Decision day for Kiev … and Moscow

December 17, 2013

Decision day for Ukrainian President Viktor Yanukovich as he heads to the Kremlin seeking a financial lifeline while demonstrators in Kiev gather again to demand he steps down.

Vladimir Putin seems set to agree a loan deal, and possibly offer Ukraine a discount on the Russian natural gas.
It seemed he was the only game in town after an EU commissioner said the bloc was suspending talks on a trade agreement with Kiev. But yesterday, European Union foreign ministers said the door remained open, which in a way makes Yanukovich’s predicament harder.

Does Russia really need this? Politically yes, but economically? Ukraine is seeking help to cover an external funding gap of $17 billion next year and is in no position to pay for its gas.

Moscow, meanwhile, has big problems of its own having admitted its failure to diversify its economy will lead to a far lower level of growth than had been expected all the way out to 2030. Putin has conceded for the first time that Russia’s economic problems are home-grown.

Ditto for Ukraine. Will it have to hand over its best assets in return for Russian help? Only a few hundred million euros of EU money is on the table so far but we know the IMF and the World Bank are quietly watching too.

Fresh demonstrations are expected in Kiev today which may explain the nuanced game Yanukovich is playing. He is not expected to sign up for a Russia-led customs union which Putin sees  as vital to creating a political and economic union stretching from the Pacific to the EU’s borders.

Angela Merkel will be sworn in for a rare third term as German chancellor in the Bundestag and euro zone finance ministers are due to meet late in the day to try and nail down a deal on banking union to be signed off by EU leaders at a summit on Thursday and Friday which, depending on its make-up, will determine whether the seeds of a future financial crisis have been sown.

European Central Bank chief Mario Draghi sounded a sharp warning yesterday, saying the latest plans for winding down failing banks may be too complex and inadequately funded, which is about as damning as he could be in public. One can only imagine what he is saying in private.

Under the latest plan, national funds to wind up failing banks – which the banks themselves will pay for – will be slowly built up to a total of 55 billion euros over 10 years at which point they will be linked up into one common fund.

Given this process won’t even start until 2016, the cost of closing a bank will be borne almost solely by a home country for several years. So the “doom loop” between weak banks and sovereigns is unbroken.

Whether 55 billion is enough to convince investors Europe’s financial system is well and truly underpinned is a big question. Many policymakers want the euro zone bailout fund, the ESM, to be able to lend to the resolution fund in emergencies. Germany opposes that.

Complexity is another bugbear. EU policymakers have drawn up a plan in which a Board of the Single Resolution Mechanism would prepare decisions on bank closures that the European Commission would have the right to veto after consulting national authorities and the ECB. We know bank failures can happen quickly. This cumbersome process could risk a bank run – fiddling while Rome burns.

If minds needed to be any more concentrated, data yesterday showed the enmeshing of banks and states is ever deeper. The European Banking Authority said the share of bonds issued by sovereigns under stress held by their domestic banks had “increased markedly” by 9.3 percent between December 2010 and June 2013.

There are a clutch of central bank meetings on our patch today with the Federal Reserve’s Wednesday decision on whether to taper or not casting a long shadow.

– Turkey’s central bank held fire on interest rates last month but signalled more tightening of day-to-day monetary policy as it worries about a withdrawal of U.S. monetary stimulus that could weaken the lira and push inflation up. Today it is expected to keep all key rates on hold with no changes either to macro prudential tools such as reserve requirements.
– Hungary is widely expected to continue cuts which have brought down its base rate to 3.2 percent from 7 percent in August 2012. It too could shift its tone with one eye on the Fed’s next move which could put downward pressure on the forint but three percent looks like the next stop and not the last.
– In Sweden, inflation has been below the central bank’s target for more than two years and pressure has grown on the central bank to cut rates. A majority of economists polled by Reuters predicted that will push the Riksbank to cut by 25 basis points to 0.75 percent this time.
– Czech rates are already near zero and the central bank last month began intervening on the currency market to weaken the crown. That had a dramatic initial effect, but the question of how to exit such a strategy is an altogether thornier one.

It’s the last big economic data week of the year.  After flash PMIs on Monday showed  euro zone businesses ended the year on a high as new orders surged, but the chasm between a resurgent Germany and wilting France widened, today we get Germany’s ZEW sentiment survey, which is forecast to edge up from an already high level.

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