3/8/15: IMF on Russian Economy: Debt Sustainability

In the previous post, I covered IMF latest analysis of Russian GDP growth. Here, another key theme from the IMF Article IV report on Russia: fiscal policy sustainability.

In its latest assessment of the Russian economy, IMF has reduced its forecast for General Government deficit for 2015, from -3.69% of GDP back in April 2015 to -3.3% of GDP in the latest report. However, in line with new Budgetary framework, the IMF revised its forecasts for 2016-2020 deficits to show poorer fiscal performance:

In line with worsening deficits from 2016 on, IMF is also projecting higher government debt (gross debt, inclusive of state guarantees):

Still, the IMF appears to be quite happy with the overall debt and fiscal sustainability over the short run and is taking a view that over the next 2-3 years, fiscal policy must provide some upside supports to investment.

One of the reasons for this is that IMF sees continued strong buffers on fiscal reserves side into 2020, with Gross international reserves of USD362.4 billion and 374.8 billion in 2015-2016 amounting to 13.6 months of imports and providing cover for 496% and 281% of short term debt, respectively.

Furthermore, IMF expects debt levels to remain benign, both in terms of Government debt and Private sector debt as the chart above shows.

Note: I will cover Private Sector Debt developments in a separate post, so stay tuned.

Overall, 

1) External debt situation remains positive and is improving in the sector with weaker performance (corporate sector):

Note: above figures do not net out debt written to Russian banks and corporates by their parent and subsidiary entities located outside Russia, as well as direct investment / equity -linked debt.

2) "...no sector shows maturity risk with short-term assets exceeding short-term debt in aggregate"

3) Fiscal stance appears to be expansionary, but moderate, with deficits below 4% of GDP forecast for the worst performance year of 2016.

4) "Exchange rate and liquidity risks are mitigated by the CBR's large reserve level"

Stay tuned for more analysis, including debt positions across various sectors.

27/7/15: IMF Euro Area Report: The Darker Skies of Risks

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang, while the second post presented IMF views and data on the euro area banking sector woes. The third post covered IMF projections for growth.

So let's take a look at the risks to the IMF's 'growth returns to Euro zone' scenario.


Per IMF: "Risks are now more balanced than in recent years when vulnerabilities dominated. On the upside, low oil prices, QE, a weaker euro, and rising confidence could bring larger than anticipated benefits. Downside risks include lingering weakness and low inflation, a potential
slowdown in emerging markets, geopolitical tensions, and financial market volatility, whether due to asymmetric monetary policies or contagion from events in Greece."

Now, let me translate this into human language:

1) Eurozone has no real drivers for current growth uptick (which is weak to begin with). Instead, all it got to brag about are: QE (extraordinary monetary policies); QE-induced weaker euro (beggar thy neighbours trade policies), some rising confidence (hopping mad global asset markets bidding everything up on foot of global QEs - extraordinary policies); and lastly - lower oil prices (that sign of global economy on a downward slide). Congratulations to all - hard work and enterprising are not required for this sort of growth.

2) Eurozone's abysmal growth is at a risk from:

• 'lingering weakness' (aka structural non-reforms that Europe worked so hard to achieve since 2008, we are all in tears… so lots of sweat, not much of gain here) and 
• 'low inflation' (a euphemism for consumers and investors on strike in this promised Land of Plenty); and 
• 'potential slowdown in emerging markets' (that thingy that makes oil cheaper - take you pick, Euro area: get crushed by higher oil prices in presence of EMs growth or get squeezed by lack of EMs growth in presence of low oil prices), 
• 'geopolitical tensions' (aka: Russkies not playing the ball with Good Europeans by refusing to buy their apples), and 
• 'financial market volatility' (wait: what on earth have we been doing since 2007 other than fight the said financial markets volatility? Looks like lots of successes here, if the said volatility is still a risk), 'whether due to asymmetric monetary policies' (in other words, if the Fed hikes rates too early too fast) or 'contagion from events in Greece' (would that be the same Greece that has been ring fenced and repaired? most recently this month?).

You have to wonder: IMF effectively says all risks that were in the euro area in ca 2011 are still in the euro area in ca 2015…

Now, recall that some time ago I said that the next step for Europe will be a fiscal / political union with less democracy for all and more technocracy for the few? (link here). And IMF does not disappoint on this too.

"Beyond the near term, there should be a concerted effort to accelerate steps to strengthen the monetary union and European firewalls. Fully severing bank-sovereign links would require a common deposit insurance scheme with a fiscal backstop, a larger and fully funded Single Resolution Fund, and easier access to direct bank recapitalization from the ESM. The greater risk-sharing implied by these measures should be underpinned by a strengthened fiscal and structural governance framework which could require possible Treaty changes. These reforms are desirable in any case, but accelerated progress could help bolster market confidence in the face of recent events."

What have we learned from the above? Why, of course that the frequent claims by the EU officials that Europe now has fully severed contagion links between banks and taxpayers are… err… a lie. And that common claims by the European officials that we now have a genuine monetary union infrastructure is also a lie. And that to make these two claims not to be a lie we will need something/rather that requires 'possible Treaty changes'… which is of course a political and fiscal union. So kiss that national sovereignty and self-determination bye-bye… assuming you still believe such exist in the Euro Land.

Here is full IMF risks assessment matrix:

Now, do some counting: out of 7 key risks, four have either high probability of occurring or bear high impact if they should occur or both.

Now, all of the above still generates a positive outlook under the IMF forecasts - positive, meaning GDP growth over 1.2-1.4 percent, never mind GDP growth anywhere near that of the U.S.

But then the IMF goes slightly gloomier and paints a "Downside Scenario of Stagnation in the Euro Area". Here we are getting some traction with highly probable reality by the highly diplomatic Fund.

"Subdued medium-term prospects leave the euro area susceptible to negative shocks. A modest shock to confidence—for example, from lower expected future growth, or heightened geopolitical tensions—that lowers private investment could affect households via labor income and wealth. Expectations of lower inflation at the zero lower bound would keep real interest rates high. For countries with high public debt, risk premia could rise, amplifying the shock and raising the risk of a debt-deflation spiral. Policy space would be limited with short-term interest rates at the zero lower bound and public debt high in countries with large output gaps (Bullard, 2013)."

What the above really means is that, given we are already in the environment of zero policy rates and unprecedented money printing by the ECB, any further shocks will have nothing offsetting them on policy side as

• Monetary policy has fired almost all its bullets already, and
• Fiscal policy has no bullets because of already high levels of debt, whilst
• Currency devaluation policy is not an option in the monetary union dominated by Germany.

Welcome to Hope Street where things can only go as smoothly as today, forever.

"An illustrative downside scenario, assuming lower investment for all euro area countries and increased risk premia for high debt countries, suggests that euro area output could be nearly 2 percent lower by 2020." Guess what: 2020 forecast growth is 1.5% (link here) which means that IMF is saying it will be -0.5% aka another recession.

"The main channels would be through higher real interest rates depressing investment and consumption as well as lower inflation and wage growth constraining adjustment within the euro area." Which means IMF is now fully buying into the Secular Stagnation (Demand Side) scenario I wrote about here.

"The impact would vary across countries with real interest rates higher in countries with weaker balance sheets. Fragmentation progress would reverse and public debt would increase more in high debt countries due to lower fiscal balances and nominal output. “Bad” internal rebalancing would follow, as current accounts in high debt countries would rise due to import compression. Lower inflation would worsen external imbalances, by forcing countries with large output gaps and imbalances to adjust through lower prices and employment."

Yeeeks!

So projections:

Double Yeeeeks!

21/7/15: Central Europe's Lesson: Fixed Euro or Floating Exchange Rates?

The EU report on economic convergence of the Accession States of the Central and Eastern Europe (CEE10) makes for some interesting reading. Having covered two aspects of convergence: real economic performance and financialisation, lets take a look at the exchange rate regime impact on convergence.

This is an interesting aspect of the CEE10 performance because it allows us to consider medium-term impact of euro on CEE10. 

Basically there were two regimes operating in the CEE10 vis-a-vis the euro: fixed regime (with national currency pegged to the euro) or floating regime (with national currency allowed to float against the euro).

First, recall, that "out of the five CEE10 countries which have adopted the euro by 2015, four (i.e. Estonia, Latvia, Lithuania and Slovenia) already operated under fixed exchange rate regimes in 2004. In their case, euro adoption did not represent an essential regime change with respect to the role of nominal exchange rate flexibility in the convergence process vis-à-vis the EA12." 

Now, EU Commission would be slightly cheeky in making this statement, since while in the first order effect this is true, in the second order effect (expectations), this is not true - a peg to the euro could have been abandoned in a severe crisis, albeit less easily under the regime of ongoing financialisation of the CEE10 economies via foreign banks lending; however, once euro is adopted, no devaluation is possible even in theory. And this is not a trivial consideration, since policymakers know that should they mess up in the longer run, there will be a risk of peg abandonment, resulting in direct, transparent exposure of their policies-generated imbalances for all to see and in serious embarrassment vis-a-vis their European counterparts. In other words, the threat of devaluation as a feasible option could have actually acted, in part, to make peg regimes more stable.

But let us allow EU Commission their assumption (undefined as such) and chug on...

From EU own analysis: "Based on the GDP per capita in PPS data, there was no significant difference in the speed of real income convergence to the EA12 between fixers and floaters over the past decade, but there was a large degree of heterogeneity within both groups. Rather than the type of exchange rate regime, a more important relationship existed between the speed of catching-up and the initial income level, with less developed countries in general converging at a faster pace. Accordingly, the fastest growing economies were, among the fixers, the three Baltic countries and, among the floaters, Poland and Romania. In addition, Slovakia, which recorded one of the best catching-up performances, floated its currency until euro adoption in 2009 and the bulk of its real convergence over the past decade actually materialised before 2009." 

What does this mean? That nature of growth during the period was similar for floating and fixed regimes: both were driven by catching-up of economies, most notably via capital investment. Being fixed to the euro or not, it appears, had no effect on rates of convergence.

But, remember, euro is about stability, not growth. So the key test, really, is in volatility of convergence path, not the path itself. Per EU Commission: "The real convergence path of floaters was in general smoother than that of fixers. This was mainly due to the more pronounced economic overheating in the latter group prior to 2008, which then also led to a larger set back during the financial crisis." Oops… so staying closer to euro hurts. Having fixed rates, hurts. Bubbles got worse in countries with pegged rates. That is not exactly an endorsement of the euro-led regimes.

There's a caveat: "Nevertheless, fixers were able to again largely close their GDP-gap to floaters by 2012, as they enjoyed an export-led recovery, supported by internal price adjustment, structural reforms and favourable export market developments." Yep, that's right: austerity and re-shifting of economy toward external sectors, rather than domestic demand is the miracle that allowed for the fixed rates regimes convergence. That, plus unmentioned, monetary policy activism. 

Still, the view of boom-to-bust euro-driven economy for the fixed rates regime remains. Not that the EU Commission will acknowledge as much.

"The extent of price level convergence over the last decade mainly reflected differences in the speed of catching-up. That said, the average household consumption price level of fixers remained close to that of floaters until 2008, but it became significantly higher in the post-crisis period, as comparative prices of floaters fell." In normal English: deflation hit fixers, while floaters avoided it. 

Core conclusion (despite numerous caveats): "Floaters appear to have been in general able to benefit from their monetary autonomy to achieve a higher degree of price stability. In the pre-crisis period, faster growth and related overheating gradually drove up inflation in fixers significantly above the average inflation rate of floaters. Subsequently, larger output drops and the inability to depreciate against the euro implied that fixers generally also experienced more pronounced disinflation. From late-2010, inflation in the two groups developed quite similarly on average, but the variance was higher among floaters."

So final note on interest rates. Remember - convergence of rates irrespective of risk is one of the poor outcomes of the euro introduction in the EA12, fuelling massive asset bubbles in Spain and Ireland, fiscal imbalances in Greece and so on. In CEE10: "Over the past decade the benchmark long-term interest rate on government bonds was higher on average for floaters than for fixers, both nominally and in real terms. This is partly a consequence of the higher average public debt level among the floaters, but to some extent it is arguably also related to more exchange rate uncertainty inherent in floating." 

EU Commission grumbling acceptance of reality is almost entertaining: "Generally, it takes longer to regain cost competitiveness via internal price adjustment [something that fixed rates economies are forced to do] than via nominal exchange rate depreciation [something that flexible rate economies have access to] and the initial shock to the real economy is more severe. However, the internal adjustment is more permanent as it requires a structural solution to the underlying problems, whereas the temporary boost generated by nominal exchange rate depreciation can actually postpone the reforms necessary for further sustained catching-up." You'd think that flexible exchange rate economies just can't ever compete with fixed rates economies. In which case we obviously have a paradox: Denmark and Switzerland vs Italy and Spain (or for that matter Belgium and France).

So the core conclusion is simply this: things are complex, but having a peg to the euro looks more dangerous in crises and in bubbles build up stages, than running flexible exchange rates regime. Who would have guessed?..

21/7/15: Eastern Europe's post-2004 Convergence with EU: Financialisation

In the previous post, I covered the EU's latest report on real economic convergence in Central & Eastern European (CEE10) Accession states. As promised, here is a look at the last remaining core driver of this 'fabled' convergence: the financial services sector (which drove the largest contribution to growth in pre-crisis period 2004-2008 and remained significant since).

In summary: debt is the currency of CEE10 convergence.

Let's start with Public Debt.

As the above shows, CEE10 debt rose during the crisis despite GDP uptick. Rate of growth in debt was slower in CEE10 than in the original euro area states (EA12), which was consistent with stronger CEE10 performance in terms of fiscal balances and lower incidence / impact of banking crises.

Scary bit: "The negative impact of the 2008/09 global financial crisis as well as the following euro-area sovereign debt crisis on financial conditions in the CEE10 revealed that, despite relatively lower general government debt levels (compared to the EA12 average), some CEE10 countries might still encounter problems to (re-)finance their public sector borrowing needs during periods of heightened financial market tensions as their domestic bond markets are in general smaller and less liquid".

And that is despite a major decline in long-term interest rates experienced across the region:

In addition, Gross External Debt has been rising in all CEE10 economies between 2004 and 2014, peaking in 2009:

Which brings us to private sector financialisation. Per EU: "CEE10 countries entered the EU with relatively underdeveloped financial sectors, at least in terms of their relative size compared to the EA12. This was the case for both market-based and banking-sector-intermediated sources of funding. In 2004, the outstanding stocks of quoted shares and debt securities amounted on average to just about 20% and 30% of CEE10 GDP, compared to around 50% and 120% of GDP in the EA12. Similarly, bank lending to non-financial sectors accounted for just some 35% of CEE10 GDP whereas it reached almost 100% of GDP in the EA12."

It is worth, thus, noting that equity and direct debt financialisation relative to bank debt financialisation, at the start of 'convergence' was healthier in the CEE10 than in the euro area EA12.

Predictably, this changed. "As the government sector accounted for the majority of debt security issuance in the CEE10, bank credit represented the main external funding source for the non-financial private sector."

"The CEE10 banking sectors have generally been characterised by a relatively high share of
foreign ownership as well as high levels of concentration. The share of foreign-owned banks and the market share of the five largest banks (CR5) in CEE10 countries remained relatively stable over the last 10 years, on average exceeding 60%. There was however some cross-country divergence as Slovenia stood out with a relatively low share of foreign-owned banks, which only increased to above 30% in 2013. At the same time, the Estonian and Lithuanian banking sectors exhibited the highest levels of concentration, with their respective CR5 averaging 94% and 82% over 2004-14. On the other hand, the role played by foreign-owned banks is rather limited in most EA12 countries while their banking sectors are in general also somewhat less concentrated, with their CR5 averaging around 55% over the last 10 years."

Which, basically, means that the lending boom pre-crisis is accounted for, substantially, by the carry trades via foreign banks: the EA12 banks had another property & construction boom of their own in CEE10 as they did in the likes of Ireland and Spain.

"The 2008/09 global financial crisis …proved to be a structural break in the overall evolution of bank lending to the non-financial private sector in the CEE10. As the pace of credit growth in the pre-crisis period was clearly excessive and unsustainable, a post-crisis correction was natural and unavoidable. However, credit to the NFPS increased by "only" some 13% between May 2009 and May 2014, with bank lending to the nonfinancial corporate sector basically stagnating while lending to the household sector expanded by
about 25%."

Shares of Non-Performing Loans rose quite dramatically, exceeding the already significant rate of growth in these in EA12 across 6 out of 10 CEE10 states.

The following chart shows two periods of financialisation: period prior to crisis, when financial activity vastly exceeded real economic performance dynamics; and post-crisis period where financial activity is acting as a small drag on real economic performance. This is try for both the CEE10 and EA12 economies, but is more pronounced for the former than for the latter:

In summary, therefore, a large share of 'real convergence' in the CEE10 economies over 2004-2014 period can be explained by increased financialisation of their economies, especially via bank lending channel. As the result, much of pre-crisis convergence is directly linked to unsustainable boom cycle in investment (including construction) funded by a combination of bank debt (carry trades from Euro area and Swiss Franc) plus EU subsidies. These sources of growth are currently suppressed by long-term issues, such as high NPLs and structural rebalancing in the banking sector.

The tale of 'convergence' is of little substance and a hell of a lot of froth… 

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.

14/7/15: IMF Update on Greek Debt Sustainability

Predictably... following yet another leak... the IMF has been forced to publish its update to the 'preliminary' Greek debt sustainability note from early July. Here it is in its full glory or, rather, ugliness: http://www.imf.org/external/pubs/ft/scr/2015/cr15186.pdf?hootPostID=2cd94f17236d717acd9949448d794045.

As discussed in my earlier post here: http://trueeconomics.blogspot.ie/2015/07/14715-brave-new-world-of-imf-debt.html, Greek debt to GDP ratio is now expected to "The financing need through end-2018 is now estimated at Euro 85 billion and debt is expected to peak at close to 200 percent of GDP in the next two years, provided that there is an early agreement on a program."

Which means that "Greece’s debt can now only be made sustainable through debt relief measures that go far beyond what Europe has been willing to consider so far."

Under the current programme (running from November 2012 through March 2016) the IMF projected "debt of 124 percent of GDP by 2020 and “substantially below” 110 percent of GDP by 2022", specifically, the projected debt at 2022 was 105%. Now, the Fund estimates 2022 debt at 142% of GDP.

Furthermore, "Greece cannot return to markets anytime soon at interest rates that it can afford from a medium-term perspective."

Worse, on the current path "Gross financing needs would rise to levels well above what they were at the last review (and above the 15 percent of GDP threshold deemed safe) and continue rising in the long term."

And IMF pours cold water over its own dream-a-little target of 3.5% primary surpluses for Greece. "Greece is expected to maintain primary surpluses for the next several decades of 3.5 percent of GDP. Few countries have managed to do so." Note the word decades! Now, IMF rejoins Planet Reality raising "doubts about the assumption that such targets can be sustained for prolonged periods."

In short - as I said earlier, politics not economics drive Eurogroup decision making on Greece. The IMF is now facing a stark choice: either engage with the euro area leadership in structuring writedowns (potentially also extending maturities of its own loans to Greece) or walk away from the Troika set up (and still extend maturities on its own loans to Greece).

Little compassion for the Fund, though - they made this bed themselves. Now's time to sleep in it...

5/7/15: Votes are in... What's next for Greece?

With over 75% of votes counted in the Greek referendum, 61.6% of the votes counted are in favour of 'No'.

So what's next? Or rather, what can [we speculate] the 'next' might be?

Possible outcome: Grexit

• This can take place either as a part of an agreement between Greece and Institutions (unlikely, but structurally less painful, and accompanied by debt writedowns, a default or both), or
• It can take place 'uncooperatively' - with Greece simply monetising itself using new currency (more likely than cooperative Grexit, highly disruptive to all parties involved and accompanied, most likely, by a unilateral/disorderly default on ECB debt, IMF debt, EFSF debt and Samurai debt. Short term default on T-bills also possible).

Either form of Grexit will be painful, disruptive and nasty, with any positive outcome heavily conditional on post-Grexit policies (in other words, major reforms). The latter is highly unlikely with present Government in place and in general, given Greek modern history.

Grexit - especially disorderly - would likely follow a collapse of the early efforts to get the EU and Greece back to the negotiating table. Such a collapse would take place, most likely, under the strain of political pressures on EU players to play intransigence in the wake of what is clearly a very defiant Greek stance toward the EU 'Institutions' of Troika. 

Key to avoiding a disorderly / unilateral Grexit will be the IMF's ability to get European members of the Troika to re-engage. This will be tricky, as IMF very clearly staked its own negotiating corner last week by publicly identifying its red-line position in favour of debt relief and massive loans package restructuring. The EU 'Institutions' are clearly in the different camp here.

EU Institutions will most likely offer the same deal as pre-referendum. Greece will be 'compelled' to accept it by a threat of ELA withdrawal, but, given the size of the Syriza post-referendum mandate, such position will not be acceptable to Greece.  In the short run, ECB can allow ELA lift to facilitate transition to new currency, but such a move would be difficult to structure (ELA mandate is restrictive) and will result in more debt being accumulated by the Greek government that - at the very least - will have to guarantee this increase.

Problem with Grexit, however, is that we have no legal mechanism for this, implying that we might need a host of new measures to be prepared and passed across the EU to effect this.

Which brings us to another scenario: Status Quo

In this scenario - no player moves. We have a temporary stalemate. Greece will be cut off from ELA and within a week will need to monetise itself with new currency. 

Why? Because July 10th there is a T-bill maturing, default on which would trigger a cascade of defaults. Then on July 13th there is another IMF tranche maturing (EUR451 million with interest). Non-payment of either will likely force EFSF to trigger a default clause. Day after, Samurai bonds mature (Yen 20bn) - default here would trigger private sector default. More T-bills come up at July 17th and following that interest on private bonds also comes up on July 19th (EUR225 million). And then we have July 20th - ECB's EUR3.9 billion due, with additional EUR25mln on EIB bonds. Non-payment here will nearly certainly trigger EFSF cross-default.

Most likely scenario here would be parallel currency to cover internal bills due, while using euro reserves and receipts to fund external liabilities. Problem is - as parallel currency enters circulation, receipts in euro will fall off precipitously, leading inevitably to a full Grexit and a massive bail-in of depositors prior to that. Political fallout will be nasty.

Most likely outcome is, therefore, a New Deal

This will suit all parties concerned, but would have been more likely if Greece voted 'Yes' and then crashed the current Government. This is clearly not happening and the mandate for Syriza is now huge. Massive, in fact. 

So there will have to be a climb-down for the EU sides of the Troika. Most likely climb-down will be a short-term bridge loan to Greece (release of IMF tranche is currently impossible) and allowing use of EFSF funds for general debt redemptions purposes. 

The New Deal will also involve climb-down by the Greek government, which will, in my view, be forthcoming shortly after Tuesday, especially if ECB does not loosen ELA noose. 

Bad news is that even if EU side of Troika wants to engage with Greece, such an engagement will probably require approval of German (and others') parliament. Which will require time and can risk breaking up already fragile consensus within the EU. In fact, only consensus building tendency in the wake of today's vote is for a hard stand against Greece. Even in an emergency, EU is very slow to act on developing new 'bailouts' - in Cypriot case it took almost a year to get a deal going. For Portugal - almost 1.5 months. Urgency is on Greek side right now, not EU's, so anyone's guess is as good as mine as to how long it will take for a new deal to emerge.

That said, short-term approach under the status quo scenario above might work, as long as:

1. Greece engages actively, signalling willingness to deal;
2. Greece does not monetise directly via new currency (IOUs will do in the short run); 
3. IMF puts serious pressure on Europe (unlikely); 
4. ECB plays the required tune and keeps ELA going (somewhat likely); and
5. There is no fracturing of the EU consensus (if there is, all bets are off).

In a rather possible scenario, EU does opt for a new deal with Greece, which will likely involve pretty much the same conditions as before, but will rely on removing IMF out of the equation altogether. In this case, EUR28.7 billion odd of Greek debt held by the IMF gets transferred to ESM. The same will apply to ECB's EUR19 billion of Greek debt. The result will be to cut Greek interest costs (carrot), and involve stricter conditionality and cross-default clauses (stick). Euro area 'Institutions' therefore will end up holding ca 73% of all Greek debt in that case. Terms restructuring (maturities extension) can further bring down Greek costs in the short run. 

The negative side of this is that such a restructuring & transfer will be challenged in Germany and Finland, and also possibly in the Netherlands. 

It is. perhaps, feasible, that a new deal can involve conversion of some liabilities held by the euro area institutions into growth-linked bonds (I am surprised this was refused to start with) and/or a direct conditional commitment (written into a new deal) to future writedowns of debt subject to targets on fiscal performance and reforms being met (again, same surprise here). Still, both measures will be opposed by Germany and other 'core' economies. 

Either way, two things are certain: One: there will be pain for Greece and Europe; and Two: there will be lots of uncertainty in coming weeks.

As a reminder of where that pain will fall (outside Greece):
Source: @Schuldensuehner 

12/6/15: Ukraine Debt Haircuts

Important article today in the FT on the issue of write downs on Ukrainian debt: http://www.ft.com/intl/cms/s/0/949628a4-102a-11e5-bd70-00144feabdc0.html#axzz3cg6nwFC9

In my view, the write down should take into the account discounts at which current debt holders have taken their long positions, so that vulture funds and distressed debt speculators take a larger haircut than someone who held debt over longer term and bought it at lower discounts. This will put heavier penalty onto distressed debt speculators and reduce penalty on investors who acquired Ukrainian debt before the crisis started.

Meanwhile, Ukraine's probability of default is climbing. Here are two sources: implied bonds probability of default at >95% and Credit Default Swaps implied probability of default at almost 82%.

Source: @Schuldensuehner

Source: CMA

The latest spike in default probabilities took place following IMF comments (see:  http://www.imf.org/external/np/tr/2015/tr061115.htm) that effectively altered markets expectation as to whether or not the IMF will allow Kiev to default on private debt. It now appears that the IMF has little problem with Kiev using strong-arm tactic of threatening (and enacting) a default on private sector debt. Prior to this week, the understanding was that the IMF will not lend to Ukraine if it goes into a default - a position that allowed private debt holders to argue that their intransigence is supported by the pressure from the IMF on Kiev to conclude a deal. Now, that pressure is gone and IMF seemingly is giving green light to Kiev to default, as long as such a default does not take place after any deal conclusion.

Update: The strategy deployed by IMF in the case of Ukraine - the strategy of actively forcing a default as a credible threat to private sector holders of debt - is not new. It was outlined in this document from 2002 (see page 28 of http://www.imf.org/external/pubs/ft/exrp/sdrm/eng/sdrm.pdf): "There may be a risk that creditors would withhold an extension of the stay in the hope that the IMF would provide more financing or call on the member to make additional adjustment efforts. For example, even in circumstances where the member is implementing good policies and negotiating in good faith, creditors may refuse to extend the period of the stay as a means of persuading the member to turn to the IMF for financing that could enhance the terms of any restructuring. The creditors could threaten to lift the stay to force the debtor to agree to more adjustment than contemplated under the IMF-supported program. Such risks could be reduced, however, by the resolute application of the IMF’s policy of lending into arrears, under which it signals its willingness to continue to support a program, even if the member has interrupted payments to its creditors."

31/5/15: IMF slashes Ukraine Economy Outlook

IMF statement on Ukraine with some pretty ugly forecast revisions.

[Note, emphasis in italics is mine]

"Press Release No. 15/243, May 31, 2015

IMF Statement on Discussions with Ukraine on First Review under the Extended Fund Facility Arrangement

An International Monetary Fund (IMF) mission visited Kyiv during May 12-29 to hold discussions on the first review under the Extended Fund Facility Arrangement (EFF) in support of the authorities’ economic reform program (see Press Release No. 15/107).

At the conclusion of the visit, Mr. Nikolay Gueorguiev, mission chief for Ukraine, made the following statement today in Kyiv:
 ...
“The authorities’ commitment to the reform program remains strong. All performance criteria for end-March were met and all structural benchmarks due in the Spring are on course to be met, albeit some with a delay. This good program implementation has been achieved notwithstanding an exceptionally difficult environment, in part related to the unresolved conflict in the East, which took a heavier than expected toll on the economy in the first quarter of 2015.

Accordingly, the mission has revised down growth projections for 2015 to -9 percent and projects end-year inflation at 46 percent. Inflation was mostly driven by one-off pass-through effects of the large exchange rate depreciation in February as well as the needed energy price increases.

“In recent months, signs that economic stability is gradually taking hold are steadily emerging. The foreign exchange market has remained broadly stable. Gross international reserves, although still very low, have increased to US$9.6 billion at end-April. Banks’ deposits in domestic currency have been recovering. The budget outturn in the first months of 2015 was stronger than expected, partly due to temporary factors.

“The authorities recognize that decisive implementation of economic reforms is indispensable for entrenching financial stability and restoring robust and sustainable growth. They are committed to advancing fiscal consolidation and energy sector reforms, including further energy tariff adjustments to eliminate the large losses of Naftogaz, reduce energy consumption, and foster energy independence. They are also moving ahead with the rehabilitation of the banking system, and the improvement of the business environment to enhance the productive potential of the economy.

“The authorities are also determined to complete the ongoing debt operation in line with program objectives. This will ensure that public debt is sustainable with high probability and the program remains fully financed, which are requirements for the completion of the review. More broadly, continued financial support for Ukraine’s reform efforts from official and private creditors is vital for the success of the program.”

Let's hope IMF optimism wins over the reality, but just two and a half months ago, the IMF projected gross international reserves for 2015 at USD18.3 billion, and now they are celebrating reserves at USD9.6bn. IMF programme sustainability analysis was forecasting real GDP decline of 5.5% in 2015 - not 9% decline the Fund now projects. See: http://www.imf.org/external/pubs/ft/scr/2015/cr1569.pdf for more details.

One has to wonder, just how 'flexible' the Fund became in recent years when it comes to 'hard' numbers underpinning it's 'programme sustainability' arithmetic.

31/5/15: Remittances from Russia Sharply Down in 1Q 2015

Latest Central Bank of Russia data shown decline in private forex outflows in 1Q 2015 as migrants and Russian citizens cut back on transfers abroad. In 1Q 2015, based on CBR data, private money transfers from Russia were down to USD2.1 billion - the lowest level of transfers since 1Q 2010 and down on USD3.9 billion in 1Q 2014 and USD4.3 billion in 4Q 2014. The data covers only cash transfer (wire transfers) and does not include bank transfers. Still, the number is significant for two reasons:

1. In 2014, cash wire transfers amounted to USD21 billion - or nearly 1/3 of total private residents transfers (USD69 billion).
2. Transfers decline signals slowdown in remissions from migrant workers - a major problem for a number of countries net senders of migrants into Russia (see an earlier note on this here: http://trueeconomics.blogspot.ie/2015/01/1312015-remittances-from-russia-big.html).

Transfers outside the CIS zone amounted to USD348 million (down 39% y/y and down 45% q/q), transfers to CIS zone states fell 47% y/y and 51% q/q to USD1.8 billion.

Net transfers deficit was USD1.1 billion in 1Q 2015, down from USD3 billion in 1Q 2014 and 4Q 2014. Reminder: net outflow of capital (corporate and households, plus banks) fell 31% y/y in 1Q 2015 to USD32.6 billion (see earlier notes on this here http://trueeconomics.blogspot.ie/2015/04/18415-fitch-postpones-russian-ratings.html and here: http://trueeconomics.blogspot.ie/2015/04/14415-russian-external-debt-redemptions.html)

Key drivers for slower rate of capital and forex outflows are:

• Ruble devaluation impacting earnings of migrant workers, while Ruble strengthening in 2015 so far reducing demand for forex accounts amongst Russian depositors and improved confidence in Russian banking sector (in part due to doubling of deposits protection levels to RUB1.4 million). Higher deposit rates offered by the Russian banks also helped.
• Decline in real earnings (http://trueeconomics.blogspot.ie/2015/05/30515-russian-demand-down-sharply-in.html)
• External debt redemptions (see earlier links)
• Exporters reducing overall demand for forex deposits

A side note: in 1Q 2015 household deposits in Russina banks rose RUB537 billion (+2.9% y/y to RUB19.6 trillion) in contrast to 1Q 2014 when deposits fell 2.3% (to RUB16.6 trillion). CBR projects deposits rising 8% over 2015 y/y.

Another factor responsible for improved outflows is change in the migration laws. Prior to January 1, 2015, citizens from countries with visa-free entry to Russia were allowed to remain in Russia for 90 days and could re-enter any time after exiting the country. From January 1, the new rules require them to stay maximum 90 days and after exiting the country, remain outside Russia for 90 days before re-entering. It is worth noting that this is identical to similar rules applying to visa holders in many Western countries. As the result, based on Federal Migration Service data, inflow of migrants into Russia fell 70%. One outcome of this is that unemployment levels in Kyrgyzstan, Tajikistan and Uzbekistan - three key net senders of migrants to Russia - jumped, while remittances from Russia to Uzbekistan fell 16% in 2014, and to Tajikistan  by 8%. Third largest net sender of migrants to Russia was Ukraine, with remittance to Ukraine down 27% y/y in 2014.

21/5/15: IMF to Russia: Do What You've Been Doing, Because We Say So

So the IMF released the summary statement on its Article IV 'consultations' for Russia. The stuff reads like something generated by a pre-historic algo with insight of a first order non-stochastic linear equation.

"The Russian economy is in a recession due to lower oil prices and sanctions. In addition, long-term growth remains low given structural bottlenecks." You have to laugh. IMF knows that sanctions are tertiary to Russian recession. Oil prices are primary and structural slowdown that started in late 2012 is secondary.

"The authorities’ macroeconomic policies have helped stabilize the situation, but there remain significant uncertainties regarding oil prices and geopolitical risks. Given these risks, the macroeconomic policy stance must be prudent." In IMF-speak this means that the Russian authorities did an excellent job so far managing the crisis, but they have done it without using IMF 'advice' or 'tool kit'. Which means that, to IMF, they haven't done it as well as the IMF could have done it. Obviously. Really.

So the bad Russkies better deploy the fabled IMF's 'structural reforms' pack:

• Stay low budget deficits (on which they really have no choice and are so far planning to do the same without the IMF 'advice'); 
• Lower central bank rates (which they are already doing without the IMF 'advice'), 
• Provide "limited stimulus" from the fiscal policy side (which, again, they are doing as much as they can). On Central Bank rates: to remind you, on 30 April, the CBR cut its key rate by 150bp to 12.5%. Without IMF's 'help'. I suspect the CBR will move rates below 10% by the end of 2015, unless there is a major reversal in ruble position, or if inflation reverses its (for now very fragile) moderating dynamics (inflation declined from16.9% y/y in March to 16.4% in April)... and… hold it… 
• "Finally, re-invigorating the structural reform agenda and avoiding de-integration from the world economy remain crucial to lift potential growth." Ah, there, IMF said it… 'structural reforms'. 

In other words, IMF is clamouring for some credit in the above. Ex-post the start of Russian adjustments, IMF recommends exactly the same adjustments, so when anyone asks what did IMF do when Russia was clawing its way out of the crisis, the IMF can say: we recommended them.

Of course, another bit that fills one with wonder in the IMF statement is how can Russia 'avoid de-integration from the world economy' any differently than it has been doing to-date?

To recap last 12 months or even last 12 years: Russia initiated a huge whirlwind of 'global integration' projects and activities in Asia Pacific, the Central Asia, India and Latin America. May be these are not quite 'global' enough for the IMF? Or should Russia somehow magic up 're-integration' with the EU? Actually it is trying to do so on a bilateral basis (proposing trade sanctions relaxation with a handful of countries) and tried - unsuccessfully so far - with the EU itself. Did Russia 'de-integrate' itself out of South Stream? Did Russia de-integrate itself from joint energy projects in the Arctic? Did Russia 'de-integrate' itself from the debt and investment markets in Europe? Nope, not them - that was the EU de-integrating Russia. But Russia did continue to de-de-integrate itself in nuclear energy sector, for example, in Hungary and Finland and Turkey and elsewhere...

IMF's generalities aside, the Fund updates some of its point estimates for the Russian economy.

A month ago in its April World Economic Outlook update, IMF forecast Russian economy to shrink 3.83% y/y in 2015 and 1.096% in 2016. Now, one month later, the forecast is for the economy to shrink 3.4% in 2015 (a 0.4 percentage points improvement in one month) and post a "mild recovery" (as in positive growth) in 2016. The Fund 2015-2020 projection in April was for an average rate of growth of 0.096% and 2016-2020 average of 0.9%. This time around, the Fund is expecting a medium-term growth to be 1.5% per annum. Seems like at least someone in the Fund is starting to look at the real dynamics in the economy.

Here's more of what the Fund does get right: "Persistently low oil prices or an increase in geopolitical tensions could further weaken the economic outlook... However, in the near-term, sizeable buffers, including high international reserves, low public debt, and a positive net international investment position should help safeguard external sustainability." Yes, the risks are there. But, the idea that Russia is just going to run out of reserves by the end of this year - often repeated by numerous analysts, including some who should know better - is bonkers, unless something really massively negative happens. Which may happen. Or may not. IMF is of little help on this point estimate.

One interesting bit: "The re-pricing of the FX liquidity facilities was adequate. The central bank could consider limiting further the FX allotments to ensure that the facilities remain sufficient for emergency purposes. The announced program of FX purchases to build precautionary buffers is welcome."

Did you hear that? Yes, Russia is again building up its forex reserves. Not the stuff you normally read in the Western press. Things are short-term, for now, but Russian FX reserves bottomed out in the week of April 17th at USD350.5 billion. Last week, they were at USD362.3 billion. Again, things might change and these increases can be reversed, but when was the last time that you read in the mainstream media that the CBR is now buying dollars and euros rather than selling them?

Russia will need higher reserves. Its economy is being held back by the severe impairment to its companies access to capital markets - reaching well beyond the intended targets of the sanctions. The West, which imposed these sanctions under the explicit stipulation that they were not supposed to hurt ordinary businesses and households, is doing absolutely nothing to rectify the problem.

Meanwhile, gross fixed investment continues contracting: in March down for the 15th consecutive month at -5.3% y/y. Net capital inflows in the non-banking sector totalled USD18 billion in 1Q 2015, second weakest in 12 months period, while total net capital inflows were USD32.6 billion - second highest year-to-date. The IMF is forecasting Russian aggregate investment to drop from 21.6% of GDP in 2013 and 19.9% of GDP in 2014 to 17.6% in 2015, before recovering slightly to 17.9% in 2016. This clearly puts strong emphasis on the need to support investment activity in the economy.

The IMF does note the serious drag on medium term growth exerted by the structural weaknesses in the economy. In line with what many, including myself, have argued before, the IMF puts forward a set of very general 'directional' reforms needed:

• "Less regulation and a reduction of the government’s role in the economy remain crucial to foster efficiency, confidence and investment". It worth noting that the Fund does suggest more and better regulation in the banking sector.
• "…improving protection of property rights" - a perennial problem that can only be resolved over the long run
• "…enhancing customs administration and reducing trade barriers" - a problem that is unlikely to be sorted because the Russian Government is pursuing medium-term growth strategy based on imports substitution - a strategy that, if executed correctly (a big 'if') can be quite productive
• "…empowering the Federal Antimonopoly Service (FAS) to eliminate entry barriers to several sectors/markets" - really a pipe dream at this stage, unfortunately.
• "…to improve labor force dynamics in the face of negative demographic trends, pension reform should be a priority" - which is something that was well underway prior to 2014 crisis, but got derailed by the extreme demand for dollar liquidity in the system triggered by the 2014 crisis.

Can't wait to see the 70-pages-plus full report. At least it promises colourful charts, if not an incisive insight... 

7/5/15: Europe's Non-Performing Loans: Still Rising & Getting More Toxic

In the world of scary stats, there's no place like Europe.

Even the perennial optimists at the IMF - that place where any debt is sustainable as long as there are structural reforms underway - agrees. This is why the IMF published this handy chapter as a part of its Global Financial Stability Report for Q1 2015 (http://www.imf.org/External/Pubs/FT/GFSR/2015/01/pdf/c1.pdf).

In this report it said that [italics are mine]: "Asset quality continued to deteriorate in the euro area as a whole in 2014, although at a slowing pace, with total nonperforming loans now standing at more than €900 billion. Furthermore, the stock of nonperforming loans in the euro area is unevenly distributed, with about two-thirds located in six euro area countries. [The stock of nonperforming loans in Cyprus, Greece, Ireland, Italy, Portugal, and Spain in total amounts to more than €600 billion]. In Cyprus, Greece, Ireland, Italy, Portugal, and Slovenia, a majority, if not all, of the banks involved in the ECB’s Asset Quality Review were found to have nonperforming assets of 10 percent or more of total exposure."

Roll in two super scary charts:

So far so bad… But it gets worse. "These bad assets are large relative to the size of the economy, even net of provisions. Euro area banks have lagged the United States and Japan in the early 2000s in their write-offs of these bad assets, suggesting less active bad debt management and more limited improvement in corporate indebtedness."

And another spooky illustration in order here:

Now, let's sum this up: after 6 years of 'reforms', deleveraging, special bad loans vehicles set ups, extraordinary legislative and regulatory measures aimed at dealing with loans arrears, waves of corporate and household bankruptcies, a minestrone worth of alphabet soups of various 'Unions' etc etc etc…

• Bad debts pile in Euro area is rising;
• Bad debts pile in Euro area is not matching dynamics in other countries, specifically the economic wasteland of Japan; and 
• The best performing country in the group - Ireland - has the second worst performing banking balance sheet in the group (even after Nama and IBRC are netted out).

Clearly, successful resolution of the crisis is at hand.

1/5/15: Good News May Hide Bad News When it Comes to Greece

Greek 5 year CDS (Credit Default Swaps) continued to tighten dramatically today:

Source: CMA
Note: CPD refers to Cumulative Probability of Default (5 years)

Per Bloomberg, this is down to Greek Prime Minister Alexis Tsipras stepping up "efforts to clinch a deal that would unlock financial aid… The ASE Index of stocks jumped the most since September 2012 from a two-year low on April 21. It ended up 6.1 percent in April, the biggest rally in western Europe. Bonds returned 13 percent, while securities in the rest of the region fell. Investors put money into Greek assets in April, betting the rally may have more to go if a default is averted. The nation and its creditors hope to reach a preliminary agreement by Sunday, ahead of a scheduled meeting of euro-area finance ministers on May 11, according to three people familiar with the matter." More on this here: http://www.eubusiness.com/news-eu/greece-debt-imf.10za.

One factor unmentioned is sidelining of Greek Finance Minister in leading the negotiations with the Troika. Another factor is growing discontent within the Greek ruling coalition - a move that increases pressure on Tsipras to get a new deal. My sources in Greece claim there are big disagreements within the Government and main parties. Much of this is focused on hard left's view that Syriza is abandoning its Programme promises. But, as common, much of it also about individual personalities.


Greece is a recurring nightmare - for Europe and for Greece itself.

The country had to be bailed out twice already, borrowing EUR240 billion from the European partners and the IMF. Its Government debt stands at 177% of GDP. The economy is down 25% since 2010 and unemployment rate is at 26%.

It is crunch time for the country:

• European position is that there is no question that Greece is responsible for the mess the economy is in. The problems - with external and fiscal imbalances - started with misguided policies, dishonest accounting and reporting of the fiscal environment, and this continued over many years. The problems were exacerbated by structural weaknesses in the Greek economy. So from the European perspective, a member state, like Greece, simply cannot continue endlessly violating rules. Which means that Greek debt write down via official channels is impossible. And since the banks and private investors have already taken a 50%+ write down on their claims, further debt relief is not on the cards.
• The Greek view is the exact opposite. And it has some reasonable ground under it too. Greeks see their situation as being forced onto them by Europe and, rightly, recognise that the country simply cannot repay the debts accumulated. Worse, the economy, in its current state, can't even fund these debts. We are now witnessing weekly liquidity squeezes, the latest being over the tiny EUR200 million interest payment this week.

Greece is being squeezed on liquidity front much more seriously than the immediate pressure points suggest.

Banks are losing deposits - probably over EUR5bn in April, on top of some EUR27 billion in 1Q 2015 which marked a 16% decline. These are being replaced by weekly increases in ELA by the ECB. In April alone, ECB hiked ELA by EUR5.6 billion.

Government is also running out of money. In first two weeks of May, Greece will need to refinance EUR2.8 billion of Treasury T-bills, repay EUR800 million on IMF loans. In June - EUR1.5 billion of IMF debt, EUR3.2 billion in T-bills. So there are big bills coming due.

Meanwhile, the Government is having difficulty paying pensions and public sector wages. The Government have already drained the local authorities funds, requiring their transfers to the Central Bank. Which provided somewhere between EUR1.6 and EUR1.9 billion in deposits. Not enough to cover May liabilities.

Beyond that: big redemptions are due in 2016: total of just over EUR5 billion, 2017 - over EUR6 billion, and 2019 - just under EUR11 billion. These are completely unfunded at this stage, as Greece needs to negotiate a new support package with the EU, IMF, and ECB - the so-called Institutions.

And things are still very trigger happy.

• "Panic descended in Athens on Thursday as Greece’s 2 million pensioners were hit with delays to their monthly state stipend. Pensioners raided their accounts and broke into a board meeting, according to reports."
• And quoting from the EUBusiness news linked above: "...the Greek government, ...insists it will not back down from 'red lines' on labour protection and wage cuts. A Greek government source on Thursday said Athens wanted a deal without austerity "crimes" against the Greek people. ...would not back down on labour issues, income cuts, the sale of state assets at whatever cost and a hike in VAT.""
• And the external environment remains also volatile. As Reuters described this scenario: "“We’re going bust.” “No, you’re not.” “You’re strangling us.” “No we’re not.” “You owe us for World War Two.” “We gave already.” The game of chicken between Greece and its international creditors is turning into a vicious blame game…" The problem, as anyone familiar with the game theory knows, that in the game of chicken, switching into unstable strategies may lead to a worse outcome if expected payoffs from non-cooperation (head-on-collusion) are raised. When you start publicly accusing the other side of being intentionally damaging and/or dishonest, you are getting the cost of stepping down from brinkmanship only much higher.

Three options are open:

• Structured write down of official sector debts : EFSF, ESM, and ECB. But not the IMF, leading to no Grexit and a path toward repaired economy;
• Hard default with resulting Grexit and massive mess across both the EU and Greece; and
• Kicking the can down the road once again by securing another bailout agreement to take Greece through 2015-2016. The problem here is that unless Greek economy starts a dramatic recovery, 2017-2020 will see renewed pressures of default and Grexit.

All in, the third option is currently the most likely one. Welcome to Europe's Groundhog Day, Season 8.

1/5/15: Russian Economy: Latest Forecasts and Debates

Russian economy has been surprising to the upside in recent months, although that assessment is conditioned heavily by the fact that 'upside' really means lower rate (than expected) of economic decline and stabilised oil prices at above USD55 pb threshold. On the former front, 1Q 2015 decline in real GDP is now estimated at 2.2% y/y - well below -3% official forecast (reiterated as recently as on April 1) and -2.8% contraction forecast just last week, and -4.05% consensus forecast for FY 2015. It is worth noting that contraction in GDP did accelerate between February (-1.2% y/y) and March (-3.4% y/y). 2Q 2015 forecast remains at -3%.

In line with this, there have been some optimistic revisions to the official forecasts. Russian economy ministry has produced yet another (fourth in just two months) forecast with expected GDP decline of 2.8% this year. Crucially, even 2.8% decline forecast figure still assumes oil price of USD50 pb. Similarly, the Economy Ministry latest forecast for 2016 continues to assume oil at USD60 pb, but now estimates 2016 GDP growth at +2.3%

These are central estimates absent added stimulus. In recent weeks, Russian Government has been working on estimating possible impact of using up to 80% of the National Welfare Fund reserves to boost domestic infrastructure investment. This is expected to form the 3 year action plan to support economic growth that is expected to raise domestic investment to 22-24% of GDP by 2020 from current 18%. The objective is to push Russian growth toward 3.5-4% mark by 2018, while increasing reliance on private enterprise investment and entrepreneurship to drive this growth.

An in line with this (investment) objective, the CBR cut its key rate this week by 150bps to 12.5%. My expectation is that we will see rates at around 10%-10.5% before the end of 2015. From CBR's statement: "According to Bank of Russia estimates, as of 27 April, annual consumer price growth rate stood at 16.5%. High rates of annual inflation are conditioned primarily by short-term factors: ruble depreciation in late 2014 — January 2015 and external trade restrictions. Meanwhile, monthly consumer price growth is estimated to have declined on the average to 1.0% in March-April from 3.1% in January-February, and annual inflation tends to stabilise. Lower consumer demand amid contracting real income and ruble appreciation in the recent months curbed prices. Inflation expectations of the population decreased against this backdrop. Current monetary conditions also facilitate the slowdown in consumer price growth. Money supply (M2) growth rate remains low. Lending and deposit rates are adjusted downwards under the influence of previous Bank of Russia decisions to reduce the key rate. However, they remain high, on the one hand, contributing to attractiveness of ruble savings, and, on the other hand, alongside with tighter borrower and collateral requirements, resulting in lower annual lending growth."

There is an interesting discussion about the ongoing strengthening in Russian economic outlook here: https://fortune.com/2015/04/29/russia-economy-resilience/. Here's an interesting point: "Russian-born investment banker Ruben Vardanyan pointed out that the collapse of the ruble left much of the economy untouched, with roughly 90% of the population not inclined to buy imported goods. And that population, Vardanyan points out, has only increased its support for Vladimir Putin in the months following the imposition of sanctions." I am not so sure about 90% not inclined to buy imports, but one thing Vardanyan is right about is that imports substitution is growing and this has brought some good news for producers in the short run, whilst supporting the case for raising investment in the medium term.


Meanwhile, The Economist does a reality check on bullish view of the Russian economy: http://www.economist.com/news/finance-and-economics/21650188-dont-mistake-stronger-rouble-russian-economic-recovery-worst-yet.

The Economist is right on some points, but, sadly, they miss a major one when they are talking about the pressures from USD100bn of external debt maturing in 2015.

Here is why.

Russia's public and private sector foreign debt that will mature in the rest of this year (see details here: http://trueeconomics.blogspot.ie/2015/04/14415-russian-external-debt-redemptions.html) does not really amount to USD 100bn.

Foreign currency-denominated debt maturing in May-December 2015 amounts to USD68.8 billion and the balance to the USD100bn is Ruble-denominated debt which represents no significant challenge in funding. Of the USD68.8 billion of foreign exchange debt maturing, only USD2.01 billion is Government debt. Do note - USD611 million of this is old USSR-time debt.

Corporate liabilities maturing in May-December 2015 amounts to USD45.43 billion. Of which USD12.46 billion are liabilities to direct investors and can be easily rolled over. Some USD963 million of the remainder is various trade credits and leases. Also, should the crunch come back, extendable and cross-referenced. Which leaves USD32.07 billion of corporate debt redeemable. Some 20% of the total corporate debt is inter-company debt, which means that - roughly-speaking - the real corporate debt that will have to be rolled over or redeemed in the remaining months of 2015 is around USD26-27 billion. Add to this that Russian companies have been able to roll over debt in the markets recently and there is an ongoing mini-boom in Russian corporate debt and equity, and one can be pretty much certain that the overall net burden on foreign exchange reserves from maturing corporate debt is going to be manageable.

The balance of debt maturing in May-December 2015 involves banks liabilities. All are loans and deposits (except for demand deposits) including debt liabilities to direct investors and to direct investment enterprises. Which means that around 25-33% of the total banks liabilities USD26.57 billion maturing is cross-referenced to group-related debts and investor-related liabilities. Again, should a crunch come, these can be rolled over internally. The balance of USD19.9 billion will have to be funded.

So let's take in the panic USD100 billion of foreign debt claimed to be still maturing in 2015 and recognise that less than USD50 billion of that is likely to be a potential (and I stress, potential) drain on Russian foreign exchange reserves. All of a sudden, panicked references in the likes of The Economist become much less panicked.

Meanwhile, Russian economy continues to post current account surpluses, and as imports continue to shrink, Russian producers' margins are getting stronger just as their balance sheets get healthier (due to some debt redemptions). It's a tough process - deleveraging the economy against adverse headwinds - but it is hardly a calamity. And The Economist, were it to shed its usual anti-Russian biases, would know as much.

That said, significant risks remain, which means that a prudent view of the Russian economy should be somewhere between The Economist's scare crow and the Fortune's and the Economy Ministry's cheerleading. Shall we say to expect, on foot of current data and outlook, the 2015 GDP growth to come in at -3.5-4%, with 2016 economic growth to come in at +1.5-2%?