some analysts predicted that such a move would trigger significant write downs of banking sector assets. According to Sukhov, CBR currently sees no risk to the banking sector from forex mortgages conversions, with the number of banks exposed to such a risk being very small. The vast majority of such mortgages were issued prior to the Global Financial Crisis of 2008 with issuance of these loans slowing down very significantly after 2008.


Sector Consolidations

In 2014, CBR forced absorption of 7 Russian banks into bigger entities and the CBR is now expecting 2015 to be a much more active year for banking sector consolidation. Meanwhile, average T1 capital ratios for Russian banks remained above 12% in the first two months of 2015. As the result of organic changes in balance sheets, as opposed to sector players' consolidations via mergers and shutdowns, market share of 5 largest banks in Russia rose to around 52% in 2014 from roughly 49.5% in 2013. In 2015, the CBR expects market share concentration to increase to above 55%, potentially reaching 60% by the end of 2016.


Banks Profitability

This is consistent with the CBR view on the overall profitability across the banking sector. In February, banks' losses rose to RUB36 billion from RUB24 billion in January. However, Sukhov noted that the CBR does not expect banking sector losses to rise significantly over 2015, noting that some estimates of up to RUB1 trillion losses for 2015 across the Russian banking sector carry "very low probability" of materialising. Instead, Sukhov expects more polarisation across the banking sector, with greater concentration of losses. Sukhov's estimates for losses across the system of "one-two hundred billion rubles" is roughly half the estimate produced by CBR back in February (CBR forecast is for RUB300-400 billion in cumulative losses for 2015, against cumulative profit of RUB589 billion in 2014 and RUB990 billion profits recorded in 2013).

16/3/15: Ukraine's Government Debt Projections: Smiling IMF, Whinging Private Lenders

Few weeks ago I covered in some details the implications for Ukraine of the latest IMF-led lending package: http://trueeconomics.blogspot.ie/2015/02/18215-imf-package-for-ukraine-some.html. My projection was for the debt/GDP ratio reaching over 100% in the medium term (2016-2017) based on the timing of disbursal of the new loans package and the composition of the package at the time.

The latest IMF forecasts (http://www.imf.org/external/pubs/ft/scr/2015/cr1569.pdf) show debt/GDP ratio peaking at 94.6% of GDP in 2015. IMF latest estimate is based on the assumption that, having posted primary deficit of 1.15% of GDP in 2014, Ukraine will return a primary surplus of 1.1% of GDP in 2015. As IMF notes, average primary balance in 2004-2013 in Ukraine was -2.4% of GDP, so, as some would say... 'good luck' with that.

And the programme is also anchored to the private sector-held public debt restructuring. Here's MOU from the Ukrainian authorities on this: "To secure adequate public sector financing in the coming years, while also putting public debt firmly on a downward path, we intend to consult with the holders of public sector debt on a debt operation to improve medium-term debt sustainability. To facilitate this consultation, and in line with international best practice, we have hired financial and legal advisors (prior action). While the specific terms of the debt operation would be determined following our consultations with creditors, it would be guided by the following program objectives: (i) generate US$15 billion in public sector financing during the program period; (ii) bring the public and publicly guaranteed debt/GDP ratio under 71 percent of GDP by 2020; and (iii) keep the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019–2025. The restructuring is expected to be based on the program baseline macro framework applicable at the time the debt operation is launched. The debt operation is expected to be finalized by the time of the first review." Or in more simple terms, the IMF has already pre-committed to Ukraine cutting USD15.3 billion off its Government debt levels via private sector 'participation' in the programme. Something that is (a) questionable in terms of Ukraine's ability to deliver on, and (b) making a number of very powerful lenders quite unhappy (see http://www.themoscowtimes.com/article.php?id=517502).

And outside the baseline scenario, here is IMF's assessment of risks to Ukraine's debt profile: "Under a growth shock, entailing a cumulative growth decline of over 9 percentage points in 2016–17, the debt-to-GDP ratio reaches nearly 119 percent in 2017. A real exchange rate shock not dissimilar to the one in 2014 would also keep the debt ratio above 100 percent of GDP throughout the projection period. The combined macro-fiscal shock, an aggregation of the shocks to real growth, interest rate, primary balance and exchange rate, produces unsustainable dynamics, sending debt above 200 percent of GDP in 2017. The contingent liabilities shock highlights the risk of a further deterioration of the banking sector and associated higher fiscal costs. Its impact is mitigated by the buffer embedded under the baseline for larger-than-expected bank restructuring costs. By imposing a large associated shock to growth (14 percentage points below the baseline in 2016–17) and given the resulting deterioration in the primary balance together with an increase in interest rates, under the contingent liabilities shock debt peaks at 116 percent of GDP in 2017."

So in simple terms, I will largely stick with my original estimates that around 2016-2017, we are likely to see Ukraine's government debt around 100% of GDP marker.

16/3/2015: Some new 2015-2018 forecasts for the Russian Economy

Amidst much of the (occasionally informed) speculation as to the whereabouts of Russian President Putin (see for example this rather informative piece: http://uk.businessinsider.com/what-is-putin-doing-2015-3?r=US#ixzz3UWqOOHLc), President Putin has finally reappeared from wherever he might have been over the last how-many days... Of course, his reappearance promptly led to some 'highly informed' Western analysts seeing President Putin's double...

The matters of conspiracy aside (for their endless supply makes their value trend toward absolute zero pretty fast), the Economy Ministry has been busy preparing new forecasts for Russia for 2016, trailing behind the recent forecasts from the Central Bank.

Minister Ulyukaev today said that the economic outlook for Russia is based on the view that Western sanctions will remain in place "at least over the period of 2015-2016" and "most likely, in the following years". Beyond this, the Minister said that 2016-2018 will likely see 2.5%-3% average rate of growth in real GDP and that 2016 growth is likely to be in the same range. New forecasts, according to Mr. Ukyukaev - currently in preparation stages - see economic recovery starting in 2016. This, if confirmed in the official forecasts, would represent a dose of optimism not matched by many independent analysts, and well in excess of the cautious gloom of the Central Bank (see below).

Meanwhile, as The Moscow Times (not a paper known for expressing pro-Kremlin sentiments) noted: foreign investors are heading back into Russian markets http://www.themoscowtimes.com/article/517481.html. I wish them well - they are in for a rough ride, but should enjoy some upside, on average. Do note some of the risks and concerns voiced at the end of the article.

Of course, amidst all this positivity, the real signs are pointing to growing concerns about the state of the economy.

Central Bank published forecasts show "at risk scenario" forecast of -5.8% contraction in GDP in 2015. This assumes average oil prices in the range of USD40-45pb.

Under the base scenario, oil prices are expected to average USD50-55pb in 2015, rising to USD60-65pb in 2016 and USD70-75pb in 2017. These assumptions support GDP growth forecast of -3.4% to -4.0% in 2015, followed by a contraction of -1.0% to -1.6% in 2016, and growth of 5.5% to 6.3% in 2017. In effect, these forecasts imply 2015-2017 growth of between 0.4% and 0.9%, cumulative. Under the base scenario, growth of 4.6% in 2017 would be required to get Russian economy back to the end-2014 levels.

The CBR forecasts decline of USD50 billion in its forex reserves to around USD307 billion in 2015 and no change in reserves in 2016. The balancing out of reserves is based on current account surplus forecast of USD90 billion in 2016 up on USD64 billion in 2015. CBR projects current account surplus of USD119 billion in 2017.

My view is that the above figures err on optimistic side. I expect Russian economy to shrink by around 4-5% in 2015, post GDP growth of between -1.5% to +0.5% in 2016 and grow by around 3% in 2017. I also expect CBR forex reserves to drop by around USD80 billion in 2015 and closer to USD40-50 billion in 2016 to USD225-230 billion at the end of 2017.



Note: a fascinating and exhaustingly detailed account of the short history of Russian Government and business struggles for who will be building the bridge to Crimea: http://www.forbes.ru/print/node/282637 (in Russian).

13/3/15: Irish Bilateral Trade in Goods with BRIC: 2014

Full year 2014 data on Irish bilateral trade in goods with the BRIC countries is showing some interesting changes to historical patterns worth highlighting. Let's start with country-specific analysis:

Russia: 

Irish exports to Russia (goods only) reached EUR722 million in 2014, up 13.3% y/y from EUR637 million in 2013. Over the last five years, Irish exports to Russia almost doubled, rising 198%. Russia now accounts for 21.6% of Ireland's total exports to BRIC economies, up from 8.2% in 2009. Trade balance with Russia (goods only) has risen more modestly to EUR496 million, up just 1.43%, marking the second highest bilateral trade balance with Russia (the highest one was achieved in 2012 at EUR503 million). Still, Ireland's trade balance with Russia is the largest for all BRIC and Irish exports to Russia now exceeds the combined exports from Ireland to Brazil and India for the fourth year in a row. Over the last 5 years, cumulative trade in goods surplus in favour of Ireland in trade with Russia stands at EUR2.085 billion.

Brazil:

Irish exports to Brazil fell from EUR262 million in 2013 to EUR256 million in 2014 (a drop of 2.3% that effectively reverses the rise of 2.34% recorded in 2013). As the result, 2014 exports to Brazil exactly matched EUR256 million level of exports achieved in 2013. Over the last 5 years, Irish exports to Brazil have grown only 21.2% cumulatively - the second worst performance in BRIC. As the result of sharper contraction in imports, Irish trade balance with Brazil actually managed to improve in 2014. 2014 trade in goods surplus for Ireland's trade with Brazil was EUR97 million as opposed to a deficit of EUR12 million recorded in 2013 and a deficit of EUR260 million recorded in 2012. Over the last 5 years, cumulative trade in goods deficit against Ireland in trade with Brazil stands at EUR7.9 million.


India:

Irish exports to India fell from EUR304 million in 2013 to EUR248 million in 2014 (a drop of 18.4% that significantly reverses the rise of 29.4% recorded in 2013). As the result, 2014 exports to India almost matched EUR235 million level of exports achieved in 2013. Over the last 5 years, Irish exports to India have grown only 56.5% cumulatively - the second best performance in BRIC after Russia. As the result of a small rise in imports, Irish trade balance with India actually managed to deteriorate in 2014. 2014 trade in goods deficit for Ireland's trade with India was EUR154 million as opposed to a deficit of EUR83 million recorded in 2013 and a deficit of EUR130 million recorded in 2012. 2014 was the worst deficit year in our bilateral trade with India since the data on bilateral trade became available in 1998. Over the last 5 years, cumulative trade in goods deficit against Ireland in trade with India stands at EUR673.7 million.


China:

Irish exports to China rose from EUR1,941 million in 2013 to EUR2,111 million in 2014 (a rise of 8.8% that largely reverses the fall of 10.4% recorded in 2013). As the result, 2014 exports to China almost matched EUR2,167 million level of exports achieved in 2013. Over the last 5 years, Irish exports to China have shrunk by 9.4% cumulatively - the worst performance in BRIC. Adding insult to the injury, as the result of a small rise in imports, Irish trade balance with China actually managed to deteriorate in 2014. 2014 trade in goods deficit for Ireland's trade with China was EUR1,370 million as opposed to a deficit of EUR1,150 million recorded in 2013 and a deficit of EUR693 million recorded in 2012. 2014 was the worst deficit year in our bilateral trade with China since 2008. Over the last 5 years, cumulative trade in goods deficit against Ireland in trade with China stands at EUR3,849 million.


Combined bilateral trade with BRIC:

Irish exports to BRIC markets (goods only) rose to EUR3,337 million in 2014, rising 6.2% y/y from EUR3,114 million in 2013 and virtually reversing the losses sustained between 2013 and 2012 to almost match 2011 level of EUR3,324 million. Over the last 5 years, exports from Ireland into BRIC economies rose 13.4% cumulatively - hardly an impressive performance. Meanwhile, Irish imports from BRIC rose from EUR3,900 million in 2013 to EUR4,268 million in 2014. As the result, Irish trade deficit with BRIC economies rose from EUR756 million in 2013 to EUR931 million in 2014. Thus, 2014 marked the worst trade deficit with BRIC economies since 2008. 5 year cumulative trade deficit between Ireland and BRIC currently stands at EUR2,445.8 million

Quite surprisingly, Irish bilateral trade in goods with Russia - subject to EU sanctions, US sanctions-induced lower propensity for US multinationals to engage in Russia, and subject to severe disruption of financial flows, including trade credits and insurance - has managed to substantially outperform our trade with other BRIC economies and expand by 20.8% y/y in terms of combined trade flows and 13.4% in terms of exports to Russia. The reason for this the longer-term nature of our exporters engagement in the Russian markets and more partnership-based approach to trade. Irish exports to Russia are strongly dominated by indigenous, smaller exporters who tend to secure longer-term relationship-based engagement in the market. In addition, Irish exports to Russia are strongly developed in the areas of food production and agri-food technologies - two sectors that saw growth in investment in Russia.

13/3/15: Emerging Markets Corporate Debt Maturity Squeeze

H/T to @RobinWigg for the following chart summing up Emerging Markets exposure to the USD-denominated corporate debt redemptions calls over 2015-2025. The peak at 2017 and 2018 and relatively high levels for exemptions coming up in 2016, 2019-2020 signal sizeable pressure on the EM corporates that coincides with expected tightening in the US interest rates cycle - a twin shock that is likely to have adverse impact on EMs' capex in years to come. With rolling over 2017-on debt becoming a more expensive proposition, given the USD FX rates and interest rates outlook, the EMs-based corporate sector will come under severe pressure to use organic revenue generation to redeem maturing debt. Which means less investment, less hiring and less growth.

The impossible monetary policy trilemma that I have been warning about for some years now is starting to play out, with delay on my expectations, but just as expected - in the weaker and more vulnerable markets first.

13/3/15: South Stream Redux: Rejecting the Hungarian-Russian Nuclear Power Deal

A pretty nasty confirmation of the overall hostile approach by the EU toward national autonomy in dealing with the energy markets by the member states came in yesterday. As reported in the FT: http://www.ft.com/cms/s/0/9a6467e2-c8c1-11e4-8617-00144feab7de.html#ixzz3UCYrZfix, the EU has blocked Hungarian deal with Russian Rosatom to develop and supply new nuclear energy facilities at Paks. The EUR12 billion, 1,200 MW facility was to be designed, built and maintained by Rosatom under a contract that is pretty bog-standard around the world and included (also standard) long term exclusive agreement to supply fuel. Paks current output accounts for 40% of total Hungarian electricity generation and the country effectively has no options other than either burn Russian gas, Polish and/or Ukrainian coal or using nuclear. Notably, Polish and/or Ukrainian coal is perhaps the dirtiest generation alternative available to Hungary.

As reported in the FT: "Many EU officials also expressed concerns that Moscow was using energy policy to divide Europe and undermine the bloc’s consensus on sanctions imposed on Russia over its actions in eastern Ukraine."

Which simply means that the EU is now arbitrarily exceeding its own sanctions and is using trade as a conduit for political influence.

It is worth noting that long-term supply agreement for fuel is a necessary part of the agreement that is part-financed (EUR10 billion) by Russian credits. Recovery of these credits is built-into the fuel supply contract.

Another thing worth noting: the EU rejection is not based on the separate concern as to the nature of procurement contract involved. Russia is not liable for the procurement procedures deployed by the Hungarian authorities that might have been in breach of the EU procurement rules.

Net impact: the EU rejection of the contract not on the basis of procurement rules violation, but simply because the EU does not like long term contractual fuel supply arrangements with Russia represents a drastic departure from the EU rhetoric of supporting free trade. Just as in the case with Nord Stream and South Stream pipelines, the EU is currently cartelising energy procurement and development policy (see earlier note here: http://trueeconomics.blogspot.com/2015/02/5215-gazproms-nord-and-south-streams.html). In addition, the EU is now clearly erring on the side of becoming completely unreliable trading partner for Russia, as even the areas not impacted by sanctions are now openly being used as a tool for strengthen sanctions impact.

The twin effect of these exchanges should accelerate Russian pivot East and South away from Europe. This pivot is costly to Russia, but it is also costly to the EU, signalling in the longer run EU's dropping out of the Asia-Pacific, Central Asian and Russian trade and investment blocks. For you may or may not be a fan of Russia or Moscow's policies, but what you cannot escape in all of this is the simple fact: EU has now fully politicised its energy markets. And if so, then who is to say it won;t do so in other markets? The ones that might be important to, say, India or China or Asia Pacific or Latin America? Who is to say that the current trade flows are a permanent and protected feature of the world that EU inhabits? And who is to say that the risk of EU politicising another sector - aviation? transport? industrial machinery? - under the pretence of creating another 'Energy' Union is a risk that the non-EU world should ignore in dealing with Europe?