Recent Russian reports provide more color on Russian official sector’s move out of the the USD in Q2 of last year. The big focus of the CBR reserves composition report (see thread here) was the move into CNY assets, making Russia is now one of the largest holders of offshore CNY reserve assets. Despite the speeding up of the reserves diversification (most of which continues to be into EUR). the USD continues to dominate in cross-border trade and financial transactions. The move, already visible in the US data last summer, raised questions about the impact on broader USD assets at a time of fiscal and monetary pressure on USTs. The risks of Russia purchases look overstated, given the relatively small size of its holdings, continued purchases by other countries (including other oil producers) and ability of the Federal Reserve to provide liquidity if needed. Bigger long-term concerns around USTs should focus around the fiscal position, which is going to increase the amount of issuance in coming years – likely increasing the US cost of financings. Local and foreign investors are likely to bear this cost unless there are any signs the U.S. willingness to pay is shifting.
Russia’s move to sell USD was political, following the April 2018 sanctions on Russia and the local press estimated realized losses of $1.5b – admittedly small compared to Russia’s stock of assets and not necessarily something of concern to the government.
The move sped up the shift away from the USD in Russia’s FX holdings. The increase brings CNY holdings up to $62 billion of Russia’s $430b+ portfolio, meaning Russia now accounts for about 1/3 of the $192 billion in global reported CNY reserve holdings (IMF COFER) and just about all of the $40 billion increase in global reserve holdings of CNY in Q2. This is but one of the increasing links between Russia and China, which I’ve previously cited as a source of resilience for Russia. Of course, CNY-denominated bonds are not very liquid, and bilateral trade in CNY is still quite low between the countries suggesting limited benefit for reserve assets, particularly given the likely interest rate moves.
What does this mean for broader USD holdings?
Figure 1: Holdings of Long-Term US Treasurys (USD million)
Compared to turnover of the USTs even the 100b is not something that big… but would be more important if other countries followed suit.
That doesn’t seem to be happening. Chinese holdings are pretty stable with ups and downs due to currency management and GCC countries (KSA but also Kuwait and Qatar) seem to have been parking funds in USTs at the end of last year- at least for now. The increase in Saudi holdings of USTs (net $40 billion) in Q3 partly offsets the sharp decline in Russian holdings, likely reflecting the increase in energy revenues. The increase in KSA holdings far outpaces its reserves growth suggesting that the Saudis may have been parking the funds in UST after raising the funds in some of the bond issuance.
The increase in cash flow from Saudi Arabia energy sales inQ2 and Q3 last year (and maybe the bond issuance) seems to have gone into USTs and may have helped them finance the outflows that resulted when locals and foreigners continued to flee after the Kashoggi murder. Given the fiscal dynamics there and fall in oil prices this increase was likely temporary. Still, there is reason to expect that any shortage of buyers and associated interest in rates, would likely bring in more pensions, insurers and others looking to match their asset and liability portfolios.
Of foreign holders, China remains key – and the PBoC seems unlikely to cut holdings for political reasons. As I’ve written in the past, Chinese Treasury holdings reflect domestic economic choices rather than geo-political ones suggesting that local capital outflows and FX management will drive its foreign portfolio. Attempts to reduce treasury holdings would put appreciation pressure on the renminbi, undermine global and Chinese financial stability and likely reduce the value of their existing holdings.
That’s not to say that de-dollarization is not something to watch, but it looks to be a slow moving machine. Other critical policies to watch remain efforts by the European authorities to skirt U.S. sanctions, which are so far having only limited rhetorical impact. More important is the fiscal outlook of the U.S. which will likely put pressure on a range of assets.
Thought-Provoking Reads 2018
As 2018 winds to an end, and 2019 lookaheads are completed, its time to share a few books that stuck with me this year from the 50 non-fiction books I read or listened to this year. Given my IPE teaching this fall, and ongoing macro risk work for clients, my non-fiction reading was dominated by corruption, country risk cases as well as a lot on AI, future of work and big data. Surprisingly, I read a lot of fiscal policy, perhaps fitting in the year when the biggest expansionary policy in peacetime came into effect and in which the costs of unwinding the big monetary stimulus experiment began.
What were your favorites, what did I miss and what’s on your reading list?
Saudi Arabia released its 2018 budget with great fanfare today, including a meaningful increase in spending directly and via off-balance sheet funds such the public investment fund (PIF). With the oil sector no longer a drag and the non-oil sector benefiting from government pump-priming, economic growth should accelerate, from near-recessionary levels, part of a broader trend among oil producing nations. Still, private sector contribution is likely to lag as credit demand struggles, government funds dominate and questions remain about the rules of the game after the anti-corruption crackdown. Changes to energy policy are unlikely.
The budget included the largest planned spending (figure 1) of any budget, 978 billion riyal ($260 billion) and an additional 150 billion riyal in spending from various development funds. It comes close to the actual spending peaks of the early 2010s boom years. Given the spending increase in Q4, and a tendency to overspend budgets, actual spending in 2018 may again outstretch plans and in the longer 5 year plan. Adding in the spending from the PIF, there's likely to top that. This will reinforce the bounceback in growth after several years of moderate recession and austerity. It may be less effective in generating private sector activity, which is likely to lag consumption and government investment.
Figure 1: Actual and Government Spending (USD billion)
Source: Saudi Arabian Ministry of finance, Author's Calculations
The more expansive stance is not unique to Saudi Arabia. Most of its GCC and energy producing peers will also have more expansive or at least less austere budgets in 2018, helped by stronger oil and gas prices and still relatively easy global credit conditions that make it easier to issue debt. In Nigeria and Russia as well as Bahrain and Oman, less austerity is likely rather than stimulus. Still these decisions reinforce several trends for 2018 including a belated recovery for many commodity producing nations (catching up to the broader expansion seen in 2017), a bottoming out/improvement in EM investment and some pickup in inflation. All of these generally support EM and local equity over bonds.
With OPEC members and friends (and the ever growing energy journalist cohort) meeting in Vienna, it seems apt to look at the economic adjustment of some of the participating oil producers. While most would gain from rising prices. Russia, and Iran, smaller GCC countries (Kuwait, UAE and even Qatar) as well as some U.S. producers would look to be the relative winners. The slowbleed of capital outflows, external and fiscal deficits are likely to moderate across most of the other producers including Saudi Arabia, Oman, let along more vulnerable countries like Nigeria, Angola which are still struggling with the aftermath of their FX policies. With U.S. and global interest rates edging up, expect continued rate and sovereign risk divergence.
Rachel's musings on macroeconomic issues, policy and more.