Sunday, September 27, 2009

Economics 27/09/2009: Leverage across Ireland Inc

Crunching through the IMF database on Financial Stability reveals some serious structural problems in Irish Government&Monetary Authorities positions, as well as in Banks and Non-Banking Sectors of economy. These are long-term themes worth considering.

First General Government & Monetary Authorities:
Chart below shows how extreme is our recent performance in terms of maturity mismatch risk on our General Government & Monetary Authorities debt, with Ireland now leading the group of comparable economies in terms of overall share of short-term (highest risk) borrowing relative to total borrowing.
Chart below shows that we also lead peer group of countries in terms of issuance of new debt despite the fact that the peer group includes such 'sick puppies' as Latvia, Estonia, Greece, and Hungary (some subject to IMF rescues in the last 18 months). Although IMF database does not contain comprehensive data on Iceland, it is clear that Ireland is fiscally in worse shape than all of the APIIGS and even Latvia, Estonia & Hungary. Furthermore, despite Q2 2008 announcements by the Irish Government that it will undertake significant corrective measures on fiscal insolvency side, chart below shows that our 'corrective measures' to date have been mostly about borrowing more in international markets, while the chart above shows that, increasingly, this borrowing is short-term.
Chart below provides an index of General Government and Monetary Authorities debt, setting Q4 2002 level of debt at 1. This dramatically illustrates the scale of Irish insolvency, with debt accelerating from Q1 2006 at a rate far in excess of all other peer group countries.
Banking Sector:
Looking at our banking sector, total sector debt in Ireland now exceeds all other peer countries debt, despite the fact that many of these countries have bigger economies and populations than Ireland. It is fallacious to attribute this result to the presence of IFSC institutions, as the data above is comparable with Hong Kong and Luxembourg - both of which are major IFS centres themselves.
In line with other borrowing trends, Irish banking sector now runs the second highest proportion of short term debt liabilities relative to all debt liabilities. As expected, our banking sector maturity mismatch risk is only marginally lower than the same risk in the general government and monetary authorities accounts.

Who's more reckless in risk taking, you might ask, the Exchequer or the Bankers? Sadly, when it comes to maturity mismatch risk, it is the Exchequer.The rate of debt accumulation in Irish banking sector, however, is in rude health, with banks in this country deleveraging much faster than the Exchequer (which is leveraging up instead of paying down debts, and this is before Nama), the Corporates (see below) and the Households. In other words, while the entire country is scrambling to help bankers, it is other sectors of economy that are bearing increasing burden of rising debt exposure.

Furthermore, an important footnote to Nama: chart below also indicates that the likely direction of Nama funds once banks receive state transfers will be to further reduce leveraging in the banking sector. As I have predicted earlier, Nama will be used to pay down more expensive interbank loans, with preciously nothing going into economy in the form of new credits.Index of total debt for Banks shows the rate of debt increases (leveraging up) since Q4 2002.

Non-banking Corporate Sector:
Total debt in Irish corporate (non-Banking) sector stands out as an outlier in the reference group of countries. This is an apt illustration of Corporate Ireland's obsession with leveraged buyouts, M&A binges at the top of corporate valuations and other debt-financed 'growth' deals done by Irish companies.

The above chart clearly shows the extent of the risk that is inherent in Irish Corporate Finance structure and the high probability that Nama will be followed by a new wave of banks balance sheets deterioration - this time on Irish corporate side. It also indicates that a restart of 'normal credit cycle' in Ireland will require an actual and drastic deleveraging of Irish companies, not a new lending out by the banks to prop up debt-ridden enterprises.

Chart below reinforces this point, by showing that our corporate debt represents an excessively high proportion of overall debt.
Not surprisingly, growth dynamics in Irish corporate debt were equally extreme as chart below illustrates.
Interestingly, Irish corporate borrowing activities remained relatively static when compared to the growth rate in total debt obligations of the country.Perhaps the only 'good news' is that most of our corporate borrowings were in form of longer term debt - a sign that any crisis in corporate insolvencies due to debt overhang will be delayed in time relative to other sectors (Government, Banks and even households).

Direct Investment decline:
Lastly, a quick look at direct investment flows to Ireland (from debt side). As the country engaged in uncontrolled debt spree, overall role of direct investment in economy has fallen in time from over 15% of total debt stocks to under 12%.
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