MBS Blog

This is the right way to close out 2008!! The most tumultuous year in decades was a turning point for everyone in the wake of a global economic tsunami.  As the tide recedes…the doubters, deniers, dreamers and dogmatists some of whom once thought socialism was the way forward, have begun to pillory the very system that has brought the greatest amount of wealth, prosperity and progress to humankind.  Capitalism..or at least what is referred to describe the current system-if that is possible-is again the enemy. 

On the eve of a new year, Caroline Baum writing on www.bloomberg.com , nails the manifesto-however old and tattered- to the public square of the internet for all to see. In the light of examination and reflection, her thesis stands.

Happy New Year from MBS, Ltd!

Capitalism Is Worst System Except for the Rest

Commentary by Caroline Baum

Dec. 30 (Bloomberg) — The year 2008 will be remembered as one that exposed the fatal flaws in free-market capitalism, sending it to an untimely death.

Or will it?

That capitalism’s obituary is already being written suggests the enemies of the free market were waiting to pounce.

Last week, Arianna Huffington, co-founder of the Huffington Post, wrote that laissez-faire capitalism, “a monumental failure in practice,” should be “as dead as Soviet Communism” as an ideology.

On National Public Radio, Daniel Schorr pronounced “the death of a doctrine” in his year-end review.

All I could think of was Winston Churchill’s assertion about democracy. Capitalism is surely the worst economic system, except for all the others that have been tried.

With its ideology under fire and its practice falsely maligned, it is to the defense of free markets that I devote my final column of the year.

Before you can declare free markets a failure, you have to establish that they exist, says Paul Kasriel, chief economist at the Northern Trust Co. in Chicago.

“We do not have free markets in credit in the U.S. or anywhere else that I know of,” he says. “The price of short- term credit is fixed by central banks. It would only be by accident that a central bank would fix the price of short-term credit” at the precise level that a free market would.

Chosen People

Fixing the price of any other commodity, including labor, has proven to be a failure, an affront to the inviolable invisible hand. Yet when it comes to setting the interest rate that will keep the economy on an even keel, we put our faith in a chosen few to get it right.

All sorts of unintended consequences flow forth from central bankers’ fixing of a short-term rate. Hold the rate too low, and it leads to a misallocation of capital into, say, housing or dot- com stocks. That’s what happened in the late 1990s and again in the early part of this decade.

“We are now experiencing the economic and financial market fallout from (Alan) Greenspan’s interference with the free market,” Kasriel says.

In a true free market, risk-takers are punished for bad bets. Not so in the current crisis, where financial institutions — with the exception of Lehman Brothers — are deemed too big to fail and rescued, merged or recapitalized.

Army of Regulators

One supposed nail in capitalism’s coffin is the assertion that deregulation created the problems. This is curious, given that banks, which are at the root of the credit crunch, are among the most highly regulated institutions.

“There is a small army of people overseeing the banking industry,” says Paul DeRosa, a partner at Mt. Lucas Management Corp. in New York. And yet “we’ve had a banking crisis every 15 years since 1837. The number of people devoted to regulation doesn’t seem to matter.”

Regulators from the Federal Reserve, Securities and Exchange Commission, Office of the Controller of the Currency and New York State Banking Commission are “on the premises 365 days a year,” he says.

The regulatory structure may have been antiquated and overlapping. That’s no excuse for the regulators to be caught napping.

Censuring the free market is a way of deflecting blame from the true source, according to Dan Mitchell, senior fellow at the libertarian Cato Institute in Washington.

Compromised Overseers

“The genesis of the problem is bad government policy,” Mitchell says, pointing to everything from easy money to “affordable lending schemes” to the “corrupt system of subsidies from Fannie Mae and Freddie Mac” to the tax code’s favorable treatment of debt (the interest is deductible) versus equity.

Fannie’s and Freddie’s generous campaign contributions (anywhere else, these would be called bribes) encouraged Congress to look the other way as the two housing finance agencies used their implicit government guarantee to increase their leverage and buy riskier mortgages.

Those clamoring for more regulation as a solution to the current crisis are forgetting that Congress has oversight responsibility for the regulator of those agencies.

“I have no confidence regulation will solve the problem,” says Allan Meltzer, professor of economics at Carnegie Mellon University in Pittsburgh. “Lawyers and bureaucrats make regulations. Markets figure out how to circumvent the costly ones.”

Imperfect Like Us

As a case in point, Meltzer pointed to the Basel Accords, which “required banks that hold more risky assets to hold more reserves. So they held them off their balance sheet, where they went from being poorly monitored to not monitored at all.”

Capitalism has spread across the globe, lifting millions out of poverty as “a direct consequence of government stepping out of the way,” DeRosa says.

Yet critics of free-market capitalism are implicitly arguing for a bigger role for government.

Alas, government isn’t some benevolent matriarch acting in the public interest, even if it knew what that was. It is a conglomeration of politicians acting in their own self-interest, guided by payoffs from special-interest groups. That’s a poor substitute for the market’s price signals, not to mention a guarantee of inefficiency and waste.

“Capitalism is the only system that produces both growth and freedom,” Meltzer says. Unlike socialism and communism, “it doesn’t depend on someone’s ideas of perfection.”

Yes, markets are guilty of excess, greed, even corruption.

“We’re not perfect people,” Meltzer says. “Capitalism matches mankind.”

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Went for a run early morning this Christmas Day here in Odessa. At the end of my run on the historic Primorskiy Bulvar not far from the Potemkin Steps, I noticed a throng of people holding banners and flags saying, “I speak Russian!”  I talked with a few observers and apparently people were peacefully protesting the increasing statutory imposition of the Ukrainian language in all aspects of life.

The Ukrainian Parliament recently passed a law that required TV, advertising and motion pictures to be in the Ukrainian language only. Television programs and movies are now required to be dubbed into the Ukrainian language. It is kind of strange as you can still hear the original language (Russian, English, French and Italian) with dubbed Ukrainian overlayed at a higher volume. For me, it is annoying but educational, as I can pick up some of the local language easier. For many Ukrainians, it is more than an annoyance.  

I have heard that some people walked out of a movie theatre showing the latest James Bond film due to this dubbing. The mediocre film (everyone is a movie critic) might have been a motivating factor as well. Nontheless, many people are feeling very uncomfortable with the change.

Amongst the Russian speaking population in Ukraine-and this would include the population in the South and East of Ukraine, but in reality…most of Ukraine-Russian is the language of choice.  Ukrainian is used more widely in Kyiv and in western cities like Lviv, but everyone understands the Russian language due to the Soviet “occupation” if  you will.

This brings many issues to fore. Ukraine is a divided nation and unable to reconcile its past. This is keeping it from moving forward to achieve its full potential. Of course, I am a guest in this nation and I tread as softly as I can. However, it pains one…and there are many who feel the same… to think that a country like Ukraine-which has so much to offer…and so much to gain, cannot seem to break the shackles of its past.

This does NOT mean that Ukraine should purge itself of its Russian ties and past-regardless of the pain associated with it (Holodomar for example). Russia and Ukraine are bound together on so many levels that neither can be separated to the extent that they may seek. In a sense, both Russia and Ukraine-as peoples and as cultures…are parents of children. They can “divorce,” but they will always be tied by their mutual connection to their offspring. The descendents are the modern nations of Russia and Ukraine, both born in Kyvian Rus. 

While it understandable that Ukraine would want a separate identity as much as sovereignty, it needs to chart a course that takes into account the Russian within and without. It is not just about the power of Russia or Russian influence-though this is important and cannot be ignored-but also about the positive aspects of these ties. One can wish that Russia had a different type of government, economy or leadership, but Russia will always be there, and defiantly so.

Geography may be destiny but it is up to people to shape that destiny. Ukraine has a unique opportunity because of geography. As the “borderlands” between what is East and West, Christian and Islamic, between Europe-now the expansionist European Union- and Russia..which is European and Asian, and neither…Ukraine is perfectly situated to take advantage of its position. The model for Ukraine should be Switzerland. 

Why Switzerland? Well…Switzerland was at one time a poor agricultural country bordered by neighbors who could be hostile and threatening. The multi-ethnic Swiss were able to transform their nation into an economic powerhouse while maintaining their sovereignty. Of course, the indomitable Alps helped keep Switzerland secure to a great extent. However, there other factors.

The most important of these was the establishment of a federal republic in Switzerland. Each canton…which is like a state…has an enormous degree of autonomy within the Swiss Confederation.  Every canton sets its own tax policy that allows for competition and economic growth. Imagine if Ukraine’s provinces (called Oblasts) were allowed to compete with each other? This would increase the efficiency of the overall economy.

The acceptance, indeed the promotion of multiple languages within Swiss society also gives the nation an advantage. The Swiss speak the languages of Europe and the international language: English. As any visitor to Zurich, Geneva and Lugano can tell you, each region or canton has a dominant language, but all are officially recognized.

Official recognition and acceptance should be the aim of Ukraine. In this way, the friction, factions and “Balkanization” in a multi-lingual society are kept to a minimum. This could give Ukraine an advantage over Russia as well as other East European neighbors, especially if Ukraine ALSO adopted English as an official language. 

There are other steps Ukraine could take:

1. Neutrality- A neutral Ukraine would be a secure Ukraine. Ukraine has a large enough population to raise a sizeable military force in addition to the force it already has. Neutrality…which would mean NO to NATO, would also signal to Russia that Ukraine was not a threat, while also reminding Russia of Ukraine’s determination to maintain her sovereignty. For Russia, a neutral Ukraine is a buffer against any encroachment-perceived or real- by Europe or any other alliances that exist today or in the future.
2. Economic Independence- like Switzerland, Ukraine should say NO to the European Union. It is the EU that needs Ukraine more than Ukraine needs Europe. The recent rejection of a membership action plan (MAP) for Ukraine into NATO…which is also seen as a precursor to EU membership, could be remembered as the strongest nail in the NATO coffin. However, Ukrainians- a majority of whom do not want to be in NATO-should thank the vision less politicians in Western Europe.  Ukraine needs to have the flexibility to develop in its own way, while having the ability to foster direct bi-lateral ties with the West as well as Russia. By staying out of the EU, Ukraine can realize its potential as an emerging market making its own decisions with nations such as China, India and the USA. 
3. Free Market Economy- Ukraine should continue the reforms it has begun towards liberalization of the economy. Low taxes…which the EU cannot compete against due to its bias towards the type of socialism that Ukraine experienced under the Soviets, as well as its aging populations dependent on weath transfers to the most unproductive parts of its economy…would attract companies as well as stimulate entrepreneurship. Currently, Ukraine is too dependent on the steel industry. It needs foreign investment and technology, especially in the agricultural sector as well as development of its banking sector. Imagine if Ukraine established the same type of  bank secrecy laws that made Switzerland prosperous? Europeans, and especially Russians, would flock to Ukraine to save and invest.
4. Crimea- When Ukraine has taken the steps above, the government in Kyiv might want to propose a referendum for residents of Crimea. In this way, those in Crimea can choose whether they want this region to be part of Russia again, or remain in the new Ukrainian Confederation (thinking Swiss again). While most in Crimea have expressed their preference for Russia, they could decide differently if  Ukraine were on a different path than its current course. This could also preempt an almost certain move by Russia to retake Crimea overtly, or through the fait-accompli of passport issuance by Moscow. It would also strengthen Ukraine as a democracy ruled by law and the consent of the people….even those that speak Russian by choice.

It may be too much to hope for, but if Ukraine were to take some of these steps, it could go a long way towards making this nation prosperous, as well as limit the damage caused by 21st century version of the  ”Great Game,” where Ukraine has been reduced to the status of a pawn, ready to be sacrificed at the whims of others.

Technorati Tags: Christmas Day, Anton Olff, MBS Ltd., Odessa, Ukraine, Primorskiy Bulvar, Russian language, Ukrainian language, Ukrainian Parliament, TV, advertising, motion pictures, English, French, Italian, dubbing, James Bond, South Ukraine, East Ukraine, Kyiv, Lviv, Soviet occupation, Soviet union, Russian culture, Kyvian Rus, Holodomar, geography, Switzerland, European Union, Christian, Islamic, Asia, agricultural, multi-ethnic, Swiss Confederation, Oblasts, cantons, Zurich, Geneva, Lugano, balkanization, factions, official language, neutrality, sovereignty, NATO, China, India, USA, socialism, banking sector, agricultural, entrepreneurship, Crimea, Great Game

Ukraine risks mass worker protests

The last week here in Ukraine has been interesting. Just when you think you have seen or heard it all, you get surprised. Well…the surprise for us here “on the ground” are the depths people will go to convince themselves that things are OK when they know they are not.

I am referring-indirectly-to the real estate market here in Ukraine. While there are new market realities, it seems that the average Ukrainian, and landlords in particular, have not gotten the message. Many still believe that the global economic crisis is happening somewhere else to someone else. Of course, the standard line in Russia and Ukraine is that it is America’s fault.

Even as their friends are fired from jobs, or their own pay is cut or their salary unpaid for the last 3 months, there is a stubborn streak within the Ukrainian soul that does not allow it to acknowledge the obvious. Of course, there is a global economic crisis out there and everyone, everywhere is affected. Wealth, businesses and jobs are disappearing.

As we have noted on this site for the last month, the value of the Ukrainian currency is evaporating quicker than a drop of water in the desert. You would think that would change the perspective of people here.  

When I went to look at a new apartment for myself over the last week, few of the landlords I met with considered negotiating the rents down a bit from pre-crisis bubble prices…even when foreign currency is offered as the form of payment. You would think they would look at the value of the hryvnia shrinking every day and be happy to take a bit less, knowing that they are being paid in a currency that still has some value (for how long Mr. Obama and Mr. Bernanke?).

Of course, the Ukrainian Government is playing the “if you can’t beat them, confuse them” strategy with the currency. A late week intervention by the Government pushed the value of the hryvnia  up quite a bit. Naturally, people took that as a sign that things weren’t that bad after all (those Americans are just spreading gloom and doom!!) so they stopped talking real estate price adjustments, and went shopping. Reports from friends in four Ukrainian cities suggest that the crowded stores I was seeing here in Odessa were no aberration.

Well…the news this morning was that the Prime Minister (the super wealthy blonde with the braid) had accused the President (the formerly handsome one of Orange Revolution fame) of playing currency games so that his cronies could make some money on some contrarian bets. Of course, as soon as the games end the hyrvnia will go back to its original trajectory (it has dropped over 50% since May 2008). Is the IMF watching?

Meanwhile, I am out of the market until after the holidays. I figure once the holidays end, the “hangover” is going to be just the time to talk with people about real estate. In fact, many of businessmen we know are headed here from Europe and the USA, but with investment real estate plans on their minds.

Technorati Tags: Ukraine, currency, hryvnia, Ukrainian Government, President Obama, Prime Minister, President, Orange Revolution, USA, IMF, Ben Bernanke, , Anton Olff, real estate, rentals, landlords, Russia, global economic crisis, wealth, regulations,

Here is the weekend update from MBS staff…and an article from www.businessneweurope.eu

While we agree with much of Ben here, we note the wide disparity not only between Ukrainian Government projections-which are optimistic to say the least-but also among the various firms tracking the Ukrainian economy.

We find it ironic that Ukraine’s economy is considered more diverse than many other economics, yet the emphasis is still on steel prices. The consensus would be that it is the lynchpin of the Ukrainian economy.

The one thing we believe will happen are more privatizations. We also don’t think the Ukrainian Government projection of a 7.30 hryvnia to the U.S. dollar as the average rate for 2009 is realistic. We believe the hryvnia will depreciate further in 2009. That could however, accelerate reforms. However, Ukraine will have to endure economic pain during that transition period. 

UKRAINE 2009: tough times ahead

Ben Aris in Berlin  December 20, 2008                Ukraine will have a harder time of it in 2009 than any other country in the region. It enters the year in recession and the prospects for growth in the second half of the year depend heavily on what happens to the global economy.  In general, the economy remains more resistant to external shocks, as it is relatively well diversified by Eastern European standards and the large consumer base helps. However, public finances are in mess and monetary policy is weak. The banking system was also teetering on the brink of collapse in late 2008 when the National Bank of Ukraine had to resort to administrative measures to prevent bank runs and a total meltdown.  The crisis was feeding through into the retail sector by the end of 2008 as retail turnover fell by 1.1% in November after growing by 16% the month before, bringing a consumer boom that has been running for years to an end.  An emergency $16.5bn loan from the International Monetary Fund (IMF), of which $4.5bn was already disbursed before the end of 2008, saved Ukraine’s bacon during the worst of the instability.  Still, the outlook for the second half of 2009 is rosier and Ukraine has made a lot of progress in recent years. “By many measures, Ukraine is currently much more immune to cyclical shocks: foreign exchange reserves have increased substantially, foreign capital increased its share on the local financial market (which is now well capitalized and profitable), the fiscal system has a strong budget code (with defined roles and responsibilities in the budget process) and the [World Trade Organisation] has liberalized external trade,” Maryan Zablotskyy, macroeconomist at Erste Bank Ukraine, points out.  Ukraine’s economic policy is weak both fiscal and monetary wise. On the one hand, the state budget has had a good balancing influence on fiscal policy - since 2000, the average budget deficit has stood at just 0.75% of GDP. However, budget planning was only conducted for one year, which meant that the government has tended to increase spending in nominal terms during times when steel prices and growth were increasing and this tends to amplify the economic cycle and the impact of steel price volatility on the economy. Consequently, the sudden plummeting of steel prices in the current crisis caught the government off guard.  ECONOMIC FORECAST  Ukraine will see the sharpest slowdown of all the countries in Eastern Europe in 2009. The cabinet released its macroeconomic forecast for 2009, projecting real GDP growth of just 0.4% on year. These numbers are based on the Economy Ministry’s optimistic scenario and assume an improvement in foreign demand and effectiveness of the government’s anti-crisis measures. Earlier, the ministry announced an estimated 5% GDP decline based on the pessimistic scenario, which the ministry has not released.  Dragon has a bit more pessimistic scenario, with GDP declining by either 0.7% in case of a fast global recovery, or by 4%, in a more pessimistic case. Fitch forecasts a contraction in Ukraine’s real GDP in 2009 by 3.5%. Erste analysts project a recession of 2.5% of GDP in 2009, with economic growth returning only in the second half of 2009.  “Despite clearly having very strong international support, it will take some time to sort out the imbalances. Still, as the political sphere is now united by a foreign anchor (International Monetary Fund loan), we believe that there is a good chance that Ukraine might finally start implementing the reforms that it did not do for 10 years,” says UBS.  If it does, the medium term looks good: “GDP growth will return to its potential growth of 5-6% in 2010, while inflation is likely to come down to a single-digit figure,” conclude Erste analysts.  Ukraine had the highest rate of inflation in Europe in 2008, but the crisis was a blessing in that it at least helped slow to 22.3% in November the galloping price rises. “We consider the government’s one-digit inflation forecast much less realistic as the hryvnia’s sharp depreciation will put significant pressure on domestic prices. We currently expect inflation in Ukraine to rise by 14.2% on year (base case) or 16.9% on year (pessimistic case) in 2009,” says Dragon  inflation forecasts  Government 9.5%  Dragon 14.2% (base) - 16.9% (pessimistic)  Fitch 17.5%  Foyil Securities 14.5%  DEVALUATION  Ukraine is vulnerable to external shocks to its currency as nearly 50% of total lending in Ukraine is in foreign currency. After spending more than $7.5bn – 20% of its reserves – to support the hryvnia in October and November, the NBU lowered both its official rate repeatedly, and its interbank intervention rate to finally unify them both at the IMF’s behest.  The hryvnia lost nearly 60% of its value from its high in May 2008 of UAH4.5/USD as a result of the crisis. By the end of December the currency had probably oversold and was trading at UAH8.2/USD, at which point the government said it would stabilize.  The optimal level of the UAH/USD will depend on steel prices and Erste analysts project the optimum level to be around UAH7 per dollar, which suggests the currency has overshot at UAH8/USD. However, ultimately the value of the currency will depend on where steel prices settle.  In order to remove some of this unpredictability from the public finances, one of the strings the IMF has attached to its loan is the government must set up a UAH40bn stabilisation fund that can be used to issue stabilisation loans and bail out banks. The fund will be maintained in the future partly from privatisation receipts and the whole privatisation programme has been put back on the agenda for 2009.  The average exchange rate in 2009 will be UAH7.30/USD, according to the government. However, the currency will be affected by Ukraine’s unpaid gas debts to Russia and the price it has to pay for gas imports.  However, the really big change is the current crisis has effectively smashed the foreign currency trading band inside which the NBU has kept the hryvnia more or less constant at about UAH5/USD for most of the last five years.  CURRENT ACCOUNT DEFICIT  The government is hoping to reduce the current account deficit in 2009 as a result of the devaluation. “I hope that a fall in fuel prices, a very moderate rise in gas prices and the exchange rate will bring a zero or a deficit of the current account at 1-2% [of GDP],” Deputy Governor of the National Bank of Ukraine Oleksandr Savchenko said in December.  Fitch estimates the current account deficit will rise to $4.5bn, while the total foreign debt that needs to be paid in 2009 is $45.6bn, equivalent to 157% of Ukraine’s international hard currency reserves. Andrew Colquhoun, the director of sovereigns group at Fitch Ratings, said that clearly Ukraine will not be able to meet these payments unless it can raise some external financing.  With steel exports falling and the compensatory inflow of foreign direct investment (FDI) also slowing, balancing the current account has become a major challenge going forward. FDI in Ukraine in 2008 is projected at $8bn-9bn and in 2009 at over $5bn, said the NBU’s Oleksandr Savchenko.  BANKS  Ukraine’s fast growing bank sector came close to collapse and the rescue measures are likely to have far reaching consequences on the whole sector.  “The government received the right to borrow money in foreign currency on the local market and use government bonds to buy troubled banks [as part of its new crisis powers]. These, alongside the increase in the state fund guarantee for deposits from UAH50,000 to UAH150,000 (covering 99% of individual accounts) and the increase in refinancing activities by the NBU are meant to secure overall banking system stability, which is likely to go through a period of large-scale evolutionary changes,” say analysts at Erste. “The IMF and Ukraine have effectively agreed on driving further consolidation in the banking sector. Even with minimum capital requirements twice those in Europe, Ukraine has some 170 banks, a number that could fall by as much as 30% in 2009 and 2010.”  An attempt to rescue the troubled Prominvestbank seems to have failed and is likely to be nationalised. The whole sector should enter a period of consolidation running into 2009.  EQUITY  After equity prices rose 136% in 2007, the Ukrainian equity market lost nearly 80% in 2008, wiping out all the gains for the last several years in the process. By the start of 2009, Ukraine was one of the cheapest markets in the world in terms of P/E ratios. Only Russia is cheaper.  “Ukraine’s premiums over Russia are justified in our view, as the Ukrainian economy is to a large extent hedged against decreasing commodity prices,” explain analysts at Galt & Taggart. “The country is a large net importer of hydrocarbons, which impact directly on production costs for energy-intensive Ukrainian industries. We believe any potential natural gas price hike in 2009 is more likely to be symbolic. Despite Gazprom’s fear-mongering rhetoric, reference prices are falling and Ukraine holds the transit and storage keys to the bulk of Russian gas exports to Europe. In addition, a bottom-up inspection offers a number of national champions like Enakievo Steel and Ukrsotsbank, among others, which have some of the lowest valuations in their Eastern European peer groups.”  But comparisons to Russia are of limited value due to the vast difference in the size of the markets. Daily trading volumes on the Russian markets are in the billions of dollars whereas in Ukraine the volumes have crashed from between $30m-60m down to about $1m a day as of the end of 2008. Such tiny liquidity makes prices extremely susceptible to shocks.  “Given the liquidity and volatility issues are likely to plague the Ukrainian market until the world finds answers to the financial upheaval, we recommend investors look at shares traded abroad, namely London and Warsaw. Liquidity on those markets remains better than on the local market due to stricter disclosure requirements, better market infrastructure and the presence of ‘quality’ long-term investors. For all intents and purposes, the Ukrainian agricultural sector is represented only on foreign bourses and we see the sector as a solid performer in uncertain times,” says G&T.

Technorati Tags: MBS Ltd., fiscal policy, commodity prices, Galt & Taggart, natural gas prices, Gazprom, Romania, Hungary, Poland, equity, P/E ratios, Prominvestbank, Oleksandr Savchenko, bank sector, Andrew Colquhoun, Fitch Ratings, foreign direct investment, FDI, current account deficit, foreign debt, Russia, NBU, inflation, domestic prices, slowdown, recession, economic growth, monetary policy, budget planning, Maryan Zablotskyy, economic cycle, GDP, steel prices, external trade, World Trade Organization, Erste Bank Ukraine, foreign exchange reserves, International Monetary Fund, IMF, instability, East Europe, National Bank of Ukraine, Anton Olff, retail sector, reforms, hryvnia, U.S. dollar, depreciation, privatiziations, www.businessneweurope.eu, Ukraine, economy,

As we have been reporting on this space, the Russian and Ukrainian currencies have been declining along with their economies. While Russia has been able to stave off a complete collapse due to the foreign currency reserves it holds, it is only a matter of time before the ruble descends to much lower levels.

For now though, the Russian Government has managed a slower depreciation. When the foreign reserves decline further, and oil & gas prices continue their current trend, capital flight will accelerate in 2009. This will force the ruble lower. 

For Ukraine there are fewer options. No cash reserves or oil resources means that Ukraine is subject to the whims of a volatile market in crisis. The recent emergency loan from the International Monetary Fund (IMF) to Ukraine stabilized the markets here to a great extent, but the real stabilization will come when the market hits bottom and government reforms. The loan from the IMF in fact, was contigent on reforms. 

As for 0900 this morning of Friday the 19th of December, the Ukrainain currency-the hyrvnia (UAH) is selling at 7 to 1 U.S. dollar at local kiosks here in Odessa. Yesterday it was at 10 to 1 U.S. dollar.

As we have mentioned in an earlier post on this blog, it is a seasonal ritual.  During the holiday season or summer tourist season, the Ukrainian Government shores up the hryvnia against foreign currencies. This past summer for example, the hryvnia was at 4.6 to 1 U.S. dollar. As soon as the tourists departed, it went back up to the 5 to 1 U.S. dollar rate where it had been averaging for the past several years in a tight trading range or “peg.”

In the end, neither the Russian or Ukrainian Governments will not be able to over-rule the markets.

Technorati Tags: Russia, Ukraine, U.S. dollar, Anton Olff, currencies, Odessa, ruble, hyrvnia, UAH, International Monetary Fund, IMF, economy, foreign reserves, foreign currency, Russian Government, depreciation, oil, gas, capital flight,

Although this article from the Russian News & Information Agency at www.en.rian.ru states that money will make its way to Switzerland and Cyprus. OOPS!! They don’t actually say that…but wherever it winds up, it will not be in Russia.

We believe that capital outflows will be higher than $90 billion if the crisis continues. On the other hand, much of this capital will eventually return to the Russia when the crisis passes as investors see beyond the current mess to burgeoning opportunities in this emerging market.

MOSCOW, December 18 (RIA Novosti) - Capital outflow from Russia is expected to continue, and hit $90-91 billion next year, a deputy economics minister said on Thursday.

Andrei Klepach said Russia’s international reserves are expected to decline $110-140 billion amid the ongoing global financial crisis, but remain above $300 billion.

Russia’s Central Bank announced on Thursday that its international reserves, which hold foreign exchange and gold, stood at $435.4 billion as of December 12, down $1.6 billion against $437 billion on December 5.

International reserves declined $28.9 billion in November, $71.5 billion in October, $25.6 billion in September and $14.3 billion in August. The reserves had been increasing in the months prior to August.

Inflation in Russia in 2009 could drop to 10-12% from the economics ministry’s revised 2008 forecast of 13.4%, Klepach said.

Russia is expected to keep its foreign trade balance favorable at $18 billion, with $303 billion in exports and $283 billion in imports, Klepach said.

In its macroeconomic forecast for next year, the ministry also said that crude exports from Russia were expected to decline 3.8%, year-on-year, in 2009 to 235 million metric tons (1.7 billion barrels).

Natural gas exports from Russia are expected to grow from 203 billion cubic meters in 2008 to 208 billion cubic meters in 2009, the ministry said.

Russia’s oil production is expected to decline 1.6%, year-on-year, in 2009 to 480 million metric tons (3.5 billion barrels) while natural gas output is likely to increase 0.7% to 670 billion cubic meters, the economics ministry said.

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Although many have been walking around wondering if the sky is falling, there are a few cool heads amongst us whom are able to see vast opportunities on the horizon. One of those is Arik Shtern of www.odessaapts.com and www.kievapts.com.  Arik is on the “front lines” of the real estate business and has a good vantage point from which to see the overall economy here in Ukraine.

Here are a few of his recent comments:

“Interesting times we are in, to say the least.  I
was in Kiev the other week, dining at the finest restaurants the capital
has to offer for about a 50% discount compared to 4 months ago. One can have
everything included meal currently in the top tier Kiev restaurant for about
$70 for two.  Brings back the memories of the late 90s.

We are holding up overall okay although of course there is a dramatic slow
down in the worldwide travel.  Kiev is hurting particularly badly, and real
estate there for all intents and purposes has crashed on both the rental
and the sales market.  I personally think it will get much worse before it
gets better.  Rents in Kiev right now are down on average 30% and in some
cases much more. To give you an example, a two bedroom unit (standard, not
luxury) which used to rent for $110 per night or so with 90% average occupancy
last year is now being offered for $1500 per month on long term rental market.
 Last year, they probably wouldn’t have accepted anything under $2800.  There
are many similar options available, and keep in mind that Ukrainians as you
obviously know are quiet stubborn so whatever they’re asking, they probably
would need to accept about 80% of that to get the deal done.  Same thing
is seen on the sales front, apartments in the center of Kiev are slowly becoming
‘affordable’, relatively speaking as now on say Basseyna Street, there are
options for around $4000 sq/mt which was unheard of a year ago, with most
everything selling at $6K - $10K range on Basseyna.

Also, I looked at options in Odessa (only through newspaper ads just to gauge
the prices) and they are clearly now back to a level seen at least 2-3 years
ago.  Particularly interesting appear to be options in those new buildings
in Arkadia, as they are now actually being sold in many cases below the prices
that these people bought them for.  As you probably know, many of them were
purchased by speculators before the buildings were constructed and now, they
can clearly see they will not sell them at any profit – they are ready to
dump them for a fraction of their investment.  I think that the 2009 could
be a very good ‘opportunity’ year for real estate.  There are also some foreclosure
proceedings (these are more complicated) which allow well ‘connected’ individuals
to buy properties for about 50% of market rate too.  These are a bit more
difficult transactions, but nevertheless possible”

Most of us on the ground here in this emerging market agree with Arik’s assessment. Moreover, many of us are witnessing a sharp price deflation offering huge opportunities to invest in businesses, land…particularly agricultural land (more on that later in an upcoming series of reports) as well as commercial and residential real estate.

The next several months are a good time for investors and entrepreneurs to examine these opportunities on a first hand basis.

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This article by the editor of the Far Eastern Economic Review in the Wall Street Journal (www.wsj.com)  should be posted in every government office in the World and shouted from the rooftops!!!  

The current Global Economic crisis-like the Great Depression in the 1930s-fosters doubt about markets and capitalism. In this atmosphere, the statists and collectivists re-emerge to “right the wrongs.” 

 The World is now experiencing a backlash against decades of reform and free markets. It has even taken place in the United States, and under a Republican President…as well as in China where the golden goose of capitalism has been laying golden eggs since Mao died. Will other emerging markets…many of whom are poised to leapfrog ahead of the mature economics if they stayed the free market course…go backwards? Are we all Keynesians now?

 The Lessons From 30 Years of Chinese Reform

One of the greatest economic booms in history, but an emerging turn back to the left.

By HUGO RESTALL

Thirty years ago this week, Deng Xiaoping and the Chinese Communist Party turned their backs on Maoism and embarked on a reform program that led to the most remarkable period of wealth creation the world has ever seen. From today’s vantage point this process appears surprisingly smooth. But it hasn’t been, and still isn’t.

Above all, there has never been total agreement in Beijing about the wisdom or course of reform. Nor has there been a clear road map. Rather, especially under Deng, it was a fairly personal process. He could launch reform because in 1978 China was in a state of ideological and economic exhaustion, and internal opposition to “following the capitalist road” was weak. The adoption of pragmatism as a guiding principle was popular because people were so fed up with political campaigns and class struggle.

Deng also played a crucial role as “paramount leader” at key moments in the 1980s and early ’90s, pushing through changes using his personal prestige when reform seemed to founder. In the early stages, economic reforms created many winners and very few losers, as private enterprises started small, coexisting with the state-owned industrial dinosaurs.

In Deng’s famous phrase, China’s policy makers adopted a gradualist approach, “crossing the river by feeling for the stones.” Small-scale experiments often led to success on a national scale, such as allowing farmers to keep what they produced from private plots and the establishment of special economic zones along the coast. The major involvement of foreign enterprises in the Chinese economy was never planned. It simply evolved. But the lack of a reform blueprint also led to some notable failures. China’s stock market remains dysfunctional because it started as a no-cost source of money for state-owned enterprises. Allowing the market to become a viable source of capital for entrepreneurs would hurt these companies and those who own their overpriced shares.

This gradualist approach, and the underlying lack of consensus, had political consequences. During the 1980s, reformist and hard-line forces within the Communist Party still fought over the pace of reform, and intellectuals had a modicum of freedom to debate. The crackdown after the 1989 Tiananmen Square massacre sharply reined in that debate, but within a few years economic reform and growth were back on track. By the mid-’90s, the party successfully recast itself as a collection of society’s elites from all backgrounds, including entrepreneurs. The only competition over policy was between technocratic elites and leaders of patronage networks, while the government bought the allegiance of intellectuals with improvements in their lifestyles.

China became a remarkably laissez-faire economy in the late 1990s and early 2000s. The government’s revenues as a share of GDP shrank to around 11%, from 31% in 1978. At the same time, Beijing unilaterally cut tariffs and joined the World Trade Organization, while shrinking the public sector. In the space of a few years starting in the 1990s, inefficient, state-owned enterprises shed about one-third of their workforce, by some estimates 60 million jobs. As a result, for about three decades the “socialist market economy” churned out double-digit growth year after year.

Unfortunately this run is coming to an end, and not just because of the global financial crisis. Today the pendulum is swinging back toward ideological competition and big government. With the country still without a true consensus on the virtues of free-market reform, the communists-turned-capitalists are morphing into European-style social democrats.

In the late 1990s, the bureaucrats set out to re-establish their power. Beijing fixed a target of restoring national revenue to 20% of GDP by improving the tax collection system. Last year, revenue hit 20.8% of GDP, growing by 32.4%, far ahead of economic growth of 11.4%.

Spending has risen just as fast, and this is now part of an ideological shift back toward statism. Government leaders portray themselves as the answer to every problem, expressing their willingness to use public resources to help those left behind by the new prosperity, rather than counting on new businesses to create jobs. While China’s social safety net remains small in comparison to European countries, it is expanding rapidly. Given that China remains a poor country and has a rapidly aging population, this may not be sustainable.

Meanwhile, after welcoming foreign trade and investment to a degree seldom seen in a developing country, Beijing is quietly shifting tack to impose some nontariff barriers to foreign products and investment. The state is pushing the creation of new national champions, enterprises that are tied to the government by various ownership structures and enjoy generous financing from the state-owned banks. A new labor law goes far beyond basic workplace protections, incentivizing workers to organize and instigate disputes with management.

All of this is reducing the opportunities open to the true private sector, which has been the engine of China’s rapid growth. As growth slows and the politically well-connected cadre managers enjoy the lion’s share of opportunities, inequality and resentment grow. If this prompts the government to expand spending further to buy off the discontented, the virtuous cycle of economic reform could turn into a vicious cycle of ever greater government intervention.

In the political sphere, the close alignment of government and business elites means that any emerging opposition to the Communist Party will likely be antibusiness. We already see evidence of this. Among intellectuals, a nationalist movement advocating greater government control of the economy — known as the “new left” — is the hottest trend.

None of his means that China is necessarily going to reverse course after 30 years of reform. But the straight-line projections some have drawn of the country’s growth are too optimistic. The drawbacks of the Communist Party’s monopoly on power are becoming more evident, as vested interests protect their control of the economy by holding back development of the banking system and stock market.

The coming year is expected to be critical, both economically and politically. China’s export-dependent economy is especially vulnerable to a global slowdown. But the Communist Party has shown itself adept at adjusting to new challenges. We can expect that the feeling for the stones will continue, even as the pace of reform slows.

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