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Here are highlights from Thursday's Analyst Blog:

DOW Reels In Rohm & Haas Deal

The Dow Chemical Co. (DOW) announced that it completed the acquisition of Rohm and Haas.

Synergies are targeted to be $1.3 billion. Dow has decided to exercise its option to have the Haas Family Trusts make an additional $500 million investment in Dow equity. This is consistent with Dow's disciplined plan to retire the bridge loan for the financing of the Rohm and Haas transaction by the end of 2009.

Hana Bio Report a Non-Event

On March 31, 2009, Hana Bioscience (HNAB) reported fourth quarter 2008 financial results.

The Company reported a net loss of $6.1 million (including non-cash expenses), or $0.19 per share, for the three months ended December 31, 2008, compared to $3.6 million, or $0.10 per share, for the same period in 2007.

AMD Growth Plan Breakdown

Over the last few years, Advanced Micro Devices, Inc. (AMD) has consistently churned out lower-cost alternatives to Intel Corp.'s (INTC) offerings. AMD was the first to introduce 64-bit Athlons and Opterons for desktops and servers, respectively. More recent introductions include the Phenom and Barcelona processor families for desktops and servers, respectively.

The company has launched both quad-core and triple-core versions of these products. The triple-core products are expected to be a lower-cost alternatives for price-sensitive customers, although the quad-core products are also expected to do very well. The new technology is expected to provide a number of architectural advantages, including more efficient power usage.

Amphenol Exceeds Target Price

Amphenol Corp. (APH) designs and manufactures connectors and interconnecting systems that are used primarily to conduct electrical and optical signals for a wide range of sophisticated electronic applications.

We had recently increased our target price on the stock from $29 to $30, based on comparative valuation (P/E of 15.8x our FY2009 estimates, compared to the historical average of around 17X). Buoyed by the market in general, the stock has shot over our revised target price and is trading up over 9% today.

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"The Italian guarantee and swap scheme is an effective instrument for boosting market confidence and the commitments we have secured from the Italian authorities ensure that distortions of competition are kept to a minimum," EU Competition Commissioner Neelie Kroes said in a statement.

"That this is about providing credit to Austrian companies is just a pretense," said Matthias Siller, who manages emerging market funds at Baring Asset Management. "This move is a clear commitment to eastern Europe......But this has nothing to do with charity. Those (Austrian) banks are system-relevant banks in central and Eastern Europe, and if they had to withdraw capital from there, this would set off a landslide," he said.

``We do expect the Indian business cycle to be the first to bottom in Asia. And, it should, in theory, be first to emerge,'' Sharmila Whelan, senior economist at CLSA, said ``The worst will be over by mid-2009 and by 2010 you should be able to see the next investment-led business cycle taking root.''

Ironically, the current global situation is also making India's measured pace of economic reform look wiser than before. At a time when Western countries are frantically nationalising banking assets, the Indian government's reluctance to sell more than 49% in its state-owned banks—which control some 70% of banking assets—now seems reassuring. In addition, India has not yet introduced full capital-account convertibility, which protects its currency, while its careful control of foreign borrowings by domestic companies limits dependence on the global financial system. Regulators have also periodically introduced curbs to slow the formation of potential asset bubbles, such as higher provisioning and prudential requirements on real-estate lending.
The Economist

“For India we have marked our forecast down to 6.3% of 2009 calendar year. That is considerably below what we consider to be India’s potential growth,” IMF deputy director for Asia Pacific region, Kalpana Kochhar said. “There is a specific meaning to “potential” - it is the rate at which you can grow without causing inflation. And for India we estimate that to be 7.5% to 8%. Our forecast of 6.3% would put it quite a bit below the potential,”.

"The outlook for the manufacturing sector appears to be bleaker in the backdrop of tough local and global economic conditions," said ABN AMRO Bank N.V. senior economist Gaurav Kapur.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

"October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003."
David Hensley, Director of Global Economics Coordination at JPMorgan

``The global financial and economic headwinds adversely affected foreign demand for Indian manufactured goods,'' said Gaurav Kapur, an economist at ABN Amro Bank in Mumbai. ``The growth of total incoming new work to the Indian manufacturing economy lost considerable momentum.''

The world manufacturing sector suffered its sharpest contraction in survey history during October, as the ongoing retrenchment of global demand and further deepening of the credit market crisis negatively impacted on the trends in output, new orders and employment. The JPMorgan Global Manufacturing PMI posted 41.0, its lowest reading since data were first compiled in January 1998 and a level below the no-change mark of 50.0 for the fifth month in a row.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

"October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003."
David Hensley, Director of Global Economics Coordination at JPMorgan

The French manufacturing purchasing managers index was revised down to a series low 40.6 in October, down from both the 'flash' estimate of 40.8 and September's 43.0 figure, Markit Economics said in a press release issued on Monday.

Disaggregating the figures, the output component fell to an all-time low of 37.8 from September's 41.7 level, while new orders slipped all the way to a series low of 34.9 for the month, down 2.6 points from September's 37.5 level. Purchase quantities and new export orders also saw some new record lows in October, falling to 33.7 and 38.5 respectively.



Eastern Europe


Hungary's manufacturing industry contracted sharply in October, with the PMI dropping 5.2 points to hit 44.7 in October - a historic low, and 0.8 points below the previous worst reading registered in October 1998, according to the latest data from the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM).

In Poland the ABN Amro Purchasing Managers Index fell for the sixth month running to 43.7 (down from September's 44.9) a record low and well below the neutral reading of 50, according to Markit Economics yesterday. In the Czech Republic, manufacturing output contracted for the seventh month in a row, and the index hit an all-time low of 41.2, just above the revised euro zone figure of 41.1. As the Eurozone itself contracts, these economies which are heavily dependent for exports to the zone will be buffeted, especially now that forex loans for their domestic housing markets have all but dried up.




US Manufacturing

The US manufacturing PMI dropped back to 38.9 in October from 43.5 in September, indicating a significantly faster rate of decline in manufacturing when comparing October to September. It appears that US manufacturing is experiencing significant demand destruction as a result of recent events. October's reading is the lowest level for the US PMI since September 1982 when it registered 38.8 percent. On the other hand inflationary pressures are evaporating rapidly, and the Prices Index fell to 37, the lowest level since December 2001 when it registered 33.2 percent. Export orders also contracted for the first time in 70 months.


The BRICs

China's PMI dropped to lows not previously seen in October, confirming that the economy of the so-called factory of the world is now decelerating along with everyone else. Two international surveys measuring the PMI independently corroborated the evidence of a cooling Chinese industrial economy.

According to a survey complied by securities firm CLSA, China's PMI fell to 45.2 in October, its third consecutive drop, from 47.7 in September, as new orders and exports, as well as pricing power, were squeezed by the global financial crisis.

"The very sharp fall in the October PMI confirms that China is more integrated into the global economy than ever. Chinese manufacturers are seeing their order books cut, both at home and abroad, as the world economy falls into recession," said Eric Fishwick, CLSA's head of economic research, in a report released Monday. "Costs are falling but so are output prices. The coming 12 months will be difficult ones for manufacturers, China included."

Quotable
"A good conspiracy is unprovable. I mean, if you can prove it, it means they screwed up somewhere along the line.”
Jerry Fletcher (played by Mel Gibson), Conspiracy Theory

FX Trading – Kookburger Time!  A rant it is!
----------
Editors Note: Warning to gold lovers, conspiracy nuts, and US haters.  This rant you may want to avoid. 
----------
The conspiracy crowd is working overtime these days.

Many “deep thinkers” among the gold crowd still spout conspiracy stuff on a regular basis to help explain why their beloved metal is not now sitting at least $2,000 an ounce.  Could it really be that each morning Fed Chairman Bernanke, Treasury Secretary Paulson and, of course, V.P. Dick Cheney wake from their slumber and huddle in the safe room to discuss how they can manipulate the gold market.  We tend to think they have bigger fish to fry. 

What’s odd about the gold conspiracy theory crowd is that gold’s price action, and minor role in the system, is very rationally explainable (granted the explanation may be wrong) on standard economic terms.  But gold guys all seem to have the secret handshake and “know” it’s manipulated.  Odd indeed!  Does it make one feel better to say you lost money because of some nebulous “manipulation” you can’t really define?  Guess so.  And isn’t it disconcerting when the “manipulators” push gold up for no particular reason and a believer makes money?  We don’t get it. But then again, Philistines we are. 

But it’s getting better than that out there.  Over the past couple of days we’ve been made privy to some whoppers in the making.  If you don’t already know, let us clue you in on a couple: The Amero is on the way.  This conspiracy uncovered says the US will soon toss away its world reserve currency status in order to distribute new currency that has Mexican and Canadian politicians’ pictures on the front.  Aren’t American politicians on our money enough already?  It’s a loony idea indeed. 

And a new conspiracy uncovered, and emailed to us, stars on You-Tube.  A gentleman there has revealed a well heeled crowd in the Middle East will use its vast wealth to take over Russia of all places; after it crushes the US economy in its spare time.  Hmmm…wouldn’t Spain be a lot nicer given those nasty winters in St. Petersburg?  We’ve heard real estate prices are looking good in Barcelona.   

Do powerful people do all they can to advance their interest and power in the world?  Absolutely!  Are markets “manipulated” by pools of capital at times?  No doubt.  But, this doesn’t automatically equal conspiracy.  At least we don’t think so.

“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen,” wrote Frederic Bastiat.

We don’t think Bastiat was talking conspiracy theory here.  We do think he was talking about all the stuff underneath the surface of an advanced and complex, yet fragile, system of decisions by millions of players with all types of varying interests that make up what we call an economy. 

Just because we can’t discern what’s going on below the surface, it doesn’t mean it isn’t at least as important, or more important, than the stuff we see going on above.  And because we can’t always apply our Newtonian cause and effect to what we see above, it doesn’t mean we should create conspiracy theories as explanation. 

I’ve recently talked about the doom and gloom crowd getting it exactly right with their broken clocks, but most got it exactly wrong too as they believed US dollar doom was the upshot of the story.  What we found interesting as we followed the dollar doom and gloomers along this long path was the degree to which price action seemly proved them right, hiking their egos along the way, yet the reality bite now shows maybe they were simply fooled by randomness, and shouldn’t have chalked up their rightness to their rather pedestrian intelligence.

Nassim Taleb said it well in Fooled by Randomness: 

“By some viciousness of the structure of randomness, a profitable person like John [trader of rather pedestrian intelligence], someone who is a pure loser in the long run and correspondingly unfit for survival, presents a high degree of eligibility in the short run and has the propensity to multiply his genes.  Recall the hormonal effect on posture and its signaling effect to other potential mates.  His success (or pseudo-success owing to its fragility) will show in his features as a beacon.  An innocent potential mate will be fooled not thinking (unconditionally) that he has superior genetic makeup, until the following rare event.  Solon seems to have gotten the point; but try to explain the problem to a naïve business Dawarinist—or your rich neighbor across the street.”

Let me put this yet another way.  Many so-called “currency experts” got it right for many years because of the trend and carved out guru-like status along the way.  The root of their argument was the US was, and still is, all bad.  The US fundamentals were terrible.  The US is the root of all global financial evil.  Thus, despite this “bounce” of 23%+ in the US dollar, to hell in hand basket it will still go.  This crowd has no clue as to what is and has gone on below the surface for the most part, yet glib they still are. 

I’m sure the US haters will wine and complain about our defense of the US financial system—so be it.  But what if all of you who bashed the US for its “dependency” for money flow to support its deficits got it completely wrong?  It would explain why many of you find it so confusing the dollar could dare to rally.

What if the US was the lynch-pin for the global financial system and therefore charged with finding a proper home for all those forex reserves built up by dictatorial countries who were very happy not to reinvest in their own people lest they create wealth that could come back to challenge their rule?  What if they just kept dumping all this stuff into the bad old US where their assets were most efficiently processed and protected by the rule of law, which isn’t quite available at home?  What if the US current account is what we have always said it was, a representation of US dollar credit greasing the wheels of all global asset markets for the betterment of the this thing called globalization (which helps explain why the last two times we got what the economists and whiners wanted, an improvement in the current account, which coincided with stock market crash in 1987 and 2000)?  What will happen to all those resources re-funneled by the US financial system to strengthen export sectors the world over when said export demand by the bad old US falls?  

In short, blame the US financial system if you wish.  But be careful about your diagnoses on the dollar.  If all this efficient recycling of resources which sparked a massive run-up in global growth by creating massive dollar-based credits for others around the globe to grow is now heading home and said export models built on credit come crashing down, this little dollar bounce could easily morph into a multi-year bull market; which is what we expect after applying our pedestrian-like intelligence to the stuff we can and can’t see.   

And of course you can just imagine the plethora of conspiracy theories hatched when the world realizes the good old greenback’s world reserve currency status is poised to soar in a way it never has before.  This will make the Plunge Protection Team look like child’s play.  Stay tuned. 

Is the dollar finally correcting?  We’ve been playing for it near-term and getting steamrolled by it.  But this morning, it’s getting whacked a bit as stocks are actually bidding higher pre-open and did well in Europe. Hopes of a US rate cut tomorrow from the Fed seem to be lifting spirits, and some calmness in the interbank market suggesting the credit may be normalizing a bit. 

The high yielders, which have been whacked so hard recently, are flying today…

AUDUSD 90-min: Just above near-term resistance.

Given the dollar index chart is looking parabolic, any correction that does materialize could be very powerful.

…and by the shape of the open interest and mix of overwhelming bears to bulls in the euro currency futures, maybe Mr. Market is due to shake off some dollar bulls…
 
Regards,
Jack&JR

Yesterday, the Ukraine received a USD16.5bn loan from the IMF and the IMF at the same time said that it would agree with the Hungarian government on a rescue package in the coming days. Under normally circumstances this would be good news for CEE assets. However, it seems like the markets are totally giving up on CEE. This morning the Hungarian stock markets have dropped more than 10% despite the promise of an IMF package.

......it is worrying that the CEE markets continue to sell-off despite IMF’s clear commitment to support the region’s markets and economies. One might in fact see the lack of positive response to IMF’s rescue packages for Hungary and the Ukraine as an indication that these packages are in fact making the markets even more nervous that something “is seriously wrong in CEE”.
Lars Christensen, Chief Analyst Danske Bank, CEE: Markets fail to respond to IMF packages, 27 October 2008

The Polish government has also announced on Monday that Poland is considering guaranteeing interbank transactions - according to Deputy Prime Minister Waldemar Pawlak speaking on Polish public radio. Pawlak said that the government is examining the possibility of taking bank shares as collateral in exchange for any guarantees offered. According to Pawlak external investors in Polish banks have been applying policies that are "too strict" in the Polish context, since the credit problems encountered elsewhere have not affected Polish banks in the same fashion. This is a classic example of what we economists call "contagion".

According to the draft of the new law which is set to go before the Polish cabinet on Tuesday, Poland's government will be empowered to guarantee commercial banks loans from the central bank and other lenders on the interbank markets. The government will also be able to lend cash and state securities to banks. Poland's central bank has already injected 9.3 billion zlotys ($3.42 billion) of liquidity into the banking sector (last week), in the form of 14-day repos. The latest decision seems to have been taken in order to try to ease strains on the Polish money market, and in particular the availability of forex loans.

Poland's deputy prime minister also issued a warning that local bank capital was at risk of capital being transferred to financially-strapped foreign banks who own the local banks and urged the country's financial watchdog to stay vigilant in the face of this. Here we see the reverse side of the coin of having non-national banks in such a dominant position. Previously this was thought to be a great advantage, since the parent banks were thought to be ready willing and able to fund domestic lending almost ad-infinitum. Now we see that this is not at all the case, and that their behaviour moves in a pro-cyclical direction, exaggerating the boom in the good times, and sharpening the downturn in the bad ones.

"There is a risk that the capital will be transferred from Polish institutions to their parents," Waldemar Pawlak, who is also the economy minister and heads the governing coalition's junior party, was quoted as saying by PAP newswire.

As a consequence of this governmental concern the Financial Oversight Commission (KNF) has asked banks domiciled in Poland to report all transactions with their foreign owners on a daily basis. KNF head, Stanislaw Kluza, said in a newspaper interview last week that the he considered the risk of capital transfers to be very low, however, because the European banks Polish outlets, with only $284 billion in total assets, were much too small to rescue large players in Europe and the United States. This is evidently true, but some of these bank are now under great pressure to avoid additional exposure in the East, and withdrawal of funds can equally correspond to this kind of damage limitation strategy.

Foreign financial groups, among them Italy's UniCredit, the Dutch ING Groep, and KBC Group NV, Belgium's biggest bank and insurer by market value (all of whom are struggling with major problems at the present time), control two-thirds of the Polish banking sector after buying stakes in local lenders during the banking sector privatisation of the 1990s.


Polish lenders have been especially hurt in recent weeks by concerns over their ability to obtain foreign currency through interbank markets and worries about the fate of their foreign parents. Executives at some Polish banks have urged the government to consider introducing guarantees after the central bank's moves to boost liquidity on the interbank market, including foreign exchange swaps, failed to boost confidence between lenders. The financial watchdog KNF said on Saturday that Poland should think about measures to boost the Swiss franc positions of Polish banks, along with guarantees of interbank transactions or an eventual "institutionalisation" of the interbank market. But the regulator, the government and central bank insist Polish banks remain solvent and enjoy "over-liquidity."

Many of Poland's banks, like other lenders in the region, have been forced to introduce severe curbs on mortgages in Swiss francs due to pressure on their own liquidity and balance sheets. Such lending had become popular in Poland in recent months due to lower interest rates available from Switzerland and what was once favourable exchange rate.

Millennium BIGW.WA and PKO BP PKOB.WA, two of Poland's top home loan lenders, have gone so far as to announce that they were going to tighten rules for new mortgages due to the rising cost of money and fears that global financial nervousness may lead to much slower economic growth in Poland. Millennium Chief Executive Boguslaw Kott said last week that the group - which is Poland's third-biggest mortgage lender would ask for a 35 percent downpayment for popular Swiss francs-denominated home loans, a move which is likely to put a sharp brake on the growth of its mortgage portfolio.

PKO, Poland's largest mortgage lender, also confirmed it would ask new clients to put up 20 percent of the value of property when borrowing in francs. Millennium, which is controlled by Portugal's Millennium bcp, will now also require customers to cover 20 percent of investment when borrowing in Polish zlotys. Both banks had previously been offering mortgages equal to the entire value of the new home (100 LtV). Basically, what the hell these people thought they were doing by continuing to lend at 100% LtV after we have seen all that has happened in the US, and that is now happening in the UK and Spain is totally beyond "my ken", it really is.

Chief Executive Boguslaw Kott described the move as a precautionary one, and said it did not reflect any liquidity problems, adding that it was now more difficult to get Swiss francs on the interbank market. Marek Juras, head of research at BZ WBK brokerage is quoted as saying: "At times like these it is more important for banks to take care of their liquidity than drive their sales even higher." He estimated that for some lenders this would translate into a drop in new mortgages by between one-third and one-half.

The two market leaders join other smaller lenders, which in recent days moved to raise the bar for mortgage lending in foreign currencies as banks become more conservative and try to lure more cash on deposits by offering even higher yields. Mortgage adviser Expander said Getin's DomBank and Santander and GE Money had tightened their lending requirements. Many banks have also boosted margins on their mortgages in the past two weeks.

The Polish mortgage market has expanded rapidly since 2003, driven by economic growth and soaring wages, with annual growth exceeding 40 percent in the first half of this year. Large numbers of central and Eastern European housebuyers hold loans in foreign currencies, especially Swiss francs.

Most major Austrian banks, including UniCredit's Bank Austria, Erste Group Bank and cooperative Raiffeisen have now completely stopped lending to Polish domestic retail customers in foreign currencies.


After a meeting with economic advisers President Kaczynski advised Poles to keep faith in the zloty as the currency suffered further setbacks on the markets on Friday. Kaczynski recommended that loans should be taken in zlotys, not foreign currencies in order to avoid losing money on currency exchange.

"The depreciation of the zloty, which has its good sides for exports, boosts
mortgage loan installments for those who took them especially in the Swiss
franc. This may, however, be a lesson to us all to take loans in the Polish
currency. Considering low inflation, this gives the best results," Polish
President Lech Kaczynski told a press conference last Friday.

Seventy percent of the Polish banking sector is owned by foreign banks leading to concern that the impact of the general crisis in the banking sector will be felt in Poland. On Tuesday, Polish business Daily, Gazeta Prawna wrote, "The global financial crisis may cause large shifts in the Polish banking sector, AIG Bank Polska will soon be sold and there has been speculation that Fortis, Dominet, Citi Handlowy and even Bank Pekao may change hands."

Sell off speculation has surrounded the Italian owned Pekao bank over the last two weeks. It was subject to a 20 percent share price decrease in October prompting concerns that owner UniCredit may have been considering selling of all its Central and Eastern European assets. This has since failed to materialize but shows the current lack of faith surrounding the Polish banking sector.

Slawomir Skrzypek, president of The National Bank of Poland stated it had no intention of stepping in to help the zloty as it continues to weaken on the foreign currency market in a statement to reporters on Friday.


The sale of apartments in Poland has dropped by 70 percent in comparison to the same time last year, showing that the credit crunch is beginning to bite in Poland. The tightening of lending policies by banks has caused demand to fall and though prices are decreasing by 10 to 20 percent in some areas, buyers are looking for smaller flats, or withdrawing from the transaction altogether. The financial crisis has also influenced the situation of those clients who wanted to buy apartments without needing to get a mortgage, the number of which is declining due to losses on the stock market, says Gazeta Prawna.

Polish banks are to crack down on credit lending for housing loans after Poland’s financial regulator asked them to get tougher on lending practices. Millennium bank is one of the first high street banks to react and will now expect customers to cover 35% of the loan if they borrow in a foreign currency or 20% if borrowing in Polish zloty. The move is thought to be a precautionary one and not an indication of any liquidity problems, according to CEO Boguslaw Kott who told a news conference on Tuesday, “The decision practically blocks an increase of our mortgage portfolio.” He also told reporters that Swiss francs are harder to come by on the interbank market. Millennium Bank has been a dominant force in the Polish housing lending market with 80% of its mortgages being in Swiss Francs. This reflects a trend across Central and Eastern Europe where many house buyers have loans in either Swiss or other foreign currencies.

PKO BP, another major Polish mortgage lender, has joined Millennium in giving credits up to 80% of the value of the real estate. Fears that the Polish housing market could suffer similar repercussions to that of some western banks are as yet premature although the move does indicate a degree of uncertainty on behalf of the lending sector’s big hitters.

"We are extending between 35 and 60 million zlotys worth of mortgages each day, the vast majority of those in Swiss francs." Mariusz Grendowicz Head of BRE Bank BREP.WA "To fund our growth in mortgages, we were the only bank to the best of my knowledge that was using not swaps, which were the cheapest alternative, but actually taking a three- to four-year loan in Swiss francs to fund the book,"

The role of forex lending is clearly more important in housing loans than in general lending (see chart below).

One of the reasons for the recent uptick in Swiss Franc lending has been the monetary tightening cycle initiated by the central bank (see chart below), which made the cheaper interest rates available in CHF more attractive even though there was an evident currency risk involved.



If we look at the next chart the year on year rate of increase in the forex loans (the Polish central bank don't distinguish in their data between CHF and Euro, but all the anecdotal evidence cited above points to a significant role for the CHF, and especially given the role of Austrian banks were this type of lending has been commonplace.




The big problem is really that the CHF is a "carry trade" currency, and carry currencies have a strong tendency to shoot up in value as risk sentiment retreats, quite simply because people all try to liquidate their positions at the same time. Hence carry currencies have a kind of "pro-cyclical" role, adding to the boom during the good times, and making the bad times even worse. Which would be one very good reason why if you really do want an fx mortgage, using a currency other than a carry one would be a good idea. Obviously those who have euro denominated mortgages - while not being immune from the present problems (see the Baltics) - are less exposed, since the movements in the relative value of the euro tend to be in the opposite direction to those of the CHF and the Japanese yen.




Where Does All This Leave Us?


Well obviously Polish GDP growth is now set to slow quite dramatically. At this point just how dramatically is hard to see. Credit Suisse Group recently cut its forecast for Polish economic growth next year, predicting that the global financial crisis will hurt consumption and investment.




Credit Suisse said Poland's gross domestic product will rise by less than 4 percent in 2009, compared with the 4.4 percent rate it had previously forecast, according to a note to clients last week. The revision, amid rising aversion to risk in emerging markets, pushed the zloty to a two-year low against the euro. I think, basically, even Credit Suisse are being over optimistic at this point, although I think we need to see some real economy data before putting numbers on just how over-optimistic they may be.

Poland's `` private consumption and investment should fall further than we had anticipated due to our expectations of an increasingly restrictive credit environment in 2009,'' Jacqueline Madu, an emerging-markets research analyst at Credit Suisse in London, wrote in the note.

If we actually look at the level of the seasonally adjusted index, then the steep increases in the levels of construction output become apparent. We should also notice how since about April the level has stopped rising, and this seems to suggest that the expansion in the industry had been slowing even before the latest credit shock. Be ready for this to be followed by a sharp slowdown in the months to come.

If we look at the chart for year on year industrial activity, then it is clear that the expansion in output has been fading for months now - not a good sign, not good at all, since it means that there is little underlying stability to resist the knock. The thing is running out of energy.

This becomes even clearer when we look at the seasonally adjusted index, since it is pretty evident that industrial output went into decline at the end of last year, killed-off in part by the high zloty, and in part by excess internal wage and cost push inflation.

"A substantial financing package in support of these strong policies will be announced when the program is finalized in the next few days," IMF Managing Director Dominique Strauss-Kahn said in a statement that did not indicate the size of the package.

An aide to Ukraine's president accused Prime Minister Yulia Tymoshenko on Monday of putting a big IMF credit at risk by linking quick approval of financial legislation with the country's long-running political upheaval......Tymoshenko and her supporters last week blocked discussion of the financial package for four days in order to prevent inclusion in it of any funding for disputed early elections, called by Yushchenko for next month.


Ukraine's prime minister and the head of the IMF called on parliament to pass legislation quickly to underpin a loan deal and described political stability as a key part of the process, the government said on Tuesday. The government issued the statement ahead of a scheduled sitting of parliament, blockaded for a week by protesting deputies, to consider a package of financial measures.

Consultations to forge a package were proceeding in parliament, which has a long history of fractious behaviour. It was uncertain debate would go ahead as scheduled. Ukraine remained gripped by its latest bout of political turmoil after President Viktor Yushchenko dissolved parliament last month and called a snap election. Tymoshenko opposes the election and her supporters disrupted debate last week to prevent any bid to finance the poll.

``The Belarusian economy and its access to external finance,'' have been hurt by the credit squeeze, IMF Managing Director Dominique Strauss-Kahn said in its Belarus statement. ``At the same time, changing conditions in trade have negatively affected the country's balance of payments. A Fund mission will begin discussions with the authorities in the next few days.''

"The agreement contains standby access to resources, which will significantly reduce Hungary's exposure to foreign market financing," according to one anonymous source.

With Hungary's commitment to strengthened economic policies, Strauss-Kahn said he expected Hungarian banks and other financial institutions would be able to start lending. "The policies Hungary envisages justify an exceptional level of access to fund resources," Strauss-Kahn added.

“The IMF/Hungary package could prove significant to the extent that it seems it will explicitly include EU and some EU govt funding. This is clearly positive for the rest of the EU27 including Romania and Bulgaria. Although big underlying problems remain, we'd remain flat EUR/HUF and Hu, Ro and Bg CDS into this weeks likely Hungary IMF financing announcement. In short, the big question now is the scale of EU/EU govt funding."

Daimler has on Monday signed an agreement with Hungary's government to invest around EUR 800 million in a new plant in Hungary that will manufacture over 100,000 compact cars annually from 2012, and create up to 2,500 jobs. “Mercedes-Benz is building the plant in order to create additional production capacity in the compact car segment, where the model range will be expanded from two to four vehicles. The plant contributes to the profitability of the product portfolio extension," Daimler said in a statement.

“The latest flash PMI indicates the alarming extent to which the financial crisis has developed rapidly into an economic crisis, with the Eurozone economy contracting at the fastest rate for over ten years in October. Manufacturers are the hardest hit, with the sector contracting at a pace exceeding even the most pessimistic of forecasts polled by Reuters.
Chris Williamson, chief economist at Markit.

The eurozone economy continued the contractaction registered in the third quarter in October at a speed not seen since the start of the euro in 1999, with the kock-on effects of the global bank crisis hitting manufacturing industry especially hard, and making a huge dent in industry’s order books.These are the grim conclusions which can be drawn from the latest - Flash - Purchasing Manager Index (PMI) readings for the economies of 15-country currency zone. The low readings registered are provisional, but experience shows that they are unlikely to be that far off the mark, and they obviously make even more likely substantial cuts in European Central Bank interest rates over the coming months, especially since price pressures also cooling rapidly as overcapacity issues yawn before us. The results only serve to add to concern that the recession which the eurozone in all likelihood entered on April 1 2008 that will prove to be a long drawn out and protracted affair.

Eurozone Composite Reading Falls Sharply


- Flash Eurozone Services Business Activity Index at 46.9 (48.4 in Sep.); lowest since Oct. 2001

- Flash Eurozone Manufacturing PMI(3) at 41.3 (44.5 in Sep.); new record low

- Flash Eurozone Manufacturing Output Index(4) at 40.5 (44.1 in Sep.); new record low




The Markit Flash Eurozone Composite Output Index sank to a new record low in October, signalling the steepest monthly reduction in private sector output since the survey data were first compiled in July 1998 and the fifth successive monthly contraction.

Output fell at a new record pace in manufacturing, while services activity showed the second-sharpest deterioration ever recorded, with the decline exceeded only by that seen in October 2001. Expectations of business activity in 12 months' time in the service sector plummeted and hit a new record low - and by a wide margin. Falling output and business confidence were linked to a record monthly drop in demand for goods and services, as measured by the composite new orders index. Overall, new orders have now fallen for six consecutive months.

The “composite” purchasing managers’ index, covering manufacturing and services, slumped from 46.9 in September to 44.6 in October, the lowest since the survey began in July 1998. A figure below 50 is taken to indicate a contraction in activity. Eurozone manufacturers’ new orders fell at the sharpest rate recorded, led by a slump in export orders. Service sector new business did not contract as fast but still saw the second steepest fall on record.

We only have a breakdown of country secific indices for France and Germany, and French manufacturing is evidently performing a lot worse than its German equivalent, although the contraction in German industry is getting sharper by the month, and anecdotal evidence does suggest that there may be much worse to come as demand from the very important customer base in Eastern Europe comes virtually to a dead stop in the wake of the credit crunch. So even Germany saw private-sector output contracting for a second consecutive month, and business sentiment for the next 12 months sank to the lowest level registered there since records began in June 1997.


The composite reading for manufacturers' new orders fell at the steepest rate yet registered by the survey, led down by a record fall in new export orders. In comparison, new business in the service sector showed a more modest rate of decline, though still posted the second largest contraction yet seen by the survey.

Input price inflation, on the other hand, having hit a near-eight-year high back in July, eased back again for the third successive month in October, dropping to the weakest pace since July 2005. The monthly fall in the rate of price increases was the sharpest ever recorded by the survey, led by a steep easing in manufacturers' input price inflation, which in turn reflected lower commodity prices and an increased willingness among suppliers to cut prices to sell stock. Input cost inflation also moderated in the service sector.

Output prices rose only slightly during the month, the rate of increase having slowed for the third successive month from July's record high to reach the weakest since December 2005. Upwards pressure on charges was alleviated by weaker growth of input costs, but also reflected discounting in the face of falling demand.

“Price pressures are collapsing alongside falling demand, which will hit profits further but will help pave the way for lower interest rates.” Chris Williamson, chief economist at Markit

Deceleration in Germany's Manufacturing Sector Accelerates

"October's PMI indicated the sharpest decline in German private sector activity
since mid-2003," Tim Moore, an economist at Markit Economics, said in a
statement. "Market demand was shaken by the latest global financial turmoil, as
firms became increasingly concerned about the economic outlook and access to
credit."

The rate of expansion in the German economy dropped back to its lowest level in more than five years in October. The preliminary flash estimate of the composite purchasing managers' index for what is the euro zone's biggest economy fell to a 64-month low of 46.7 in October from 48.5 in September. Manufacturing activity in contracted for the third straight month with the reading plunging to 43.3 from a final reading of 47.4 in September.

In addition, economic activity in the service sector stalled for the first time since January as the flash reading slipped to 49.7 from 50.2.


However, the data showed input price inflation eased to its slowest for more than three years in October, with the month-on-month fall in the index was the largest since the series began in January 1998. This reinforces data out this morning (Friday) from the German Federal Statistics Office which showed that German import prices fell 1.0% month-on-month in September after declining 0.8% in the August, as crude oil prices continued to pull back from their record high in July. On an annual basis, the rate of import price increase slipped back to 7.6% from 9.3% in August.

The data suggests that the German economy may well continue to be in recession in the fourth quarter (assuming that the forthcoming 3rd quarter data do show a contraction) as demand across the global economy continues to falter, a process which will hit an export dependent economy like the German one especially hard.

French Manufacturing Now In Sharp Retreat


French manufacturing activity contracted at its fastest pace in a decade in October, while new orders in both manufacturing and services fell at their sharpest pace in 10 years. The flash estimates of the Markit/CDAF PMI showed the headline figure for manufacturing fell to 40.8 in October, its lowest since data was first collected in April 1998, from 43.0 in September.




The services sector, which accounts for around two-thirds of the euro zone's second largest economy, saw its index slip to 48.8 from 50.1 in September, while the new orders sub component fell to 45.3 - its lowest since the survey began in May 1998.




With the new order index for manufacturing also hitting a series low - it fell to 34.7 in October from 37.5 in September, all the indications are that tough times lie ahead given the extent of the worldwide economic slowdown.


According to the latest estimate from France's national statistics office INSEE, the French economy contracted in Q3 2008, if that is the case I am left asking myself which of the big four eurozone economies could possibly be expected to have expanded in the July to September period. Certainly not the Spanish one, which while not technically in recession yet (you need to consecutive quarters of negative growth to classify as being in recession) can hardly have expanded. The German economy almost certainly contracted, and while the Italian one could sneak a surprise "horses-nose" expansion (given the low level it had reached in the 2nd quarter) I think it is unlikely. So here we go - recession in the eurozone.

France's gross domestic product probably shrank by 0.1 percent in the third quarter after a contraction of 0.3 percent in the three months through June, according to the latest Insee estimate. The economy is also likely to shrink 0.1 percent in the final three months to cut growth to 0.9 percent for the full year, the slowest pace since 1993, Insee added.

"Unfortunately nothing here indicates that we've hit bottom," said Chris Williamson, chief economist at Markit. "The availability of credit is definitely becoming a problem and if that doesn't turn around quickly then output numbers will probably follow those order book numbers down."

“We think the most important announcement at this stage is the possibility to convert CHF loans to HUF. If households chose to do this it would ultimately mean a switch in FX mismatch from households to banks (who would then hold HUF assets but CHF liability). Banks in turn would then need to close their FX mismatch, through FX swaps (buying CHF).........It's not clear who would provide sufficient HUF liquidity to do this. Ultimately the NBH would presumably provide liquidity to avoid banks being left with a significant FX mismatch."
Martin Blum, Gyula Tóth, UniCredit, Vienna

"Herd behavior occurs when people do what others do rather than rely on their own (incomplete) information, which might be suggesting something different (Banerjee, 1992). The suppression of private information could lead to “information cascades” when decisions are made sequentially and a large enough number of people choose identical actions. In such settings, the decisions of a critical few people early on are enough to tilt group behavior toward a certain direction. Mimicking the behavior of others might be rational because of uncertainty about one’s own information as well as the need to economize on information-gathering costs. Rational herd behavior is the subject of a recent strand of behavioral finance (see Montier, 2002, for an introduction). "

Total cross-border claims of BIS reporting banks expanded by $1 trillion in the last quarter of 2006. After more modest growth in mid-2006, a pickup in interbank claims accounted for 54% of this expansion. A surge in credit to nonbank entities contributed $473 billion, pushing the stock of cross-border claims to $26 trillion, 18% higher than in late 2005.

The flow of credit to emerging markets reached new heights through the year 2006. Claims on emerging markets grew by $96 billion in the final quarter of 2006, bringing the volume of new credit throughout the year to $341 billion. This amount exceeded previous peaks ($232 billion in 2005 and $134 billion in 1996), both in nominal value and in terms of growth. The current annual growth rate has risen to 24%, having surpassed for the sixth consecutive quarter the previous peak of 17% recorded in early 1997.

Emerging Europe overtook emerging Asia as the region to which BIS reporting banks extend the greatest share of credit. Since 2002, growth in claims on the region has consistently outpaced that vis-à-vis other regions. With a record quarterly inflow, emerging Europe received over 60% of new credit to emerging markets, bringing its share in the stock of emerging market claims to 34%. Less of the new credit went to the major borrowers (Russia, Turkey, Poland and Hungary) than to a number of smaller markets, notably Romania and Malta, as well as Ukraine, Cyprus, Bulgaria and the Baltic states.


The currency denomination of cross-border claims on emerging Europe tilted further towards the euro. In the stock of claims outstanding, the euro and dollar shares were 44% and 31%, respectively, but the gap in the latest flow data was more pronounced (61% and 5%). While the sterling share has remained close to 1%, the yen has lost ground to the Swiss franc, thus continuing a trend seen over the last six years. Yet there is little evidence in the cross-border data of unusual borrowing in Swiss francs that might correspond to Swiss franc-denominated retail lending in several countries. Borrowing in the Swiss currency remains on average below 4% of cross-border claims, and exceeds 10% only in Croatia and Hungary.


Nearly 20% of reporting banks’ foreign claims were in the form of funds channelled to emerging market borrowers. Claims on residents of emerging Europe continued to account for the largest share of these funds.

So, although the BIS find "little evidence in the cross-border data of unusual borrowing in Swiss francs that might correspond to Swiss franc-denominated retail lending", they do make an exception in the cases of Hungary and Croatia, where they note that lending in Swiss francs to retail clients reaches over 10% (and of course in the Hungarian case well over 10%) of the total retail loans in those countries. Indeed, as I indicate above, swiss franc loans now seem to account for over 80% of all newly generated housing related credit in Hungary. The reason why Hungary has gone for Swiss franc rather than euro denominated loans undoubtedly has to do with the role of the Austrian banking sector in Hungary, as is explained in my fuller posting on this topic linked to below.

Additional References On Swiss Franc Loans and "Translation"

For fuller examination of just why it is that Switzerland (or for that matter Japan) have such low interest rates, see my "Swiss Franc Loans and Ageing" post.

For an examination of the potential implications of the presence of all these foreign currency loans across the EU10 in the event of any generalised emerging markets crisis see Claus Vistesen "Translation Risk in the Baltics and Other Matters".

Balance Sheet Consequences: The Academic Research


Well, given what I am saying above about the rapid and imminent demise of foreign exchange loans among Central and East European nationals, it is clear that the topic which is now about to come back into fashion (and to replace the forex loans themselves as the centre of attention - at least among theoretical economists) is that of the so called "balance sheet consequences" of excessive forex leveraging, so to give people some background, and a bit of a push start, I have hastily compiled a brief reading list on the topic.

Do Balance-Sheet Effects Matter for Brazil? Felipe Farah Schwartzman, May 2003

The past ten years have seen a number of currency crises, typically followed by a sharp drop in output in the countries involved. An explanation advanced for both the crisis and the recession is that firms in these countries had a large amount of debt indexed in foreign currency (Krugman, 1999). The exchange rate devaluation left the firms insolvent, reducing credit and production in the economy. Apart from crisis, balance-sheet effects have been advanced as an explanation for the “fear of floating” detected by Calvo and Reinhardt (2000) in developing economies in normal times.

Krugman, P. (1999), “Balance Sheets, the Transfer Problem and Financial Crisis,” in: International Finance and Financial Crises, P. Isard, A. Razin and A. Rose (eds.)

For the founding fathers of currency-crisis theory ..........the emerging market crises of 1997-? inspire both a sense of vindication and a sense of humility. On one side, the number and severity of these crises has demonstrated in a devastatingly thorough way the importance of the subject; in a world of high capital mobility, it is now clear, the threat of speculative attack becomes a central issue - indeed, for some countries the central issue - of macroeconomic policy. On the other side, even a casual look at recent events reveals the inadequacy of existing crisis models. True, the Asian crisis has settled some disputes - as I will argue below, it decisively resolves the argument between “fundamentalist” and “self-fulfilling” crisis stories........ But it has also raised new questions.

One way to describe the problem is to think in terms of Barry Eichengreen’s celebrated distinction between “first-generation” and “second-generation” crisis models. First-generation models, exemplified by Krugman (1979) and the much cleaner paper by Flood and Garber (1984), in effect explain crises as the product of budget deficits: it is the ultimately uncontrollable need of the government for seignorage to cover its deficit that ensures the eventual collapse of a fixed exchange rate, and the efforts of investors to avoid suffering capital losses (or to achieve capital gains) when that collapse occurs provoke a speculative attack when foreign exchange reserves fall below a critical level.

Second-generation models, exemplified by Obstfeld (1994), instead explain crises as the result of a conflict between a fixed exchange rate and the desire to pursue a more expansionary monetary policy; when investors begin to suspect that the government will choose to let the parity go, the resulting pressure on interest rates can itself push the government over the edge. Both first- and second-generation models have considerable relevance to particular crises in the 1990s - for example, the Russian crisis of 1998 was evidently driven in the first instance by the (correct) perception that the weak government was about to be forced to finance itself via the printing press, while the sterling crisis of 1992 was equally evidently driven by the perception that the UK government would under pressure choose domestic employment over exchange stability.

In the major crisis countries of Asia, however, neither of these stories seems to have much relevance. By conventional fiscal measures the governments of the afflicted economies were in quite good shape at the beginning of 1997; while growth had slowed and some signs of excess capacity appeared in 1996, none of them faced the kind of clear tradeoff between employment and exchange stability that Britain had faced 5 years earlier (and if depreciation was intended to allow expansionary policies, it rather conspicuously failed!) Clearly something else was at work; we badly need a “third-generation” crisis model both to make sense of the recent crises and to help warn of crises to come.

In the paper which follows Krugman sketches out yet another candidate for third-generation crisis modeling, one that emphasizes two factors that had been omitted from previous formal models to date: the role of companies’ balance sheets in determining their ability to invest, and that of capital flows in affecting the real exchange rate. The model was at that point (and as Krugman himself says) quite raw, with lots of loose ends hanging about. However, it did seem to tell a story with a much more realistic “feel” than some of the earlier efforts. It could be hoped that now that he has had time to recover from the shock of his recent Nobel, he may get interested once more in this earlier centre of his attention, since the model badly needs updating, and in particular to take account of the shift in the risk away from the corporate and towards the household balance sheet.

Balance Sheet Effects, Bailout Guarantees and Financial Crises
MARTIN SCHNEIDER UCLA and AARON TORNELL UCLA and NBER

This paper provides a model of boom-bust episodes in middle income countries. It features balance of- payments crises that are preceded by lending booms and real appreciation, and followed by recessions and sharp contractions of credit. As in the data, the non-tradables sector accounts for most of the volatility in output and credit. The model is based on sectoral asymmetries in corporate finance. Currency mismatch and borrowing constraints arise endogenously. Their interaction gives rise to self-fulfilling crises.


In the last two decades, many middle-income countries have experienced boom-bust episodes centered around balance-of-payments crises. There is now a well-known set of stylized facts. The typical episode began with a lending boom and an appreciation of the real exchange rate. In the crisis that eventually ended the boom, a real depreciation coincided with widespread defaults by the domestic private sector on unhedged foreign-currency-denominated debt. The typical crisis came as a surprise to financial markets, and with hindsight it is not possible to pinpoint a large “fundamental” shock as an obvious trigger. After the crisis, foreign lenders were often bailed out. However, domestic credit fell dramatically and recovered much more slowly than output.

This paper proposes a theory of boom-bust episodes that emphasizes sectoral asymmetries in corporate finance. It is motivated by an additional set of facts that has received little attention in the literature: the tradables (T-) and nontradables (N-) sectors fared quite differently in most boom-bust episodes. While the N-sector was typically growing faster than the T-sector during a boom, it fell harder during the crisis and took longer to recover afterwards. Moreover, most of the guaranteed credit extended during the boom went to the N-sector, and most bad debt later surfaced there. Our analysis is based on two key assumptions that are motivated by the institutional environment of middle income countries. First, N-sector firms are run by managers who issue debt, but cannot commit to repay. In contrast, T-sector firms have access to perfect financial markets. Second, there are systemic bailout guarantees: lenders are bailed out if a critical mass of borrowers defaults.

And please note the last sentence: "lenders are bailed out if a critical mass of borrowers defaults", this, I imagine, is what we are about to see happen next.

A Balance Sheet Approach to Financial Crisis
Mark Allen, Christoph Rosenberg, Christian Keller, Brad Setser, and Nouriel Roubini :

The paper lays out an analytical framework for understanding crises in emerging markets based on examination of stock variables in the aggregate balance sheet of a country and the balance sheets of its main sectors (assets and liabilities). It focuses on the risks created by maturity, currency, and capital structure mismatches. This framework draws attention to the vulnerabilities created by debts among residents, particularly those denominated in foreign currency, and it helps to explain how problems in one sector can spill over into other sectors, eventually triggering an external balance of payments crisis. The paper also discusses the potential of macroeconomic policies and official intervention to mitigate the cost of such a crisis.

"The Kazakh government is ready to step in,'' Kazakhstan's Prime Minister Karim Masimov said this morning in a telephone interview with Bloomberg "The Kazakh banking system with the support of the government and central bank will fulfill all obligations to international investors.....We have our own specific plan to survive without any external support....I don't think we need support from the International Monetary Fund or overseas.''

Ranked as the ninth largest country in the world by size, it is also the world's largest landlocked country, with a territory of some 2,727,300 km² (which is greater than the whole of Western Europe). It is bordered by Russia, Kyrgyzstan, Turkmenistan, Uzbekistan and China. On the other hand, and despite its enormous size, Kazakhstan has a comparatively small population. No one actually has an exact idea of the actual size of the Kazakhstan population (not to mention the thorny issue of just how many foreign migrants live and work there), but the US Census Bureau International Database list the current population of Kazakhstan as 16.763 million, while sources drawing their data from the United Nations (like the IMF which I have relied on for the chart below) give a 2008 estimate of 15.135 million. In any event the current population level, after falling in the early 1990s as ethnic Russians left, has now stabilised, and is virtually stationary. This virtually stagnant population constitutes, as we will see, a significant problem for a country with such a massive resource base, and such enormous economic and development potential as Kazakhstan would seem to have.

Record Oil Revenue Boom

Kazakhstan is the biggest energy producer in Central Asia and the country's $100 billion economy has in fact grown at an average of 10 percent a year rate since 2000 (see chart below), in particular as the price of oil has surged. This rapid GDP growth produced a rapid increase in per capita income as well as national creditworthiness, and these in turn sparked in their wake a substantial construction boom. Indeed it has precisely been the bursting of this boom in the autumn of 2007 - on the back of the seize-up in global wholesale money markets which followed August's financial turmoil in the USA - which lies at the heart of Kazakhstan's current growth slowdown. Kazakhstan's economy expanded at a 'mere' 5.3 percent rate in the first quarter of 2008, half the pace achieved in the same period a year earlier, following a dramatic curtailment in bank lending, and if Kazakhstan is still able, despite all the problems we will see below, to maintain some sort of growth momentum at this point it is undoubtedly the result of the oil and other commodity resources which the country has at its disposal, and indeed as part of its initial response to the present crisis the country increased crude production by an annual 6.3 percent in the first four months of the year, according to official government data.




Now one of the most curious details about the present slowdown in Kazakhstan, has been the fact that at the very same time as the economy started to lose velocity the central bank found itself busy struggling to curb an inflation rate which was steadily shooting onwards and upwards towards the outer stratosphere, as revenue from record oil prices pushed up domestic demand, and the resulting construction and consumption boom drove up wages far beyond normal "productivity-gain" rates of increase (remember, there are not THAT many people in the country, and much of the population is rural and unskilled in relation to the needs of a modern technological and services economy). In fact inflation hit year-on-year rates of increase approaching 20% in the autumn of last year (see chart below), although it had dropped by to an annual 18.2% by September.




So, as well as containing the property bust, the Kazakh authorities have also had to conduct an inflation fight (more details below). So far from lowering rates like the US Federal Reserve has been able to do, Karakhstan's central bank was forced to raise the key interest rate to 11 percent in December 2007, at a time when annual inflation was riding at almost 19 percent, the highest for the country in over eight years. The refinancing rate was then maintained at the 11% level until it was finally lowered to 10.5% at the last central bank meeting in July.



Not Just Energy - Vast Resource Potential

The fact that Kazakhstan's industrial output growth has lost a lot of momentum in 2008 as the slowdown in the building industry provoked a slump in cement and other materials production should not take our minds too far away from the fact that the underlying potential in Kazakhstan is enormous. In fact while industrial output growth was reduced to an annual 3.8 percent growth rate in the January-June period, it was at least still growing.

The low point seems to have been hit back in January, when cement production which, not surprisingly, was among the hardest hit sectors, was down 26 percent year on year, the sharpest January fall in five years, as growth in the construction industry stalled, brought to a halt by the fact that the Kazakh banks, who had been struggling to borrow from abroad following the collapse of the U.S. subprime mortgage market, virtually stopped lending to homebuyers and builders.

Copper and rolled-iron output also declined an annual 13 percent in January while output from oil refineries and manufacturing industry decreased an annual 2.9 percent as the problems rolled in. Thus there is evidence of a very sharp shock initially hitting the local economy. On the other hand, since the country is resource rich and the given that first half of 2008 saw a very significant global commodities boom, there were other economic sectors to fall back on, and mining production was up 6 percent from a year earlier in the first quarter, bolstered by an increase in natural gas and coal output, which climbed 15 percent and 11 percent respectively. At the same time crude oil production went up by an annual 5.4 percent.

Apart from oil and gas Kazakhstan has a huge array of potential resource reserves just waiting to be tapped. Among these there is copper. London-listed Kazakhmys accounts for the bulk of Kazakh copper output - and this was down 17.5 percent year-on-year in January-April. Industrial output in Karaganda region, home to Kazakhmys and Arcelor Mittal mines and smelters, declined 5.5 percent year-on-year in January-April.

Kazakhmys reported that their first-quarter output fell 9.9 percent on "severe winter weather'' and repairs at its Balkhash smelter. Production of finished copper plates, or cathodes, from the company's ore fell to 75,500 metric tons, from 83,800 tons a year earlier. These drops in output are, of course not entirely associated with the credit crunch, but they do give an idea of the challenging and volatile environment in which the mining and extraction industries work in Kazakhstan. Realistically speaking it seems quite likely that output in these sectors will return to more normal levels during the second-half of 2008, having alreadt rebounding significantly from the low point reached in the first-quarter.

On the other hand industrial output in capital Astana and commercial hub Almaty, where most construction activities are based, was down 13.2 percent and 8.6 percent, respectively, in January-April, and this activity may well take much longer to recover.

Kazakhstan has also had to cut its 2008 oil production forecast to 67.6 million tonnes (1.35 million barrels per day) from a previous estimate of 70 million tonnes citing maintenance works and transport bottlenecks. The country is able to produce a lot of oil, but it does have a large problem getting that oil to the places where people want it. Three major pipeline routes - the Atyrau-Samara and Caspian Pipeline Consortium (CPC) links to Russia, and the Atasu-Alashankou pipeline to China - carry Kazakh crude off towards its end destinations, but none of these are proving sufficient to the demands on them.

"It is impossible to transport crude out of Kazakhstan without some difficulties," Senior Associate Klara Nurgaziyeva from law firm Dewey & LeBoeuf told an oil and gas conference last week in the Kazakh financial capital Almaty.

In a smoke-filled bar in the Kazakh financial capital Almaty, the laughter of Scottish ex-pats is loud and boisterous. More than three thousand miles (5,491 km) separate the Scottish Highlands and the Central Asian steppe, but a mutual interest in oil and gas has created a surprising alliance. Residents estimate that around 400 Scots live in ex-Soviet Kazakhstan, a resource-rich country roughly the size of western Europe.

Most come from Aberdeen, Britain's northeastern oil hub, and they bring with them their technical expertise."We're going to try attract Kazakhs to Aberdeen over the next few years and look at initiatives, and create further investment in Scotland from Kazakhstan," Lord Provost Peter Stephen of the Aberdeen City Council told an energy conference last week in Almaty. He said over 100 companies from in and around Aberdeen are active in Kazakhstan, and the Scottish oil town even has a Kazakh consulate to serve the hundreds of Kazakhs who go to Scotland to train up for the oil business. The Kazakh-British technical university, set up by a group of Scottish universities seven years ago, occupies a grandiose columned building in the centre of leafy Almaty, which housed parliament before the capital was moved to Astana.

Prices for residential property soared 30.2 percent in 2007, reaching a record average mid-year high of 161,300 tenge ($1,338) per square meter, up from 123,900 tenge in 2006, according to the Astana-based state statistics agency. In the financial capital, Almaty, the average price was 345,200 tenge.

The drop in prices from these peaks and the sudden drying up of credit has caused numerous problems for would.be buyers, and Bank TuranAlem, Kazakhstan's second-biggest bank by assets, received $81.2 million last December from the state emergency investment program simply to finance the completion of unfinished construction projects.

The most recent government bailout of the construction sector was announced during the summer - just two weeks before the celebrations of Nazarbayev's 68th birthday and the 10th anniversary of the founding of the new capital Astana on July 6 - following the announcement by a group representing people who had purchased apartments in the unfinished buildings that they were planning a protest march to be held in Astana bang in the middle of the official festivities.

The Industry and Trade Ministry have said that there were 939 residential buildings, with 45,130 apartments pre-paid by homebuyers, under construction as of last January. Minister Edil Mamytbekov said in July that the cases of 4,558 homebuyers in 18 buildings "remain problematic'' because of conduct for which the builders in question had been "charged with crimes.'' The Kazakh Prosecutor General's Office said 123 construction companies that received 104 billion tenge ($865 million) in pre-payments from homebuyers were behind schedule or haven't even begun work on new apartment buildings.

Assets of "careless construction companies,'' including buildings and vehicles, have been seized to compensate lost investments of homebuyers and the government, according to the Prosecutor General's Office. Criminal investigations have been opened into eight companies. A total of 285 companies are building 407 residential projects in Kazakhstan and have received 231 billion tenge in pre-payments from more than 50,000 individuals and companies, prosecutors said. Of 200 ``problem'' projects delayed by at least six months, 110 are located in the capital Astana and 42 in Almaty.

The July rumpus was provoked by the fact that at the start of the summer the Kazakh government had spent only 51 billion tenge to complete stalled residential projects, a fraction of the bailouts promised by Prime Minister Karim Masimov in the autumn of 2007, according to data made public by the Ministry of Industry and Trade on June 23. The government had said on Nov. 14 2007 that it would spend $1 billion by the end of 2007 and another $3 billion in 2008 to "provide economic stability and growth'' by supporting the real estate market and small and medium-sized businesses. Following publication of this data, and some international press coverage, Masimov said that his original emergency investment program was in the process of being expanded, and his government announced plans to spend 17.2 billion tenge to complete residential projects in Astana.

President Nursultan Nazarbayev instructed the state to step in and finish projects, ``which have no source of financing,'' to ``help to reduce social tension,'' according to Edil Mamytbekov, a deputy minister of industry and trade, on June 20. President Nursultan Nazarbayev also said it was necessary to take ``tough measures against careless builders". As a result the Almaty mayors office announced on July 26 that another 46.4 billion tenge had been allocated to support residential projects in Almaty. The state had already invested 22.4 billion tenge and was going to spend the remaining 24 billion tenge by year's end, according to the announcement.

In April, however, the government had announced that the state development holding Kazyna would distribute 59 billion tenge to commercial banks during 2007 to finish 131 buildings in Almaty. Sergei Kuyanov, spokesman for Almaty Mayor Akhmetzhan Yesimov, declined to comment on the discrepancy between the numbers when question by journalists in July.

Whatever the complications of the present situation and the ins-and-outs of putting the construction and banking problems straight, we should not lose sight of the fact that Kazakhstan has, large financial resources which will surely help it weather the current situation. Official foreign currency assets totaled $46 billion in early June, comprising NBK reserves of $21 billion and oil fund (NFRK) assets of $25 billion. Commercial banks also have foreign assets of which about $3.5 billion are thought to be liquid. Total foreign assets broadly match foreign liabilities when the intracompany debt of the oil sector is excluded, while liquid foreign currency assets comfortably cover potential short-term foreign currency drains.


Favourable Demographics But Migrants Needed, And With Them Modern Citizenship Rights


The chart you will find below is known as a “heat chart”. It depicts the ongoing changes in Kazakhstan's age structure. Each dot represents the number of people in any given age group at any given point in time. A dark red dot represents the largest concentration of people, by age, in a particular year while deep blue dots show the lowest concentrations. A single dark red dot is the equivalent of almost 406,000 people while each deep blue dot represents nearly 23,000 people.


In the upper left-hand corner of the chart the bright reds and yellow areas depicts the population boom that started in the mid 1970s and lasted until the late 1990s. The remnants of that boom extend downward from left to right across the chart. The band also narrows as this population segment ages. This is simply a reflection of the reduction in the total numbers in the population bulge cohorts as out-migration has taken its toll.

Many ethnic Germans and Russians, for example, left Kazakhstan during the years following the end of the Cold War. In the lower left-hand side of the chart there is a preponderance of dark blue dots, indicating a relatively small number of people over the age of 60 years. Over time these dark blue dots are replaced by light blues and greens, a pattern reflecting a gradual but steady increase in the number of elderly people.