14/11/2014: Russia Risks Up, but No Panic, yet

Euromoney Country Risk published an interesting analysis of the country risk scores for Russia. Here are some of the highlights (link up once Euromoney produce undated note).


"As sanctions and falling oil prices force the rouble’s slide, country risk experts are questioning the ability of privately owned and/or state backed
banks and corporates to obtain credit and repay their debts amid capital flight and an economy in decline Russia’s country risk score has fallen precipitously this year, in tandem with Ukraine."

The beef is in the details: "An 8.3 point correction since 2013, to 46.2 points out of a maximum 100 available, has sent the sovereign careering 17 places down ECR’s global rankings to 71st out of 189 countries worldwide. That marks a lower score compared with 2008, indeed the lowest since Russia defaulted in 1998, with the sovereign slipping into the fourth of ECR’s five tiered groups commensurate with a B to BB+ credit rating, signalling its triple-B credit ratings are overdue a downgrade."

Per ECR: "Russia’s plight is understandable. Oil prices have come off their peak since June, falling more than $30 per barrel to $81, as of Thursday."

You bet. Here's the updated chart:

As I noted before, oil price leads Ruble, not the other way around. And also note volatility in recent days - as predicted here: http://trueeconomics.blogspot.ie/2014/11/7112014-russian-ruble-rough-days-ahead.html

Back to ECR analysis: "With sanctions causing an estimated $130 billion of capital outflow this year, according to the central bank, the rouble has plunged to $46/$, depreciating by 42% since the end of 2013 and forcing an abandonment of its target corridor in favour of a (virtual) free float absorbing the shock and preventing forex decline."

The point worth mentioning here is that capital outflows recorded are official flows, which include:

1. Repayment of maturing debts by Russian banks and corporates (which is now becoming a serious issue, given the state of debt markets in the wake of the sanctions); and
2. Forex positions taken by households and corporates, even when deposits are held inside the country.
3. In addition, capital outflows reflect exits by financial investment funds, which are not having a direct impact on the economy in the short run, but can have adverse impact on corporate funding and investment forward over the longer term.

For the repayments schedule, see here: http://trueeconomics.blogspot.ie/2014/11/11112014-another-wild-ride-for.html

Experts opinion

"Russia’s FX reserves totalled $429 billion as of end-October, down from $524 billion the year before. The true total is a little lower due to adjustments for the reduced valuation of gold reserves and changes in official agency reserves."

Note, I wrote about the latest foreign reserves position figures here: http://trueeconomics.blogspot.ie/2014/11/11112014-another-wild-ride-for.html these stood at USD416.23 billion at the end of October, excluding IMF-held funds, SDRs, and covering only gold and foreign exchange.

Danske Bank analysts "believe the $50 billion FX repo facility is “reasonable
enough to cover the most urgent needs of Russian corporations regarding their external debt repayments” through to 2016. Some banks, after all, have surplus liquidity that can be redistributed to those in need, and the central bank’s forex stockpile is sufficient to imbue some confidence in averting a crisis."

Kaan Nazli, senior economist at Neuberger Berman "expects a turnaround next year “due to the currency devaluation effect, and as private sector debts are
paid down with refinancing options limited by the sanctions.”

My own comment quoted in ECR note is as follows: I do "not believe a sovereign or even selective (large scale) private sector defaults are likely in the short term in spite of some talk of difficulties. “Such an event is not in the interest of the Russian authorities and can be prevented by using the existent foreign exchange reserves cushion,” he says. However, if oil prices remain low for a prolonged period and, simultaneously, Russian companies’ and banks’ access to foreign funding is severely curtailed, “we are likely to see a significant uplift in sovereign and banks’ credit risk”, he adds."


My 'wider angle' view to add to the above comment is as follows:

In my opinion, Russian Ruble dynamics vis-a-vis the USD and EUR are underlining the overall structural and geopolitical pressures on the Russian economy.

Amongst the structural factors, the largest weight can be assigned to the developing risks to economic growth, that have been at play since H2 2012 and H1 2013.

However, additional pressures are now being presented by the geopolitical factors, namely the crisis in Ukraine and the related sanctions on Russian companies and banks, including the indirect effects of these sanctions.

Decline in the oil prices - triggered in part by the sluggish global demand, and in part by the geopolitical decisions of the Gulf countries to withdraw supply-side support for oil - a having a significant short term impact on Russian exports revenues and are driving down Ruble valuations. Financial sector sanctions have de facto cut off all Russian companies and banks (including those not explicitly covered by sanctions) from the largest foreign funding markets, triggering high outflows of capital (as Russian companies pay down their maturing foreign currency loans exposures instead of rolling them over). As the result, Russian international reserves have been depleted from USD524.3 billion at the end of October 2013 to USD428.6 billion at the end of October 2014 (although one must take into the account reductions in this figure due to lower valuation of gold reserves and changes in official agencies reserves).

Going forward, changes in the inflationary environment, global and Russian economies dynamics, as well as continued demand for corporate and banks' deleveraging from foreign debt exposures, we can expect more downward momentum in the Ruble valuations and more pressure on the Government fiscal position.

However, devaluation of the Ruble and decline in oil prices do not have a linear one-to-one effect on sustainability of Federal fiscal balance sheet, as Government expenditure is denominate in Rubles, not US dollars or Euro. Furthermore, decline in oil prices is also not translating in one-for-one decline in Russian external balances, as Russian economy is capable of very quick and deep correction in imports demands, as 2009 experience clearly indicates.

As the result, in the short- and medium-term (up to 18-24 months), I do not foresee a significant acceleration in the risk of either a Federal or selective (large scale) private sector defaults. However, if WTI price stays for a prolonged period of time (2+ years) below USD95/barrel and, simultaneously, Russian companies' and banks' access to foreign funding remain severely curtailed, we are likely to see a significant uplift in sovereign and banks' credit risk.

Risk of selective (bank of corporate) default event is harder to asses than sovereign risks, but I do not expect - at this point in time - a large-scale event involving any big Russian corporates. Such an event is not in the interest of the Russian authorities and can be prevented by using the existent foreign exchange reserves cushion. The material risk here is that a number of larger Russian banks and companies, impacted severely by the sanctions, are likely to see dilution of the current shareholdings of foreign and domestic investors, as any liquidity support from the Government will likely see issuance of new equity to the state.

13/11/2014: ECB Boldly Going Where It Doesn't Want to Go

ECB is falling way behind its own target for liquidity injections into the economy. Frankfurt has managed to shrink, not expand, its balance sheet last week, down EUR22.3 billion to EUR2.030 trillion which is roughly EUR970 billion short of the target.

Remember, ECB has set the target of expanding its balance sheet to EUR3 trillion at the last Governing Council meeting (although the target is 'soft') to bring it in line with 2012 average.

Here's the dynamic of the ECB balance sheet, courtesy of @Schuldensuehner

13/11/2014: Size of Government vs Growth

BCA Research are usually not known for silly charts and comparatives. But yesterday, they did produce a blooper …

As chart above (via BCA) shows, there appears to be a strong linear relationship between higher Government Spending as % of GDP (averaged over 2008-2014) and lower real GDP per capita growth. In fact it is very strong - at 63% explanatory power (as measured by R-Sq).

The problem with the above chart is that

1) There are likely influential outliers in the data - Hong Kong, Korea, Taiwan and Singapore

2) We are not quite certain that a linear relationship is a reasonable one

3) There are questions with the sample range: for example 2008-present is a sample covering the period of higher spending due to crisis (including banks measures, but also automatic stabilisers, such as unemployment insurance etc), and

4) GDP per capita is a better metric than GDP itself, but it disfavours younger economies and older economies (where a greater share of population is not at work due to age, education and training) in contrast to middle-aged economies.

So here is the exercise carrying across longer range of data (2000-2014 averages) and on the basis of actual real GDP.

Chart above shows that positive relationship continues to exist when we switch to a longer period average and base our estimates on real GDP metric, as opposed to GDP per capita. It also shows that the relationship is pretty similar for the measure of Government size either by expenditure or revenues. The former is more subject to change over time due to banks rescue measures, while the latter is more prone to change due to GDP changes.

Crucially, however, the relationship is by far not as strong as in the BCA data: we only get a R-Sq of 34.9% for Government Expenditure and even lower R-Sq of 25.3% for Government Revenue relationship to real GDP growth. 

Also note, I run analysis for logarithmic and cubic relationships and these confirm the above R-Sq readings, suggesting that a linear relationship is a reasonably good approximation to reality.

However, we still have the potential problem of outliers in the above. Which appear to be the same ones as in BCA case. So I take 1.5 sigma weight to the mean for each data set and remove all observations that fall outside 1.5 sigma range. This removes 4 countries altogether from the set and also removes another 2 countries from the set covering Government Revenue.

Chart above shows just how dramatically the relationships change when we control for influential outliers. Both R-Sq readings collapse to the point of being no longer significant at all. In other words, absent influential outliers, there is no statistically significant relationship between long-term average real GDP growth and Government spending or revenue.

Which strongly suggests that BCA findings are biased to the upside in terms of reported relationship between the size of Government and GDP by:

1) Demographic effects; and

2) Idiosyncratic factors relating to four Asia-Pacific Tiger economies.

Note: I tested the second set of estimated relations for sensitivity to model specification, including non-linear models (log, cubic, quadratic and exponential) and the result stands - there is no statistically significant relationship.

13/11/2014: Irish Banks: In a Bad League of Their Own

Standard & Poor's report published yesterday (link here) offers a dark view on the French banks, arguing that their capitalisation, based on S&P own metric, puts them into a "weaker position against their European and international peers than according to regulatory ratios".

The S&P looked at the rank order of national banking systems, "resulting from the capital measure that Standard & Poor's Ratings Services uses in its ratings analysis, the risk-adjusted capital (RAC) ratio… According to the latest available comparative data on Dec. 31, 2013, the five French banks (the four mentioned above plus Groupe Crédit Mutuel) had an average RAC ratio of 7.0% versus 7.7% for our top 100 rated banks. …The gap between our in-house measure and the regulatory one (the fully loaded ratio) mostly stems from the banks' internal models for credit risk that we view as less stringent on some asset classes than for some peers. It also results from our stricter treatment than under Basel III of French banks' large insurance subsidiaries."

So in basic terms, S&P used higher quality test of capital buffers. And here are the results for the select sample of European banking systems:

One thing is clear from the above: Ireland's banking system is faring the worst - by a mile - in the sample. In fact, by S&P measure, it is in the league of its own.

13/11/2014: There is a Household Income Crisis Out There

Irish League of Credit Unions have published their Q4 2014 survey yesterday. Some very interesting results overall (see full release here: http://www.creditunion.ie/communications/news/2014/title,8698,en.php)

• 1.76 million of adults (51% of total adult population in Ireland) have less than EUR100 left in disposable income each month after key bills and taxes are paid. This means that de facto, more than 1/2 of Irish adults have not enough money left every year to cover a mild dental emergency or child's braces.
• 730,000 of working adults in the country (41% of working adult population) have less than EUR100 left at the end of the month. This means that for an average household with 2 working adults, assuming no emergency demands on their funds, a saving of 10% downpayment on an average (nationwide) house will require 9.6 years worth of savings.
• A person aged around 35-40 should be saving around EUR350-400/month to cover pension top up, as well as to provide some cushion for emergencies. Only 632,000 people in the country currently can afford such a 'luxury' - only 21% of our adult population. Of working adults, only 427,000 (24%) can afford reasonable pensions and insurance savings cover.
• 37% of adults in this country cannot afford (regularly) to pay their bills in full every month. This is up on 32% a year ago and up on 31% in August 2014 survey.
• In Q4 2013, 90% of Irish adults said they either occasionally or regularly rinding themselves in a position of not being able to cover their monthly bills. In Q4 2014 survey, this number rose to 92%.
• The survey results largely confirm the trends in household deposits recorded by the Central Bank of Ireland.

12/11/2014: Traders 2.0: Emotionlessly Perfect and Perfectly Inhuman

My blogpost for Learn Signal blog on innovation in trading relating to neuro-finance is available here: http://blog.learnsignal.com/?p=117

11/11/2014: Another Wild Ride for Rollercoaster Ruble

On the first day of its quasi-somewhat-sort-of-free float, Ruble is, as predicted (http://trueeconomics.blogspot.ie/2014/11/7112014-russian-ruble-rough-days-ahead.html) is showing no trend other than the one in rising volatility.

Two charts: one day and five days:

Both: MarketWatch 

It has been a wild ride. The shorts are having their lunch:

 Source: @Schuldensuehner 

Remember, CBR abandoned regular interventions strategy and opted for free float of the Ruble. But the float is not quite free, as CBR said it will instead intervene in limiting supply of foreign currency to trading and debt cover only, removing the so-called speculative positions of Russian banks and corporates.

This will be tough to strategise, since much of the so-called 'capital outflow' (Western terminology) or 'speculative demand' (Russian terminology) is related to debt maturity redemptions. These are hitting Russian economy hard in the wake of virtual shut-down of Western debt markets for all Russian companies and banks (including those not covered by sanctions):

Source: Reuters

Still, something will have to be done. Russia is losing foreign exchange reserves fast:

The latest statistics from the CBR covering October show that, inclusive of gold holdings, the value of Russian foreign exchange reserves fell to USD416.23 billion at the end of October, down USD94.76 billion year on year (-18.5%) and down USD63.93 billion (-13.3%) since the first round of sanctions was introduced. Actual foreign exchange reserves (currency holdings) are down USD96.02 billion year on year to USD370.92 billion.

The only surprising bit - given the rate of reserves depletion - is that Russia still did not introduce direct capital controls, although CBR decision this week is looking increasingly like a veiled control regime.

Note: more detailed comments on the Ruble are forthcoming in Euromoney report and Expresso, so stay tuned for links.

7/11/2014: Russian Ruble: Rough Days Ahead

Things are getting ugly in the Ruble corner today:

First this:

Via @Schuldensuehner

Then a bit of a recovery to this:

Via @Schuldensuehner

And in the longer run, this:

Three points:

1. Ruble is supposed to move to a free float by the end of 2014;
2. Central Bank of Russia abstained from intervening in forex markets between May and the end of September, but it has burned through ca USD68 billion so far this year in total defending the currency with USD22.21 billion of this in October alone (see chart below).
3. Central Bank announced two days ago that it will limit its interventions in the markets going forward to just USD350 million per day maximum cap. The Bank is taking a more 'random walk' approach to interventions, announcing that it will intervene in the markets only sporadically. This increased the uncertainty about Ruble supports. So far, Ruble is down more than 27% y/y to USD.

Remember, weaker Ruble offsets, in part, adverse effects of weaker oil prices on Russian fiscal balances. The bad news - from the exporting countries point of view - is that Russia's imports are becoming less and less affordable, pushing more activity away from European exports and in favour of domestic substitution. 

Per official accounts, CBR has sold USD25.232 billion and EUR 2.159 billion (gross of purchases) in the entire 2013, with major purchases starting in Q2 2013. In contrast in the 10 months of 2014 so far, CBR sold USD66.247 billion and EUR 5.426 billion, gross. Net of purchases, 2013 net sales of USD24.261 billion against 2014 (through October) net sales of USD63.426 billion; and 2013 net sales of EUR2.048 billion against 2014 net sales of EUR5.189 billion.

Overall, we can expect more rough days ahead for the Ruble, but a possible recovery in Q1 2015 once the risk re-pricing takes hold post free float and the effects of USD repricing in the wake of the US Fed policy decisions is complete.

6/11/2014: Population Changes from 1960 Mapped

A really insightful animated mapping of global population changes from 1960 through today: http://russiansphinx.blogspot.ie/2014/11/how-world-has-changed-from-1960.html

6/11/2014: Ifo Survey of Business Climate & Expectations: Euro Area

CES Ifo published their Economic Sentiment Indicators for Euro Area for Q4 2014, showing marked slowdown in the economy on the basis of both current conditions and market expectations 6 months forward.

Here are the details.

Economic Climate Indicator overall has fallen from 118.9 in Q3 2014 to 102.3 in Q4 2014.  This is the lowest reading since Q3 2013 when the index stood at exactly the same level of 102.3.

Present Situation sub-index fell from 128.7 in Q3 2014 to 106.3 in Q4 2014, marking the lowest reading since Q4 2013 when it stood at exactly the same level as in Q4 2014.

Six months forward Expectations sub-index fell from 113.1 in Q3 2014 to 100.0 in Q4 2014, the lowest reading since Q3 2013.

The gap between expectations and present conditions worsened to 94.1 (a reading below 100 means that there is expected deterioration in underlying conditions over the next 6 months compared to current conditions).

The index overall has underestimated the downward momentum in previous quarter.

Chart to illustrate:

As shown above, the European Commission survey of Business Sentiment posted a slight improvement at the end of October, reflected in the Q4 figure to-date. However, we do not have actual projections for full Q4 2014 yet.

6/11/2014: BRIC PMIs: Heading for a Recession...

BRIC PMIs are out for October, signalling sharp drop-off in economic activity across the EMs. Here is the updated data:

Manufacturing:

• Brazil Manufacturing PMIs slipped deeper into contraction territory for the second consecutive month, dropping from 49.3 in September to 49.1 in October. 3mo average is now at 49.5 compared to 3mo average through July at 49.0. Year on year, 3mo average is down 0.7 points.
• Russia Manufacturing PMI slipped from 50.4 in September to 50.3 in October, also signalling a slowdown in growth, but not an outright contraction as in the case of Brazil.
• China Manufacturing PMI improved to 50.4 in October from 50.2 in September. 3mo average through October is now at 50.3, up slightly on 50.0 on 3mo period through July 2014 and almost unchanged on year ago (50.4).
• India Manufacturing PMI improved from 51.0 in September to 51.6 in October, with 3mo average through October at 51.7, slightly below 51.8 3mo average through July. Year on year 3mo average through October is up very strongly 2.4 points (from 49.2 in August-October 2013).

Overall, Manufacturing activity across BRICs remains highly subdued with India being the only country posting a weak, but positive trend from Q2 2013 on.

Services:

• Brazil Services PMIs fell sharply into contraction territory, from 51.2 in September to 48.2 in October. 3mo average is now at 49.5 compared to 3mo average through July at 50.6. Year on year, 3mo average is down 1.4 points. This means both sides of Brazil's economy are now in contraction, first time this happened since August 2013.
• Russia Services PMI contracted sharply from 50.5 in September to 47.4 in October, also posting an outright contraction as in the case of Brazil. 3mo MA is now at 49.4 which is a shallower contraction signal than 48.1 3mo average through July. A year ago, 3mo average was running at 51.9.
• China Services PMI posted a slowdown in growth to 52.9 in October from 53.5 in September. 3mo average through October is now at 53.5, up on 51.3 for the 3mo period through July 2014 and higher than 52.6 reading a year ago.
• India Services PMI deteriorated from 51.6 in September to 50.0 in October, with 3mo average through October at 50.7, below 51.3 3mo average through July. Year on year 3mo average through October is up very strongly (from 46.4 in August-October 2013).

Overall: Services activity deteriorated in all BRIC economies, while Manufacturing performance deteriorated in two economies and improved in 2 other.

Summary of both PMIs changes is here:

Using a simple total of two PMIs, we can trace overall trends in the BRIC economies (without weighting these by lagged services v manufacturing shares). The dynamics are striking:

Overall economic conditions across the BRIC economies deteriorated in October compared to September, with Russia leading with a sharp downturn. Downward trend in the BRIC economies has now been in place since January 2013, with Russian economy leading in this dynamic from October 2012.

Note: you can read more detailed analysis of Russian PMIs here: http://trueeconomics.blogspot.ie/2014/11/6112014-russia-pmis-signalling-poor.html

6/11/2014: Russia PMIs: Signalling a Poor Start to Q4

Russia's PMI indices out for October 2014 signal further deterioration in growth conditions at the start of Q4.

• Manufacturing PMI barely remained above 50.0 line posting a reading of 50.3 in October, down from the already statistically insignificant 50.4 in September. 3mo MA is now at 50.6, still better than 3mo MA through July (49.7) and 3mo MA through October 2013 (50.2), but all of this is down August reading (51.0). The index is trending well below historical average of 51.8. As a reminder, Manufacturing sector has been posting weak PMIs since around March 2013, with sub-50 readings from November 2013 through June 2014.
• Services PMI fell sharply in October to 47.4 (signalling a sharp contraction) from 50.5 in September. 3mo MA through October is now at 49.4, which signals slower decline in output in the sector than 3mo MA through July (48.5), and stands contrasted by the robust expansion in 3mo through October 2013 (51.9). The index is well below the historical average of 55.7.
• Composite PMI has fallen below 50.0 line for the first time after 4 consecutive monthly readings above 50.0. October reading is at 49.1, down from 50.9 in September. 3mo MA is at 50.4 against previous 3mo MA at 49.5 and 52.0 a year ago.

Chart below illustrates:

As sanctions against banks and corporates bite, Russian companies are aggressively deleveraging out of foreign-listed and intermediated debt. This is cutting back investment and lending activities across both Manufacturing and Services sides of the economy. The October figures are not reflective of the aggressive hikes in interest rates passed through by the Central Bank of Russia (+1.5% to 9%), so we can expect even further deterioration in activity in November. It now appears that, as expected, Q4 2014 will post negative growth in the economy.