21/7/15: Eastern Europe's post-2004 Convergence with EU: Unimpressive to-date

EU Commission latest report on real economic convergence in the EU10 Accession states of Eastern and Central Europe (CEE10) sounds like a cheerful reading on successes of the EU and the Euro. The report overall claims significant gains in real economic convergence between the group of less developed economies post-joining the EU and the more advanced economies of the EU.

However, there are some seriously pesky issues arising in the data covered.

Firstly, consider the sources of convergence (growth) over the period 2004-2014.

As chart above shows, in 2004-2008 pre-crisis period, Private Consumption posted significant contributions to growth in all EU10 economies )Central and Eastern European economies of EU12 group). This contribution became negative in 6 out of 10 economies in the period 2009-2014. It fell to zero in 2 out of 10 and was negligibly small in another one. Poland was the only CEE10 economy where over 2009-2014 contribution of personal consumption was positive and significant, albeit it shrunk in magnitude to about 40% of the pre-crisis contribution.

Likewise, Gross Fixed Capital Formation (aka investment) contribution to growth also fell over the 2009-2014 period. In 2004-2008, investment made positive and significant contribution to growth in all CEE10 economies. Over 2009-2014, Investment contribution was negative for 7 out of 10 economies and it was negligible (near zero) for the remaining 3 economies.

Thus, about the only significant factor driving growth in 2009-2014 period was net exports - the factor that does not appear to be associated with investment growth.

As the result, overall growth rates have fallen precipitously across the region in 2009-2014 period compared to 2004-2008 period.

Gross value added across all main sectors of the economy literally collapsed over the 2009-2014 period across all CEE10 economies, with only Poland posting somewhat decent performance in that period compared to 2004-2008.

One thing to note here is that even during the robust growth period of 2004-2008, Agriculture - a significant sector for a number of CEE10 economies was largely insignificant as a driver for gross value added in all but one economy - Hungary, where agricultural activity strength in overall economic activity traces back to the socialist times (1970s reforms).

Market services activity registered robust growth in 2004-2008 across the region predominantly on foot of major expansion of financial services.

Adding farce of a comment to the real injury of the above data, per EU Commission report: "As a result of relatively higher GDP growth rates, CEE10 countries achieved significant real convergence vis-à-vis the EA12 between 2004 and 2014. The CEE10 average GDP per capita level in purchasing power standards (PPS) increased from about 50% of the EA12 level in 2004 to above 58% in 2008. After having declined somewhat in 2009, it increased gradually to some 64% of the EA12 level in 2014." Much of this convergence is really due to the decline in GDP in the rest of the EU, rather than to growth in GDP in the CEE10. Not that the EU Commsision would note as much.

"However, there was a considerable cross-country variation with the pace of convergence in general inversely related to initial income levels. Considering the three most developed CEE10 economies in 2004, Slovenia has not enjoyed any real convergence, while the catch-up was also relatively limited in the Czech Republic and Hungary (as also pointed out by e.g.
Dabrowski (2014)). On the other hand, relative GDP per capita levels in PPS increased by about 20 percentage points in Baltic countries, Poland, Romania and Slovakia. Nevertheless, Bulgaria, which started with the second lowest GDP per capital level in 2004, also only achieved a below-average pace of convergence of some 11 percentage points."

In simple terms, the above means that the core drivers for any convergence would have been down to reputational and capital markets effects of accession, rather than to real investment in future capacity, skills and knowledge. Building roads, using Structural Funds, and getting Western Banks to lend for mortgages seems to be more important in the 'convergence' story than creating new enterprises and investing in real jobs.

As the EU notes: "The rapid pace of economic convergence in the pre-crisis period partly reflected an investment boom. The average share of gross fixed capital formation (GFCF) in the CEE10 increased from below 25% of GDP in 2004 to above 29% of GDP in 2007 and 2008 while it remained below 24% of GDP in the EA12. This investment boom was stimulated by optimistic growth expectations and supported by external funding availability. …Although on average roughly half of GFCF consisted of construction both in the CEE10 and the EA12, housing accounted for only about fourth of construction activity in the CEE10, compared to more than 50% in the EA12. This could be interpreted as overall indicating a more productive investment mix in the CEE10 in the run-up to the 2008/09 global financial crisis." Or it can be interpreted as heavier reliance on EU Structural Funds and Convergence Programmes that pumped money into roads and public infrastructure construction. Which may be productive or may be irrelevant to future capacity, as all of us can see driving on shining new roundabouts in the middle of nowhere, Ireland.

Nonetheless, "The contribution of investment activity to real convergence was not sustained in the post-crisis period. The average share of GFCF in the CEE10 declined to about 22% of GDP in 2010 and then remained broadly stable up to 2014 (while it declined to below 19% of GDP in 2013-14 in the EA12) as growth prospects were reassessed and private funding availability tightened but investment activity in the region was still supported by substantial inflows of EU funds. ...On the other hand, the decline was overall broadbased
across all main asset types in the CEE10 while it was largely driven by a drop in housing
construction in the EA12."

On External Balance side, current account balances turned positive for the CEE10 only in 2013-2014, much of this due to contraction in domestic demand:

Meanwhile, FDI collapsed across all countries, ex-Slovenia (where FDI figure for 2009-2014 is distorted to the upside by banking sector flows). As EU notes: "Although net FDI inflows remained positive in all CEE10 countries they on average amounted to some 2% of GDP in 2009-14 (after having exceeded 5% of GDP in 2004-08)."

All together, the picture of economic convergence is there, but it is more characterised by convergence via financialisation and transfers (both public and private) than by organic growth. This conclusion is equally pronounced before and during the crisis period. Much of the 2004-2008 period convergence was driven by private debt accumulation and 2009-2014 period convergence was primarily driven by adverse growth environment in the rest of the EU, plus public debt accumulation. 

Note: I will be blogging on debt issues in the next post, so stay tuned.

You can access full report here: http://ec.europa.eu/economy_finance/publications/eedp/pdf/dp001_en.pdf.

20/7/15: Of 'Break-Even' Oil Prices & Russia

An interesting chart via Deutsche Bank Research putting break-even (fiscal budget) figures on oil prices for major oil producers:

Which puts Russian break-even at USD105 pbl.

Reality is: Russia has capacity to increase oil output further and has done so already (note that it is now world's largest oil producer). It can also raise some other exports volumes, though general global conditions are not exactly supportive of this. Which underpins revenue side of the budgetary balance somewhat.

Meanwhile, Russian Government own budgetary estimates put break-even price of crude at around USD80-85 pbl, not USD105 pbl, closer to UAE, than to Oman.

Worse, for Deutsche, Russian budget is expressed in rubles, not USD, which means that FX valuation of the Ruble to a basket of currencies (Russian exports are not all priced in USD) co-determines the break-even price. Moderating (albeit still very high) inflation and EUR trend, compared to USD trend, suggest falling 'fiscal break-even' price of oil for Russia.

There are too many variables to attempt to estimate effective and accurate 'break-even' price for oil for Russia.

What is, however, clear is that Russian current account (external balance) is in black and it is improving, not deteriorating. Latest Balance of Payments data shows current account surplus of almost USD20 billion in 2Q 2015. Over 12 months through June 2015, current account surplus is at 4% of GDP. The driver here: decline in imports (down 40% in dollar terms in 2Q 2015 y/y) outpacing drop in exports (down just under 30% y/y). In January-June 2015, trade surplus was USD70 billion (USD210 billion in exports, USD140 billion in imports).

Balance of payments is also being supported to the upside by a decline in capital outflows. 2Q 2015 capital outflows amounted to ca USD20 billion, predominantly comprising banks repayment of maturing foreign debt (remember, this improves banks' balancesheets and deleverages the economy). However, direct investment from abroad into Russian non-fianncial corporations rose over the 2Q 2015, resulting in an increase in foreign debt held by the non-financial sector.

Overall, Russian Central Bank shows foreign debt position at ca USD560 billion (or 30% of GDP) at the end of 2Q 2015 - basically unchanged on 1Q 2015 and down from USD730 billion at the end of 2Q 2014.

And another reminder to fiscalistas:

• Russian public (Government) external debt currently stands at USD35 billion. 
• State-controlled banks hold further USD90 billion in external debt (total banking sector external debt is USD150 billion and 60% of that is held by state-owned banks).
• State-controlled NFCs firms hold ca 40% of USD360 billion foreign debt written against Russian NFCs, or USD144 billion. 
• Accounting for cross-holdings and direct equity-linked debt, net foreign debt that has to be repaid at maturity or refinanced by NFCs and Banks owned by the Russian Government is probably around USD150-160 billion. 

Sizeable, but less than 12% of GDP even after including the official public debt and state-owned enterprises debts.

20/7/15: Greece clears IMF arrears. Almost broke, again.

Having borrowed EUR7.2bn, Greece promptly settled its arrears with the IMF (EUR1.996 billion at exchange rates of June-July, but closer to EUR2.05bn in current rates), opening up the way to pay on maturing EUR3.492 billion ECB and NCBs funds today.

Have a new credit card? Will travel… for now… but only for now, as with today's payments we have less than EUR2 billion credit line remaining available for the country.

Next stop: see here http://graphics.wsj.com/greece-debt-timeline/.

Meanwhile, banks reopening - overhyped on both sides (by the mainstream media as a non-event (re: no mayhem) and by alternative media as a run-waiting-to-happen (re: mayhem)) - came relatively calmly, as banks remain under severe capital controls, limiting withdrawals to EUR420 per person per week. On top of which, checks are cashed only into bank account (no cash); withdrawals abroad and money transfers abroad are not allowed, even on pre-paid cards; limits placed on use of credit and debit cards abroad; no new savings or deposits accounts can be opened; repayments of loans can only be done in line with scheduled payments (no advanced repayments possible except by using cash or transfers from abroad); only unrestricted payments are for tax purposes, social security or bank liabilities payments, plus payments to hospitals and for education.

Any wonder there were no bank runs today? Ah, sure, who would run on an open bank with no cash in it? A taxman?..

But coming back to those bridge finance funds. The EU is now saying the Bailout 3.0 will take 6-8 weeks to agree and structure. There is EUR3.188 billion worth of ECB maturities coming up in 5 weeks, EUR1.344 billion of IMF loans due in September, and EUR3.8 billion worth of short term bonds maturing before 8 weeks runs out. Which begs a question: where will Greece get the money to cover these liabilities?

19/7/15: The Hardships of our Politico's Public Sacrifices: Pensions

One of them rare occasions that RTE supplies a superb data summary. This time around - it is on politicians' pensions packages: http://www.rte.ie/iu/pensions/.

Just take a look how the Great of this Land live... at your expense...

19/7/15: Ireland's Commitment to Competition in Banking... It's Overwhelming...

Let's take three stylised facts:

Fact 1: Irish Government policy from 2010 on consisted of two contradictory objectives: sector consolidation in the hands of 3 Pillar banks, and rhetorical justification of higher lending margins as being necessary to attract new competition to the market.

Fact 2: In recent months, the only significant uplift in new lending to non-financial enterprises took place in the segment of larger corporates, larger loans issuance, consistent with lower risk lending.

Over the last 24 months (though April 2015), compared to 24 months through April 2013, quantum of new loans issued to households in Ireland fell 14.1%, while new loans issued to Non-Financial Corporates rose 31.2%. Within the corporate market segment,  larger (>1 million euro) loans rose 43.6% for loans with short rate fix, and 83.2% for longer rate fix. Smaller corporate loans (<1 12.2="" 44.2="" and="" by="" euro="" fell="" fix.="" fix="" for="" in="" lending="" longer="" million="" nbsp="" new="" p="" rose="" short="" term="" volume="">
Fact 3: In the segment of safest (lowest risk) new lending, Irish banks currently enjoy high margins compared to their euro area counterparts and compared to historical averages for their own market history.

So what is the outcome of the three facts above? Where did we get with this model of higher charges = greater competition when it comes to banking?

Now, remember, Ireland pursued the same model (higher charges on end-users in exchange for more competition) in energy sector under the CER regulatory remit for years. As the result, we achieved the exact opposite: no real competition and highest / second highest energy costs in Europe.

Just as in the energy sector, in Irish banking, the incumbents are enjoying pricing power protected by the State policy. Just as we talk about competition, markets and consumer benefits... Aptly, the degree of market concentration in the hands of incumbent banks in Ireland rose from the average of 0.0547 for 1997-2006 period to 0.0674 for 2009-2014. 

Just because we really, really, really 'want' competition for our banks...

17/7/15: Eurogroup tightens screws on Greece: Bridge v MoU

Eurogroup statement on Greece (h/t @FGoria):

Key:

• Bridge finance via EFSM (as rumoured, so no surprise here);
• Bridge finance security cushion via SMP profits being moved to an escrow account (unexpected) clearly to ensure Denmark's and UK agreement to use EFSM. Bad news: SMP profits should be rebated back to Greece to alleviate debt burden, not 'securitised' to increase debt burden;
• Good bit - SMP profits are to be returned to Greece unless used as EFSM bridge loan cushion. So at some point in time, Greeks will get these funds to, presumably, cover a part of bridge finance funding;
• The bit "...he risks of not concluding swiftly the negotiations with the ESM remain fully with Greece" (emphasis mine). This amounts to setting pressure very high on Greek Government to basically accept MoU conditions unaltered, as presented to them and, thus, makes the very idea of 'negotiations' a farce. Given that EFSM cover (bridge) is only for July, at most for first week of August, this statement basically puts Greece on notice: either agree immediately to ESM (Bailout 3.0) conditions or face a loss of SMP funds on top of everything else.

In effect, Eurogroup is driving home the tactical advantages gained by over-extending Bridge loan negotiations into the last minute and from Tsipras' total surrender at July 12-13 meetings. Greece has no where to go, but to ESM at this stage, so my suspicion is that MoU will be tougher than Bailout in Principle position of July 12-13.

17/7/15: Brussels makes its excuses and leaves us with no answers

My op-ed for Irish Independent on the EU Commission report on Ireland's 'Adjustment Programme' 2010-2013 and its analysis of the Irish Banking Guarantees: http://www.independent.ie/opinion/comment/brussels-makes-its-excuses-and-leaves-us-with-no-answers-31383508.html.

17/7/15: ECB Rate Decision & Monetary Conditions in the Euro Area

Yesterday, ECB left unchanged their key policy rates. Updating my central banks' policy charts,

First, current policy rates for major advanced economies:

Next: duration and magnitude of rates overshooting (target range set outside mean (pre-crisis period, Euro coverage) +/-1/2 STDEV)

We are now into 80th consecutive month of interest rates statistically outside the mean range, with magnitude of deviation of some 3.05% down on the mean. This implies mean-reversion (increase in the rates) of between 2.70-3.4%.

Meanwhile, 12 mo Euribor margin over policy rates is up to 0.119% in Jul (to-date) compared to 0.113% in June. Corporate rates for new loans (>1mln Euro and 1-5 years duration) margin over ECB rate was up at 2.28% in May compared to 2.03% in April. May was the month when direction of Euribor margin diverged from direction of corporate loans margin, implying increase in banks margins.

Overall, the above shows that pressure on rates reversion to the mean is building up, while banks margins were improving (though we only have data through May on this). Nonetheless, banks margins are down on 2012-2014 averages, implying that more of the costs of any mean reversion in policy rates under current conditions will have to be absorbed by the borrowers.

Good thing, ECB is in no rush to get ahead on rates increases, yet…

16/7/15: Lifting Greek ELA by Eur900mln: Tiny Step, Strong Signaling

So ECB lifted Greek banks' ELA by EUR900mln to EUR89.9 billion today for the first time since June 23rd.

This suggests that Mario Draghi and the team ECB have found a way, for now, to set aside all concerns about Greek banks solvency and extend the lifeline to Greek banks until at least the end of July. The lifeline, however is not sufficient to cover deposits withdrawals that would occur if the Greek government were to lift capital controls.

Going forward - two-three weeks time, the ECB will have to deal with two issues at the same time:

• Increase ELA once again and do it either in small drip format (as today) - sustaining capital controls and possibly even extending these to cover corporate sector - or increase ELA by EUR5-7 billion to cover built up of demand for deposits monetisation and corporates' operational pressures; and
• Addressing the severity of ECB haircuts on Greek banks' collateral eligible for ELA. Here, the problem is severe: even before the mess with capital controls, Greek banks held poor cushion of eligible collateral. With capital controls, this cushion is even weaker as many households and companies have stopped funding their loans. The ECB will have to lower haircuts on collateral and/or broaden collateral pool - both moves would be hard to pass as it is now publicly apparent to all that Greek banks health is deteriorating rapidly. 

So today's moves is a small positive of largely symbolic size. Much work is yet to be done...

16/7/15: Ah Shure, matey, de Banks were Solvent... and Still Are...

You know the meme... "Banks are/were solvent"... It replays itself over and over again, most recently - well, just now - in the Banking Inquiry hearings in Ireland.

Ok, so they are:

Source: http://www.valuewalk.com/2015/03/non-performing-loans-europe/

Yes, that is 4 years after Irish banks were recapitalised, more than 3 years after they passed 'stringent' stress-tests and over 2 years of 'rigourous' work-outs (with 'strict' targets being met) of NPLs.

16/7/15: Thinking of Nama, don't forget them IBRC junior IOUs sale...

Having just posted on Nama's latest basking in the spotlight here, I came across this good old Namawinelake analysis of yet another debacle Nama was a player in: the IBRC junior notes sale.

Yes, that is yet another EUR440 million wasted, burned through, by the exceptionally skilled (otherwise, why would they enjoy such lavish pay) business brains in Nama that are also so concerned for maximising returns to taxpayers?

16/7/15: Nama: The Gift of Giving That Keeps on Giving...

While Greece is limping to its Bailout 3.0, our national heroes at Nama are busy fighting massive (California-sized) forest fires.

The Northern Ireland story (covered on this blog here) is refusing to go away:

1. An academic legal eagle exposition from the U.S. It's in NYTimes, which is on the 'radar' of all our development agencies (the folks that do have Good Minister's ear to whisper into).
2. And Irish News is covering the statement issued by Mr. Ian Coulter, the former managing partner of Belfast law firm Tughans. Sluggerotool.com covers same with extra details. Same covered in the Journal.ie piece here.
3. A good article from the Irish Times on Cerberus (the fund in the middle of Nama's Northern Ireland's case) and its use of Irish companies as vehicles for purchasing some EUR19 billion worth of assets. "Each of the Irish companies owns hundreds of millions, or in some cases billions, of euro in assets but has no employees in Ireland and in some instances, pays no corporation tax here. Cerberus has established at least 10 such companies in Ireland since it started its European property loan shopping spree in 2013, all of which appear to be owned by Promontoria, a Dutch fund that is 100 per cent owned by Cerberus Capital Management." 
4. Another person in the middle of Norther Irish deal - Mr. Frank Cushnahan was, it appears, a 'serial director' in "over 30 companies" according to this article in the Irish Times. Which, obviously, qualified him to advise Nama.
5. Deputy Mick Wallace went on to add to the story, claiming that Nama was aware of the suspicious aspects of transaction in the North, 'since January'. Nama categorically denied this.
6. The UK National Crime Agency will investigate Deputy Wallace's claims.

Meanwhile, back at the foot of this mountain of proverbial... err... at home in Dublin, revelations that our Government appointments to Nama posts could have been... surprise-surprise... political. Who would have thought this much?

There is a documentary trail now to prove that Nama was a party to Government-related discussions about 'fixing' the land market in the Republic. In this, the State's objective of attempting to control the supply of land for development and improve saleability of assets is uncovered and Nama cooperation is identified. Nothing like manipulating the markets as a direct policy objective, folks. We had, of course, back in June this year, Deputy Mick Wallace's allegations that Nama has some unorthodox dealings with the rental sector in Ireland, allegedly "a “cartel” of big property owners had driven up rental costs in Dublin" as “A small group of players now control a large chunk of the rental market in Dublin"... He also said Nama likes to sell properties in big blocks “that only investment funds, vulture funds, mostly from America, have the money to be buying”.

A good old article from Bloomberg archives covering another Nama deal fiasco. The deal was a dodo: Morgan Stanley bought about 220 million pounds of loans to West Properties for "about 65 million pounds ($103 million), or a 70 percent discount". Nama does not sell properties to parties connected to original developers... you know...

And to top it all, we have a new load of revelations from Mick Wallace, TD on further fun-under-the-sun relating to the Holy Grail of Irish Solutions to Irish Problems: the claim made under "Dáil privilege, ... a person in construction who wanted to exit NAMA and was asked to pay €15,000 “in a bag – in cash.”

Wallace also referenced recently the Chicago Spire case (covered earlier here in my compendium of 10 worst deals on Nama's record). A quote: "I would like NAMA to explain its approach when a bidder went to buy not the loans but the debt of the Chicago Spire, which was at $78 million plus costs which brought it to approximately $93 million. An investor sought to buy the debt, and this was every penny that was owed to the bank. This was not the reduced value, but the par value. In other words, this investor was prepared to pay the debt in full but NAMA gave it to Jones Lang LaSalle in New York to sell. This was a site in Chicago. Even if NAMA thought it could get more for it, it was not in New York that it would have got it. It would have been interesting if it had marketed it in Chicago. Why could NAMA not accept the debt being bought out? It is estimated that it was sold for $35 million. NAMA refused $78 million, plus the cost, and it accepted a figure in the region of €35 million. That was claimed to be in the interests of the taxpayer."

It is worth repeating that Nama has denied any wrongdoing in any of the above cases and has now requested that Gardai investigate Deputy Wallace's claims. All other players in the Northern Ireland saga also denied allegations.

Of course, when it comes to Nama asking Gardai to investigate N. Irish deal allegations and denying any knowledge of wrongdoing, without putting their intent and their denial into question, one might recall that Nama is fully aware of another wrongdoing relating to IBRC interest rate overcharging (as detailed and documented here: http://trueeconomics.blogspot.ie/2015/06/11615-full-letter-concerning-ibrc.html). But so far, Nama is in no rush to address the matter it has been notified about some ages ago (see details here: http://trueeconomics.blogspot.ie/2015/06/12615-anglo-overcharging-saga-ganley.html). Lest we forget, NAMA was the biggest buyer of the IBRC loans to which the interest overcharging applied, and, it is alleged (see here: http://trueeconomics.blogspot.ie/2015/06/1062015-bombshell-goes-off-on-anglo.html), this overcharging continued for loans transferred to Nama and still continues, despite the High Court Ruling of October 2014.