Monday, January 19, 2009

Talking up our economy

Today, Brian Cowen has issued a Bertiesque warning to commentators 'talking down Irish economy'. I beg to disagree. Firstly, the problem Ireland is facing is not that some commentators want to uncover the truth, but that our Government is failing to listen to anyone, save for a handful of public sector mandarins and political appointees. Secondly, lest anyone accuses myself of scaremongering, I remind our Taoiseach and his Cabinet that I have publicly put forward a constructive proposal for dealing with the current crisis as far back as in August 2008.

Here are few details:

In August 2008 edition of Business&Finance magazine, I predicted that Ireland will continue its downward trajectory in terms of stock market valuations and economic performance unless the Government were to tackle the issue of public sector overspend and consumer debt. In early October, from the same platform, I re-iterated a call for the Government to get serious with the problem of rising household insolvencies and corporate debt burden. At that time, I provided an outline of a basic plan that I hereby reproduce (some of the modifications to the original plan were featured in my article in Business&Finance in November).

Here is a bold, but a realistic proposal for moving the Government beyond its current position of playing catch up with deteriorating fundamentals. The Exchequer should:
  • Announce a 10% reduction across the entire budget and an up to 60% cut on the discretionary non-capital spending under the NDP, generating ca €12-15bn in savings. The cut should include a 100% suspension of all overseas assistance until the time the economy returns to its long-term growth path of ca 2.5-3%.
  • Cut, permanently, 10% of the public sector employment (effecting back office staff alone), saving ca €1bnpa after the costs of the measure are factored in.
  • Freeze pensions indexation in the public sector for 2008-2015 and make mandatory a 50% contribution to all pensions plans written in the public sector, generating ca €1-2bn in savings.
  • Stop the unfunded contributions to the NPRF, saving some €1.5bn per annum.

Combining all the savings, the Government should be able to :
  • Bring 2009-2010 deficits to within the Eurozone limits; and
  • Supply temporary tax refunds of ca €5,000pa per household in 2009-2010 ring-fenced for pensions plans and mortgages funding only.
The resulting capital injection of ca €7.5bn pa will be able to:
  1. de-leverage the households (amounting, by the end of 2010 to a ca 25% reduction in the total households’ debt), improving consumer sentiment and re-starting housing markets;
  2. help recapitalize the banks and improve their loans to capital ratios more efficiently than a debt buy-back, a nationalization, a direct injection of capital from the Exchequer or a debt guarantee.
It will result in a sizeable (ca 5% of the entire economy) annual stimulus, without triggering inflationary pressures associated with the Santa-like Government subsidies or consumption incentives.

This proposal implies no burden on the future generations, as the entire stimulus will be paid from the existent fiscal overhang and the set-aside public funds, with the public pensions covered by the contributory schemes.

Lastly, to achieve a morally justifiable and economically stimulative recapitalization of the banks, the plan would require Irish institutions receiving any additional public financing to issue call options on ordinary shares with a strike price set at the date of the deposit and maturity of 5 years. These shares should be distributed to all Irish households on the flat-rate basis.

Thus, assuming the need for additional capital injections of €6-9bn in the Irish financial institutions through 2010 (over and above the €7.5bn pa injected through mortgages repayments and pensions re-capitalizations), Irish households will be in the possession of options with a face value of €4,000-6,000 per household, thus increasing their financial reserves. At the time of maturity, assuming options are in the money, the Exchequer will avail of a special 50% rate of CGT on these particular instruments. Assuming that share prices appreciation of 40% between 2009 and 2014, the CGT returns to the Exchequer will yield ca €1.8bn, ex dividend payments.
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