The invisible hand

Why Argentina needs free trade more than ever  |  There is little doubt that Argentina needs a miracle, or at least a helping hand. No, this is not another reference to football: just a simple statement of fact.

It has until the 30th July to find USD 1.3bn in order to avoid default. Argentina’s trade performance has suffered as a result of poor economic and trade tariff management since 2011. Trade declined in 2012 by over 4% and while it grew in 2013 and is expected to return to growth of around 7% this year, this will only take it back to the levels of exports last seen in the middle of 2011. Policy makers have focused instead on attracting inward investment to develop the large shale gas reserves, taking their eye of the trade ball. Yet even this policy has stalled: Delta Economics is forecasting that Foreign Direct Investment levels will increase in 2014 but this will again only take them just above the 2011 levels. Put simply: if Argentina is to stave off the permanent threat of default and encourage enduring FDI, it will have to bring the invisible hand back into its trade markets.

At first glance, it does not appear that trade matters unduly to the Argentinian economy. It still runs a trade surplus, although not as substantial as it was and this is reflected in its positive terms of trade (the value of exports in relation to the price of imports). Yet there appears to be very little correlation (-0.37) between its terms of trade and the value of the Argentinian Peso (ARS), as illustrated in Figure 1.


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Figure 1  |  Argentina’s terms of trade vs ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


This matters in so far as countries with high correlations between trade and their currency values are less prone to speculative attacks on their currency. The Peso has weakened by around 50% since the financial crisis: the last time the deterioration in its value was as substantial, Argentina was gripped by its last sovereign debt crisis. While the decline in value has been over a longer period of time, it does suggest that traders are speculating against Argentina being able to re-pay its debt.

If this is the case, then it is more than worrying. Argentina needs to default on its debt a bit like its football team needs the Netherlands to score 2 goals in the first fifteen minutes of the game on Wednesday. If it defaults, then it will find it very difficult to raise the external capital/inward investment that it needs to begin the process of extracting shale gas. But as Figure 2 shows, Argentina is no longer a net exporter of oil and gas, so, in order to restore its self-sufficiency urgently needs this inward investment.


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Figure 2  |  Value of Argentina’s oil and gas trade (USDm) versus ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


The Peso is barely correlated with oil and gas exports (-0.42), although it is correlated with its imports (0.72) suggesting that as the currency weakens (values are in Peso per USD), it is more likely to import oil which is worrying because it suggests that oil imports are plugging a structural weakness in Argentina rather than a response to imported oil being proportionately cheaper. And as the correlation with exports is so weak, it reinforces the view that the currency is more closely correlated with its economic condition than with its trade position.

So what is the scale of the challenge ahead? What does the Argentinian government need to do if it is indeed to create substantial economic growth through the inward-investment associated with shale gas production? Figure 3 presents the specific six-digit subsectors within natural gas that represent shale.


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Figure 3  |  Value of Argentina’s natural gas imports and exports (USDm), 2001-2026 (forecast)

Source  |  DeltaMetrics 2014


Other things being equal, that is, if inward investment continues at the pace we are currently seeing it and if policy and the economic climate remain unchanged, then the picture is not rosy for Argentina’s shale gas revolution. Our model suggests that imports are already outstripping exports and that trend will continue to grow over time. The chance of a trade surplus is remote, as is the chance of self-sufficiency in gas.

It is not the intention to enter a debate on shale in Argentina, still less to suggest that this is the only way out of the current crisis. Instead, just take a look at where policy really can have an influence: trade. Argentina’s openness, in other words its trade as a proportion of GDP has grown from just under 30% in 2001 to over 60% now. The economy is more dependent on trade as a result since it is so important in relation to GDP.

Yet oil and gas is not the sector, arguably, where it should be focusing in the short term. There are two reasons for this. First, the normalised revealed comparative advantage of oil and gas has deteriorated from a position where it was competitive in 2001 (0.39) to a position where it is uncompetitive now (-0.51). We are expecting its position to deteriorate still further to -0.60 by 2020. In contrast, Automotives were uncompetitive in 2001 (-0.12) but are competitive now (0.32) and will be more so by 2020 (0.38).

Second, there appears to be a much stronger correlation between automotive trade and the value of the currency suggesting that some of the speculation may dissipate if the manufacturing side of the economy can be allowed to flourish as Figure 4 shows.


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Figure 4  |  Value of Argentina’s automotive exports overall and to Brazil (USDm) vs ARS per USD, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


If Argentina can grow its manufacturing sector then it stands a chance of creating real export-led growth, particularly if it focuses on the regional automotive supply chain to Brazil since the correlation between it and its currency is particularly high for that trade route. As the currency has weakened, this has strengthened the position of Argentina’s automotive sector in relation to Brazil and has provided a platform for growth.

This is where policy makers should focus to address the challenges of growth and currency stability in the long run and to provide a clear message to markets and arguably the US Supreme Court to stave off default in the short run. Trade suffered between 2001 and 2012 when tariffs were first imposed and Argentina can in no sense afford to make this mistake again. Free trade is as key – otherwise the “hand of God” may well start to look like an Argentina own goal.



Well Oiled?

Why Russia’s threats on gas will not damage European growth | The good news: the European economy is beginning to look healthier. In the first full week of April, data suggested that German, Italian and French industrial production rose in February and Greece took its first steps back into bond markets buoyed by an IMF report stating that austerity was paying off, but there was still a long way to go. The bad news: President Putin has warned Europe that its gas supplies could be cut off because of a long-standing dispute with the Ukraine about non-payment of its bills. What impact is this likely to have on Europe and what is the threat to Europe’s fragile recovery?

Since 2009 when Russia halted gas supplies through the Ukraine for similar reasons, Europe’s oil and gas has been less reliant on supplies through the Druzhba pipeline that runs through the Ukraine; its supplies increasingly come from the Nord Stream pipeline directly from Russia. This makes Europe more dependent on Russia, but not as dependent on the Ukraine. In fact, the Ukraine does not feature in the top ten direct oil or gas importers into the European Union because its oil and gas is supplied from Russia (Figure 1a, 1b, 1c – ordered top to bottom).




Figure 1a/1b/1c | European importers of crude and refined oil and gas, share of total imports 2014

Figure 1 Source | DeltaMetrics 2014

The charts are, of course, slightly under-stating the extent of Russia’s influence in the oil and gas sector. For example, the Netherlands is the largest importer of refined oil into the rest of Europe but its third largest importer of refined oil is Russia, illustrating Russia’s pervasive influence across the region. That said, it is likely to be Germany, as the largest economy and the one that is most reliant on Russian oil and gas, that will be most affected. The drop in imports of oil and gas that we are currently forecasting up to the end of August 2014, is very marked, as shown in Figure 2.


Figure 2 | German imports of oil and gas from selected countries, June 2001-Dec 2015

Figure 2 Source | DeltaMetrics 2014

The forecasted decline in German oil and gas imports in the second two quarters of 2014 is marked. For example, we expect imports in April 2014 to be around 6% below their value in 2013, in July to be nearly 2% below and in August over 3% below their 2013 year-on-year values. However, this is part of a general downward trend in the second two quarters of this year as we are expecting similarly lower values for imports of oil and gas into Germany from the UK and from Norway.

This points to a more general issue: after a bruising few years, the recovery in Europe is acknowledged to be fragile and nervousness about its vulnerability has affected markets in the early part of April. Yet the Euro remains strong against the dollar and the Delta Economics trade forecast for Europe in 2014 shows a mild improvement since Q4 last year: from a net decline in exports forecast for 2014 of 0.3% to flat-lining growth now. This helps to explain the strength of the Euro: trade is a good proxy for competitiveness and, using Germany as the Penis Enlargement Eurozone’s strongest trading nation for illustrative purposes, as trade improves, the value of the Euro against the US dollar appreciates.


Figure 3 | German imports of oil and gas from selected countries, June 2001-Dec 2015

Figure 3 Source | DeltaMetrics 2014, Bloomberg

But while no-one has questioned the strength of Germany and its trade competitiveness, the competitiveness of the peripheral regions has been a concern of both investors and policy makers alike since the sovereign debt crisis. Even here there is evidence that Greece and Portugal in particular are beginning to pull through. Austerity measures have been tough but wages are falling and competitiveness measured this way is beginning to be restored even if circumstances remain tough for businesses and people in those countries. Delta Economics is forecasting that Greek merchandise trade will grow by 3% this year and Portugal’s by over 4%. These are above average for the European Union; more than that, there is a similarly strong relationship between the value of the Euro and their trade, illustrated in Figure 4.


Figure 4 | Greek and Portuguese exports versus USD per Euro, Last Price Monthly, June 2001-March 2014

Figure 4 Source | DeltaMetrics 2014, Bloomberg

What is really intriguing about this chart is that, compared with Germany, the correlation of exports with the USD-Euro exchange rate is almost as high for Portugal and higher for Greece. For Greece, the whole time period correlation is 0.86 while for Germany it is 0.85.

Maybe, then, we should be looking to Greece and its trade routes as a bellwether for the European economy after all. The Greek trade economy is proportionately small but where the Greek economy as a whole appears more stable and on a path to recovery, it certainly calms market nerves and signals that the policies that have been implemented may gradually be having an impact on competitiveness and the risks of further bailouts or contagion reduced. Greece’s largest export product is refined oil accounting for some 26% of its exports, and Delta Economics is forecasting that this trade will grow by 8% in this year and next. In itself, this helps explain the relative buoyancy of Greece’s exports. Iron and steel bars will grow by 6% and steel tubes and piping by nearly 7% and it is the role that Greece is playing as a transit hub for oil, gas and infrastructure products that is really gathering pace, albeit from a low base.

One note of caution: Greece does produce oil itself but it also imports a great deal of oil for export. Its largest import partner is Russia with volumes some ten times higher than the next import partner, India. While India’s imports are growing rapidly (at 11% over the next two years), this will not be sufficient to reduce Greece’s trade dependency on Russian oil. There are risks to Greek trade, and they are linked to the crisis in Russia, but its restored attractiveness as a trade and transit hub across a range of sectors will grow as its competitiveness continues further giving it the opportunity to broaden its exports beyond a dependency on Russian oil. The trends augur well but we should also remember the words from ancient Greece, “A ship should not ride on a single anchor, nor live on a single hope.”

Russia, Ukraine & Oil Prices

Why Crimea will be an economic flashpoint | Will the Crimean crisis have an enduring effect on oil prices? Europe teeters on the brink of a crisis that could, at best re-draw the post-Cold War borders between a Russian aligned Crimea and eastern Ukraine and a European aligned western Ukraine and, at worst, re-open the East-West fault-lines of the Cold War. Underlying the global geo-political tensions that are a consequence of the current stand-off is an equally pervasive and persistent tension between Russia and the Ukraine around oil and gas supply. Since 2006 Russia has interrupted its supply of oil and gas into the Ukraine in response to political and economic disputes (specifically non-payment by the Ukraine of its bills for gas supply). In January 2009 this caused a complete shut-down of oil and gas supplies by Russia to the Ukraine for thirteen days. Memories still linger and there will undoubtedly be nervousness in markets now as European energy security threatens to coincide with broader political instability.

It is easy to see why Russia is keen to retain its influence. Despite the fact that the country’s economy is bankrupt, it is the largest ex-Soviet destination of Russian oil and gas exports. Over 50% of its imports of oil and gas are from Russia and are worth over USD 6.7bn to Russia. Assuming other things are equal and that conflict is abated, growth rates in natural gas alone, are forecast to be higher than 16% in 2014 on their 2013 value.


Figure 1 | Russian exports of Natural Gas to former Soviet States and forecast growth

Source DeltaMetrics 2014

Yet Ukraine supplies oil and gas in its own right, recently entering into agreements for shale gas exploration and production. Similarly, European countries, concerned about the impact of the 2009 crisis and their dependency on Russian supply through the Ukraine, have sought energy supplies directly from the Ukraine or from elsewhere. This reduces Russia’s influence on the Ukraine, even Europe, through gas supply in particular and it is arguably for this reason that Vladimir Putin will be keen to keep Ukraine within his control.

The effect on oil prices of all this is ambiguous and this is shown in Figure 2 which shows Ukrainian exports and imports of oil and gas against the oil spot price. Exports of oil and gas from the Ukraine track the oil price closely – price rises mean increases in exports and vice versa.


Figure 2 | Ukraine’s Oil and Gas trade against the Oil Spot Last Price Monthly, June 2006-January 2014

Source DeltaMetrics 2014


Two things are clear from this chart.

First, there is a sharp increase in Ukrainian exports following the shutdown of Russia’s gas supplies in January 2009 that starts in May 2009. The increase is sharper than it was for Russia and continued until the beginning of the second quarter of 2011. Since then, Ukrainian exports have fallen: trade growth generally across all sectors has slowed following rapid catch up in 2010 from the financial crisis and oil and gas from these two countries were no exception. But equally, this drop for the Ukraine corresponds with the run up to and opening of the Nord Stream gas pipeline taking natural gas from Russia directly to Europe.

But second, since that point, trade has been relatively flat, indeed on a downward trend in both countries. Ukrainian exports have also been more volatile but until Q3 2012 moved in the same direction as oil prices. In other words, more was supplied as prices rose. Since then, oil prices and Ukrainian exports have periodically been inversely correlated with each other: that is, increases in price have been accompanied by lower exports from the Ukraine.

There is more to this than simply the breakdown of a relationship between two things in the wake of the financial crisis. Figure 3 shows Russian oil and gas exports to the Ukraine only from 2001 to 2014 against the NYSE Oil Spot Last Price Monthly over the same period.


Figure 3 | Russian exports of Oil and Gas to the Ukraine versus NYSE Arca Oil Spot, Last Price Monthly, June 2001-January 2014

Source | DeltaMetrics 2014

The turning point is even clearer in Figure 3. From September 2011, Russian exports to the Ukraine appear to have moved inversely to the oil price as both Russia and the Ukraine began to use different supply routes and corridors to export their oil and gas. At the launch of the Nord Stream pipeline, around Ukraine, Vladimir Putin was clear about what this meant: “Any transit country has always the temptation to take advantage of its transit status,” he said. “That exclusivity is now disappearing.”

What does this suggest the outcome of the current crisis is likely to do to oil prices?

Much will depend on whether or not Russia gets its way and increases its influence in the Crimea and into the Ukraine quickly. If it does, then we can expect the risks to oil supply from the Ukraine itself and into the Ukraine from Russia to be short-lived meaning that oil prices will not be affected. However, Russia is unlikely to extend its influence into Western Ukraine without deepening instability and while it does not, we can expect Russia to restrict its supplies of oil and gas accordingly. This will put upwards pressure during 2014 on oil prices, not just because of the clear inverse relationship that appears to have developed but also because of the threat to energy security that it poses.

And in the very short term, March 2014 in particular, there is almost an inevitability about increased oil prices as markets absorb the likely effects of geo-political insecurity on energy prices and, hence, the prospects for economic recovery. How long this upward pressure persists depends on how quickly and effectively the crisis can be resolved.

Yen for a change?

Why devaluation of the Yen is unlikely to boost exportsShinzō Abe could not have been clearer in 2012: reversing the appreciation of the Yen since the start of the financial crisis in mid 2007 would stimulate export-led growth and assist a general objective of reflating the economy through higher import prices. Assuming a J-Curve effect, where the trade deficit would close after a short time-lag following a currency depreciation his view was that the policy would change Japan’s economic fortunes sustainably for the better.

Last week’s news that Japan’s trade deficit had widened was a confirmation that the J-Curve effect is not happening in Japan. In fact, the Yen has been depreciating against the US Dollar since October 2012, before Abenomics, and there is no sign in the Delta Economics forecast that there will be any pick-up in exports for the foreseeable future. Our forecast for Japan’s imports in 2014 has fallen slightly from 0.77% growth to 0.75% growth since September, but our forecast for export growth in 2014 has dropped from 0.14% growth in September last year to 0.01% growth now.

Some of this is because of the general failure of world trade to pick up pace in 2014. Japan is being particularly severely affected by this. Figure 1 shows Japan’s largest export partners and its forecast growth in 2014 with each.



Figure 1 | Top ten largest export partners: forecast growth in exports 2014

Source | DeltaMetrics 2014


Trade with developed world partners is forecast largely to fall back this year with a particularly severe drop in trade with the US (-5.66%) and Germany (-1.31%). Even trade with its emerging economy partners in the Asia-Pacific region is not forecast to grow as quickly as we were forecasting in September 2013. For example, we were then forecasting that export trade with China would grow by 2.53% and we are now predicting somewhat slower growth at 2.42%.

The existence (or not) of a J-curve means that link between Japan’s trade and the value of the Yen per US Dollar exchange rate must be strong. Over the whole period, the correlation between the Yen in US Dollar terms and trade has been negative, at -0.48 which suggests both that imports may not always fall in line with expectations (rising when the currency depreciates) and that the relationship may not be strong enough for a J-curve effect. Figure 2 shows the trade ratio relative to the Yen-US Dollar exchange rate and demonstrates that the J-curve effect has not been working since April 2010.



Figure 2 | Japan’s exports and imports against Yen-USD exchange rate, 2001-2014 (Yen per 1 USD)

Source | DeltaMetrics 2014, Bloomberg


Between June 2001 and January 2004 the Yen appreciated and exports declined relative to imports. A mild depreciation of the currency in Q1 2004 led to an increase in the ratio which continued until mid 2007 when the Yen started its more than five-year appreciation relative to the US Dollar. Exports fell relative to imports during this period. The rapid increase in trade in 2010 explains the sharp increase in the ratio from Q2 2010, despite sustained appreciation of the Yen, and was a consequence of catch-up after the global trade collapse in 2009.



Figure 3 | Japan’s trade ratio (Exports divided by imports) against Yen USD exchange rate, 2001-2014 (Yen per USD)

Source | DeltaMetrics 2014, Bloomberg

However, what is really clear from Figure 2 is the sharp drop in the ratio after May 2011. This date is significant because it is 2 months after the Fukushima disaster. Exports relative to imports have not recovered since, despite mild depreciation of the currency from May 2011 and strong and sustained depreciation, arguably, since August 2011. In other words, the relationship between the Yen’s value and trade started to break down as early as 2010 when trade recovered from its global collapse.

The other striking observation from this chart is that the currency and trade are not especially correlated. There are few lags evident between a change in the currency’s value and a change in either exports or imports and over the period since the financial crisis, the correlation is relatively weak (-0.173) for imports and even weaker (-0.057) for exports. The negative correlation between imports and the Yen per US Dollar exchange rate points to a fact that as the Yen depreciates, imports will increase. Since 2011, this trend has become more obvious with the negative correlation strengthening to -0.606.

What might be behind this strengthening of the negative correlation with imports? Since Fukushima, Japan’s energy demand has been met increasingly by imports, particularly of Petroleum Gas, as illustrated in Figure 4. What this suggests is greater dependency on outside supply of energy and this is evidenced, not only in the increased imports of gas, coal and refined oil, but also in the fact that imports from Australia are forecast to grow by over 3% and from the Netherlands (which is a major oil and gas exporter) are forecast to grow by nearly 9% in 2014.



Figure 4 | Largest exports and import products: forecast growth in trade 2014

Source | DeltaMetrics 2014


A steady increase in mineral fuel and iron and steel imports has been evident in the data since before the Fukishima disaster, however. Since the post-trade collapse recovery, it is imports of iron and steel, not energy, into Japan that have grown most strongly. Although demand for mineral fuels did rise after June 2011, the acceleration was not actually as fast as the previous two-year period from mid 2009, as illustrated in Figure 5. And, as the graph also shows, since December 2012, imports overall of mineral fuels have remained relatively static with a slight dip towards the end of 2013.



Figure 5 | Top three import sectors relative to Yen-USD exchange rate, June 2001-Jan 2014

Source | DeltaMetrics 2014, Bloomberg

So is there any chance of export-led growth and a J-Curve effect? The decline in exports of Japanese cars of nearly 4% shown in Figure 4 is replicated at a sectoral level. Sector-level exports of vehicles, electronics and machinery, boilers and nuclear reactors seem impervious to changes in the exchange rate, as illustrated in Figure 6. Even during a period of strong currency appreciation exports rose and, since the depreciation in Q4 2012 exports have fallen.


Figure 6 | Japan’s Top 3 export sectors against Yen per USD exchange rate, June 2001-January 2014

Source DeltaMetrics 2014, Bloomberg


Assumptions about the J-curve and its impact on trade rest on a belief that policy can over-ride the power of markets to influence the value of a currency. Since the financial crisis, currency markets have sought a reserve currency alongside the US dollar and, until October 2012, the effect was the appreciation of the Yen versus the dollar. Abenomics has been successful in convincing markets that it is on a course to reflate the Japanese economy and set it back on a path of export-led growth. Recent data on the deficit suggest that the policy has had little effect so far. The ability of Japanese policy makers to over-ride the market will only last as long as the market belief in the policy is sustained. Delta Economics forecasts suggest that this might not be for very long and that any further depreciation, however desirable, might be because of lack of faith in Japan rather than a direct consequence of policy.