Sunday, January 18, 2009

Irish credit I

The prevailing feature of last year’s end is a growing tide of anger at the impotence of our Government to come to grips with the bleak reality of a severe downturn that is facing the rest of us. But the latest developments in global markets are suggesting that our Exchequer will have to deal with more than domestic pressure to reform in 2009.

Three events since the beginning of the New Year show the extent of the deepening global economic crisis with potentially dramatic implications for Ireland.

Sovereign debt financing
First, last week’s German 10-year bund auction, a golden standard of financial security for European markets, turned into an unmitigated disaster. The auction failed to sell 13pct of a relatively modest €6bn issue – second worst result in history that follows on the heels of seven auctions that failed to secure full placements in 2008. The latest US auction of 90-day T-bills – considered to be risk-free by the markets – was subscribed up to 50pct, while the UK’s 10-year bond issue had to be placed at 5pct.

Second, Greece has moved one step closer to a sovereign debt default and a deeper political crisis when banks bailout package triggered a wave of discontent from the crisis-impoverished consumers. To date, this has led to the firing of the Finance Minister in a Government that was, similarly to Ireland’s, elected just 16 months ago. Greek 10-year bonds are now yielding 5.31pct – dangerously close to the junk bond levels. This week’s Irish 5-year bonds being priced at 4.14pct implies that (a) adjusted for their term structure, Irish bonds would be priced to yield around 5.47pct for a 10-year bond – well ahead of Greece, and (b) the global appetite for long-term sovereign debt is in a steep decline. It is doubtful if Ireland will be capable of placing a 10-year note even in theory at anything below 5.6-6pct mark, suggesting that whatever debt we do raise in 2009 might come not only at a high price today, but at an even higher price in the future refinancing markets.

Our borrowing plans
Last, but not least, our Exchequer results for December have shown an unprecedented rate of collapse, with Q4 2008 receipts down a whooping 22pct on Q4 2007. The timeline of deterioration, highlighted in the box-out is frightening. Despite the Department of Finance forecast for 6.5pct General Government Deficit for 2009, it is likely that our GGD will exceed 9pct – three times the Stability and Growth Pact limit for the Eurozone member states by this year end.

The Government has acknowledged that Ireland will have to borrow ca €20bn in 2009 – a level of new bonds issuance that is unprecedented in Europe. And don’t forget that Ireland Inc is also likely to face the need for extra €5bn for the expected cost of banks recapitalization and guarantees and another €5bn in redemption cover for April bond.

Such borrowing, relative to the domestic economy, would imply bonds issuance of ca €450bn for the UK (well above the €160bn debt placement planned by the UK Exchequer) and €470bn for Germany. Put into perspective, the US is planning some $950bn in new bonds issuance, inclusive of some quasi corporate bonds by the likes of Fannie Mae & Freddie Mac, for an unprecedented 2009 economic stimulus. Were the country to use Irish Government fund raising plans it would have to issue over $1.8 trillion in new bonds. And while the rest of the world is using borrowings to finance economic growth, our Government is plugging the Exchequer imbalances.

The cost of digging ourselves out
All three events have one theme in common – they suggests that our economy is now firmly set on track to higher taxes and more pain for the ordinary households. For thousands of Irish businesses toiling under pressure to maintain revenue and employment this is a far more ominous threat than all external shocks combined.

The structure of pricing in the sovereign debt markets is now poised to change, with a renewed buyers’ focus on the underlying economic fundamentals. These include:
• Traditional fundamentals: fiscal deficits, inflation and economic growth prospects; and
• New fundamentals: the quality of macroeconomic management and the reasons for debt placement.
On both, Ireland offers a poor prospect. But it is in the second set that our Government’s failure to deliver leadership will be felt most, both by the NTMA trying to place our bonds and by the ordinary businesses and consumers, trying to cope with the cost of the public sector burden.

For traditional fundamentals, last year’s record unemployment claims growth (up 66pct), EU’s largest economic contraction (-2.5pct of GDP), widening of GDP/GNP gap, above EU-average inflation (especially in the state-controlled sectors), and extreme housing and construction crisis are all set to continue in 2009.

Irish property prices can decline by ca 25pct in real terms in 2009. New construction might replace only 30-40pct of the already low 2008 levels, while our unemployment is likely to climb to 11-12pct. This will be moderated, on the paper, by a rapid outflow of foreign workers and younger Irish employees. But in reality, emigration will take the most productive future employees out of this economy first. Deflation in the private economy will be exacerbated by continued inflation in the public sector as our semi-state companies squeeze Irish consumers in pursuit of increased profits demanded by the Exchequer. Taxes – both on personal income and indirect business and consumer levies – will climb, inducing a rising tide of tax evasion and minimization measures by businesses and sole-traders. All of this will imply that the Exchequer revenue will slide ca 10-12pct in 2009 on the back of a more severe growth contraction (-4.5pct GDP and -5-5.5pct GNP).

At the same time, there is little hope for spending discipline to be imposed on the public sector by this Government. For 2008, despite the extremely modest demand for €440 million in savings issued by the Exchequer in July, overall spending was up 0.7pct or €351 million. In part, this reflected high demand for social welfare benefits due to collapse in employment. In part, however, it reflects the fact that our public sector still managed to award itself the pay increases and pensions hikes set out under the last Social Partnership agreement.

A new set of challenges
New pricing fundamentals in the bond markets support the proposition that the State will find it very difficult to raise funds in international markets and that this will translate into more economic hardship for the private sector.

In 2009, debt markets will favour those sovereign issues that will be placed to provide direct growth stimuli to the economies. In contrast, Irish borrowing will be focusing on maintaining already unsustainable levels of Exchequer expenditure with little stimulus potential.

Can anyone really believe that serious international investors will back our Building Ireland's Smart Economy framework? Or that they will have serious confidence in this Government’s ability to jump-start Ireland’s economy? To date, Irish Government record on taking decisive action is, as the box-out shows, abysmal.

The problem with the current Government’s handling of the economy is that instead of facilitating growth, the State is exacerbating the effects of the global economic slowdown. Majority of Irish businesses are currently operating in the environment of severe shocks to sales, exchange rate valuations, contracting global demand, shortages of credit facilities and rising domestic costs. At the same time, majority of Irish consumers are feeling besieged by the rising risk of unemployment, taxes, debt and falling disposable incomes. None of these players can take on the task of rescuing the Exchequer out of the unsustainable spending increases.


Box Out: A record of errors
Credit ratings agencies reviewing Irish Government creditworthiness in the recent weeks have made sweeping claims that their unwillingness to downgrade Irish ratings from the gold-standard level of AAA are motivated by the speedy and adequate response by the Government to the economic crisis. In reality, our Government has shown zero capacity for leadership and for admitting its own errors. Consider the facts.

Fact: 2007 general elections brought up the need for public sector reforms to the forefront of policy debate. All parties involved made serious hay out of the calls for changing the way this state spends tax revenue on various political white elephants, bogus investments, excessive wages and perks in the public sector and so on. By the end of 2007, the Government has seen the OECD blueprint for change. By the second half this year it had its own assessment of the OECD report. There has been no action by the Government on the issue of public finances.

Fact: in mid 2007, as the credit crisis first manifested itself, a number of commentators, including this column, has told the Government that the spending path it embarked on was out of touch with reality. In late 2007, many analysts, this column included, were predicting a record slowdown in 2008 and a precipitous fall in taxes. The Government ended 2007 in deficit – despite the windfall from SSIAs and buoyant economy. The same leaders are now denying knowing anything about the crisis prior to July 2008.

Fact: The Exchequer registered a 6pct drop in Q1 2008 receipts compared to Q1 2007, 10pct drop in receipts in Q2 2008 relative to Q2 2007, 12pct decline in Q3 2008 and a catastrophic fall of 22pct in Q4, bringing about an unprecedented, by all European benchmarks, deficit of €12.7bn with a span of the year. All of this was happening right in front of this Government’s eyes and with complacent silence of the boffins from our Department of Finance. This Government still insists that it could not have foreseen these events until after the end of Q2 2008 – 7 months after the revenues collapse began.

Fact: Since the beginning of 2008, when the scope of the crisis became apparent first to the independent economist (in January-February 2008), then to the financial services experts (March-April) and later even to the ESRI and other official policy pundits (by April-May 2008), the Government took lengthy vacations and extended tea breaks to evade making any policy decisions that can be considered even remotely effective or decisive. In the year of extraordinary crisis, both the Dail and the Cabinet did not bother to take any significant extra time to deal with the issues.

In the course of 2008, this Government produced four policy documents:
• a banks guarantee scheme which provided no real support to the economy and preciously little support for the banks,
• the Budget 2009 which managed to bludgeon ordinary consumers and small businesses with new taxes and levies but produced not an ounce of reformist thinking,
• the recapitalization scheme for our banks that failed to address the issue of catastrophic household and corporate indebtedness, and
• the farcical Building Ireland's Smart Economy framework, promising more waste and government spending on politically motivated pet projects amidst the trite catch phrases richly sprinkled across 100-plus pages of largely meaningless policy proposals.

Per Hitchhiker’s Guide to the Galaxy, can this Government, please start delivering its future reports and policy papers in a plastic cover with ‘Don’t Panic’ printed on it. At least we will be properly forewarned.


This article appears in the current edition of Business & Finance magazine (January, 16, 2009).
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