Month: August 2018

Following a July 12 report from the Financial Times that senior Pakistani finance officials were drawing up options for Pakistan’s new prime minister Imran Khan to seek an IMF bailout of up to $12 billion,  U.S. Secretary of State Mike Pompeo warned against providing an International Monetary Fund bailout for Pakistan’s new government that includes funding to pay off Chinese lenders.

In an interview on CNBC on July 30, Pompeo said the United States looked forward to engagement with the government of Pakistan’s expected new prime minister, Imran Khan, but said there is “no rationale” for a bailout that pays off Chinese loans to Pakistan.

“Make no mistake. We will be watching what the IMF does,” Pompeo said. “There’s no rationale for IMF tax dollars, and associated with that American dollars that are part of the IMF funding, for those to go to bail out Chinese bondholders or China itself.”

As we reported last month, Pakistan’s urgent need for the emergency cash comes as a result of a currency crisis that saw a devaluation of the Pakistan Rupee, as Pakistan burned through a third of its reserves in the past year…

… forcing the central bank to institute soft capital controls and increasing the amount of red tape needed to access dollars. It has also presented the new government with its biggest challenge to date. Many analysts have recently said they expect that another IMF bailout, the second in five years, will be needed to plug an external financing gap.

Also notably, much of this carnage accelerated since the start of January which coincided with Pakistan’s decision to ditch the dollar (following Trump’s remarks) and get closer to China.

“SBP has already put in place the required regulatory framework which facilitates use of CNY in trade and investment transactions,” the State Bank of Pakistan (SBP) said in a press release late Tuesday, ensuring that imports, exports and financing transactions can be denominated in the Chinese currency.

“The SBP, in the capacity of the policy maker of financial and currency markets, has taken comprehensive policy related measures to ensure that imports, exports and financing transactions can be denominated in yuan,” Dawn news, Pakistan’s most widely read English-language daily, announced while quoting the SBP press release.

Furthermore, as we reported in December, Pakistan has been contemplating the move since last month’s formal launch of the Long Term Plan for the China-Pakistan Economic Corridor (CPEC), signed by the two sides on November 21. The CPEC is a flagship project of China’s Belt and Road initiative – the 3,000 km, over $50 billion corridor which stretches from Kashgar in western China to Gwadar port in Pakistan on the Arabian sea.

We concluded our article by asking, even before the IMF news hit, “Will China step up?“

Well, today’s China did just that, because as Bloomberg reports today, Boeing has agreed to a reported $2 billion loan just days after the election of a new Pakistani premier, and just days after Pompeo stressed that an IMF funded bailout of Pakistan is not acceptable to the US.

As Bloomberg notes, while cricketing legend – and new Prime Minister – Imran Khan attempts to form a coalition government, China has stepped up to reinforce a geopolitical alliance that shapes the South Asian nation’s policies toward the U.S. and India. The announcement caused Pakistan’s rupee to jump the most in nearly a decade as Khan takes power with an economy in chaos.

The friendly gesture speaks volumes to Pakistan’s ongoing pivot away from the US – whose President Trump has cut military aid to Islamabad – and overwhelming reliance on China as a source of financial, diplomatic and military support.

To be sure, Khan may not have a choice because as Bloomberg also notes, Pakistan’s powerful military has continued to push its civilian counterparts for close ties with China in order to ensure the flow of more than $60 billion in loans for the China-Pakistan Economic Corridor infrastructure projects.

“There is a deep, far-reaching political consensus in Pakistan for a continued strong partnership with Beijing,” said Michael Kugelman, a senior associate for South Asia at the Woodrow Wilson Center in Washington. “This is especially true now, with Pakistan’s relationship with America facing an uncertain future.”

Khan, who recently was elected prime minister, was quickly to state where his allegiances lie:

“Our neighbor is China, we will further strengthen our relations with it,” Khan said as he declared victory in a televised statement. “The CPEC project which China started in Pakistan will give us chance to bring in investment to Pakistan.”

China was likewise laudatory: on July 30, Geng Shuang, a spokesman for China’s foreign ministry said China welcomed the new government. Khan “will likely try to balance the U.S. and China, but China and Pakistan are mutually dependent,” said Wang Yiwei, director of Renmin University’s Institute of International Affairs in Beijing. “He won’t be able to change that.”

Aside from the usual geopolitical considerations – where China is seeking to significantly expand its Asian sphere of influence and Pakistan is a critical spoke in the plan due to its location – there is another reason why the two nations are close: Pakistan has become one of China’s top weapons clients.

Ultimately, Pakistan has no choice: it has to pick in ally in the superpower race between the US and China, and the country has picked the latter. Michael Kugelman, a senior associate for South Asia at the Woodrow Wilson Center in Washington, said that “Pakistan needs powerful friends, and China is one of the few that Islamabad can depend on — Khan knows this, and he’ll do what’s necessary to ensure that the China-Pakistan relationship remains strong.”

It also means that Mike Pompeo has nothing to worry about when it comes to an IMF-funded bailout.

Over the weekend, Karachi’s Express Tribune newspaper was the first to report that Beijing authorized a $2 billion loan to help Islamabad. At the same time, the Islamic Development Bank, a multilateral lender based in Saudi Arabia, also activated a three-year $4.5 billion oil-financing facility.

This is not the first time China has opened its wallet toward Pakistan: according to Bloomberg calculations, the amount of Chinese loans given to Pakistan over the last 13 months alone comes close to the IMF’s last loan of $6.2 billion. It is these debts to China that triggered Pompeo to state he would work against Khan’s new government getting IMF funds to pay off Chinese loans.

The new Chinese loan will help Pakistan shore up falling foreign exchange reserves, said Najam Rafique, director of the Islamabad-based Institute of Strategic Studies. He added that Khan leans toward boosting ties with China.

“China isn’t a distant power, it’s a neighbor,” Rafique said. Khan “will be trying to improve and build upon what’s already in process.”

This is probably is good news for Mr. Pompeo: it means the IMF’s funds are safe and sound, and instead as the US continues to lose power and influence across the globe, and especially in Asia, it is China that is now becoming the world’s lender of last resort.

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Authored by Vanand Meliksetiam via Oilprice.com,

The energy industry is highly sensitive to U.S. sanctions due to the petrodollar being the single most important currency in global trade. Washington is able to exert significant influence by limiting access to the dollar through its financial institutions. Russia is especially exposed to Washington’s ire as a significant part of its governments’ coffers are filled by revenues from its oil and gas sector.

In recent years, Russian companies have been increasing their activities in several unstable countries where the U.S. has imposed sanctions. This tactic from Russia comes with huge opportunities but also a significant amount of risk.

The level of this risk is illustrated by the absence of western oil companies in these areas as they are accountable to their shareholders. Privately held companies also struggle to operate in these areas due to their reliance on international financial markets and the difficulty with carrying out due diligence. Venezuela and Iran are prime examples of oil rich areas that are struggling under U.S. sanctions.

At the same time, absence of many major western oil companies in unstable regions is one of the reasons why Russian companies, both majority state-owned and privately held organizations, have got involved. Limited competition strengthens the position of Russian firms during negotiations. The host countries face a predicament in many cases as they have to choose between a bad deal or no deal at all.

A prime example of this is Moscow’s involvement in Iran, which has been ongoing for years. Even during the years of sanctions due to Tehran’s nuclear program, Russia was able to strike a barter deal where Iranian oil was exchanged for other products. This deal bypassed the international financial system and sanctions. Even now when the U.S. has unilaterally withdrawn from the Iran Nuclear Deal and is about to reinstate sanctions, Moscow and Iran are intensifying cooperation.

Days before the Helsinki summit and the meeting of Presidents Putin and Trump, Iranian officials struck a deal in Moscow for an investment of $50 billion in the oil and gas sector. While western firms are reluctant to continue doing business in Iran, let alone increase cooperation, Russian firms are seizing the opportunity to boost their portfolio with even more Middle Eastern assets.

The political instability and economic meltdown in Venezuela has caused a serious challenge for the country, but it has also created an opportunity for Chinese and Russian companies. Politically supported by their respective governments and with next to no risk of going bankrupt, these firms have extended loans and provided support where commercial western companies wouldn’t dare to.

Energy, however, is much more than just a source of revenue for Moscow. The involvement of major Russian energy company provides the host countries with much needed resources to explore their hidden riches. It makes these states more or less dependent on Russia and therefore a pliable foreign policy tool to wield in the interest of Moscow.

Although the possible returns are significant, resources can be used only ones. Every dollar, ruble or euro spent or every Russian engineer sent abroad is one more that cannot be used for the benefit of the domestic Russian industry. However, the exact same argument can be applied in the opposite direction. As Russia is extending its cooperation with OPEC – increasing the likelihood that its production cuts could be more widely applied in the future – propping up production in other countries could be a way to use resources when domestic production is artificially limited.

However, by putting Russian boots on the ground and financial resources in foreign economies, Moscow risks being tied up. Russian investments in Iran and Iraq are significant. So is its involvement in Syria. Moscow is performing a delicate balancing act with each of the actors in the conflict: Iran, the West, Turkey, Israel and the Arab world. In recent months, pressure has been mounting from the Trump administration, supported by the Saudi led bloc and Israel, to reduce Iran’s influence over Syria and the Middle East.

Iran’s significant influence over local organizations and militias in Syria and Iraq put it in a formidable position to exert influence over Russian policy in the Middle East. The recent uprising in Southern Iraq due to electricity and water shortages shows how delicate the situation is. Demonstrators, in part, aimed their ire towards the energy sector where Lukoil, for example, has significant investments. Although no damages were incurred to Russian assets, the protests are another example of just how vulnerable Russian investments in these areas can be.

Although plausible, it is unlikely that Iran will use Russia’s oil investments to exert influence. Tehran cannot afford to damage its relations with Moscow at the moment considering how isolated it currently is. It is perhaps this knowledge that is giving Russia the confidence to get increasingly involved in Iran. Only time will tell if this strategy will pay off in the long term.

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In what may represent a historic change to China’s mercantilist economy, recently we noted that in the first quarter of 2018, China had recorded its first current account deficit this century.

Now, in a note from Deutsche Bank that explains the bank’s justification to revise its USDCNH forecast higher (now expecting the Yuan to drop to 7.40 against the dollar versus 6.90 previously), the bank picks up on this observation and as chief China economist Zhiwei Zhang writes, China had a current account deficit of US$ 34bn in Q1, the first quarterly current account deficit since 2001 Q2.

He then goes on to preview that the current account balance for Q2 will be released on Aug 6, and while the monthly balance of payments data suggest that China likely has a surplus in Q2, it will be much smaller than the past years.

“Consequently the current account balance in H1 has likely turned into a deficit”, Deutsche Bank predicts.

Here are the details:

the monthly data release shows China’s balance of goods and service trade recorded a surplus of US$ 31 bn in Q2 after a large deficit of US$21 bn in Q1 ( Figure 1 ). Growth of goods exports slowed in H1 to 11% while import growth surged to 20%. The service trade deficit widened to US$149 bn in H1 from the five year average of US$90 bn ( Figure 2 ).

The Q2 income balance in the current account has not been released. To turn the current account in H1 into surplus the income balance needs to show a surplus of at least 3bn in Q2 which is quite unlikely, as it has been in deficit for most of the past three years ( Figure 3 ).

As a result, DB expects China’s current account balance to show a small deficit around US$15bn in H1 (a deficit of US$34bn in Q1 and a surplus of US$19bn in Q2), assuming the income balance in Q2 to be the average of past two years (- US$12bn).

It would be the first time China had a current account deficit on half year basis since China started to publish quarterly data in 1998.

Why is this important? As Zhivei explains, the decline of current account surplus is a structural trend which is driven by

1. consumption upgrade due to a strong wealth effect from the booming property market, particularly in tier 3 cities
2. slower growth of exports as China loses competitiveness in labor intensive products to other low income countries. The trade tension will likely put further pressure on the current account in coming years, as China tries to promote imports to avoid trade war.

He goes on to note that while the trade war has not affected China’s current account visibly yet in H1, it will certainly reinforce the downward pressure in H2 and 2019 as pressure on exports increases, especially if Trump imposes more tariffs than are already in place (which he will). Adding to the downward pressure, China is trying to promote imports to mitigate the trade tension. As a result, “the trade surplus will likely shrink in the next few years.”

Extrapolating a few years out, DB forecasts that China’s current account balance will drop to 0.6%, 0.3% and 0% of GDP in 2018, 2019 and 2020 (2017: 1.3%).

The implications of China going from current account surplus to deficit are profound: it would mean greater reliance on foreign funding, a more open capital account, a weaker CNY and deeper and less manipulated capital markets; in a nutshell it would mean that China is becoming a new America, and the Yuan would need to increasingly be seen as a legitimate reserve currency to fund the deficit. Of course, it would also mean less “ability” to massage the Chinese economy.

And as a result of the resulting downward pressure on the currency, DB revises its USDCNY forecast to 6.95 and 7.40 by the end of 2018 and 2019. However there is a twist:

We expected RMB to weaken but the pace of depreciation has turned out to be faster than we expected. The PBoC may step in to smoothen the path of depreciation but we doubt they will intervene heavily to reverse the trend of depreciation.

Actually, judging by today’s action, they are doing everything in their power to accelerate it.

Finally, there are two more reasons why the Yuan is set to keep sliding.

First, the capital outflows seem to be picking up in June after being stable for most of H1.

Second, interest rates are once again edging lower as monetary policy has aggressively loosened in recent weeks.

Of the two, the first issue is by far more the most critical variable when it comes to China’s economy, as Eric Peters recently explained, which is why DB notes that it expects China’s capital controls to be tightened in the next few years to maintain a loose liquidity condition in China without even faster depreciation.

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Thanks in part to an incessantly shrinking float, Apple just became the first publicly-traded company to be worth more than $1 trillion…

The line in the sand was $207.05 (based on Apple’s most recently updated share count)

And once it tagged $207.05, the sellers hit…

And thanks to global ETF demand combined with a buyback-driven shrinking float and rising earnings…

Tim Cook is now the CEO of a trillion-dollar company…

Tim Cook won…

Bezos won’t be happy but at least the central bank money is being put to good use…

Incidentally, as we noted previously, Apple’s unprecedented slow-motion MBO has another key function: as Bloomberg’s David Wilson writes, the decline in share count is responsible for 42% of the stock’s gain from the end of 2013 through Tuesday, as shown in the chart. And, Wilson notes, “as Apple nears $1 trillion in value, a threshold no U.S. company has ever crossed, the gap may only get wider.”

To be sure, Apple is not alone: a study published by the National Employment Law Project and the Roosevelt Institute found that U.S. companies spent 60% of net income on repurchases, money that could have been used for pay increases, reinvesting in company growth or general R&D spending – between 2015 and 2017.

Then again, Apple shareholders are certainly delighted that instead of doing any of those things, AAPL focused on what it does best, at least in recent years: rest on its laurels, borrow the best technology created by its competitors, and use the billions in cash this generates every quarter to buy back its own stock.

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Authored by Simon Black via SovereignMan.com,

In a world full of reckless and extreme monetary policy, Japan no doubt takes the cake.

The country has total debt of more than ONE QUADRILLION YEN (around $10 trillion) pushing its debt-to-GDP ratio to a whopping 224% – that puts it ahead of financial basket case Greece, whose debt-to-GDP is around 180%.

Japan spent 24.1% of its total revenue (appx. 23.5 trillion yen) last year servicing its debt – both paying down principal and interest. And that percentage has no doubt moved even higher this year.

And, keep in mind, this isn’t some banana republic. It’s the world’s third-largest economy.

The country’s economy is so screwed up that the Bank of Japan (BOJ), the central bank, has been conjuring trillions of yen out of thin air to buy government debt.

The BOJ printed yen to buy basically all of the $9.5 trillion of government debt outstanding. When it ran out of bonds to buy, BOJ started buying stocks. Now it’s a top 10 shareholder in 40% of Japanese listed companies.

Most recently, the central bank has started “yield-curve control,” which basically means they’ll do whatever it takes to make sure the government doesn’t have to pay more than 0.1% interest.

But something interesting has happened over the past few weeks…

Despite the BOJ’s promise to hold rates and bond yields down, the other owners of Japanese government bonds (JGBs) have been getting nervous. And they’ve been selling.

The selling pressure pushed bond prices down (and, inversely, yields and rates up)… In just under two weeks, yields on 10-year JGBs soared from 0.03% to 0.11% – an 18-month high.

If you own an asset and you don’t think it will perform well, you sell it. And clearly that’s how people feel about Japanese debt. The bonds pay close to zero, after all.

Japan has been fighting deflation for a long time. And with deflation, when the purchasing power of your money increases every year, you may consider holding a bond that pays close to zero… because you’re still maintaining your purchasing power.

But for the past decade or more, Japan has been committed to producing inflation. And now it’s getting inflation of around 1% a year (with a target of 2% annual inflation).

Now, anyone holding JGBs is guaranteed to lose money. And who in their right mind is going to hold an asset that guarantees you’ll lose money?

So people are selling those bonds. And yields are going up as a result.

Yields increasing from 0.03% to 0.11% may not sound like a big deal to you. But think about what it means for Japan…

The country already spends a quarter of its tax revenue just to service the debt. They cannot afford even the tiniest increase in interest rates.

And because bondholders are selling, and rates have been rising, the BOJ has intervened three times in a single week… buying up all the bonds people are selling in a desperate attempt to hold interest rates down.

This is a clear-cut case of BLATANT financial desperation.

And, to be honest, it’s a bit scary.

Japan is already in debt up to its eyeballs… but the BOJ is telling the world that they’re just getting started buying more bonds, no matter what the cost.

It’s crazy when you hear the most powerful economic policy makers in the world’s third-largest economy say that they’re going to hold interest rates down with ZERO consideration for the consequences.

It means they don’t care about fiscal responsibility, they don’t care how much they will plunder the power of people’s savings through inflation, or about their underfunded pensions struggling to generate returns. None of that matters.

The government’s only focus is to hold down interest rates… which they have to do to make sure Japan doesn’t go bankrupt.

If interest rates in Japan went to, say, just 1%, the nation’s annual debt service would literally exceed all of government tax revenue.

Here’s why this is a really big deal…

Remember how crazy things got in June, when some Italian finance minister didn’t get the job?

Markets around the world completely freaked out.

The potential downfall from what’s currently happening in Japan would be 1,000x worse. Remember, this is the third-largest economy in the world.

The Japanese government is fighting for its life right now (with absolutely ZERO concern for its other financial obligations). And it’s clear that they will spend whatever it takes to combat a rise in interest rates.

This won’t end well.

And it’s time to start loading up on the safest assets you can find.

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