BlogSpot - December 24th, 2014
Russia at crossroads
Russia’s economic situation has deteriorated quickly, with the Ruble losing more than 50 percent of its value since January, and the central bank hiking policy rates to 17%. The Economist reported that the central bank’s foreign-exchange reserves remain very large—at $419 billion—despite a sharp fall. Anders Aslund (Peterson Institute) suggests that due to liquidity concerns (the reminder is in two sovereign wealth funds and gold), effective international reserves are only $200 billion—with net external debt payments of some $100bn per year in 2015 and 2016.
The Russian economy is suffering from three shocks: first, European sanctions due to its foreign policy; second, the sharp fall in oil prices; third, large capital outflows. Oil and gas, as reported by The Guardian, account for 70% of Russia’s exports and Moscow needs an oil price of $100 a barrel to balance its budget. The Central Bank estimates that the economy would contract by 4.5% in 2015 if the oil price remained at its current level for the next 12 months even without taking into account the effect of higher interest rate. Tim Duy analyses this crisis as a currency mismatch between assets and liabilities created by the decline in oil prices. “The Central Bank of Russia is forced into defending its currency via either depleting reserves or hiking interest rates. Both are losing games in a full blown crisis”.
Probability is high for a full-blown recession. EuroIntelligence highlights that Russia's debt sustainability does not look good, especially once bank bailouts are included—and Alexei Kudrin warned of a major crisis and social unrest in Russia next year, with a fall in real incomes by 2-5% in 2015 (FT). Matt O'Brien insists that the country is heading into a full-blown depression—with oil and sanctions interacting. Russian companies not only have lower dollar revenues, but they also find it hard to roll over their dollar loans, due to the sanctions. The real instability will come from the Russian banking sector. Soft capital controls are already in place with a policy to monitor currency sales by large exporters.
The policy response—through the sharp interest rate increase—is orthodox but its results very uncertain, according to Matthew Yglesia, in VoxEU. The central bank intends to deal with both the inflationary impact of the currency depreciation and with capital outflows. The inflationary context was worrisome before the crisis already (BBC) at more than 9%. Yglesia sees that higher interest rates will encourage Russians to keep their Ruble-denominated assets in ruble, attract foreign investors, and support the currency. For Tim Duy depleting reserves or hiking interest rates will not work in a full blown crisis”. Krugman highlights the banality of this currency crisis and the foreign debt exposure, and writes that interest-rate hikes that tries to discourage capital flight will damage the economy—they were unsuccessful during the Asian financial crisis of 1997-8. Euro intelligence is concerned that high interest rates could lead towards a looming banking—quoting Marcel Fratzscher who argues that a Russian financial collapse is looking increasingly probable. The Russian government will inject 14b$ in Russian banks to prevent a financial crisis.
Beyond economics, political consequences may be large. Krugman reminds us that the Indonesian currency crisis led to the fall of its authoritarian regime. Tim Duy writes that a new, lower equilibrium will probably require an IMF program, difficult to grant under current political conditions. Bloomberg explains that Putin's confrontation with Europe at a time of low oil prices is dramatic. The population has been trading its political consent off for rising living standards since early 2000s. Daniel Gros sees a correlation between aggressive Russian foreign policy and high oil prices. With EU and US sanctions much more efficient months with low oil prices, a new, less aggressive, Russia is likely to emerge with the new equilibrium in the oil market.
Political and economic turmoil in Greece again
The brought-forward presidential election is bringing up many risks. Greek Prime Minister Antonis Samaras brought forward the presidential election to “prevent the opposition from undermining Greece’s economy and directing messages of political uncertainty to financial markets”, according to the Financial Times. It could lead to early parliamentary elections in case the current governing coalition of 155 MPs would not find 25 more fellow-members to reach the 180 necessary to elect a president in the third round (200 in the first two rounds). This could bring the anti-austerity party Syriza, currently topping opinion polls (Wall Street Journal), to power—with concerns about Greece’s implementation of its « Troika » program. Macropolis (hat-tip EuroIntelligence) finds three clear trends in recent polls: (i) a slight majority in favor of avoiding snap elections, (ii) a closing of the gap between Syriza and New Democracy and (iii) a prevalent mistrust of both the government and the opposition. Syriza is still set to win if there are snap elections but its majority would fall well short of the 36%-38% for an outright majority, and may fail to get a coalition government up and running.
Markets under stress. After Samaras’s announcement, Greek bonds fell, with the 10-year yield reaching a record high since May 2012 and the yield on the 3-year notes issued in July as Greece made its return to capital markets overstepping longer-maturity rates (Bloomberg), resulting in an inverted yield curve reflecting a rising repayment risk forecast. Luca Cazzulani from UniCredit notices greater risk aversion from the investors. These worries are reflected in a speech by Yannis Stournaras about a potential liquidity crisis that would lead to « irreparable damage for the Greek economy ». On December 9th, the Athens Stock Exchange went down 13% (Bloomberg), making it a record crash since 1987, according to keeptalkinggreece. For the Financial Times, the real issue is that investors are skeptical about Greece’s ability to finance itself once the Troika is gone. This may induce the government into accepting a precautionary credit line and monitoring from the Troika once the bailout program will be resolved.
The economic situation is still critical in Greece amidst Troika negotiation. While Greece is seeking to complete its 6th review under the 245 billion euro bailout, Finance Minister Gikas Hardouvelis expressed his worry that the election would produce a government unable to drive the review (The Economic Times), warning about a potential funding gap - as Greece needs to repay a 2.8 billion loan to the IMF by the end of March - and a lower growth - as the economy is emerging this year from a 6-year recession with a 0.6% GDP growth forecast and a 2.9% forecast for 2015 (European Commission Forecast Autumn 2014). Ekathimerini reports that several issues are currently pushing the Finances Ministry to consider a potential return of the Troika by January 2015 (even though the bailout program was due to end in 2014), among which a fiscal gap in the 2015 budget and an overhaul of the social security regime. Other figures such as the unemployment, which fell to 25.5% in Q3 2014, lowest since Q3 2012 (LFS) are also encouraging and show the need for a longstanding political order.
Ashoka Mody, in a Bruegel article, notes that the only right way forward is for the troika to allow Greece to repay its official creditors in 100 years, i.e. debt forgiveness with cosmetics acceptable to the Germans—offering a fresh start for Greece, with a primary surplus bringing back in private creditors, and market discipline (rather than Brussels’ imposed discipline).
How about QE? Potential QE (see our Warning Signals BlogSpot) could have a significant impact on Greece. David Mackie from JPMorgan sounds a word of caution, suggesting that the ECB should think twice before buying the debt of a country whose intention to honor it is not clear. Reuters reports that the ECB is currently studying the option of making « riskier » countries such as Greece bear more risk and cost of the forthcoming QE, such as setting aside extra funds or provisions to cover potential losses from any bond-buying, reflecting the riskiness of their bonds.
Several options leave the outcome of the elections open. Options for Samaras include a deal on early elections or even including Syriza in the new coalition, according to Macropolis. If the Parliament manages to gather enough votes to elect a President, general elections would not be due until June 2016. Further, Syriza’s leaders appear more amenable to various options—Yanis Varoufakis mentions a debt « renegociation » rather than a straight « memorandum », and Tsipras calls for a « negotiated » solution on debt, committed to the euro in an interview with Reuters… sufficient to reassure markets ?
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