Marshall Horn - Market Volatility - US Federal Reserve Dithers: Russia Stays Calm

Marshall Horn,

The thesis that it is US dithering about interest rates and not events in China that is behind the recent market volatility has received strong confirmation from the events of the last week.

At the start of the week financial markets - Wall Street included - plunged on fears of a September rate increase.

An article however had appeared in the Financial Times over the preceding weekend, written by the former US Treasury Secretary Larry Summers (a contender for the post of Chair of the Federal Reserve Board before Janet Yellen’s appointment last year).

In the article Summers said raising interest rates would be a dangerous mistake.

On Twitter Summers went further still - calling for more quantitative easing (ie. electronic money printing).

As news of Summers’s comments spread, the markets recovered.  

They got a further boost when on Tuesday William Dudley, a member of the Board of the Federal Reserve, also appeared to damp down prospects of a rate increase in September.

The markets responded with a spectacular recovery. In the last two days of the week oil prices surged by 15%.

Come the weekend and the pendulum in the policy debate in Washington swung back again. The monetary hardliners (who probably include Yellen) reasserted themselves, and the signals from the Federal Reserve Board went into reverse.

Comments made on Friday by Stanley Fischer, the Federal Reserve Board’s Vice Chair, suggested that an interest rate increase in September had not been ruled out after all.

This happened in conjunction with the publication of revised statistics of the performance of the US economy in the second quarter. These appeared to show the US achieving much higher growth than previously assumed.

Those who follow such things closely will know that there is a longstanding debate in the US about the reliability of US statistics.  

I am not qualified to comment on this debate. All I will say is that because the reliability of the statistics is widely doubted, when a revision of the sort we have just seen comes along there is inevitably suspicion that it has appeared for some purpose - in this case to justify a rate increase in September. Whether true or not, it is what many people believe, and it has an effect on what they do. 

Renewed concern the Federal Reserve Board will raise rates in September has had the predictable effect on the markets: they are all down, including oil which as I write this has fallen by 2.7% on the day.

The market volatility is causing concern around the world, including of course in Russia.

At the end of the last week the Russian government convened a meeting to discuss the volatility.  

The calm comments by the participants - in particular of Finance Minister Anton Siluanov and Central Bank Chair Elvira Nabiullina, which we reproduce below - show confidence that the situation is in hand.  

Siluanov said that he expects oil prices to remain low for some time. He also said Russia may have to adjust part of its budget spending to take account of this. There is no hint here of panic or crisis, just a calm acknowledgement of reality, and of steps being taken to deal with it.

As for Nabiullina, she appears to have no doubts about the underlying stability of the banking system, or of Russian banks’ and companies’ abilities to meet their foreign loan payments.  

Nor is she concerned with defending the rouble at any particular level. Her goal remains what it has always been: reducing inflation.

Achievement of this goal obviously requires the Russian authorities to take steps to insulate the economy as far as possible from the price effects of the rouble’s fall.  Nabiullina says as much.  

The sharp fall in imports already caused by last year’s devaluation, and the ban on food imports from the EU, means that to a great extent this has already been done.

At this point it is possible to make one further important point.

The rouble’s value is closely connected to the oil price, and the rouble’s fall last year was caused by the fall in the oil price.

Whilst this has also been true of the fall the rouble experienced this summer, it is important to say that because Russia is an emerging market economy the rouble would have fallen this summer anyway, even if Russia had not been an energy exporter.

The currencies of all emerging market economies, including ones that are major manufacturing exporters such as Vietnam and South Korea, have fallen this summer.  

Countries like Vietnam and South Korea are not energy exporters, so the fall in the oil prices is not the reason their currencies fell. The reason their currencies fell is because money has shifted from emerging market economies to the US in the expectation of a rate increase there.

It is the expectations of a US rate increase that is also behind the fall in the price of oil.  

It was also the trigger for the fall of China’s admittedly overvalued stock market, as money left China for the US causing the stock market to crash.

When it comes to currency depreciations, China is the big exception that proves the rule. 

Apart from a fractional and tightly managed devaluation, the value of the Chinese currency has held steady, not because China is any less affected by money flows to the US than other emerging market economies, but because China's currency is managed, and the Chinese with £3 trillion of reserves have the financial fire power to manage it.  

In the absence of such management the Chinese currency would have depreciated along with the others - according to some estimates by between 10-15% against the dollar. 

As it is China is believed to have spent around $200 billion to prop up its currency over the last few weeks - a figure that dwarfs the amounts Russia spent to support the rouble during any comparable period last year.

Russia’s currency is volatile not because Russia’s economy is insufficiently diversified. It is volatile because like other emerging market economies whose currencies have experienced similar volatility this summer, Russia’s financial system is small and immature causing Russian companies to look abroad for financing and loans.

Until this changes the rouble will remain volatile however “diversified” the economy becomes.  For this to change Russia needs to strengthen its financial system - something which is happening, but which takes time.

In the meantime, the Russian government has taken the precautions needed to protect the economy from the volatility, and it has every reason to remain calm.

---

The following report is taken from the Russian Presidential Website:

“Vladimir Putin: ……….

We are aware of the situation on the Asian stock markets and the international financial currency markets, and the situation with oil prices. All of this has its effect one way or another on our financial market. I would like Mr Siluanov to comment on these developments and give his assessments.

Finance Minister Anton Siluanov: Indeed, Mr President, in the past days we have seen greater volatility on the world financial and commodities markets. We see that stock markets have gone down by about 10 percent, prices of raw materials have also gone down, there has been a weakening of currencies, especially those of the developing countries and especially those that export primarily raw materials. The national currencies of those countries have lost 5 to 15 percent.

The reason, of course, is the increasing unpredictability of the Chinese economy’s growth. The Chinese economy is currently one of the major economies influencing world demand, including demand for raw materials. Among such reasons, we also see the overproduction of oil; there are constant excessive volumes of oil being produced, while demand is not growing at the rate that was expected earlier. We are also witnessing pressure on financial markets, expectations of increased rates from the Federal Reserve System, which, as we know, may lead to a withdrawal of capital from developing markets.

The drop in oil prices is undoubtedly having the greatest effect on the Russian financial market. During the past month, the prices went down by some 20 percent, about 10 percent in the past week alone. This inevitably had an impact on the financial market of the Russian Federation: the ruble lost about 10 percent, just as many other currencies in countries, as I have said, with developing economies; the stock market here has dropped by about 15 percent since early August.

We have already witnessed a similar situation with the exchange rate early this year, but a rise in oil prices then led to a strengthening of the ruble. We should not rule out a repeat of this development. However, analysts dealing with the oil market say the oil price drop may be long term and we need to prepare for such a possibility and work to ensure financial and budget stability.

Of course, Mr President, we will comply with all our budget commitments for this year. This year we will need to use the reserves that we have accumulated, but these reserves are not unlimited, and for next year and the following budget cycle we have to align our commitments with the new macroeconomic situation. The Government is currently working on such proposals and we will present them for your consideration.

Vladimir Putin: Ms Nabiullina, would you like to add anything?

Central Bank Governor Elvira Nabiullina: Overall, I agree with the assessment provided by Mr Siluanov, but I would like to say that the key factor affecting the ruble, which is the price of oil, is volatile. We have already seen this year that it can go up and down: this year alone there was a period when it grew by 23 percent and then dropped by 38 percent. Therefore, we can expect change any minute.

True, our financial system is part of the global system and is not protected from all the existing risks. However, we modelled various scenarios well in advance, knowing that a pessimistic one is possible, so that we could prepare. Thus, for instance, whenever possible we increased our gold and currency reserves to create a long-term basis for our financial stability and to strengthen our safety net.

We have introduced currency refinancing mechanisms. We envisaged a $50 billion limit on loans to banks to avoid excessive pressure on the currency market. We have spent $34 billion of that reserve, and we believe that the remaining $16 billion would be enough. At the same time, we decided that we would not refinance these amounts for banks that have used up their annual limits so they feel more comfortable.

Moreover, we have decided to loosen bank regulation to allow our banking system to adapt. We have curtailed a number of measures because the banks did not need them, and were planning to discontinue more as of October 1. However, now, depending on how the situation is going to develop, we are ready to retain those measures with certain modifications.

The main thing now is for the exchange rate fluctuations to have a minimal effect on prices. I mean that after the drop in the exchange rate early this year we managed to get inflation under control. For 16 weeks, weekly inflation was about 0.01 percent, with the exception of the week when we had our traditional rate increase. Therefore, we will continue in the same way to ensure a further drop in inflation.

via Marshall Horn, CFTC Market Volatility - US Federal Reserve Dithers: Russia Stays Calm

Marshall Horn - Russia Continues to Orbit British Satellites

Marshall Horn,

MOSCOW - Russia on Friday successfully launched a Proton rocket with a British satellite in the first such launch since an engine failure in May resulted in a Mexican satellite being destroyed.

A Proton-M rocket carrying an Inmarsat-5 F3 communications satellite has been launched from Baikonur cosmodrome in Kazakhstan at 1144 GMT as scheduled, Russia's space agency Roscosmos said in a statement.

“The launch went as planned as all the systems operated remarkably well,” Roscosmos spokesman Igor Burenkov told reporters.

The launch is crucial for Inmarsat, Britain's biggest satellite operator, which said that together with two other satellites, it will create “the world's first globally available, high-speed mobile broadband service, delivered through a single provider.”

 

via Marshall Horn, CFTC Russia Continues to Orbit British Satellites

Marshall Horn - Weak Ruble Drives Russian Car Production Boom

Marshall Horn,

August 26th (Sputnik) - Volkswagen and Hyundai are planning to take advantage of the weak ruble and boost production in their Russian factories of vehicles for export markets in the Middle East and Far East, company representatives announced this week.

In the coming weeks, Hyundai will begin delivering the Solaris, produced in its Russian factory, overseas to Egypt and Lebanon, the company's Russian head office stated on August 25. 

By the end of August, the carmaker's Russian factory will have produced a pilot batch of 550 cars, and has plans to deliver around 4,000 cars to countries in the Middle East by the end of the year. 

“We have carried out a lot of work in order to be ready for the beginning of our cars' exports to the Middle East, and we consider that the recourse to new markets is our contribution to the development of Russian-produced export goods,” said Choi Dong El, general director of Hyundai's Russian factory, which is located on the outskirts of St. Petersburg and employs more than 2,200 people, who produce 200,000 cars a year. 

Sergey Tselikov, head of Russian automobile analytical agency Autostat, told Izvestiya that foreign producers in Russia are able to take advantage of the greater capacity of Russian car factories:

“The real capacity of Russian car production is three million cars per year, and I estimate that this year around 1.2 million will be built. The factories are working at 50 percent of their total capacity, so it's logical to look to replace the falling demand in our country with demand from other markets,” said Tselikov, who estimated the potential export volume at 150,000 – 200,000 cars a year.

1026213003.jpg

On Tuesday, Marcus Ozegovich, general director of Volkswagen Group Russia, told Izvestiya that along with Hyundai, his company has plans to take advantage of the weakness of the Russian currency and boost exports to countries that share a border with Russia. 

“I'm not talking about exports to the Commonwealth of Independent States [CIS], which we have been doing for a long time, I have global exports in mind.”

“It's not that simple: there are global export currents, agreements, logistical expenses, tax and customs nuances of different countries, and so on.”

“It's quite a significant challenge for us, which eventually will allow us to improve our quality here.”

The plan to increase production for exports to wider markets is an unprecedented step for foreign car manufacturers based in Russia, where production has traditionally focused on the car market in Russia and the CIS.

Cars for the export market have instead been largely produced by Russian carmakers such as AvtoVAZ, which manufactures the Lada, as well as UAZ, manufacturer of off-road vehicles, and GAZ and KAMAZ, which make trucks.

Car expert Igor Morzheretto told Izvestiya that exports from Russia could even end up in the Western European car market:

“Western Europe could be among the regions which import such budget cars. For example, when Renault developed the Romanian Dacia brand, in the beginning it was also supposed that these cars are only for developing countries, and now you can see them anywhere in the European Union,” explained Morzheretto, who named the Volkswagen Polo sedan, which is produced only in Russia at the Volkswagen factory in Kaluga, as one such possible export. 

via Marshall Horn, CFTC Weak Ruble Drives Russian Car Production Boom

Marshall Horn - Ukraine Reaches Agreement With Creditors - But the Figures Don't Add Up

Marshall Horn,

An announcement on 27th August 2015 has confirmed that Ukraine has reached a restructuring deal with its private creditors.

However, as the article from the Financial Times attached below makes clear, it is far from certain that the deal comes anywhere close to meeting Ukraine's needs.  

On the face of it the agreement looks like a bad deal for Ukraine.

Ukraine was demanding a 40% haircut. It got only 20%. 

Ukraine's creditors have also agreed to delay bond (ie capital) payments on the remaining debt for four years, though Ukraine will have to continue to make coupon (interest) payments at a slightly higher rate during this period.  

In return Ukraine has agreed to a GDP linked security that will pay its creditors a percentage of its economic growth after the debt repayment holiday ends in 2019.  It seems 40% of any economic growth over 4% will have to be used to pay off debt. This will be on top of any regular capital and interest payments that fall due.

That suggests a very heavy period of debt repayments after 2019, after the four year bond payment holiday ends, and when the IMF programme also ends.  

Not surprisingly the Financial Times reports worries amongst financial analysts that this may be too heavy a burder for Ukraine to bear.

Judging from the last paragraph of the Financial Times's article, Ukraine may be hoping to overcome this problem by further borrowing in the capital markets.

It remains to be seen whether lenders, once they have done the sums, will be prepared to lend it extra money.

The agreement still needs some creditors to agree. The pressure on them to do so will however be so great that it is a virtual certainty they will do so.

The agreement does not cover the $3 billion payment on the eurobond held by Russia, which matures in December.  

What are the implications of this agreement?

Firstly, though the IMF is backing the agreement (it has no other choice), it is far from obvious that the sums add up.  

The IMF’s latest programme assumes a reduction of Ukraine’s total debt repayments over the duration of the programme of $15 billion.  

The Financial Times says the total amount of debt at issue in the negotiations is $18 billion, and says the value of the haircut is $3.6 billion (20% of $18 billion).

TASS says the total amount of debt at issue in the negotiations is $19.2 billion, and says the value of the haircut is $3.8 billion (20% of $19.2 billion).  

TASS may be giving the more accurate figure.  The Financial Times also says the total value of the write off is “close to $4 billion” - which seems more consistent with TASS's $3.8 billion figure than the Financial Times's $3.6 billion.

There is no information on how much Ukraine will save as a result of the cancellation of the interest payments for the debt that is subject the haircut. Nor do we know how much relief it will get from the four year bond payment holiday.

However, on the face of it, whether the haircut is worth $3.6 billion or $3.8 billion, the sums look too small to come anywhere close to hitting the $15 billion debt reduction target the IMF was looking for.

Ukraine’s demand for a 40% haircut by contrast would have written off £7.2 billion if the debt is $18 billion, or $7.68 billion if it is $19.2 billion, which together with cancelled interest payments and the four year bond payment holiday might have brought the debt relief target of $15 billion within sight.

More clarity will be provided as more information becomes available. However the Financial’s Times’s pessimism about the sustainability of what has just been agreed tells its own story.

If the $15 billion debt reduction target is not being achieved, then unless the West provides more money or Ukraine's economy suddenly improves, the IMF programme will fail.

Why did this agreement take so long to agree - especially given the immense pressure from Western governments on the creditors to settle - and why is it so unfavourable to Ukraine?

Firstly, it is important to say that it was not because the creditors anticipated that in the absence of an agreement the IMF would pull the plug on Ukraine - forcing Ukraine to settle on their terms.  

As we have previously reported the IMF - under political pressure - has said it will support Ukraine regardless of whether it comes to an agreement with its creditors or not.

Nor is it likely that the creditors thought that if Ukraine defaulted they would get all their money back through credit default swaps. These were unlikely to come anywhere close to compensating the creditors fully for the money they would have lost.

The creditors held out because what Ukraine was demanding was completely unreasonable.

Ukraine's debt is not unsustainable. The Financial Times says the total amount Ukraine must pay on its debt (public and private) is $72 billion. 

This ought to be perfectly sustainable for a country that is the second biggest in Europe, has a well-educated population of more than 40 million people, and which is blessed with an abundance of natural resources, large industries, a lengthy coastline, and some of the most fertile agricultural land in the world.

By contrast Greece, with a total debt of $350 billion, is a small country, has a population of just 11 million people, has very few industries, and few natural resources.

Parallels people make between the situations of Greece and Ukraine are simply wrong. Greece’s debt is obviously unsustainable. Ukraine’s debt is not.

The reason Ukraine is failing to pay its debt is not because its debt is unsustainable. It is because Ukraine is chronically mismanaged and insists on waging war rather than restoring its economy by making peace.

The creditors therefore question why they should be asked to agree to huge haircuts when - provided Ukraine ends the war and sorts out its problems - it is perfectly capable of paying them the money it owes them.

The Financial Times explains the creditors’ position clearly:

“Bondholders had rejected Ukraine’s assertion that they must take a 40 per cent upfront loss, arguing that the country’s problems were mutable and that a temporary freeze in debt payments would be a better solution, delaying a final deal until political and economic problems calm.”

Ukraine did not help its case by acting as if the creditors were under some sort of moral duty to write off the debt; and by constantly complaining that it was spending more on debt payments than on defence - leading to the inevitable suspicion that it was intending to use any money saved on debt payments to fund the war.

The result is what looks like an unsatisfactory outcome both for Ukraine and the IMF.  Given the political pressure they will doubtless press on with their programme, but the sums do not look like they add up.

Recent news of the deterioration of Ukraine’s economy anyway calls the IMF's whole programme into question. Even if a much bigger haircut had been agreed it seems unlikely the sums offered are anywhere near enough to turn Ukraine's economy round. 

It seems only capital controls are preventing the Ukrainian currency’s complete crash, and without a political breakthrough leading to an end the war there must be a question over how long the situation can hold.

In the short term this unsatisfactory agreement must however increase the possibility that Ukraine will look for some way to default on the $3 billion eurobond it owes Russia, which matures in December.

The Russians have categorically ruled out any restructuring of this debt, a position they have just reiterated.  

Given the financial pressure they are under following an agreement that fails to meet their needs, there must now be strong pressure on the Ukrainians to default on this debt, and certain comments made by Yatsenyuk suggest as much.

As I have discussed previously, if Ukraine defaults on this debt bitter legal disputes will follow, with the Russians insisting that it is public debt and the Ukrainians arguing - implausibly - that it is not.  These disputes alone might suffice to derail the whole IMF programme.

Regardless of what happens to this particular debt, Ukraine’s position, following what looks like a deeply unsatisfactory agreement, looks grim. 

---

From the Financial Times

Ukraine has secured an agreement to avert default and restructure billions of dollars of government debt in a deal that could see international investors write off close to $4bn.

Creditors, including San-Francisco based Franklin Templeton and Brazilian investment bank BTG Pactual, have accepted the proposal for a 20 per cent haircut on $18bn of the embattled country’s bonds as well as delaying debt repayment by four years.

In return they will receive a GDP-linked security that will pay holders a percentage of Ukraine’s economic growth from 2021.

However, questions remain over whether the hard-won deal, which is supported by the International Monetary Fund, will result in solvency for the country, as conflict with pro-Russian separatists imposes a heavier than expected toll on the economy.

“Ukraine could face further liquidity issues when the IMF programme is over so the extension of debt repayments is crucial,” says Vadim Khramov, strategist at Bank of America Merrill Lynch.

Under the plans agreed by Ukraine and creditors, bond repayments will be extended by four years while coupon payments will be slightly higher than the current 7.2 per cent average at 7.75 per cent. A GDP-linked warrant will be provided from 2021 to 2040 that will pay out up to 40 per cent of the value of annual economic growth above 4 per cent, although total payments will be capped at 1 per cent for the first four years.

The haircut on government bonds could mean immediate debt relief of up to $3.6bn. However holdouts on some bonds are expected by analysts, including Russia’s $3bn bond due to mature in December.

Kiev’s deal to restructure its $72bn government debt burden follows months of negotiations with investors who hold close to $9bn of Ukrainian bonds.

Although the creditor committee of Franklin Templeton, T Rowe Price, BTG Pactual and TCW have agreed to the plans with the Kiev government, other bondholders will need to be persuaded of a deal in order for a majority to agree relief on each bond.

Once the plans are submitted to Ukraine’s parliament, a prospectus will be published in mid-September and bondholders will vote on the restructuring proposal. The timing means that repayment of a $500m bond due on September 23 will be suspended while creditors consider the plans.

In August officials from Kiev, including US-born minister of finance Natalie Jaresko, flew to San Francisco, home city of Franklin Templeton, for emergency meetings as an upsurge of fighting with Russian-backed separatists controlling breakaway eastern regions of Ukraine focused attention on the deal.

Bondholders had rejected Ukraine’s assertion that they must take a 40 per cent upfront loss, arguing that the country’s problems were mutable and that a temporary freeze in debt payments would be a better solution, delaying a final deal until political and economic problems calm.

Relations with private sector creditors had soured since spring as the two sides clashed over the question of whether investors must write down their holdings in order for Ukraine to meet the terms of the IMF’s four-year $17.5bn bailout, designed to take the country’s debt below 71 per cent of GDP by 2020.

Earlier this year Ukraine took the highly unusual step of passing a bill in parliament that allows the government to halt payments on some foreign debts by declaring a moratorium, a term described by one international credit lawyer as “a polite word for default”.

The IMF alluded to the uncertainty in early August when it reiterated that although it expected Ukraine’s debt operation to be completed, it was willing to support the country even if debt discussions failed and a moratorium was imposed.

However, the repercussions of Ukraine defaulting on its debt would have been severe.

Ukrainian bonds, issued under English law, contain cross-default clauses that mean missed payments on one can trigger default on all, allowing bondholders to demand repayment, drag a country into lengthy legal battles and exacerbating existing economic problems.

S&P, the credit rating agency, said that a sovereign default would also worsen already tight liquidity in Ukraine’s banking sector, triggering panic-driven deposit withdrawals.

If Ukraine succeeds in a debt restructuring it could plausibly return to international debt markets within a year, said Yerlan Syzdykov, head of emerging markets debt at Pioneer Investments. The country has said that it plans to come back to the market by 2017.

Market prices for Ukrainian bonds have recovered in recent weeks as hopes rose that the country would avoid default, with a Ukrainian $2.6bn bond due to mature in 2017 trading at 57.4 cents on the dollar ahead of talks, up from 39.5 cents in March.

via Marshall Horn, CFTC Ukraine Reaches Agreement With Creditors - But the Figures Don't Add Up

Marshall Horn - Brave (Miserable) New Normal World

Marshall Horn,

So what’s the real story behind the made in China Black Monday (followed by a Blue Tuesday)?

Shares in the Shanghai/Shenzhen soared a whopping 150 percent in the 12 months up to mid-June. Small investors – almost 80 percent of the market – believed in a never-ending party, and often borrowed heavily to be part of the “get rich is glorious” bonanza.

There had to be a correction. Those shares – which had hit a 7-year peak - were obviously overvalued. Couple it with a mountain of data showing essentially a Chinese economic slowdown, and the result was predictable; Shanghai and Shenzhen lost all their gains so far in 2015 – and engineered a massive global sell-off. Even notorious billionaires lost, well, billions in a flash.  

Welcome to China’s new normal; or our brave (miserable) new normal world.

The crisis of the Neoliberal Disorder

The sharp correction in the Shanghai/Shenzhen is part of the end of a cycle. Goodbye to China relying on investment rates of 45 percent of GDP. And goodbye to China’s unchecked thirst for commodities.

The problem is China’s tweaking of is economic model is directly linked to the persistent coma of the neoliberal disorder, in effect since 2007/2008.  

You don’t need to be Paul Krugman to know the new normal is anemic global trade; a severe crisis in most emerging markets; Europe’s absolute stagnation cum recession; and “factory of the world” China selling less to the rest of the world.    

Meanwhile, the hyper-valued US dollar is strangling US exports; up to 3 percent decline in the first semester alone. Imports also fell by 2.2 percent; and that ties in with the structural corrosion of America’s dwindling middle class spending power.

Everywhere we look, the whole structural landscape screams crisis of the neoliberal disorder. When the Chinese engine of turbo-capitalism faces (relative) trouble that glaringly reveals how the global financial casino enjoys no dynamic support anywhere else.

Over $5 trillion in paper money has been wiped out since Beijing (modestly) devalued the yuan on August 11 – triggering the global sell-off.  

Now the Fed may postpone raising interest rates for the first time in almost a decade until the end of 2015. Still, no one dares to predict a rosy growth scenario, considering an ultra-strong US dollar, a relatively devalued yuan and a steady fall in oil prices. 

No implosion, no panic

Contrary to Western forecasts/wishful thinking, China is not imploding. Credit Suisse has released some quite level headed analysis. Here are the highlights.

“China still has a very healthy current account surplus, its capital account is still partly closed and its major financial institutions are largely state-owned. These factors combined would allow the monetary authority a free hand to create liquidity in the system if it wants to do so.”

What will happen is that “China's structural growth will continue to decelerate in the next few years.”

There won’t be a “credit-crunch triggered hard landing and the financial system/ exchange rate regime could be maintained relatively stable.”

Hoping for Chinese corporate revenue/earnings growth to “bounce back to the level of few years ago is unrealistic.” But, crucially, “the fear of a repeat of the 1997 Asian financial crisis or a 2008 global financial crisis is not warranted.”

And to sum it all up, Credit Suisse recommends…no panic; “Investors [should] focus more on China/HK stocks that have strong micro fundamentals and are less susceptible to Chinese economic growth, but were dragged down by recent market weakness.”

A black hole in Jackson Hole

So, from Beijing’s point of view, everything is (relatively) under control.

Once again; in global terms, this latest casino bubble is not remotely comparable to the Asian financial crisis of 1997/1998. Rather, that’s yet one more intimation of non-stop, recurrent global weakness enshrined as the new normal, coupled with Wall Street’s absolute refusal of strong financial regulation.

The ball now is in the Fed’s court; what to do about the tsunami of foreign money driving the US dollar up, and driving US industry to become totally uncompetitive.

The era of central banks printing electronic cash in a QE free-for-all – cheap money directly boosting “market volatility” – may not be over, yet. Let’s see what happens this Thursday, when a symposium of central bankers in Jackson Hole, Wyoming, will be examining what to do about “market volatility”.

Central banks absolutely love to drive up stock market prices for the benefit of the 0.0001 percent. So expect more delusion ahead. But be sure everything that’s solid melts into air. Including the neoliberal dream.

via Marshall Horn, CFTC Brave (Miserable) New Normal World

Marshall Horn - Don't Get Too Attached to a Weak Ruble. The Dollar Is Coming Down

Marshall Horn,

Seeing how at this very moment ruble is getting hammered by the dollar predicting a ruble appreciation seems like a very bold statement indeed. However, if one contrarian investor is right that is exactly what we should excpect. 

Peter Schiff is a financial analyst who made his fame and fortune by going against the grain. He is most known for having predicted and warned about the housing bubble and the financial crisis of 2008. Broadly speaking he is bearish on US economy and the US dollar and bullish on commodities, gold, foreign stocks and foreign currencies.

He would sum up his position something like this:

The much vaunted US recovery since the 2008 crash has not been real. Economy and disposable income of most people have not improved significantly, or at all, since then.

As such the gains made by US stock markets are not based on the state of the US economy. They are the outcome of loose money policies of the US Federal Reserve. 

When crisis hit instead of allowing a corrective recession that would have liquidated malinvestment (as well as wiped out profits for numerous investors) the Fed re-doubled its easy money policies. It ushered in an unprecedented seven year period of zero percent interest rates, and undertook three massive money-creation campaigns - each bigger than the previous - the so called “quantitative easing” (“QE”) programs.

The result has been that in the place of a housing bubble, a much larger stock-market bubble has been blown up. The high US stock market is simply a consequence of trillions of new dollars chasing after the same amount of stocks - along with money from real people who re-invested into the markets because they seemed like the only thing that was going up.

This has escaped most people who buy the explanation that due to the “stimulus” by the Fed the US stock market is now fundamentally sound. Therefore, when at the end of 2014 the Federal Reserve announced the end of their QE3 program, numerous investors believed a raise in interest rate was also around the corner.

Indeed this would have made every sense - if the markets were now sound, there was no longer a need for a heavily interventionist policy of the Fed. Indeed the Fed itself signaled and has been signaling since that it will set a higher, more conventional interest rate.

It was this expectation of a return to (relatively) hard money policies in the US that contributed to the fall of oil and emerging market currencies compared to the dollar and which is perhaps the main reason for the latest tumble in the oil price. 

(At the time QE programs were taking place dollar wasn't depreciating on foreign currency exchanges because central banks all over wanted to prevent this from happening and instituted lose money policies of their own - the Chinese are already paying the price for this having blown up a stock market bubble of their own in the process.)

However, Schiff, at least, believes A.) that actually raising the interest rate and ending a supply of free credit would set US markets for a free fall and B.) that the Fed knows this. Therefore his expectation is that the Fed will continue to prop up the phony high stock market with zero percent interest and eventually go on to restart the programs of quantitative easing starting “QE4”.

If this happens, or if the rest of the investors come to believe it will, it is inevitable the dollar will surrender all of its gains compared to commodities and foreign currencies. Both of these would push the US currency down and the ruble up. (In fact there is a possibility - albeit no guarantee - it may even serve to dramatically expose the oversupply of US dollars and burst the entire US currency bubble - albeit it just as likely this will take many more “QEs”.)

And that's a great thing for Russians. While there are those who argue that a weak ruble is “good for Russia” I don't agree.

It's true that an undervalued currency can help sell you more goods, however, we have to remember the goal of trade isn't to sell the greatest number of goods, but to earn the greatest amount of foreign currency. If you can earn the same amount of foreign currency by selling fewer goods then that's a great thing.

It means you still get to import the same amount of foreign goods, but you can redirect some of your production capacity away from exports and to domestic consumption. 

A hard, highly valued currency therefore helps you achieve the goal of economics - which is enjoying a high standard of living and satisfying the greatest number of your material needs. (Not assembling tons of stuff and shipping them overseas.)

Chances are that in six to twelve months Russians can go back to having that - unless their government follows the US in enacting hare-brained inflationary policies of its own.

via Marshall Horn, CFTC Don't Get Too Attached to a Weak Ruble. The Dollar Is Coming Down

Marshall Horn - Current Low Oil Price Has Nothing to Do With Supply and Demand

Marshall Horn,

This article originally appeared at OilPrice.com

---

It is clear that it is no longer supply and demand for oil that is dictating the price but is instead the financial markets and more importantly money flows tied to central bank policy.

Bearish sentiment in the oil markets is taking over as net short positions near record highs. According to Reuters, 50 to 60 hedge funds have taken short positions that account for around 160 million barrels of oil in near term contracts. In fact, the amount of short positions in oil options and futures now exceeds levels in the great financial meltdown of 2008, believe it or not, despite talk of a good economy and the Fed needing to raise interest rates. Madness, right?

As I have stated before , money flows into financial assets have more to do with Fed policy and FX than fundamentals. Since the consensus is for higher rates in the fall, combined with Asian turmoil stemming from the yuan depreciation, the backdrop of short interest in commodities has risen despite fundamentals improving.

However, in the past month the inverse relationship between the rising U.S. dollar and falling oil has decoupled, as the dollar is essentially flat Year To Date (YTD) while oil has fallen 35 percent to record lows. Some of this was tied to Iran supply worries in 2016, but most of it I attribute to short selling.

Fundamentally, almost every bear case presented by the media in 2015 has been proven false. Doomsday events such as rig count (vertical rigs being dropped vs. horizontal), Cushing overflowing, China demand slowing, to Iran floating storage of 50 million barrels being unleashed, U.S. production rising, have all been dispelled.

In fact, as I said, the fundamentals have even improved as U.S. production has entered into decline, crude stocks have been drawing down since the spring, and demand for gasoline is at record highs (much higher vs. expectations going into 2015).

Furthermore, the worries on Iran are completely overblown given that the hype on floating storage – the millions of barrels of crude oil sitting in tankers turned out to be low quality condensate that is hard to process. Also, the 500,000 to 1 million barrels per day (mb/d) increase tied to the nuclear deal will be absorbed by higher demand, which has averaged 1 million barrels or more each year (in 2015, it has been even higher than that; closer to 1.4 mb/d or higher).

Furthermore, China alone will add 600,000 barrels per day in refinery capacity, as it allows independent refineries to process oil. What has been incrementally negative has been additional capacity added by Iraq and Saudi Arabia since the start 2015. However, aside from Iran, OPEC doesn’t have any spare capacity left and, Saudi Arabia has already announced intentions of reducing output by 200,000-300,000 barrels per day post their seasonally strong domestic period.

Yet even though the dollar has weakened recently, oil has still collapsed some 35 percent. The E&P equities have fallen even further as in addition to shorts, there are also pressing bets on the upcoming fall credit redetermination and hedge funds taking positions in E&P bonds while shorting equities.

All these things still don’t explain the panic in oil markets other than financially driven events that aren’t directly tied to the supply and demand of oil which, as I stated, has improved vs. the start of 2015. In fact, demand is soaring while days of supply are improving dramatically as evidenced by the charts the charts below: 

 

 

In addition to the precipitous drop in oil is the mystery of oil imports which, over the last three months, have risen dramatically while U.S. production has fallen. Why would this occur as the media continues its portrayals of a supply glut in the U.S.?

Last week, and almost every week in which oil inventories have risen, it has come as a result of surging imports at a time that U.S. refineries have promised 700,000 barrels per day in additional light sweet oil capacity dedicated to shale production.

Suffice it to say, something smells rotten. Since June, U.S. imports have risen by over 1 mb/d to near record levels achieved back in April of this year. How can we be awash in domestic production yet be importing record amounts of foreign oil? I posed this very question to a senior executive of an E&P company and the answer was: Saudi Arabia.

Not many people realize that Saudi Arabia owns a 50 percent stake in the Motiva oil refinery, one of the largest in the entire nation. As a 2013 NYT article clearly states Saudi Arabia’s intention was to assure a market for their oil and, in some cases, sell it below market prices no less. I wouldn’t be surprised that the partly Saudi-owned refinery is intentionally importing more oil than needed, as it would play into the overall Saudi strategy to damage U.S. shale production.

If the chart below is correct and gasoline supplied to the U.S. domestic market rose 500,000 barrels per day while U.S. production held nearly flat since the start of 2015, how in the world are inventories in the U.S. so high according to the EIA? 

As I stated in previous articles, until the Fed admits the strong dollar and rate hike threats are off the table signaling a policy change, efforts on depressing oil prices won’t subside. The U.S. economy is weakening not strengthening and has been for some time. Historical QE initiations have started at just about these times, as markets begin to crash, yet we still hear about higher rates. Has the FED changed course on stimulus instead, using falling commodities vs. QE? Maybe for a time, but recent data indicates that isn’t working either.

Look for a significant U.S. dollar correction in the coming months, marking a turn in commodities in general. Until then, we are in a perfect storm where forces are driving prices lower with little regard for the fundamentals, due to Fed policy and just the pure greed of funds who can push oil futures lower, so as to maximize short equity returns or to buy assets on the cheap.

via Marshall Horn, CFTC Current Low Oil Price Has Nothing to Do With Supply and Demand

Marshall Horn - Russian Study Says Low Oil Price, Not Sanctions, Caused Recession

Marshall Horn,

This article originally appeared at Russia & India Report

---

The introduction of anti-Russian sanctions in relation to the Ukraine crisis resulted in the decline of Russia’s economy only by 0.5-0.6 percent. The rest of the recession was caused by record-low oil prices.

The Kommersant newspaper writes that this conclusion was made in a study carried out by collaborators of the Russian Central Bank, Andrei Sinyakov and Sergei Seleznev, as well as by economist from the International Monetary Fund Augustin Pointman. According to official information, Russia’s GDP in the January-June 2015 period fell by 3.4 percent in relation to the same period in 2014.

Vladimir Bessonov, Director of the Laboratory of Inflation Problems and Economic Growth Study at the Higher School of Economics, agrees with the conclusion. “The precision of such evaluations is inevitably relative, however, in general I confirm that Russia’s GPD fell in relation to the change in energy prices, not the sanctions.”

The main reasons

In Bessonov’s words, the proof can be found in the chronology of the Russian economy’s fall: the GDP’s main decline began not a year ago when the anti-Russian sanctions were introduced, but in the beginning of 2015, after the drastic fall in oil prices. “The influence of sanctions on various sectors of Russian industry was mixed. Some sectors were able to establish the process of import substitution. However, it is the key rate and the consequent credit cost within the country that had the main influence on the economy. The manufacturing industry suffers especially from high borrowing costs.” In particular, in the end of 2014 the Central Bank was forced to raise the key rate, which determined the cost of all credit in the country, to 17 percent. Later it was reduced to 10.5 percent.

The Central Bank analysts’ study describes the GDP dynamics model after the introduction of anti-Russian sanctions in the third quarter of 2014 and the fall of oil prices from $110 to $50-55 per barrel. The model used by the authors is based on work carried out by one of the founders of the Chicago School Arnold Harberger and Carlos Vegh from the John Hopkins University. In particular, the authors consciously use the extreme assumption that in the course of the next five years Russia will not have any access to capital in foreign markets, which by 2019 will eliminate the country’s foreign debt entirely.

To whose advantage

In the words of Alexei Baskakov, Director of the Evaluation Department at Finexpertiza, the current situation goes to the advantage of exporters of energy resources who receive payments in foreign currencies, but for the majority of the sectors in the domestic market the rising cost of money has had a bad effect. “We work with practically all sectors of the economy and today don’t see any positive structural sectorial transformations, with the exception of, perhaps, import substitution projects, which receive aid from state banks.”

Moreover, according to Georgy Vaschenko, Director of Operations on Russia’s Capital Market at Freedom Finance, due to the fall in oil process, the development of arctic shelf deposits is not profitable. Thus, there is no sense in increasing expenses for buying equipment that is affected by the sanctions. “The main reason for the recession is the inflation brought about by the ruble’s fall, which in turn is related to the fall in oil prices and the Central Bank’s refusal to support the national currency,” Vaschenko sums up.

 

 

via Marshall Horn, CFTC Russian Study Says Low Oil Price, Not Sanctions, Caused Recession

Marshall Horn - Ukraine Oligarch Investigated for Stealing $1.8 Billion (Igor Kolomoisky)

Marshall Horn,

This article originally appeared at Business New Europe

---

PrivatBank, Ukraine’s largest lender partly owned by controversial oligarch Ihor Kolomoisky, is under criminal investigation by the authorities for fraudulently diverting around what was then about $1.8bn, the bank has confirmed.

“We are aware of the existence of criminal proceedings. PrivatBank fully cooperates with the investigators and provides all the information and documents necessary to establish the objective truth of the case,” a bank spokesperson told bne IntelliNews on August 20. In a statement cited by Interfax Ukraine, the bank put the amount in question at UAH19bn (today worth about $855mn).

Kyiv’s Pechersk court ordered PrivatBank on June 10 to provide police investigators with access to confidential documents relating to the allegations of fraud, which were first reported internationally by bne IntelliNews. Financial sector regulators the National Bank of Ukraine (NBU) and the State Financial Monitoring Service both said police investigators were acting independently, without their assistance, according to Interfax Ukraine.

PrivatBank, part of Kolomoisky’s empire which encompasses aviation, television and energy, received the funds as stabilisation loans from the NBU as the February 2014 revolution and ensuing conflict with Russia unleashed economic turmoil in Ukraine. The funds were in turn paid to PrivatBank by the central bank as part of an IMF bailout of Ukraine in May 2014.

“We are convinced that the investigation by examining the documents to which access was granted by the court will be able to objectively assess all the circumstances together, and to establish the truth,” PrivatBank said in its statement.

Paper trail

As bne IntelliNews reported, the paper trail suggesting PrivatBank moved $1.8bn out of the country was hiding in plain sight in Ukraine’s online database of litigation. But regulators and law enforcement agencies ignored the signs until the international press picked up the story in the wake of bne IntelliNews’ story.

Indications of suspicious activity were the scores of apparently pro-forma lawsuits brought against offshore vehicles for failure to deliver imports as contracted that hit courts in the Dnipropetrovsk region, starting in September 2014. At the time of the alleged fraud, Kolomoisky was also governor of Dnipropetrovsk, where PrivatBank is headquartered.

The lawsuits were brought by Dnipropetrovsk-registered companies against the offshore companies for failing to deliver on massive import contracts paid in advance, and which in turn were funded by PrivatBank loans. This is a common scheme for illegal capital exports, and effectively means that PrivatBank funds had been siphoned out of the country.

Ukrainian law stipulates that where advance payment is made on an import contract without any subsequent delivery, the “deceived” Ukrainian company has to sue the foreign counterparty in Ukrainian courts for the sum of the advance payment within six months.

Processing these cases, journalist investigations identified six firms from the UK and British Virgin Islands as having received the “advance payments” in May-August 2014 totalling $1.81bn, with no subsequent delivery of goods.

42 firms registered in Dnipropetrovsk made the payments from their accounts at PrivatBank, funded by loans from PrivatBank collateralised with the goods ordered. All the Dnipropetrovsk firms are owned via offshores, but journalist investigations linked them via cross-ownership or trading operations to structures belonging to the so-called “Privat Group” of companies.

The six non-resident recipients of the funds also have links to Privat Group trading operations, according to the investigations. Tellingly, their accounts are held with PrivatBank’s subsidiary in Cyprus owned by the six UK and BVI firms. Three separate journalist investigations (here, here and here) came to the same conclusions, drawing largely on open sources and thus easily verified.

PrivatBank denied the allegations to bne IntelliNews. “We have already stated a number of times that the information about moving capital abroad does not correspond to reality and is based on fabricated data,” PrivatBank told bne IntelliNews.

Asked about the alleged scheme in a previous interview, the head of the central bank, Valeria Gontareva, said that she “did not notice” any such scheme.

Captive bank?

The criminal investigation adds to concerns over PrivatBank’s stability, given ongoing depositor flight from the lender.

PrivatBank’s business model combines that of a national savings bank, dominating retail deposits and retail credits, with that of a ‘pocket bank’ serving a single financial industrial group – the so-called Privat Group of companies controlled by bank shareholders Ihor Kolomoisky and Hennady Boholyubov. Thus, while PrivatBank holds 26% of Ukraine’s retail deposits, with over one fifth of Ukraine’s total bank branches, as much as 95% of the bank’s corporate lending reportedly goes to companies registered in its home region of Dnipropetrovsk, presumed to belong to Privat Group, according to Ukraine’s respected weekly zn.ua. PrivatBank dismisses the conclusions of the report.

Privat Group, in striking contrast to other oligarch holdings, has never been consolidated into a legal entity, which would put a limit on bank lending to the group because of banking regulations over lending to a single customer. Without such consolidation, it is impossible to fully know how much the bank has been lending to related parties, although the bank does list 26 firms as related parties.

Even without group consolidation, the bank’s disclosures reveal that fractionally over 20% of lending goes to one customer. NBU limits lending to one customer to 20%. The bank is well within all other regulatory limits. PrivatBank accounts show that around 25% of lending goes to Ukraine’s oil refining sector, where Privat Group dominates, with just under 15% going to the iron alloy sector, also dominated by Privat Group.

A cornerstone of Kolomoisky’s operations for over a decade has been effective control over state-owned oil producer Ukrnafta, with opponents accusing him of siphoning off funds from the company by selling oil and oil products at far below market prices to other Privat Group structures – an accusation that Kolomoisky has always denied.

But in March 2014 Kolomoisky clashed with President Petro Poroshenko over Privat Group control of the state-owned companies, leading to his dismissal as governor of Dnipropetrovsk and decisive moves to reduce Privat Group’s role in the state energy sector, including the switching of Ukrnafta deposits from PrivatBank to state-owned banks.

PrivatBank has suffered severe deposit outflow since 2014, and continued to receive stabilisation funds from the NBU to prop the bank up, totalling just over UAH10bn ($0.46bn) since December 2014, as detailed by the NBU. The central bank said that the bank’s shareholders had provided personal guarantees for the latest stabilisation loans.

But the most immediate challenge faced by the bank is to restructure a $200mn Eurobond due for payment on September 23. An August 13 meeting with bondholders failed to reach quorum, and has been rescheduled for August 27.

 

via Marshall Horn, CFTC Ukraine Oligarch Investigated for Stealing $1.8 Billion (Igor Kolomoisky)

Marshall Horn - Recession-Hit Russia Remains Fiscally Conservative

Marshall Horn,

This article originally appeared at Business New Europe

---

Since the EU and US imposed sanctions on Russia’s banking, defence and energy sectors in mid-2014, there has been speculation that the Russian government would use its sovereign reserves to provide cheap financing to companies effectively shut out of international credit markets.

Yet despite strong lobbying from powerful state-owned companies, the government has to date been reluctant to commit assets from its National Wealth Fund (NWF, a sovereign wealth fund) to large investment projects in Russia. As disputes over future budget spending intensify, the stability of the NWF suggests that fiscal conservatives in the government can still fight their corner.

As of August 1, the NWF held the equivalent of just under $75bn (RUB4.4tn) in assets, accumulated from surplus energy revenues during Russia’s boom years. Under government rules, up to 40% of NWF assets can be invested in infrastructure projects in Russia, with a further 10% assigned respectively to both the Russian Direct Investment Fund and the nuclear holding Rosatom.

The official purpose of the NWF is to provide sustainable support to the pension system. Its assets are, therefore, intended to be placed in secure long-term investments that offer a good rate of return.

Yet the government has in the recent past ignored these rules for the sake of short-term goals. Most notably, in December 2013 it loaned $3bn from the Fund to the government of former Ukrainian president Viktor Yanukovych, despite Ukraine’s low credit rating. Had Yanukovych not been overthrown in February 2014, Russia would have increased the loan to a massive $15bn.

Autarky bandwagon

Following the imposition of sectoral sanctions by the West, expectations were high that the Russian government would raid the NWF to bail out companies and provide short-term support to those no longer able to tap financial markets. Russia’s standoff with the West has consolidated protectionist attitudes within the leadership. From agriculture to medicine, Russian companies have leapt on the autarky bandwagon to lobby for state support and intervention for their particular sectors.

Companies quickly lined up to petition the government for support from the Fund. As early as August 2014, the massive state oil producer Rosneft floated the possibility that the NWF could buy RUB1.5tn of its bonds – coincidentally or not, almost exactly the value of its external debt stock. By October, Rosneft’s wish list had risen to RUB2.4tn, despite the fact that the company’s total investment programme for the year was just RUB730bn.

Applications followed in subsequent months from private sector gas producer Novatek, Russian Railways, the so-called Independent Oil and Gas company, the power operator Rosseti, and the Gazprom subsidiary Neftekhim Salavat. The combined value of the applications exceeded the total size of the NWF. Capturing the free-for-all atmosphere, Lukoil’s vice president Leonid Fedun told reporters that, “if everyone else is going to be applying, then we will too.”

But the Russian government has proved reluctant to hand out blank cheques from the NWF to sanctioned companies. As the chart below shows, the bulk of NWF assets remain in foreign currency held on account at the central bank. As of August 1, 69% of assets were held in foreign currency, compared with 77% in January 1, 2014 (applying August 2015 exchange rates in both cases).

Around $5.7bn has been invested in domestic infrastructure projects, but several of these, such as the Baikal-Amur Railway and the new Moscow Ring Road, were approved before the imposition of sectoral sanctions. Of the funds allocated since mid-2014, a large share of these (RUB280bn) has gone to recapitalise systemic banks through the acquisition of privileged shares. 

Rosneft, the most prominent supplicant for NWF funding, has received short shrift. In February this year, President Vladimir Putin gave a public dressing down to Rosneft boss Igor Sechin for seeking state support for a proposed refinery in the Far East. Of 28 projects put forward by Rosneft by the end of 2014, only five were considered by the government. And in early August, Vedomosti reported that Putin had rejected all but one of these proposals, leaving only an application of RUB89bn to support the construction of a shipbuilding facility on the table.

Overall, the government has so far refused to raise the 60% cap on domestic investments for the Fund, and has broadly stuck to the principle that assets should be used to support high-value infrastructure projects, not as soft loans to cover general operations for struggling state companies.

The government’s approach to managing NWF assets has wider implications for the likely trajectory of budgetary policy over the next few years. It suggests that those in the “economic bloc” advocating fiscal prudence continue to be heeded. While economic policy has taken a dirigiste turn over the past year, the government has so far balanced the demands of industrial lobbies for short-term support against the need to maintain good macroeconomic fundamentals and maintain external buffers.

However, the struggle for state resources is only beginning to heat up. With commodity prices likely to stay low over the next few years, Russia’s elite will be riven by deep disagreements over the fiscal policy and the division of public funds. The finance ministry’s ambitious plans to reduce the deficit to under 1% of GDP by 2018 will come into conflict with spiralling defence commitments and political pressures to boost spending as the next electoral cycle approaches.

The story of the NWF is an encouraging sign of how these conflicts will be managed, but it is early days.

via Marshall Horn, CFTC Recession-Hit Russia Remains Fiscally Conservative

Marshall Horn - Ukraine GDP and Exports Collapsing

Marshall Horn,

This article originally appeared at New Cold War.org

---

According to an August 11 article in the Ukrainian news outlet ZN.ua, real GDP in Ukraine fell by 16.3% during January-June 2015, compared to the same period of 2014. The report is based on reporting by Ukraine’s Ministry of Economic Development and Trade.

The ministry expects an economic recovery of sorts in the second half of the year, resulting in an overall decline of 8.9 per cent for 2015.

The fall in GDP, the ministry explains, is first of all due to the geopolitical conflict in the country, which has led to the destruction of production facilities and transport infrastructure in the Donbas region. It is also caused by the loss of loss of logistical and cross-industry links with regional and foreign economies, the worsening of relations with Russia–a major trading partner, shortages of energy raw materials, notably coal, and a substantial increase in investment risks and negative expectations of the population.

The ministry also adds, “But another, significant negative impact on the economy of Ukraine in 2015 has been accumulated systemic imbalances, the consequences of which were the devaluation of the currency and inflation shocks.”

In the first half of the year, the decline of industrial production was 20.5%. The decline in agriculture was 9.3 per cent and exports collapsed by 35.4 per cent. The collapse of exports to Russia was particularly marked. Real wages in Ukraine fell 23.9%.

“In recent months, the economic situation has stabilized and positive trends are expected to revive economic activity in the second half of 2015,” report the ministry. “As a result, the decline in GDP for the year will slow to 8.9 per cent, while inflation is expected to reach 45.8 per cent (December to December).”

The 2015 state budget of Ukraine optimistically predicted a fall in GDP of 5.5 per cent with inflation of 26.7 per cent. These were the projections assumed in the $17.5 loan agreement (Extended Fund Facility) signed in March of this year with International Monetary Fund. But in the government’s first review of the agreement, last month, it increases the expected fall in GDP this year to nine per cent and says inflation will be 45.8 per cent. (See July 21, 2015 letter, 53 pages, to the IMF by the Ukrainian government, signed by President Petro Poroshenko, Prime Minister Arseniy Yatsenyuk, Finance Minister Natalie Jaresko and National Bank of Ukraine Governor Valeria Gontareva.)

Ukraine’s National Bank predicts a GDP decline of 9.5 per cent and inflation of 48 per cent.

Ukraine’s economy contracted in 2014 by 6.8 per cent while prices rose by 24.9 per cent. In the first quarter of 2015, the GDP decline was greater than that of the last quarter of 2014, 17.2 per cent compared to 14.8 per cent.

Economic collapse, but military spending rising steeply

Military spending by the Ukrainian government is set to rise to five per cent of GDP by 2020. It has hovered around 2.7 per cent for the past 15 years, according to several reports, including the CIA Factbook, but the money spent in real money has more than doubled during that time. The 2015 state budget projects military spending of 50 billion hryvnia. It was 12.7 billion in 2011 (actual spending) says Global Security.org.

The website reports on the budget approved by the Ukraine Rada on Dec. 11, 2014. It contained an ‘action plan’ for 2015-2020 which will see annual military spending rise to five percent of the country’s GDP. The plan also projects that Ukraine will formally end its neutral, non-bloc status and join NATO and for its armed forces to switch to NATO military standards by 2020.

Newsweek reported eight months ago that Ukraine’s military budget for 2015 would be double the previous year, rising to the equivalent of $3.2 billion. But the Stockholm International Peace Research Institute (SIPRI) reported in April 2015 that spending already reached $4 billion in 2014. It projects, “In Ukraine, spending on the armed forces is expected to double in 2015, but almost half of it will go to pensions. Systemic corruption may prevent much of the rest from reaching frontline troops.”

SIPRI writes further:

SIPRI’s provisional estimate for Ukraine’s military expenditure in 2014 is 36.9 billion Hryvnia ($4.0 billion), an increase in real terms of 23 per cent compared to 2013, and 65 per cent compared to 2005. However, this estimate may not fully include war costs and the final figure is likely to be higher.

Most of the increased spending has gone towards personnel costs rather than arms acquisitions. SIPRI’s figures for Ukrainian military spending are considerably higher than most other sources as they include spending on :

• the paramilitary border guard, which has been directly involved in the fighting in the east
• interior ministry troops; and military pensions — which account for almost half of the total SIPRI figure for Ukraine’s military spending, a legacy of the Soviet era
• for 2015, Ukraine has announced a massive increase in military spending with a total budget for ‘defence and security’ amounting to 86 billion hryvnia ($3.9 billion), of which: 40 billion ($1.8 billion) will be for the regular armed forces , compared to 15 billion budgeted in 2014; 7 billion ($318 million) for the newly created National Guard, compared to 1.5 billion in 2014; and an additional 6 billion hryvnia ($273 million) in state guarantees for the Ukrainian arms industry.

Despite 14 per cent inflation, the budget for the regular armed forces will more than double in real terms. However, the effectiveness of Ukrainian military spending is severely compromised by:

• systemic corruption that includes the procure ment of substandard equipment at inflated prices in return for kickbacks
• the selling off at reduced prices of equipment and land to benefit individual senior officers
• the use of military assets and personnel by officers for their own benefit
• the payment of bribes to pass military academies, obtain desirable assignments, or avoid conscription
• and a lack of funding reaching frontline troops, such that conscripts are frequently forced to purchase their own equipment.

Ukraine’s GDP performance is worst in the world from 1991-2015

According to data of the World Bank, Ukraine’s real GDP performance for the last 24 years has been the worst in the world, writes Sergey Korablin, a doctor of economics in Kyiv, in an August 22 article in ZN.ua.

Korablin writes that of 166 countries in the world whose GDP statistics are available to researchers, GDP growth for the period 1991-2014 declined in only five countries. Ukraine’s decline was 35 per cent. The other four, negative growth countries were Moldova (-29%), Georgia (-15.4%), Zimbabwe (-2.3%) and the Central African Republic (-0.9%).

During the first nine years of independence, in 1991,  Ukraine lost nearly 60% of GDP. Korablin says the domestic economy never recovered from that shock. “Neither quantitatively nor qualitatively.”

“The beginning of the current crisis is usually associated with last year’s change of political power in Kiev. But that just added to the slide to the bottom of the economic hole in which the country landed nearly a quarter of a century ago.”

In 14 years, from 2000 to 2013, domestic GDP in Ukraine increased by 69.8%. That is the worst result among all republics of the former Soviet Union. After Ukraine, the minimum gains of GDP were shown in Estonia, at 75.7%. The maximum gains were Tajikistan (GDP grew by 2.9 times), Turkmenistan (3.1 times) and Azerbaijan (4.8 times).

In a March 2014 article, writer Slava Tsukerman with the Lancaster Country, California NewsLanc.com, wrote:

From 1990 to 2008 the share of machinery in the structure of industrial production in Ukraine has changed from 31% to 14%.

In 2009, Ukraine’s Gross Domestic Product fell by 14.8 per cent, which was one of the worst indicators of GDP growth in the world. In the same year, industrial production fell by 25. per cent.

In February 2010, Doctor of Economics Sergey Korablin wrote: “In the early ’1990s, few would even imagine a risk of conversion of Ukraine from a country of industry to one of extraction of raw materials. Today, it is no longer a risk or threat but a fait accompli, and hardly causing any discussions.”

via Marshall Horn, CFTC Ukraine GDP and Exports Collapsing

Marshall Horn - Why Criticism of Gazprom and the Chinese Pipeline Deals Is Wrong

Marshall Horn,

There has been a recent spate of articles once again implying that Russia’s gas deals with China are uneconomic and bad for Russia and for Gazprom.

These articles tend to link to the separate question of Gazprom’s market valuation.   The insinuation is that Gazprom’s low current valuation is somehow related to these deals. 

To assess these claims some background is needed.

Before the 2008 financial crash, Gazprom had an estimated market value of $360 billion - leading to a reckless prediction from its chairman Aleksey Miller that it would rise to $1 trillion.

In the event, Gazprom’s market value fell sharply during the financial crisis.  It then recovered on the back of higher oil prices, though not to the level it enjoyed before 2008.  

The collapse in oil prices has dragged Gazprom’s value back down again.  It presently stands at no more than $50 billion.

This contraction in Gazprom’s value is commonly blamed on Putin, who supposedly misuses Gazprom as a political tool to serve Russia’s geopolitical interests.  

It is insinuated that the two pipeline deals to China are both uneconomic projects foisted by Putin on Gazprom.  This supposedly is also true of Gazprom’s various European pipeline projects: North Stream, the now cancelled South Stream and Turk Stream (which has replaced South Stream). 

Most Western articles on the subject say that instead of investing in these European pipelines Gazprom should continue to send the bulk of the gas it exports to Europe through the existing Ukrainian pipelines, as it has up to now being doing.

As for the pipeline deals to China, it is said that the fall in the price of oil has rendered them uneconomic, the implication being that Gazprom should pull out of them.

These claims do not just appear in the western media.  They are widely repeated in the Russian liberal media as well.

What however is the truth of these claims?

Turning first to Gazprom and its market value, the initial collapse in Gazprom’s market value - from which it has never really recovered - took place in 2008, well before the two Chinese pipeline deals were agreed.  

North Stream was first discussed in 1997 and was formally launched in 2002, well before Gazprom’s value peaked.  

South Stream was launched in 2007 - as Gazprom’s market value was climbing and approaching its peak - which it did some months later.  

Preliminary agreement for Turk Stream happened in autumn 2014 - long after the peak in Gazprom’s market value had passed.  

It is impossible to see any direct correlation between any of these projects and the rise or fall of Gazprom’s market value or share price.

By contrast - and as one would expect given that it is an energy exporter - Gazprom’s share price has closely tracked the price of its product, which is natural gas.  

Since the price of gas is linked to the oil price, that means that Gazprom’s value has moved in line with the oil price.

Until the first half of 2008 oil prices were spiralling upwards.  They peaked at $150 a barrel in 2008, with Miller predicting they would reach $250 a barrel.  Gazprom’s market value zoomed up in unison, with its share price peaking at around $30 a share 

Expectations of further indefinite oil price increases undoubtedly added to the sentiment and influenced the level of Gazprom’s share price.   It was in this euphoric atmosphere that Miller made his prediction of Gazprom’s value reaching £1 trillion.

In 2008 the oil price collapsed and Gazprom’s share price collapsed with it, falling to $6.50 a share.  

It then recovered with the oil price.  

Oil prices have however never recovered to the level they hit in the first half of 2008, and with sentiment about oil prices being much more negative after 2008, Gazprom’s share price never recovered to its pre-crisis level, peaking at $16.80 a share in April 2011. 

Subsequently, the oil price has fallen again, and Gazprom’s value has gone down with it, with its share price falling to just $6 a share.

The point is sometimes made that Western energy companies do not suffer from anything like the same falls in value when the oil price falls.  

That however says less about Gazprom than it does about the state of Russia’s financial system, which - as we have discussed many times - is too small.  This means that Gazprom does not have the great mass of small and institutional Russian shareholders to support its share price in bad times that western energy companies typically do.

If we put aside the question the size of Gazprom’s market value - something that ultimately depends heavily on sentiment - and look at how well Gazprom actually is doing, then the picture becomes far more favourable.  It turns out that Gazprom is profitable, has an exceptionally strong asset basis, and that its financial position is also strong.

The instability in Gazprom’s market value and its small size relative to the giant scale of its operations is not therefore ultimately a comment on Gazprom - still less on Putin.  It is a comment on the small size of Russia’s financial system, which is too small for Russia’s economy causing it to struggle to cope with a company the size of Gazprom’s.  

The result is that the Russian financial system finds it impossible to price an energy giant of Gazprom’s size properly, which is why Gazprom’s market value is so much smaller than - based on its profitability, financial solvency, asset base and the scale of its operations - it should be.

What then about the economic viability of the two Chinese pipeline projects?

Basically, the two points made by critics are (1) that the fall in the gas price no longer justifies the investment in these projects, with the implication that Gazprom cannot really afford these projects; and (2) that the projects do not make economic sense because Gazprom could sell the gas at a higher price in Europe.

The dollar price of gas has indeed fallen dramatically over the last year. However what critics of the two pipeline projects fail to mention is that as the projects are being built in Russia their cost will be mainly in roubles not dollars.  

The devaluation of the rouble in lockstep with the fall in the dollar price of oil has mitigated the effect on Gazprom’s profit in roubles of its sale of gas priced in dollars.  Gazprom’s reported profit in roubles in the first half of 2015 in fact surged. 

Of course some of the equipment that will be used for the pipelines is imported. However most of the cost - including critically the cost of labour - will be in roubles.  

The rouble’s devaluation therefore means that the cost-benefit dynamic of the two projects has been far less affected by the oil price fall than the critics seem to realise, whilst the level of Gazprom’s profit in roubles means that its ability to fund these projects is not unduly affected.

What of the argument that the projects do not make economic sense because Gazprom can sell its gas instead to Europe for a higher price?

The price the Chinese have agreed to pay for the gas for the first project is not in fact significantly out of line with the price the Europeans pay for their gas.  

However this argument misses the point. Even if the Europeans were paying much more for their gas than the Chinese are prepared to do, that would still not necessarily make the two Chinese projects a bad bargain.

As I have said many times, price is only one factor in a commercial relationship.  

Gazprom is choosing to work with a new partner (China) with which it has a civil if tough-minded relationship, in place of an old partner (Europe) which has imposed sanctions on it, is busy bringing an anti-trust claim against it and which is constantly looking for alternative suppliers.  

It is not surprising that Gazprom prefers its new partner to its old one, even if the new partner will pay a lower price.

What much of the hostile commentary about these two projects anyway misses is any real appreciation of what Gazprom actually is.

Gazprom is not just an energy company. It is the gas export arm of the Russian state, with a legally enshrined monopoly on the export of natural gas from Russia.

The Russian government is Gazprom’s majority shareholder. Government officials - including Alexander Novak - the  country’s Energy Minister - sit on its board.  Gazprom itself was originally a government ministry - the USSR’s Ministry of Gas Industry - a fact confirmed by its name: a contraction of “Gazovaya Promyshlennost” - “gas industry”.

Gas supply agreements made between Gazprom and its customers - including those agreed with China - are not therefore just contracts. They are agreements the Russian government often has a hand in making. They therefore have the status of interstate agreements.

A contract between Gazprom and China to supply China with gas is not just a commercial contract. It is an agreement between Russia and China agreed at the highest level of their governments as part of the strategic relationship they have forged between them.

That does not of course mean that negotiations between Russia and China always happen smoothly or easily.  

Both the Russians and the Chinese are tough hard-headed negotiators who aim for the best possible deal for their countries.  

Neither side will allow itself in negotiating such complex agreements to be boxed in by arbitrary deadlines or by artificial determinations of price intended to benefit disproportionately one side at the expense of the other.  

If nonetheless the two sides decide that it is in their countries’ national interest to come to an agreement, then an agreement will be reached, and the pipelines will be built.

The terms of the first pipeline deal from Russia to China have been agreed, and unless there is a fundamental change in their relationship or a total transformation of the world energy market, it will almost certainty be built.  In fact work has already started.

The terms of the second pipeline deal have not yet been fully agreed. The Russians - in what looks like an opening bid - apparently asked for a very high price for the gas from this pipeline, justified by the supposedly high cost of building it. The Chinese are expected to refuse, and will no doubt in time make a counter-offer.

It is likely that because of the ongoing oil price fall final agreement on this issue will be put back until oil prices have settled so that a proper price formula can be agreed based on actual data -  though it is just possible that agreement could be reached during Putin’s forthcoming visit to Beijing in September. In either case it is unlikely that final agreement will be reached without the two countries’ political leaders becoming involved.

The mere fact that oil prices are currently low will not however stop the two countries from going ahead with the projects.  

As the Russians and the Chinese know - but Western critics of the projects apparently don’t - oil prices that go down one day are certain to go up again some other day.  

Projects of this scale are for the long term. The Russians and the Chinese are not going to be put off building them simply because of short-term fluctuations in the oil price.

Ultimately what Gazprom’s critics and the critics of Gazprom’s Chinese pipeline projects are saying is that Gazprom should content itself with the way things are.  

It should continue to pump nearly all its gas to Europe even as the Europeans sanction it and bring legal proceedings against it and look to replace it with alternative suppliers.  

It should also continue to send its gas to Europe through Ukraine, despite Ukraine having twice interrupted supplies - in 2006 and 2009 - and having threatened to do so again during the gas talks last year.

It is understandable why - writing from a purely Western point of view - Western commentators want this.

It is equally understandable why the Russians and Gazprom don’t want it and won’t accept it and why they are forging ahead instead with their Chinese and other projects.  

If the Europeans feel they have a right to look for alternative suppliers at a higher cost than the Russians will charge, then the Russians have an equal right to look for alternative customers at a lower price than the Europeans will pay.

That this is happening is a consequence of the breakdown in the relationship between Europe and Russia. Ultimately it was the Europeans who - by dragging Gazprom into their disputes with Russia - brought this about. If the Europeans are unhappy with the result, then they have no one to blame for it but themselves.  

In the meantime mendacious commentary that says it is in Russia’s and Gazprom’s interests to act in Europe’s - and Ukraine’s - interests should be seen for the straightforward propaganda masquerading as business analysis that it actually is.

via Marshall Horn, CFTC Why Criticism of Gazprom and the Chinese Pipeline Deals Is Wrong

Marshall Horn - Russia Moves to Attract Islamic Funds

Marshall Horn,

This article originally appeared at Russia & India Report

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Russia may amend its financial regulations to allow Islamic banking in a bid to attract funds from Muslim countries, as its economy struggles with a recession and Western sanctions.

The move comes as economists, including those at the International Monetary Fund, say U.S. and European sanctions are having a significant negative impact on the Russian economy by blocking important Russian companies from accessing global financial markets.

Officials have created a task force charged with implementing Islamic banking in the country, including amending the country’s banking laws, said Dmitry Savelyev, deputy chairman of the State Duma Committee on Financial Markets and the leader of the task group, the TASS news agency reported.

Islamic law, known as Sharia, places restrictions on certain types of financial transactions, such as interest payments. Over the years, a sophisticated field of banking practices compliant with Sharia has arisen to facilitate financial activity among pious Muslims, including the issuance of Islamic bonds, known as “sukuk.”

The market for Islamic finance is expanding rapidly and should reach a total size of $2.6 trillion by 2017, according to a report by global consulting firm PricewaterhouseCoopers. Another estimate by the IMF said total global Islamic assets would reach $3.4 trillion by the end of 2015.

Russia has a significant Muslim minority, estimated at about 15% of the population, which could make the practice attractive here.

Konstantin Baymukhashev, an attorney at UFS IC, said the changes in Russian legislation should help attract investment into the Russian economy from Arab countries.

Attracting Islamic assets

Rustam Minnikhanov, the president of Tatarstan, one of Russia’s predominantly Muslim regions, has been one of the most vocal proponents for bringing Islamic finance to Russia.

“The Muslim countries have not taken part in the attempts to isolate our country on the international stage, and the latest developments in the world economy have shown that Islamic banks can withstand various global crises and complement the global financial system,” Mr. Minnikhanov said in a speech in June at the KazanSummit Economic Forum.

Islamic finance will help Russian companies compensate for the lack of funding caused by the recent deterioration of relations between Russia and the West, he argued.

In July, Mr. Minnikhanov concluded a cooperation agreement with the president of Russia’s largest lender, state-owned retail banking giant Sberbank, involving the development of Islamic banking in Tatarstan.

Ahmed Mohammed Ali Al-Madani of the Islamic Development Bank, a multilateral Islamic lending organization based in Saudi Arabia, told RIR that Sharia-compliant bonds have also been issued by entities based in non-Muslim countries, including the United Kingdom, and that the worldwide amount of such assets has reached $120 billion.

“The republic of Tatarstan could be promoted as an Islamic finance hub within Russia,” Mr. Al-Madani said. Tatarstan’s largest bank, AK Bark, has already attracted some funds based on Islamic investment. Furthermore, in January 2015, local insurance operator Alliance began selling a specialized insurance product called“Halal Invest” that is compliant with Islamic norms.

“This kind of business is gaining momentum around the world, and by developing it in this country, we will diversify sources of funding and increase confidence in the banking system,” said Semyon Nemtsov, an analyst at Russ-Invest investment company.

However, analysts said Russia is unlikely to see a sudden surge of investment from Islamic countries.

“Islamic banking is first and foremost a religious and ideological concept. Its actual financial significance is secondary. This is why there are in fact a great deal of obstacles that hamper its implementation within Russia’s legal and financial system,” said Konstantin Korishchenko, deputy director of the Department of Capital Markets and Financial Engineering at the Russian Presidential Academy of National Economy and Public Administration.

According to Mr. Korishchenko, there are numerous factors that will significantly complicate the alignment of Islamic finance and standardized Western banking, including the facts that Islamic regulations require that assets be sorted according to their source and deny explicit interest payments or futures transactions.

Moreover, Russia is likely to have more difficulties introducing Islamic finance than do common law countries like the UK. The introduction of Islamic banking will require deep, fundamental changes to Russian law.

According to Mr. Baymukhashev, Islamic and Russian banking systems are radically different from each other. “Islamic banks do not provide their clients with loans in the classical sense, but rather sell actual products or act as partners (co-investors) in some kind of a project, thus bearing all the associated risks with the client,” Mr. Baymukhashev explains, adding that Islamic banking also precludes the financing of companies that produce or sell alcoholic drinks.

“The difference between those two financial systems is significant. Amending the law is only a part of the ground we will have to cover while implementing Islamic banking in Russia,” says Mr. Baymukhashev.

via Marshall Horn, CFTC Russia Moves to Attract Islamic Funds