22/4/15: Some morning links on Greek crisis

Greek crisis is accelerating once again, predictably, given the deadlines and debt redemptions looming. So what's worth reading on the subject this am?

Start with @FT's Martin Wolf and his "Mythology that blocks progress in Greece". It is good… as a summary of key myths surrounding Grexit. But...

Myth 1: "A Greek exit would help the eurozone" and Wolf view is that it is not so because with Grexit "euro membership would cease to be irrevocable. Each crisis could trigger destabilising speculation." Now, sort of yes, Martin. But by the same token, is irrevocable - no matter what - euro a good thing? Is it stabilising to know that euro is purely political currency with membership irrespective of economic and financial realities? Is it better for a city to keep town walls shut for doctors in a plague?

Myth 2: "A Greek exit would help Greece". Here Wolf is on the money… again, sort of. "Stable money counts for something, particularly in a mismanaged country." Really? Stable money in a mismanaged economy? Is that possible? Ever heard of real effective exchange rates and internal devaluations? So much for 'stable', then. Would it not be more helpful to devalue both across real and nominal margins, rather than force all pain into internal devaluation channel?

Myth 3: "It is Greece’s fault. Nobody was forced to lend to Greece." Yeah, true… sort-ish… No one was forced, but many were incentivised to lend to Greece, including by idiotic EU (and international) risk-weighting rules on sovereign debt. Wolf is right that in 2010, "Rather than agree to the write-off that was needed, governments (and the International Monetary Fund) decided to bail out the private creditors by refinancing Greece. Thus, began the game of “extend and pretend”. Stupid lenders lose money. That has always been the case. It is still the case today." Which is an argument in favour of a default. Perhaps managed default or as I call it - assisted. But default alone won't do much to correct for internal mispricing of risk and real mispricing in the economy. That requires devaluation, so back to Myth 2 above.

Myth 4: "Greece has done nothing." Agree with Wolf here. Greece has done quite a bit. But I am a bit puzzled: "Indeed, one of the tragedies of the impasse over the conditions for support is that the adjustment has happened. Greece does not need additional resources." Really? Oh, ok, then - if Greece does not need additional resources, soldier on, what's the fuss?

Myth 5: "The Greeks will repay" - Agree with Wolf - this is a sunk cost fallacy. "What is open is whether the Greeks will devote the next few decades to repaying a mountain of loans that should never have been made." This is on the money.

Myth 6: "Default entails a Greek exit." Ok, agree again. But I must add here that if we do have default and no exit, then by Myth 1 analysis by Wolf, the euro will be a currency where "Each crisis could trigger destabilising speculation". You can't have a cake and eat it, Martin.


Now, EUObserver on the European salad dressing - sorry, the meetings schedule for resolving Greek crisis. First there was Friday 24th of April as the deadline, now its May 11th summit that is going to be decisive…  Read and laugh - THIS is Europe. ""What are the 70 percent [of the programme] Greece said were acceptable and the 30 percent acceptable? When we have a firm picture of that, we’ll discuss that. But preconditions for having discussions are not there”." All sounding like a dysfunctional family attempting to deal with an unpayable credit card bill amassed by the live-at-home 'prodigal' son… One note, though - this is about meetings to shore up Greece until June. This is NOT about meetings to shore up Greece for 2016-on. In other words, the entire circus is for bridging things through 2015. Thereafter... ah, well, pass the Kool-aid jug, Roger...


Talking of dysfunctional families, one can't avoid the topic of dead-beat parents… And here rolls in the ECB. "ECB to fund Greek banks as long as they stay solvent - Coeure". Coeure is priceless. Apprently, "The European Central Bank will continue to provide liquidity to Greece's banks as long as they remain solvent and have sufficient collateral, ECB Executive Board Member Benoit Coeure" said. Wait, you mean as long as Greek banks continue to have that which they don't have enough of?

"imposing capital controls was "not a working assumption" for the ECB, while speculation about Greece leaving the euro was "out of the question."" But capital controls already ARE a "working" solution, not just an assumption and the ECB is already looking at cutting back Greek banks access to liquidity supports and Constancio did already say that capital controls can be introduced, which is sort of saying that look, Cyprus does exist.

The best bit of Coeure's statement is this: ""In recent days, there has been tangible progress in the quality of the discussions with the three institutions - the ECB, the European Commission and the IMF - which can be built upon," Coeure said." Tangible metrics of quality… only at ECB.

Meanwhile, more news about ECB considering doing what Coeure says they won't do.

May Greek Gods be with Greece today, for the whole Euro area beehive is buzzing with funny stuff… qualitatively and quantitatively "tangibly"...


Meanwhile, some factuals: Greek debt exposures by countries: http://trueeconomics.blogspot.ie/2015/04/19415-greece-in-or-out-ifo-aint-caring.html and across the official sector: http://trueeconomics.blogspot.ie/2015/04/15415-official-sector-exposures-to.html.

22/4/15: Three Strikes of the New Financial Regulation – Part 5: European Banking Union

My latest post on Financial Regulations innovations courtesy of the European Union is now available on @learnsignal blog: http://blog.learnsignal.com/?p=175. This one starts coverage of the European Banking Union.

21/4/15: Greece Heading for the Bust?

With capital controls starting to creep in and with a big peak in debt redemptions looming,  as per chart below, Greece is now entering the last stage of pre-default financial acrobatics.

Source: FT.com

The country bonds yields are now re-tracing previous peaks (more on this here):

Source: @Schuldensuehner 

And as cash transfers from the local governments to the Central Bank (see link above), plus continued depositors flight are blowing an ever widening hole in Greek balance sheets, the ECB is seriously considering to cut substantially Greek banks access to liquidity.  The cut will have to be along the ELA lines (ELA governing rules are available here). Meanwhile, Greek banks' shares are tanking, down some 50% in month and a half.

Here is the end-of-day chart for Greek banks shares index, showing historical low set today

Source: @Schuldensuehner 

and the opening levels for the same:

Source: @ReutersJamie 

All of which has, as a backdrop, pretty ominous (though entirely correct) ECB talk about the options for Greek default.

This is going to be an eventful day or two, folks.

Update 2: Meanwhile in the mondo bizzaro, the ECB is reportedly looking into dual currency regime for Greece. Which sort of makes sense as a transition out of euro area membership, but makes little sense as a tool for retaining Greece in the Euro. Which, in turn, may or may not be an indicator of ECB going the Ifo way. Go figure...

Update 1: A handy chart summing up ECB's 'headache'

Source: @Schuldensuehner 

And as @Schuldensuehner notes: "Grexit costs rise by the minute" as country Target2 liabilities have reached EUR110.4 billion, "mainly driven by ELA for banks".

Source: @Schuldensuehner 

Greek debt exposures by countries: http://trueeconomics.blogspot.ie/2015/04/19415-greece-in-or-out-ifo-aint-caring.html and across the official sector: http://trueeconomics.blogspot.ie/2015/04/15415-official-sector-exposures-to.html.

20/4/15: Greece moves in with public sector capital [cash] controls

And... we have first round of [long-expected] capital controls in Greece: http://www.ft.com/intl/fastft/310542/athens-forces-local-governments-send-cash-central-banks. Per Bloomberg report, this covers term deposits: http://www.bloomberg.com/news/articles/2015-04-20/greece-moves-to-seize-local-government-cash-as-imf-payment-looms.

Which means... capital controls and an impact [of unknown magnitude so far] on capital spending and multi-annual spending lines, let alone on current spending.

Update: in response to some questions on the above, here is my view of risks arising from the above move by the Greek Government:

1. This points to a rather desperate situation in terms of cashflow in Greece. With three payments of maturing debt looming, Greek Government is now clearly and openly signaling lack of cash. As such, this move is a potential precondition to a default, although it is not necessarily a signla of such.
2. Transfer of cash into CB accounts means that the central authorities can have a more direct control over expenditure by the local authorities, which can have a negative impact on payments of current liabilities (e.g. wages, salaries, bonuses, pensions etc) and on some contracts, including capital expenditure and procurement contracts. Non-payments and payments delays to contractors are likely to rise as well.
3. Over longer term, such procedures can have adverse impact on local authorities investment plans.
4. Finally, transfer of cash implies reduction in deposits in the commercial banks which are currently experiencing significant private deposits withdrawals. The net impact is to further destabilise banking sector balance sheets. 

19/4/15: Greece In or Out: Ifo ain't caring much

Ifo Institute calculated euro system-wide losses from Greek default under two scenarios: Greece remains in the Euro and Greece exits the Euro.

In basic terms, there is no difference between the two.

And alongside that, called for the annual settlement of euro system liabilities and higher cost of funding within the central banks system. Which would trigger Greek default literally overnight and probably make Grexit total inevitability. In effect, thus, Ifo - a very influential German think tank - is calling for shutting the lid on Greece, comprehensively, and crystalising losses across the Eurozone and Eurosystem.

19/4/15: Three Strikes of the New Financial Regulation: Part 4 – CMU's Economics

My fourth instalment on the latest policy innovation in Finance in the EU, covering the shaky economics of the Capital Markets Union is available on LearnSignal blog: http://blog.learnsignal.com/?p=173#more-173.

19/4/15: Higher Firm Leverage = Lower Firm Employment (and Output)

In a recent briefing note on the Capital Markets Union (CMU) (here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918), I wrote that the core problem with private investment in the EU is not the lack of integrated or harmonised investment and debt markets, but the overhang of legacy (pre-crisis) debts.

Here is an interesting CEPR paper confirming the link between higher pre-crisis leverage of the firms and their greater propensity to cut back economic activity during the crisis. This one touches upon unemployment, but unemployment here is a proxy for production, which is, of course, a proxy for investment too.

Xavier Giroud, Holger M Mueller paper "Firm Leverage and Unemployment during the Great Recession" (CEPR  DP10539, April 2015, www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10539) argues that "firms’ balance sheets were instrumental in the propagation of shocks during the Great Recession. Using establishment-level data, we show that firms that tightened their debt capacity in the run-up (“high-leverage firms”) exhibit a significantly larger decline in employment in response to household demand shocks than firms that freed up debt capacity (“low-leverage firms”). In fact, all of the job losses associated with falling house prices during the Great Recession are concentrated among establishments of high-leverage firms. At the county level, we find that counties with a larger fraction of establishments belonging to high-leverage firms exhibit a significantly larger decline in employment in response to household demand shocks."

In short, more debt/leverage was accumulated in the run up to the crisis, deeper were the supply cuts during the crisis. Again, nothing that existence of a 'genuine' capital markets union or pumping more credit supply (debt/leverage supply) into the system can correct.

19/4/15: Russian Current Account Surplus 1Q 2015

Preliminary data for Russian balance-of-payments for 1Q 2015 shows current account surplus slipping to USD24 billion down to just over 3% of GDP over the 12 months through 1Q 2015.

Exports fell 30% y/y in USD terms, on foot of c. 50% drop in Urals grade oil prices. Value of non-oil goods exports was down 13% and the value of goods imports was down 36% in USD terms.

Effective real exchange rate for the ruble was down about 25% y/y in 1Q 2015.

19/4/15: The costs of deflations: a historical perspective

An interesting article from the BIS on the impact of deflation risks on growth and post-crises recovery. Authored by Borio, Claudio E. V. and Erdem, Magdalena and Filardo, Andrew J. and Hofmann, Boris, and titled "The Costs of Deflations: A Historical Perspective" (BIS Quarterly Review March 2015: http://ssrn.com/abstract=2580289), the paper looks at the common concern amongst the policymakers that falling prices of goods and services are very costly in terms of economic growth.

The authors "test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt."

But there is much more than this to the paper. So some more colour on the above.

"Concerns about deflation [are] …shaped by the deep-seated view that deflation, regardless of context, is an economic pathology that stands in the way of any sustainable and strong expansion."

Do note that I have been challenging this thesis for some time now, precisely on the grounds of: 1) causality (deflation being caused by weak growth, not the other way around) and 2) link between corporate and household debt and deflation via monetary policy / interest rates channel.

Per authors, "The almost reflexive association of deflation with economic weakness is easily explained. It is rooted in the view that deflation signals an aggregate demand shortfall, which simultaneously pushes down prices, incomes and output. But deflation may also result from increased supply. Examples include improvements in productivity, greater competition in the goods market, or cheaper and more abundant inputs, such as labour or intermediate goods like oil. Supply-driven deflations depress prices while raising incomes and output."

Besides the supply side argument, there is more: "…even if deflation is seen as a cause, rather than a symptom, of economic conditions, its effects are not obvious. On the one hand, deflation can indeed reduce output. Rigid nominal wages may aggravate unemployment. Falling prices raise the real value of debt, undermining borrowers’ balance sheets, both public and private – a prominent concern at present given historically high debt levels. Consumers might delay spending, in anticipation of lower prices. And if interest rates hit the zero lower bound, monetary policy will struggle to encourage spending. On the other hand, deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive."

Note: the authors completely ignore the interest cost channel for debt.

Meanwhile, "…while the impact of goods and services price deflations is ambiguous a priori, that of asset price deflations is not. As is widely recognised, asset price deflations erode wealth and collateral values and so undercut demand and output. Yet the strength of that effect is an empirical matter. One problem in assessing the cost of goods and services price deflations is that they often coincide with asset price deflations. It is possible, therefore, to mistakenly attribute to the former the costs induced by the latter."

The BIS paper analysis is "based on a newly constructed data set that spans more than 140 years, from 1870 to 2013, and covers up to 38 economies. In particular, the data include information on both equity and property prices as well as on debt."

The study reaches three broad conclusions:

• "First, before accounting for the behaviour of asset prices, we find only a weak association between goods and services price deflations and growth; the Great Depression is the main exception."
• "Second, the link with asset price deflations is stronger and, once these are taken into account, it further weakens the association between goods and services price deflations and growth."
• "Finally, we find some evidence that high private debt levels have amplified the impact of property price deflations but we detect no similar link with goods and services price deflations." Note: this means that the ECB-targeted deflation (goods and services deflation) is a completely wrong target to aim for in the presence of private debt overhang. Just as I have been arguing for ages now.

Let's give some more focus to the paper findings on debt-deflation links: "Against the background of record high levels of both public and private debt (Graph 7 below), a key concern about the output costs of goods and services price deflation in the current debate is “debt deflation”, ie the interaction of deflation with debt."

"The idea is that, as prices fall, the real debt burden of borrowers increases, inducing spending cutbacks and possibly defaults. This harks back to Fisher (1933), who coined the term.16 Fisher’s concern was with businesses; today the focus is as strong, if not stronger, on households and the public sector. This type of debt deflation should be distinguished from the strains on balance sheets induced by asset price deflations. This interaction has an even longer intellectual tradition and has been prominent in the public debate ever since the re-emergence of financial instability in the 1980s."

Yep, you got it - the entire monetary policy today is based on the ideas tracing back to the 1930s and anchored in the experience that is only partially replicated today. In effect, we are fighting a new disease with false ancient prescriptions for an entirely different disease.

To assess the link between debt and deflation effects on growth, the authors take two measures into account:

• "One is simply its corresponding debt ratio to GDP." 
• "The other is a measure of “excess debt”, which should, in principle, be more relevant. We use the deviation of credit from its long-term trend, or the “credit gap” – a variable that in previous work has proved quite useful in signalling future financial distress."

Per authors, "The results point to little evidence in support of the debt deflation hypothesis, and suggest a more damaging interaction of debt with asset prices, especially property prices. Focusing on the cumulative growth performance over five year horizons for simplicity, there is no case where the interaction between the goods and services price peaks and debt is significantly negative. By contrast, we find signs that debt makes property price deflations more costly, at least when interacted with the credit gap measure."

So deflation in asset prices (property bust) is bad when household debt is high. Why?

Per study: "…these results suggest that high debt or a period of excessive debt growth has so far not increased in a visible way the costs of goods and services price deflations. Instead, it seems to have added to the strains that property price deflations in particular impose on balance sheets. …Why could the interaction of debt with asset prices matter and that with goods and services prices not matter, or at least less so? A possible explanation has to do with the size and nature of the corresponding wealth effects. For realistic scenarios, the size of the net wealth losses from asset price deflations can be much larger. Consider, for instance, the 2008 crisis in the United States,... the corresponding losses amounted to roughly $9.1 trillion and $11.3 trillion, respectively. By contrast, a hypothetical deflation of, say, 1% per year over three years would imply an increase in the real value of public and private debt of roughly $1.1 trillion (about $0.4 trillion for households and roughly $0.35 trillion each for the non-financial corporate and public sector). Moreover, the nature of the losses is quite different in the two cases. Asset price deflations represent declines in (at least perceived) aggregate net wealth; by contrast, declines in goods and services prices are mainly re-distributional. For instance, in the case of the public sector, the higher debt burden reflects the increase in the real purchasing power of debt holders."

And herein rests a major omission in the study: following asset (property) busts, accommodative monetary policy leads to a reduced cost of debt servicing for households that suffer simultaneous collapse in their nominal incomes and in their net wealth. This accommodation is deflating the cost of debt being carried. If it is accompanied by goods and services price deflation, such deflation is also boosting purchasing power of reduced nominal incomes. In simple terms, there is virtuous cycle emerging: debt servicing deflation reinforces real incomes support from goods and services deflation.

Now, reverse the two: raise rates and simultaneously hike consumer prices. what do you get?

1. Debt servicing costs rise, disposable income left for consumption and investment falls;
2. Inflation in goods and services reduces purchasing power of the already diminished income.

Any idea how this scenario (being pursued by the likes of the ECB) going to help the economy? I have none.

19/4/15: New Evidence: Ambiguity Aversion is the Exception

A fascinating behavioural economics study on ambiguity aversion by Kocher, Martin G. and Lahno, Amrei Marie and Trautmann, Stefan, titled "Ambiguity Aversion is the Exception" (March 31, 2015, CESifo Working Paper Series No. 5261: http://ssrn.com/abstract=2592313) provides empirical testing of ambiguity aversion hypothesis.

Note: my comments within quotes are in bracketed italics

When an agent makes a decision in the presence of uncertainty, "risky prospects with known probabilities are often distinguished from ambiguous prospects with unknown or uncertain probabilities… [in economics literature] it is typically assumed that people dislike ambiguity in addition to a potential dislike of risk, and that they adjust their behavior in favor of known-probability risks, even at significant costs."

In other words, there is a paradoxical pattern in behaviour commonly hypothesised: suppose an agent is facing a choice between a gamble with known probabilities (uncertain, but not ambiguous) that has low expected return and a gamble with unknown (ambiguous) probabilities that has high expected return. In basic terms, ambiguity aversion implies that an agent will tend to opt to select the first choice, even if this choice is sub-optimal, in standard risk aversion setting.

As authors note, "A large literature has studied the consequences of such ambiguity aversion for decision making in the presence of uncertainty. Building on decision theories that assume ambiguity aversion, this literature shows that ambiguity can account for empirically observed violations of expected utility based theories (“anomalies”)."

"These and many other theoretical contributions presume a universally negative attitude toward ambiguity. Such an assumption seems, at first sight, descriptively justified on the basis of a large experimental literature… However, …the predominance of ambiguity aversion in experimental findings might be due to a narrow focus on the domain of moderate likelihood gains… While fear of a bad unknown probability might prevail in this domain [of choices with low or marginal gains], people might be more optimistic in other domains [for example if faced with much greater payoffs or risks, or when choices between strategies are more complex], hoping for ambiguity to offer better odds than a known-risk alternative."

So the authors then set out to look at the evidence for ambiguity aversion "in different likelihood ranges and in the gain domain, the loss domain, and with mixed outcomes, i.e. where both gains and losses may be incurred. …Our between-subjects design with more than 500 experimental participants exposes participants to exactly one of the four domains, reducing any contrast effects that may affect the preferences in the laboratory context."

Core conclusion: "Ambiguity aversion is the exception, not the rule. We replicate the finding of ambiguity aversion for moderate likelihood gains in the classic ...design. However, once we move away from the gain domain or from the [binary] choice to more [complex set of choices], thus introducing lower likelihoods, we observe either ambiguity neutrality or even ambiguity seeking behavior. These results are robust to the elicitation procedure."

So is ambiguity hypothesis dead? Not really. "Our rejection of universal ambiguity aversion does not generally contradict ambiguity models, but it has important implications for the assumptions in applied models that use ambiguity attitudes to explain real-world phenomena. Theoretical analyses should not only consider the effects of ambiguity aversion, but also potential implications of ambiguity loving for economics and finance, particularly in contexts that involve rare events or perceived losses such as with insurance or investments. Policy implications should always be fine-tuned to the specific domain, because policy interventions based on wrong assumptions regarding the ambiguity attitudes of those targeted by the policy could be detrimental."

18/4/15: Escaping the Middle Income Trap: Historical Evidence and China's Chances

A very interesting paper from the Asian Development Bank Institute on the topic of the middle income trap (see below) and the debate as to whether China can escape one.

Full paper is available here: http://ssrn.com/abstract=2590289.

In basic terms, when the economy starts at lower income levels, this usually involves increasing productivity in agriculture - often a dominant sector in a lower income economy - which frees surplus labour and makes it available to industrial activities and services. As manufacturing and industrialisation rise, the economy moves into middle income category.

When surplus labour from agriculture moves into manufacturing, its productivity is low, so naturally, the emerging middle income economies are focused on low wage, low productivity and low value-added manufacturing. As income rises toward middle-income levels, wages also rise. In order to continue growing, the economy requires either to increase quantity of inputs (capital and labour) - a pattern of development known as extensive margin, or it needs to increase quality of its economy activity, raise the value added by workers and capital used - a pattern of development known as the intensive margin.

The problem is that for an economy with relatively fixed (in the short run) workforce, attempting to continue growing on the extensive margin is simply impossible. Instead, the economy needs to switch - at some point - toward producing better quality and higher value-added output.

As the authors remind us, this "requires a shift in the types of products that it makes (shirts to computers), in the value or sophistication of those goods (low quality shoes to designer shoes), and/or in the value-added contribution to end products (electronics assembly to chip manufacturing)… These shifts require increases in the sophistication of technology, an educated workforce, and changes in work organization and motivation."


The authors thus investigate "the situation of middle-income economies around the world. Since 1965, only 18 economies with a population of more than 3 million and not dependent on oil exports have made the transition to being high income. Many more have not been able to move beyond the middle-income stage." In simple terms, the authors confirm existence of a significant middle income trap.

By testing "differences between two groups of economies across a range of growth and development variables", the authors find that "middle-income economies are particularly weak in the following areas: governance, infrastructure, savings and investment, inequality, and quality — but not quantity — of education." In other words, to shift from extensive margin growth to intensive margin growth you need serious institutional, communications and social capital.

With this in mind, the authors then turn to China. "While the size of its economy is large, the PRC is still a developing country with a modest per capita income. Only in the late 1990s did it graduate from low- to middle-income status. As it continues to expand, increasing attention is now focused on whether it will become a high-income country like several of its neighbors in Northeast Asia or, instead, whether it will suffer the fate of Latin America and
Southeast Asia by remaining at the middle-income level of development for decades."

Interestingly, the authors find that China "…already has many of the characteristics of a high income country, the key exceptions being governance and possibly inequality." The best way to look at the paper results relating to China is presented in Table 23, where the authors "developed a ranking system based on the medians" for all the drivers that were found to be significant in helping countries escape the middle income trap. "For each
variable, the economy received three points for being above the median, two points for
being below the median but above the median of the median, and one point for being
below the median of the median. The results were summed and divided by the number
of variables for which there were data for each economy."

The result is below (partial table)

The core conclusion is that China does indeed appear to rank well in terms of key drivers necessary for escaping the middle income trap. Should it continue gaining in the near future in terms of all these factors at the same rate as it has been gaining in the past, China will join the club of the rich nations, not only because of the scale of its economy and population, but also because of the average or median per capita incomes.

18/4/15: Fitch Postpones Russian Ratings Review on Improved Data

As noted yesterday, both Fitch and S&P came out with (well, sort of came out in Fitch case) updated ratings for Russia. I covered S&P ratings here: http://trueeconomics.blogspot.ie/2015/04/17415-conservative-to-surprising-degree.html

Now onto Fitch.

According to the Russian Finance Minister, Anton Siluanov, Fitch postponed formal ratings review and held Russian ratings at BBB- - just a notch above junk grade. Fitch, thus, retains the only non-junk rating for Russia amongst the Big 3 agencies, with S&P at BB+ and Moody's at Ba1. According to Siluanov, the postponement reflects improved data outlook for the Russian economy.

Fitch was the first of the Big 3 to cut Russia’s rating back on January 9 (see http://www.reuters.com/article/2015/01/09/fitch-downgrades-russia-to-bbb-outlook-n-idUSFit89012120150109). Since then, Russian eurobond issue, maturing 2030 posted a 13 percent plus rise. In part, this reflects firming up of the ruble, and to a larger extent - the unprecedented levels of liquidity flowing into sovereign bonds markets worldwide. But in part, improved yields are also reflective of adjusting expectations concerning Russian economy. For example, alongside their February downgrade, Moody's estimated Russian capital outflows for 205-2016 at USD400 billion and Russian GDP was forecast to fall by 8.5%. Current consensus in the markets is that outflows will be closer to USD150-170 billion (on expected debt maturities) and the economy is likely to contract by closer to 4-4.5%.

Capital outflows figures stabilisation has been rather significant, especially given the level of debt redemptions in 1Q 2015 (see here: http://trueeconomics.blogspot.ie/2015/04/14415-russian-external-debt-redemptions.html). In 1Q 2015, estimated outflows totalled just USD32.6 billion, compared to USD77.4 billion in 4Q 2014 and with USD48 billion outflows in 1Q 2014. While banks continued to deleverage, non-financial sector was able to roll over much of maturing debt and were repatriating assets into Russia. The net result was inflow of forex into the Ruble market.

Deleveraging in the Russian economy is going at a breakneck pace: in mid-2014 Russian external debt (over 90% accounted for by private sector) stood at just over USD730 billion. By the end of 1Q 2015 estimated external debt has fallen to USD560 billion, implying net debt reductions of USD170 billion over the span of 9 months, well above my earlier estimate of net repayment of USD96.5 billion that excluded Ruble devaluation effects. The USD170 billion estimate includes devaluation of the Ruble and roll-overs when these involved conversion from forex-denominated inter-company loans and equity into Ruble-denominated ones. It is worth remembering that roughly 1/4 of Russian external debt is denominated in Rubles.

When it comes to sovereign ratings, it is also worth remembering that Russian public sector external liabilities amount to less than 10 percent of the total external debt.

Overall, Fitch decision to hold Russian ratings under review is a reflection of the recent improvements in the economic outlook, but also the fragile and early nature of these. As I noted on numerous occasions before, the situation is fragile and the risks to the downside are prominent, so Fitch's more cautious approach to ratings is probably better justified by the current environment.