Friday 19th December 2014
NEWS TICKER: THURSDAY DECEMBER 18TH 2014: Scotiabank’s Commodity Price Index dropped -4.8% m/m in November (-6.1% yr/yr) and will end 2014 in a ‘deflationary’ mode, says economist Patricia Mohr. "Significant capacity expansion and the defence of market share by major oil and iron ore producers— against a backdrop of lacklustre world economic growth — account for the softness at the end of the year," she says. Mohr adds that the decision by Saudi Arabia not to reduce output to shore up international oil prices, but instead to allow prices to drop to levels curbing US shale development appears to be having a negative impact on confidence in a wide variety of other commodity as well as equity markets. She predicts prices will fall further this month, but will start to rebound in mid 201 - Jonathan Hill, the EU's financial-services commissioner, says he plans to pursue rules that separate a bank's proprietary trading from retail operations. "The sensible thing to do is to seek to make progress quickly" on the issue, Hill said. "There are still areas of risk in some of the biggest and most complicated banks,” reports Bloomberg- CME Group, said yesterday that it will change daily price limits in its CME Feeder Cattle futures effective today, pursuant to its emergency action authority. The current daily price limit for CME Feeder Cattle futures is $3.00 per hundredweight and will change to $4.50 per hundredweight effective on trade date December 18th Additionally, effective December 19th (tomorrow) these limits will have the ability to expand by 150% to $6.75 per hundredweight on any business day in the event that one of the first two contract months settles at limit on the previous trading day. CME Feeder Cattle futures have been locked limit for five consecutive days as a result of various factors. The change to daily price limits is necessary to ensure continued price discovery and risk transfer, says the CME. Daily price limits for CME Live Cattle futures will remain unchanged at $3.00 per hundredweight. Effective Friday, December 19th, these limits will have the ability to expand by 150 percent to $4.50 per hundredweight in the event that one of the first two contract months settles at limit on the previous trading day - The Straits Times Index (STI) ended +16.42 points higher or +0.51% to 3243.65, taking the year-to-date performance to +2.49%. The FTSE ST Mid Cap Index gained +0.29% while the FTSE ST Small Cap Index gained +0.71%. The top active stocks were Keppel Corp (+2.68%), SingTel (-1.02%), DBS (+2.36%), Global Logistic (-3.21%) and UOB (+0.30%). The outperforming sectors today were represented by the FTSE ST Basic Materials Index (+3.13%). The two biggest stocks of the FTSE ST Basic Materials Index are Midas Holdings (+6.38%) and Geo Energy Resources (unchanged). The underperforming sector was the FTSE ST Telecommunications Index, which declined -0.98% with SingTel’s share price declining -1.02% and StarHub’s share price declining-0.73%. The three most active Exchange Traded Funds (ETFs) by value today were the IS MSCI India (+2.56%), DBXT CSI300 ETF (+0.42%), STI ETF (+0.61%). The three most active Real Estate Investment Trusts (REITs) by value were Ascendas REIT (-0.42%), Keppel DC REIT (unchanged), Suntec REIT (+0.26%). The most active index warrants by value today were HSI23400MBeCW150129 (+7.32%), HSI22600MBePW150129 (unchanged), HSI24000MBeCW150129 (+12.50%). The most active stock warrants by value today were KepCorp MBeCW150602 (+21.95%), DBS MB eCW150420 (+29.29%), DBS MB ePW150402 (-18.03%) - Spain’s Director of Public Prosecutions, Eduardo Torres Dulce, has resigned from the post for “personal reasons”, Spanish daily El Mundo reported this morning. A spokesman for the Public Prosecutor’s office confirmed the news by telephone to The Spain Report, saying that Mr. Torres Dulce had informed Justice Minister Rafael Catalá of his decision: “but that it perhaps would not come into effect until they find a replacement”. That decision is taken at cabinet level. The next cabinet meeting for Rajoy’s government is tomorrow morning - Hedge funds including Marshall Wace, Odey Asset Management and Lansdowne Partners are shorting OTP Bank Plc, a Hungarian lender with a Russian subsidiary whose shares have fallen almost 6% this month reports Albourne Village. All three London-based funds took or increased their position this month in OTP, Hungary’s largest lender, according to data compiled by Bloomberg. The ruble rose today in Moscow after plunging as much as 19%against the dollar yesterday, when Russia’s central bank increased interest rates to 17% percent from 10.5 percent in an attempt to stem the decline. The ruble is down 52% this year and has taken a disproportionate beating in the wake of sanctions and falling oil prices. The country still has the third largest currency reserves in the world and so is unlikely to default. According to Eric Chaney, Manolis Davradakis and Greg Venizelos from AXA IM’s Research and Investment Strategy team Russia will likely resort to fiscal stimulus to contain the risk of social and political unrest. Capital controls, political unrest and even default on private hard currency debts are possible outcomes they say. They credit default swaps market is pricing a one-third probability of sovereign default within five years - Indonesia is ramping up financing for its $439bn development program, planning an almost fivefold increase in sales of project sukuk. The government is seeking to raise IDR7.14trn rupiah (around $568m) from notes that will fund particular construction ventures next year, compared with IDR1.5trn this year, which say local press reports, will help finance its estimated spending of about IDR5,519trn from 2015 to 2019 to build roads, railways and power plants.

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The European Review

By Patrick Artus, chief economist at Natixis

The Calculation for Spain

Tuesday, 31 July 2012 Written by 
The Calculation for Spain To alleviate its debt and escape its state of crisis, we think Spain has two strategies to choose from. The first one, already in place since 2009, involves a reduction in the fiscal and external deficits while accepting aid from other eurozone countries. If Spain were to continue with this strategy, it would need to incorporate regular debt purchases by the ECB and possibly the ESM, and provide assistance to recapitalise its banks. The second strategy would be to leave the euro, which would mean a default on its gross external debt and a sharp devaluation of its currency. Both of these strategies contain negatives that need to be considered: the question is, which one would be the least detrimental to the country’s economic future? http://www.ftseglobalmarkets.com/

To alleviate its debt and escape its state of crisis, we think Spain has two strategies to choose from. The first one, already in place since 2009, involves a reduction in the fiscal and external deficits while accepting aid from other eurozone countries. If Spain were to continue with this strategy, it would need to incorporate regular debt purchases by the ECB and possibly the ESM, and provide assistance to recapitalise its banks.

The second strategy would be to leave the euro, which would mean a default on its gross external debt and a sharp devaluation of its currency.

Both of these strategies contain negatives that need to be considered: the question is, which one would be the least detrimental to the country’s economic future?

Strategy One: Spain's present strategy of adjustment...A Catch-22 situation?

Spain’s high levels of external debt mean it cannot increase its external borrowing (except for emergency borrowing from the EU or the ECB). Therefore, it must balance its current account.



Its present strategy of adjustment is clear: a restrictive fiscal policy; an improvement in cost-competitiveness to rebalance foreign trade; and the acceptance of European aid to recapitalise banks in distress. The last action hinges on purchases of government bonds to push down long-term interest rates. However, this strategy is risky.

A scenario may help us better understand this strategy: a fall in real wages due to price-stickiness discourages household demand, which has a knock-on effect to make business investment decline. Hence, there is a major decline in domestic demand and activity, making it very difficult to reduce fiscal deficit. In early 2012 we saw this in action when Spain’s fiscal deficit widened considerably, due both to tax revenue short-falls and higher-than-expected government spending. A continuation of this strategy therefore may lead to a further increase in unemployment and a decline in activity.

There could also be a reduction in the external deficit due to the decline in purchasing power. That said, imports would have to be reduced by a further 20% for Spain's current account deficit to disappear, which would mean a decline of at least 12% in domestic demand and real income.

The only hope for this strategy is that improvements in cost-competitiveness could increase Spain's exports and market share, and improved profits could eventually increase business investment.

Strategy Two: Exit from the euro, default and devaluation...A possible solution or suicide?

The other strategy would be for Spain to leave the euro, sharply devalue its currency, and inevitably default on its gross external public and private debt. This would obviously be a big problem for Spanish multinational companies, given the size of debt and the impossibility of servicing it following devaluation.

But what would the likely consequences of this strategy be?

For a start, it requires an immediate rebalancing of foreign trade. The country could no longer borrow, which would result in a much weaker economic situation in the short term.

Our econometric estimate shows elasticity to the real exchange rate of 0.73 for Spain's exports and 0 for imports, in volume terms. If we assume 30% devaluation, the foreign trade gain in volume terms would be 7.7 percentage points of GDP, which is very substantial.

Devaluation would increase the price of imports and therefore reduce real income by about 5.9 percentage points, which would leave a net gain of approximately 2 percentage points of GDP.

When the Spanish peseta was devalued in the early 1990s (twice in 1992, once in 1993), the current account deficit disappeared in 18 months, exports accelerated strongly, while domestic inflation reacted only slightly to the rise in import prices. The decline in GDP only lasted one year, and from that point growth was strong because of falling interest rates.

In today’s instance, devaluation would also increase the competitiveness of tourism and increase the surplus for these services in local currency, though perhaps not in foreign currencies such as the euro.

As financing becomes completely domestic, it is not impossible that there could be a reduction in the sovereign risk premium.

Devaluation could subsequently attract direct investment by businesses. With 30% devaluation, for example, labour costs in Spain would fall to EUR 14 per hour, 60% less than in Germany. However, since the size of Spanish industry is relatively small, new activities need to be considered for it to generate a large surplus.

Conclusion: What strategy to choose for Spain?

If the improvement in Spain's cost-competitiveness and profitability does not produce quick results, the present strategy will fail: wages would have to be reduced on a greater scale to eliminate the external deficit, and the fiscal deficit would remain very high.

The other strategy (leaving the euro, devaluation and default) could be successful if the devaluation attracted new activities, but it involves a lot of uncertainties – such as the impacts on Spanish multinationals, interest rates and foreign trade.

As stated earlier, both strategies are rather bleak, but positive aspects are still evident. Considering all of the factors, we believe that the strategy of devaluation and default could be the most efficient, particularly due to the high price elasticity of exports and the fact that Spain's entire current account deficit is accounted for by the interest on its external debt. As in 1992, it could also be effective due to the domestic financing of fiscal deficits, which will prevent a rise in interest rates.

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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