Saturday 30th April 2016
NEWS TICKER: Central bank policy is still dominating the trading agenda, even though most analysts believe that the Fed will, if it does move, move only once this year and will raise rates by a quarter of a percent. The statement of the US FOMC was terse and most likely signals extreme caution on its part, though there is a belief that hawkish voices are rising in the committee. The reality is though that the US economic growth story is slowing. Many think the June meeting will spark the uplift. Let’s see. The US dollar is continuing to lose ground across the board after data showed the US economy expanded at its slowest pace since the second quarter of 2009, according to the BEA, which FTSE Global Markets reported on last Friday. GDP increased at a 0.5% annualised rate - versus an expected 0.7% - after rising 1.4% in the fourth quarter of 2015 as personal consumption failed to boost growth in spite of low gasoline prices. Central bank caution makes sense in that context, however timing will be sensitive. If the central bank moves in the autumn it threatens to unbutton the presidential elections; but the reality is that mixed data will emanate from the US over this quarter which will make a June decision difficult. It’s tough being an FOMC member right now. The Bank of Japan meanwhile signalled its intention to stay the course this week with current policy, which discombobulated the markets. The Japanese markets were closed today for a public holiday, so it won’t be entirely clear if the market will suffer for the central bank’s decision. Certainly if fell 3.61% yesterday and is down 5% on the week. so the omens aren’t great. Of course, the pattern that is well established of late is that as the market falls, the yen appreciates. The yen was trading at 107.14 against the dollar last time we looked, compared with 108 earlier in the session, having at times touched 111/$1 yesterday (the lowest point for more than 18 months) The month to date has seen a rise in both the short term and long term volatility gauges. Coinciding with the rise, Nikkei 225 Index Structured Warrant activity has also significantly picked up. Nikkei 225 Structured Warrants showed increased activity with daily averaged traded value up 33% month-on-month. The Nikkei 225 Index Structured Warrants had significant increase in trading activity year-on-year with total turnover up by 6.8 times. – ASIAN TRADING SESSION - Australia's ASX 200 reversed early losses to close up 26.77 points, or 0.51%, at 5,252.20, adding 0.3% for the week. The uptick today was driven by gains in the heavily-weighted financials sub-index, as well as the energy and materials sub-indexes. In South Korea, the Kospi finished down 6.78 points, or 0.34%, at 1,994.15, while in Hong Kong, the Hang Seng index fell 1.37%. Chinese mainland markets were mixed, with the Shanghai composite dropping 7.13 points, or 0.24 percent, at 2,938.45, while the Shenzhen composite finished nearly flat. The Straits Times Index (STI) ended 12.42 points or 0.43% lower to 2862.3, taking the year-to-date performance to -0.71%. The top active stocks today were SingTel, which gained 0.26%, DBS, which declined 1.03%, NOL, which gained closed unchanged, OCBC Bank, which declined 1.00% and CapitaLand, with a 0.63% fall. The FTSE ST Mid Cap Index gained 0.60%, while the FTSE ST Small Cap Index rose 0.49%. Structured warrants on Asian Indices have continued to be active in April. YTD, the STI has generated a total return of 1.3%. This compares to a decline of 4.9% for the Nikkei 225 Index and a decline of 6.3% of the Hang Seng Index. Of the structured warrants available on Asian Indices, the Hang Seng Index Structured Warrants have remained the most active in the year to date with Structured Warrants on the Nikkei 225 Index and STI Index the next most active – FUND FLOWS – BAML reports that commodity fund flows went back to positive territory after taking a breather last week, supported again by inflows into gold funds. “The asset class is currently the best performer, with year to date % of AUM inflow at 15%, far ahead of all other asset classes. Global EM debt flows reflected the bullish turn of the market on EMs, recording the tenth consecutive week of positive flows. On the duration front, short-term funds recorded a marginal inflow, keeping a positive sign for the last four weeks. The mid-term IG funds continue to record strong inflows for a ninth week. But it looks like investors have started to embrace duration to reach for yield, as inflows into longer-term funds have recorded a cumulative 0.8% inflow in the past two weeks,” says the BofA Merrill Lynch Global Research team – GREEN BONDS - Banco Nacional de Costa Rica is the latest issuer with a $500m bond to finance wind, solar, hydro and wastewater projects. The bond has a coupon of 5.875% and matures on April 25th 2021. Banco Nacional will rely on Costa Rican environmental protection regulations to determine eligible projects. This is the fourth green bond issuance in Latin America, according to the Climate Bonds Initiative (CBI). Actually, Costa Rica is one of the global leaders in terms of renewable energy use. In the first quarter of 2016 it sourced 97.14% of its power from renewables. Hydro's share alone was 65.62%. – SOVEREIGN DEBT - After coming to market with a 100 year bond last week, the Kingdom of Belgium (rated Aa3/AA/AA) has opened books on a dual tranche bond; the first maturing in seven years; the second in 50 years, in a deal managed by Barclays, Credit Agricole, JP Morgan, Morgan Stanley, Natixis and Société Générale. Managers have marketed the October 22nd 2023 tranche at 11 basis points (bps) through mid-swaps and the June 22nd 2066 tranche in the high teens over the mid of the 1.75% 2066 French OAT – LONGEVITY REINSURANCE - Prudential Retirement Insurance and Annuity Company (PRIAC) and U.K. insurer Legal & General say they have just completed their third longevity reinsurance transaction together, further evidence that longevity reinsurance continues to be a vehicle for UK insurers seeking relief from pension liabilities exposed to longevity risk. “This latest transaction builds on our relationship with Legal & General and solidifies the platform from which future business can be written,” explains Bill McCloskey, vice president, Longevity Risk Transfer at Prudential Retirement. “It's also a testament to our experience in the reinsurance space and our capacity to support the growth of the U.K. longevity risk transfer market.” Under the terms of the new agreement, PRIAC will issue reinsurance for a portion of Legal & General's bulk annuity business, providing benefit security for thousands of retirees in the UK. PRIAC has completed three reinsurance transactions with Legal & General since October 2014 – VIETNAM - Standard & Poor's Ratings Services has affirmed its 'BB-' long-term and 'B' short-term sovereign credit ratings on Vietnam. The outlook is stable. At the same time, we affirmed our 'axBB+/axB' ASEAN regional scale rating on Vietnam. The ratings, says S&P, reflect the country's lower middle-income, rising debt burden, banking sector weakness, and the country's emerging institutional settings that hamper policy responsiveness. Even so, the ratings agency acknowledges these strengths are offset by Vietnam's sound external settings that feature adequate foreign exchange reserves and a modest external debt burden. The country has a lower middle income but comparatively diversified economy. S&P estimates GDP per capita at about US$2,200 in 2016. “Recent improvements in macroeconomic stability have supported strong performance in the sizable foreign-owned and export-focused manufacturing sector (electronics, telephones, and clothing). This strength will likely be offset by weaker domestic activity as the impetus to growth stemming from low household and company sector leverage is hampered by weak banks and government enterprises, and shortfalls in infrastructure. We expect real GDP per capita growth to rise by 5.3% in 2016 (2015: 5.6%) and average 5.2% over 2016-2019, reflecting modest outlooks for Vietnam's trading partners. Uncertain conditions in export markets and the slow pace in addressing government enterprise reforms, fiscal consolidation, and banking sector resolution add downside risks to this growth outlook – RUSSIA - Russia's central bank held interest rates steady at 11% today, in line with expectations, although it hinted that if inflation kept on falling it would cut soon. Last month, the bank held rates steady, warning that inflation risks remained "high" and that the then oil price rise could be "unsustainable." However, the decision came at a time of renewed hope for Russia's beleaguered economy and the country's oil industry with commodity prices showing tentative signs of recovery. The central bank noted that it "sees the positive processes of inflation slowdown and inflation expectations decline, as well as shifts in the economy which anticipate the beginning of its recovery growth. At the same time, inflation risks remain elevated." Yann Quelenn, market analyst at Swissquote explains: "The ruble has continued to appreciate ever since it reached its all-time low against the dollar in early January. At that time, more than 82 ruble could be exchanged for a single dollar note. Now, the USDRUB has weakened below 65 and even more upside pressures on the currency continue as the rebound in oil prices persists. The outlook for Russian oil revenues is more positive despite the global supply glut. Expectations for increased oil demand over the coming years and the fear of peak oil are driving the black commodity’s prices higher – MARKET DATA RELEASES TODAY - Other data that analysts will be looking out for today include Turkey’s trade balance; GDP from Spain; the unemployment rate from Norway; mortgage approvals from UK; CPI and GDP from the eurozone; CPI from Italy; and South Africa’s trade balance – FTSE GLOBAL MARKETS – Our offices will be closed on Monday, May 2ndt. We wish our readers and clients a happy and restful May bank holiday and we look forward to reconnecting on Tuesday May 3rd. Happy Holidays!

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Is Greece offered any other choice to a slow death and a sudden death?

Friday, 06 July 2012 Written by 
Is Greece offered any other choice to a slow death and a sudden death? The adjustment programme that Greece is putting in place with the Troika, even if it is toned down and spread out over time, will eventually lead to a fall in Greeks' purchasing power until Greece's external deficit disappears. And in light of Greece's economic structure and the disproportion between its imports and exports, this will imply a collapse in living standards in Greece. The other possibility for Greece is to leave the euro and massively devalue its currency, but this would instantly mean a loss of purchasing power due to the deterioration of the terms of trade, and a massive decline in domestic demand, which would in any case be inevitable because there would then be no more lenders to finance Greece's external deficit. http://www.ftseglobalmarkets.com/

The adjustment programme that Greece is putting in place with the "Troika", even if it is toned down and spread out over time, will eventually lead to a fall in Greeks' purchasing power until Greece's external deficit disappears. And in light of Greece's economic structure and the disproportion between its imports and exports, this will imply a collapse in living standards in Greece. The other possibility for Greece is to leave the euro and massively devalue its currency, but this would instantly mean a loss of purchasing power due to the deterioration of the terms of trade, and a massive decline in domestic demand, which would in any case be inevitable because there would then be no more lenders to finance Greece's external deficit.

For Greece to escape a slow death (austerity programme) or a sudden death (exit from the euro), a massive European aid plan would be needed to rebuild the Greek economy and create jobs, a plan that is unlikely at present, and very different from the present bailout which merely finances debt servicing on Greek government bonds held by public investors.

The logic of the adjustment programme for Greece: Slow death



Even if Greece and the Troika renegotiate the adjustment programme, its fundamental characteristics will remain the same:

·                                  a restrictive fiscal policy to eliminate the fiscal deficit;

·                                  a fall in wages to improve competitiveness and reduce domestic demand, until Greece's external deficit disappears.

The main idea of the adjustment programme is that Greece's domestic demand exceeds its production capacity, thereby generating a structural external deficit. So Greeks "are living beyond their means", with a rise in living standards far exceeding growth in production capacity, and it is therefore legitimate to reduce domestic demand both through a restrictive fiscal policy and wage cuts.

The fall in wages could also bring about an improvement in competitiveness, hence an improvement in foreign trade, but its main objective is to reduce domestic demand and imports.

The problem with this approach is that:

·                                  it is showing its ineffectiveness: despite the decline in domestic demand, the current-account deficit has declined little; due to the shortfall in activity, public finances are no longer improving;

·                                  its cost in terms of jobs and purchasing power is gigantic. Greece is a country in which the weight of industry is very small and where, as a consequence, the disproportion between imports and exports is very great.

A substantial decline in purchasing power in Greece is therefore needed to eliminate the external deficit, with a further fall of about 30% in real wages. Purchasing power would have to be brought back to the level of the early 1990s to balance the current account, and this is of course rejected by the population. The fundamental problem is twofold:

·                                  even if there is a fall in wages, the improvement in price-competitiveness is limited by price stickiness;

·                                  since the size of industry is small, the adjustment must be achieved mainly through a fall in imports, hence a decline in income.

Exit from the euro and devaluation: Sudden death

Faced with this prospect of a "slow death" due to the austerity programme, Greeks could decide to leave the euro and devalue. But in that case the shock would be sudden and terrible, because there would be both:

·                                  a rise in import prices;

·                                  an obligation to eliminate the external deficit, because no one (neither the private sector nor the public sector) would any longer lend to Greece;

·                                  a weak positive impact of the gain in competitiveness, due to the small size of industry.

Greece would default on its gross external debt, and would therefore no longer have to service that debt, which is positive (it would gain six percentage points of GDP in interest payments on external debt). But the rise in import prices would even further exacerbate the foreign trade imbalance, while the potential for external borrowing would disappear. There would inevitably have to be a reduction in domestic demand to restore the foreign trade balance despite the rise in import prices, hence inevitably a collapse in imports in volume terms.

This is reminiscent of the process in Argentina, in similar circumstances, in the early 2000s: a collapse of activity following the huge devaluation, the need to switch to a current-account surplus which required dividing imports by three - hence a collapse in the real wage due to imported inflation, and in domestic demand and employment.

From 2003 onwards, there was  a sharp improvement in Argentina's situation, but it is important to remember that it had considerable structural advantages by comparison with Greece at present:

·                                  substantial weight of industry (22% of jobs);

·                                  before the crisis, exports and imports of the same size;

·                                  a smaller current-account deficit to reduce (five percentage points of GDP).

The shock would be far more violent and prolonged for Greece.

So what would be the solution for Greece?

We have seen that Greece is at present offered two solutions:

·                                  a "slow death", through a stifling of the economy via the austerity plan, even if it is softened down;

·                                  a "sudden death", if there is an exit from the euro and devaluation.

In either case, gradually or suddenly, there must be a substantial decline in purchasing power to eliminate the external deficit which is no longer financeable. For Greece to escape this dreadful choice, Europe's aid would have to be allocated not to debt servicing on Greece's government bonds held by public investors (EFSF, ECB) - which in and of itself is an incredible situation where Europe is borrowing in order to pay to itself the servicing of the Greek debt it holds - but to help rebuild the Greek economy and create jobs, which is definitely not being done at present.

Patrick Artus

A graduate of Ecole Polytechnique, of Ecole Nationale de la Statistique et de l'Adminstration Economique and of Institut d'Etudes Politiques de Paris, Patrick Artus is today the Chief Economist at Natixis. He began his career in 1975 where his work included economic forecasting and modelisation. He then worked at the Economics Department of the OECD (1980), before becoming Head of Research at the ENSAE. Thereafter, Patrick taught seminars on research at Paris Dauphine (1982) and was Professor at a number of Universities (including Dauphine, ENSAE, Centre des Hautes Etudes de l'Armement, Ecole Nationale des Ponts et Chaussées and HEC Lausanne).

Patrick is now Professor of Economics at University Paris I Panthéon-Sorbonne. He combines these responsibilities with his research work at Natixis. Patrick was awarded "Best Economist of the year 1996" by the "Nouvel Economiste", and today is a member of the council of economic advisors to the French Prime Minister. He is also a board member at Total and Ipsos.

Website: cib.natixis.com/research/economic.aspx

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