Saturday, January 31, 2009

DofF Forecast: does it hold any water?

I have a serious question to ask of our Government: Do budgetary projections by the DofF in (e.g those contained in their January 2009 Addendum covered here) hold any water?

In particular, no one has yet taken the DofF forecasters to a task of explaining how on earth, with projected:
  • shrinking GDP (-€7.6bn in 2009 in nominal terms relative to 2008) and GNP,
  • negative inflation (-1%),
  • rising unemployment (+2.9 percentage points on 2008) and falling employment (-4%), and
  • rising, not falling, Net Current Expenditure (+4.3bn in 2009),
does DofF come up with a revenue fall-off of just €3.9bn for 2009 relative to 2008 and total revenue as a percentage of GDP actually rising from 33.6% in 2008 to 33.7% in 2009? (Those of you who are impatient enough, see one potential answer at the end of this post)...

These numbers - the backbone of Irish Government plans for the year - are suspiciously incongruous. Not only because they do not seem to add up. But also because we have no reason to trust DofF forecasts on the basis of their historical accuracy.

Do Government numbers hold up to scrutiny?
This week, it came to media attention that the entire Department of Finance employs only one PhD-level economist. As far as I am aware, we do not know:
  1. Where and when did this person obtain her/his degree?
  2. Was her/his degree in the field of macroeconomic modeling?
  3. Has he/she ever published peer-reviewed research in the areas of taxation and/or macroeconomic forecasting?
In other words, we have no idea how qualified this economist is to carry out macroeconomic forecasting, policy evaluations and risk analysis.

Furthermore, per my knowledge, no one knows who exactly is responsible for supervision and execution of forecasting in DofF and what model is being used. Searching DofF website for Chief Economist reveals no such person. We do not know whether forecasting function is, indeed, an established and managerially resourced function of the Department. Ditto on the Risk Analysis side, which requires both an expert in microeconomic risk modeling and macroeconomic risk specialist.

It is simply not sufficient to say that accountancy or previous budgetary experience, potentially possessed by some DofF employees (how many?) qualifies the Department to deliver any sort of economic analysis or projections. Certainly not the ones which can used by the Government to argue about the need for one reform or another.

In fact, to see the absolute poverty of economic policy research output produced by DofF one should go straight to the source: here. They might as well publish these reports in Gaelic only, for no serious economist would recognize this as proper economics.

One example: in the sole document relating to economic reviews and outlook for 2008, titled Irealnd's Contribution to the Public Consultation Process on the Review of the EU Budget (I am not kidding - they couldn't even spell Ireland correctly). Here, DofF's 'Research' team devotes only 4 pages to the entire analysis of a vital fiscal policy process. The issue of EU-wide tax - something that was a hot topic of debate in Ireland throughout 2007-2008 is given 148 words! Of course, DofF gives five times this much to the discussion of CAP - suggesting, perhaps, our Finance boffins are more comfortable in the cow sheds than in the world of macro-finance and macroeconomics.

Getting basic research wrong - something that is being done by virtually all Irish Government departments on a routine basis - is a serious issue. Brandishing as a major reform a promise to get policies onto an 'evidence-driven' platform, as our Government did last week (see here: 3rd bullet point under Taxation heading), while having no capability to prepare proper economic analysis is hardly a responsible way of governing.

When even the mighty fail by poor research

Few months back, I was sent a research note from PIMCO's cult giant, Bill Gross. Gross is an archetypal salesman, in my view, who has fantastic intuitive understanding of the market (which is way more than our public sector mandarins and politicians have). This is, in most instances, sufficient to earn high rates of return and to contain downside risks.

But, it is not enough to do two things -
(a) provide rigorous analysis of your position in the market at any point in time - past, present, or future; and
(b) explain to others why your intuitive searchlight is capable of picking the right opportunities out of the mass of potential investment strategies.

Published in June 2008 (see here: those of you who attended my class last Fall in TCD's MSc in Finance would recognize it) the note contained a rant about US inflation indices. Specifically, Gross expended some 4 pages of small print arguing that
  1. US inflation has been historically higher than measured by the CPI;
  2. True US inflation should be much closer to the 'global' average (including such economically stable and developed countries like Venezuela, Indonesia, Brazil, Philippines, Thailand, Columbia, Turkey, Ecuador and Vietnam - out of a sample of 24 countries chosen, seemingly, to deliver Gross' point).
All of this led to the following conclusion:
"What are the investment ramifications [of the 'fact' that U.S. inflation is closer to worldwide levels than previously thought]? With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC-like economies are obvious choices for investment dollars."

  • serious analysis - Gross tweaked the evidence to support his own premise;
  • proper investigation of academic and practitioner research - Gross ignored the fact that several Congressional and academic investigations since the early 1990s have concluded that CPI actually overestimates the true extent of inflation in the US by between 0.5% and 1% pa,
he produced a call to arms for investors that cost PIMCO and those who follow its strategy an arm and a leg. How? Gross' advice - issued in June 2008 -
  • has missed a significant H2 2008 rally in Treasuries, Munis and TIPS;
  • calling for heavier weighting for commodities-linked economies came at the time of extreme valuations of these economies (e.g Russia and Brazil both have peaked in June-August 2008), before they fell off the cliff in H2 2008;
  • led to an unprecedented cancellation of dividends by several PIMCO munis funds - the first time in known history any fund suspended payouts for what is, in effect, a monthly yield-generating securities class.
I do enjoy the fact that, being criticised at the time for arguing against Gross' June note, I did turn out to be right about both his call on inflation (he was concerned with hyper-inflation as the world was teetering on the verge of deflation) and on emerging markets.

Back to DofF numbers
But I am not telling this story with some malice towards Gross or PIMCO in mind. At the very least, the man can spell Ireland better than our DofF boffins can. Instead, I am using it as an illustration as to the importance of proper research in backing any strategy - investment and/or policy-related. PIMCO's operations are much more superior to what is going on in our DofF and the rest of civil service when it comes to the quality of research and analysis. This implies that if people like Gross can get things spectacularly wrong, people that occupy our DofF - quipped with one token PhD level economist - simply have no chance at getting anything right.

Remember their latest numbers:
  • shrinking GDP (-€7.6bn relative to 2008),
  • negative inflation (-1%),
  • rising unemployment (+2.9 percentage points on 2008) and falling employment (-4%),
  • a revenue fall-off for the Exchequer of just €3.9bn for 2009 relative to 2008, and
  • a total revenue as a percentage of GDP actually rising from 33.6% in 2008 to 33.7% in 2009
Well, of course to get these things to add up, one has to assume that tax increases passed in the Budget 2009 will not reduce tax revenue. In other words, that the Laffer Curve does not work. We shall see, of course, but empirical studies provide little comfort that such an assumption is a reasonable one. Ditto the numbers on retail spending in the NI and South of the border, SuperQuinn's plan to shut down supermarket located near Newry and loads of anecdotal evidence showing that Irish shoppers are fleeing the Republic for that VAT heaven of NI.

This spells serious trouble for the Government. Suppose that due to increases in the income tax, VAT and other taxes, the revenue were to decline by, say, 2.1% of GDP - as it did in less recessionary 2008. This would imply that tax increases will still be contributing positive revenue growth for the Exchequer, although on a much smaller scale. In such a scenario,
  • the net Exchequer borrowing will jump from 6.3% of GDP to 8.4% of GDP,
  • the General Government Deficit will rise by €3.8bn in 2009 - from 9.1% of GDP projected by DofF assuming €2bn in savings goes through, to over 12%.
Now, suppose tax increases wipe out any revenue gains by 2010 - the deficit will then rise to above 13% of GDP in 2009 and 15% in 2010.

Add to this the fact that while DofF was basing its numbers on -4% growth rate in GDP for 2009, the economy quite probably will contract by at least 5% - balooning potential deficit to 15-16% this year.

A scary thought, indeed, because even the IMF will not lend Mr Cowen a penny with such financial performance on the plans. So much for Brian, Brian&Mary's 'evidence-based' policies...

Friday, January 30, 2009

Debt Mountain 'Ireland Inc'

For those of you who missed my yesterday's article in the Indo on this topic, see here. The article was filed before we had latest figures on the stupendous amount of negative net worth on Irish corporate balance sheets (here).

JohnM was right in his comment that the State has been 'dumping' risk on taxpayers. The irony is - the state has been 'dumping' risk also onto the shoulders of debt-loaded companies, households and even the stock markets. About the only segment of the population that escaped this 'benevolence' of our Leaders is the public sector. Although one must recognise that some workers in the public sector are being paid too little, given that a few of them are actually productive in their jobs, just as one must recognise the fact that not everyone in Fianna Fail is happy to support what the Government has been doing to us.

The above caveats aside, it is, thus, the difference between ZanuPF and ZanuFF that the former cronies are wearing military uniforms, while the latter favours grey suits of the civil service and bearded folks from the unions.

Mushroom Cloud Redux II

Per excellent comment (see here and scroll to comment) to an earlier post on this matter, here are comparatives for Irish Banks index vis-a-vis European Banks. The first chart plots, as before, time series of indices.
In many ways, the series do indeed co-move much closer together until about October 2008, when things are starting to go per-shape for Ireland. This trend of significant deviations in Irish Banks from their peers in Europe accelerated through today, although to see this more clearly, consider the second chart below.
If you look at the correlations between Irish bank shares and both indices, it should be pretty clear that a relatively close link between Irish and European financials broke down around September 29th and was never repaired since. (Note that these are weekly moving correlations, so that a date of 13/10/2008 corresponds to data from 7/10/2008 through 13/10/2008.)

In fact things have spun completely out of sync starting in mid November - precisely when Irish Government got busy 'repairing' our Banking sector. In fact, things got much more dramatic in terms of Irish v EU Banks than in terms of Irish Banks v EU markets since the end of December.

Overall, my strategy still stands, but it is even more pronounced in terms of Irish Banks v European Financials: "Lenihan/Cowen are about to speak? Short Ireland, long Europe"... The only thing worth examining at this junction is whether 'long Europe' might be inferior to, say, 'long US' or UK. But that has nothing to do with our Government's ability or with the topic of this post.

Update: Irish bank shares correlations with both EU Financials and EU total price index are now moving down - ca 96% last night's close (in weekly moving correlations terms) to 86% today... Watch these!

Thursday, January 29, 2009

Mushroom Cloud Redux

Per my earlier posts, here are the latest comparisons between our Financials and the broader European markets.

A new dip is courtesy of our Government's 'Best 5 Ways to Ruin a Country' Framework that I released yesterday (beating the Irish Times in bringing it to public attention by some 12 hours - here).

But enough bragging - back to charts.

The first one is self-explanatory:Mass of volatility (risk) being dumped onto Irish shares by our Government wobbling on economic crisis and banks is self evident. If the Government was really accountable for its actions, maybe investors could have taken it to courts for value destruction.

Alas, this is not how the real world works. Here, on Planet reality, Brian-Brian-Mary prevaricate (in taking hard decisions), we pay. And so it looks like we've had a bear rally and now we are back on a downward track. The only hope - it might bottom out at somewhere above 550 for ISEQ FIN this time around, fingers crossed.

It is the second chart that opens up a more detailed picture of the latest outbreak of the Irish markets disease.
As shown above, weekly correlation between Irish Financials (ISEQ FIN) shares index and the broader Eurozone markets had a series of rollercoaster rides ever since the current Government took up a task of 'fixing' our economy. In particular, Irish markets forays outside the 'No Hedge' territory - into low positive (below 0.25 or negative) correlation values implies that at virtually every point of change in the Government policy, an investor would have done better by betting against the Irish market and in favour of the broader European indices. As powerful of an indication as one can get that markets do not trust this Government in resolving Ireland's economic crisis.

I mean, how bad can the things get for a Government if selling into Brian-Brian-Mary's statements can become a winning strategy for investors?..

Wednesday, January 28, 2009

Government's Plan for Ireland: Exclusive... Part 5

Per earlier posts, italics are my

5. Work together to implement a reform agenda

(i) to implement an agenda for enterprise and competitiveness based on the Framework for Sustainable Economic Renewal: Building Ireland’s Smart Economy including:
  • building on strengths in the Agriculture, Fisheries and Food sectors (back to De Valera's Dream, then?)
  • developing the ideas economy with intensified R&D activity and greater commercialisation of the output of that research (more MIT Media Labs and E-voting machines?)
  • supporting the manufacturing sector (How?)
  • encouraging entrepreneurship and business start-ups (by raising taxes and taking more money out of families' pockets?)
  • pursuing opportunities to expand the services sector, in particular international services (by doing what?)
  • realising the long-term potential of the tourism sector (How? By setting a minimum wage that makes our labour uncompetitive? By hiking VAT rates and adding new taxes on tourism?)
  • improving trade, investment and tourism links with new and fast-developing markets (more junkets to exotic destinations for the Cabinet?)
  • pursuing opportunities in the Green Enterprise sector, including in the area of energy efficiency (aka we take your money and your light bulbs?)
(I have commented on this plan before. It is a road map to nowhere for a number of reasons outlined here and here. But what is truly egregious in all of this is that the ‘plan’ above comes after the promise of carrying out only evidence-based expenditure programmes, despite most of it being based on no evidence at all and parts of it having the preponderance of evidence against them.)

(ii) to develop a new approach to upskilling and reskilling those in employment and those outside the labour market; we will convene a Jobs and Skills Summit in March 2009 to devise innovative approaches to maintenance of employment, creation of new employment and early and active engagement with those losing their jobs; we will also seek to maximise eligible support from the European Globalisation Adjustment Fund for initiatives to support those who are made redundant

(Read: we'll get FAS to fly back to see NASA and beg the EU to give us some handouts to pay for their trips)

(iii) to ensure that sheltered sectors of the economy, including professional services, bear their full share of the burden of adjustment

(This Government cannot even force its own employees to take a cut, imagine them going after protected professions? But what they will do is tax. Tax anyone with a degree - for people who invested in their education tend to earn more. Tax anyone with skills - for people with skills tend to earn more. Tax anyone with experience - for... well - you get the wind.)

(iv) to implement the employment rights provisions in the Towards 2016 Transitional Agreement

(And raise wages and perks for the least productive in our economy?)

(v) to deliver measurable public service reform to improve the efficiency and quality of public services, based on the Government’s Statement on Transforming the Public Service published in 2008

(Since 2008, the Government sat on its hands, doing absolutely nothing about this. Will they change their mind? Not. The entire programme proposed by Mr Cowen today is a give-away to the public sector trade unions and politically-connected lobbies. Mark my words - there will be no change!)

(vi) to continue implementation of the Health Service Reform Programme, including utilising the Health Forum under Towards 2016

(After a gratuitous increase in pay for consultants in exchange for no new responsibilities or any work load increases, there hardly anyone in the country who believes in this drivel)

(vii) to finalise a comprehensive framework for future pension policy which responds to the challenges facing the Irish pensions system in the years ahead

(Read: mandatory pensions, claw back of tax benefits for pensions savings and vast transfers of pensions-linked wealth from the private sector. In other words - another tax!)

(viii) to ensure our approach to regulation, accountability and corporate governance delivers a sustainable society and economy

(Mr Cowen's speak for more red tape on ordinary businesses!)

6. Conclusion

The Government and Social Partners commit to work intensively over the immediate period ahead to develop specific measures to finalise and then implement a Pact based on this framework.


This 'plan' is a classic example of “How to Destroy a Country in Five Easy Steps” guide:
1) Raise taxes in a recession;
2) Yield on everything to the narrow interest groups;
3) Spend precious taxpayers cash on feel-good Government waste;
4) Pile on more regulation and delegate democracy to an unelected group of public sector lobbyists;
5) Keep rolling back your previous promises and commitments (i.e Mr Lenihan’s repeated promises that he will not raise taxes)

If this is Mr Cowen’s way, his philosophy, would the last person leaving this country turn of the lights, please!

Government's Plan for Ireland: Exclusive... Part 4

Continued, as earlier italics are my:

Part 3:

An Equitable Approach

The Government and Social Partners believe that support for these adjustments will be strengthened by measures which demonstrate that the burden is being shared equitably across society. This includes:
  • the need to ensure that moderation in respect of executive remuneration is seen to contribute meaningfully to the adjustment required
  • that those who benefited most from the economic boom should make a particular contribution to the adjustment required
(This is it? Given that wages in the public sector earn 40%+ premium on pay in comparable private sector occupations, who, Mr Cowen, has benefited most from the boom?)

Delivering the Fiscal Stabilisation Framework

The Government and Social Partners agree that a credible response to the fiscal situation requires a further adjustment at this stage of the order of €2 billion in 2009.

(But this is the same response Mr Lenihan announced in July. This means that either the Government finds no need to change its response to the crisis as it evolved since July, or that Brian-Brian-Mary are simply dumping more than 90% of the budget deficit for 2009 onto the shoulders of the private sector alone, with the unionized public sector carrying less than 10% of the burden. Is this their version of evidence-based equitable policy?)

In addition to this immediate adjustment required in 2009, the Government and Social Partners commit to working together under the Pact to support the further adjustments required to reduce the General Government Deficit below 3% over the remainder of the five year period.

(Can the authors of this document explain how on earth can this Partnership deliver on cuts of €4bn in 2010, €2bn in 2011, €1.75bn in 2012 and €1.25bn in 2013 – as envisioned by the DofF January 2009 forecast (see here if the same Partnership is having such a hard time delivering a €2bn cut this year? Furthermore, observe that there is not a word about cutting excessively high public sector pay, freezing public sector wages or reforming public sector pensions and perks. None! This leaves the cuts to come solely from the service side.)

4. Short-term Stabilisation of the Economy

In order to maximise economic activity and employment in the short-term, the Government will:
  • provide a fiscal stimulus in 2009 and 2010 by maintaining capital investment at a high level by both international and historical standards
(In other words, their emergency response is to continue with NDP investment planned well before the crisis hit. This is equivalent to doing nothing, Brians)
  • re-prioritise this capital expenditure in 2009 and 2010 in order to support labour-intensive activities where possible
  • bring forward further proposals to support enterprises during this extremely difficult period, recognising in particular the pressures arising from currency movements, and thereby support those in vulnerable employments
(What does this mean? There are no details on any of these measures and it is impossible to determine what exactly can the Government do to achieve these objectives)
  • act quickly to improve competitiveness including increasing competition across the economy and reforming price regulation in areas such as energy

It is recognised that stabilising the financial and banking sector is essential to secure a banking system which is fit for purpose. Accordingly, Government action will seek to:
  • assist those who get into difficulties with their mortgages; in early 2009 a new statutory Code of Practice in relation to mortgage arrears and home repossessions will be brought forward, and the mortgage interest scheme will be reviewed
(Again, no details on a crucially important promise.)
  • maximise the flow of credit to the enterprise sector and ensure early introduction of a code of practice on business lending
(This is pure financial and economic nonsense. The Government cannot ‘maximize’ credit flows and short of requiring the banks to issue sub-prime equivalent high risk business loans at knock down rates, no ‘code of practice’ will help restaring credit flows to failing businesses. Subsequently, this section simply proves economic and financial illiteracy of our leaders.)
  • introduce controls on the remuneration of senior executives, in accordance with the recommendations of the independent committee established by the Minister for Finance...
  • maximise sustainable employment in the sector
(What sector? How about maximising sustainable employment of proof-readers for future Government programmes?)

Recognising that unemployment will rise significantly in the period ahead, the Government and Social Partners will work together to maximise employment and help those who lose their jobs by:
  • designing a flexicurity approach appropriate to Irish conditions which keeps people working where feasible and equips people to return to employment as quickly as possible by maximising the availability and impact of education, upskilling and training supports
(Flexicurity is an unproven approach to labour market regulations that can be cost-prohibitive to the society at large and ineffective in delivering real employment gains. The Government, having committed itself earlier in the document to ‘evidence-based’ policies has just committed to a policy which was never debated and the evidence in support of which is thin and contradictory. What is far worse than that however, is that the entire labour market policy of Ireland has been at the will of the Government surrendered to an unelected, unaccountable to the taxpayers Partnership. This is an afront to democracy.)
  • redeploying resources to ensure efficient and timely delivery of direct State supports to those who lose their jobs including social welfare payments, redundancy payments and payments to workers in cases of insolvent companies
The Government and Social Partners will address the serious and urgent difficulties facing private sector pension schemes.

(Again, after wobbling through a list of secondary measures, a major area where reforms in the public sector and private sector are truly needed is left unadressed!)

More to come, stay tuned...

Government's Plan for Ireland: Exclusive... Part 3

Continued as before, italics are my:

Part 2

Framework for a Pact for Stabilisation, Social Solidarity and Economic Renewal

3. Stabilising the Public Finances

The Government and Social Partners are agreed on the necessity to progressively reduce the level of Exchequer borrowing over the next five years in order to reduce the General Government Deficit to below 3% by 2013 through an appropriate combination of expenditure and taxation adjustments.

Public Expenditure

The adjustment to be achieved through reductions in expenditure will be based on the following criteria:
  • ensuring a fair and equitable spread of the burden of adjustment
  • maximising the level of sustainable employment
  • solidarity with those now losing their jobs
  • maintaining high-priority public investments
  • careful forward priority planning
  • increased efficiency, effectiveness and a focus on outcomes
(Recap the above bullet points: if the new Framework were to deliver careful forward planning, does the Government now admit that such was not used in the past? Can anyone explain to me how any of these bullet points constitute any sort of a forward-looking programme to deal with the crisis?)

The scale of the necessary adjustment requires scrutiny of all areas of public expenditure including agreeing measures on how to constrain growth in public sector pay and pension costs.
(Don't hold your breath - when we get to these in a second, you'll see that there is scarcely any change in Government's traditional modus operandi on public expenditure...)


The adjustment to be achieved through further taxation measures will be informed by the following principles:

  • Changes to be fair and equitable with a higher proportion falling on higher incomes while minimising distortionary effects between different forms of tax
(No details are given, but given that a further tax increase on those earning €100K pa are going to yield only a modest, if not negative, revenue increases to the Exchequer, expect ‘higher incomes’ to mean middle class – i.e. YOU! Of course, notice that the above means everyone’s taxes will go up.)

  • Support the productive sector of the economy to keep Ireland competitive
(How can this be achieved? This Government, has been blabbering about this objective since the beginning of this century and has managed to do nothing to deliver on it. Do any of us believe they can do any better this time around? With Mary Coughlan at the helm of ETE?)

  • Ensuring that tax expenditures are fully evidence-based
(This a pure case of political ‘gibberish’. What does ‘evidence-based’ mean in relation to tax expenditure? Evidence of the money being spent? Of efficiency? When no one, neither in the Government, nor in the civil service is made accountable – with their jobs, pensions, perks – for any failure in delivering on promises made, who cares if their spending decisions are ‘evidence-based’ or ‘we-just-feel-like-doing-it’-based? Does anyone care if Mr Cowen has evidence to support his lofty Building Ireland's Smart Economy ideas? It simply cannot work - evidence or none (see here)!)

  • Broaden the tax base and make changes that are straight forward, easily understood and easy to administer
(Broadening tax base means finding new taxes to pin onto us. Oh, but the above is not enough, so…)

  • Additional progressive tax measures consistent with the social solidarity approach

Additionally, given the urgency of the situation and the role that taxation will have to play in bringing stability back to the public finances, the Government is asking the Commission on Taxation to identify appropriate options to raise tax revenue and to complete its report by September 2009.

(So, recap – general taxes will go up, new taxes will be thought up and then there will be more progressive tax measures. And in return, the over-worked civil servicemen and underpaid ministers are going to give us ‘evidence’. And compassion.)

Stay tuned for more...

Government's Plan for Ireland: Exclusive... Part 2

Here is the document I promised to post, with some of my own comments in italics.

Part 1:

28 January 2009

Framework for a Pact for Stabilisation, Social Solidarity and Economic Renewal

1. The Challenge
…While the uncertainty about international developments makes predictions difficult, Ireland now faces the prospect of:
  • a reduction of up to 10% in national income over the 2008-10 period (January 9, 2009 Addendum to the Irish Stability Programme Update from the DofF states that we are expecting a cumulative of 6.2% decline in GDP and an 8.2% decline in GNP. Where is the ‘up to 10%’ figure is coming from?)
  • a loss of more than 120,000 jobs over 2009 and 2010 (this is consistent with DofF latest forecast, so if the Government expects national income to fall more than the DofF predicts, should the unemployment figure expectations be higher as well?)
  • an increase in unemployment to more than 10%
  • tax revenues in 2008 more than €8 billion below expectations, and a further fall projected in 2009, creating an unsustainable Exchequer deficit
  • without further adjustments, a General Government Deficit in the range of 11% to 12% of GDP for each year up to 2013
There are in fact significant downside risks to these projections including:
  • a steeper or more prolonged downturn in our main trading partners
  • the possibility that global financial market problems deepen or persist for some time
  • further exchange rate appreciation
  • a further decline in international and domestic confidence and investment
(So nothing really to do with us, then? Clearly our leaders do not think that the loss of competitiveness, sky-high costs, climbing taxes, inept governance, lack of any economic development platform for the future and a host of other problems besieging Ireland Inc are not something we should be concerned in the future...)

This document therefore sets out a framework within which the Government and Social Partners have agreed to develop a Pact for Stabilisation, Solidarity and Economic Renewal.

2. Shared response through partnership

...In developing a Pact, the Government and Social Partners are fully committed to an approach in which all sectors of society contribute in accordance with their ability to do so, and conversely the most vulnerable, low paid, unemployed and social welfare recipients are insulated against the worst effects of recession.

(It will be interesting to see how the Government is going to achieve this. Is the Revenue going to treat those of us who become unemployed in 2009 when it comes to collecting taxes for 2008 with kid gloves by ‘insulating’ us from the need to pay back taxes if doing so puts our families over the edge or is this a case of caring going too far? The Government certainly gave it no thought when it raised taxes in Budget 2009.)

The Government and Social Partners believe that by making the correct decisions now, and committing to working together through the further difficult challenges which lie ahead, we can deliver reforms which allow us to still realise our shared goals for Irish society, most recently outlined in Towards 2016, while also laying the foundations for sustainable economic recovery.

(Need I remind you that Towards 2016 is a document primarily designed to reward public sector workers, offering nothing to the vast majority of our private sector employees, taxpayers and consumers. Furthermore, I personally fail to see how, if the Government expects the crisis to continue through 2013, can we deliver on what was originally conceived as an 10-year long plan within 2 last years of its existence?)

More to follow...

Government's Plan for Ireland: Exclusive... Part 1

Watch this space - I will be publishing Government's Briefing to the Social Partners - received from my academic sources - as soon as I read through the document. For now, part 1 of analysis...

Since the beginning of this week, a media circus surrounds the hot air factory we call the Upper Merrion Street.

Yet, ask anyone in the street what they think will be the outcome of the Social Partnership talks and the responses you get are pragmatic. "Taxes will go up for all!" "[the unions] will make us pay for public sector salaries and job security." "The Partners will get nowhere. Look, the Government can't control its own spending."

They are right. Common sense tells us that the Government that sat on its hands as the crisis unrolled through out 2008 is simply incapable of change. Our Cabinet has no progressive thinkers at the top.

When Mr Cowen took over from Bertie the reigns of this state, his first economic argument was in favour of preserving lavish wage increases granted to senior public sector employees and politicians. Incidentally, this was also the last thing Bertie did as far as economic policy is concerned. When President Obama sat down for his first day in office, he froze salaries of senior public officials.

Notice the difference? Right, it's that leadership thing that Obama seems to have, while our Brian- Brian- Mary Tri-Headed Hydra appears to absolutely lack.

But don't take my words for it. Look at the economic policy tofu they've been feeding to the markets and the Social Partners in the last couple of weeks.

Per sources advising the talks participants on economics side, the Government has forwarded a proposal to the Partners that includes:
  • significant 'income adjustments',
  • the adoption of budgetary 'stabilization' programme for 2009-2013,
  • a nationwide 'jobs and skills summit' to be presided over by FAS,
  • a reform of taxation – after the Commission on Taxation produces its recommendations, and
  • unspecified public expenditure 'savings' after mid-2009, and a reform of pensions.
All of these ideas have been floated by the Government since July 2008 and none have seen any progress, with exception for the first round of 'income adjustments' (oops, tax increases) passed in Budget 2009.

In fact, the Government has now fallen so far behind the news curve, that it is undoing its own earlier plans. For example, Department of Finance January 2009 Stability Report factors into its budgetary deficit projections the minimum level of public expenditure savings of €16.5bn through 2013. Yet, according to the news coming out of the Partnership talks, the Government was asking for 'up to €15bn in spending cuts in 2009-2013'.

So much for the adoption of a budgetary stabilization programme. DofF's forecast is for the Exchequer deficit to run at 9.5% of GDP in 2009, 9% in 2010, 6.5% in 2011 and 4.75% in 2012, assuming the Government cuts €16.5bn starting now, not in the second half of 2009. Without these cuts – we are likely to be in an Icelandic deficit territory through 2020.

Surreal? Wait till you look closer at the rest of the Government proposals.

'Income adjustments' for 2009 and beyond are nothing else but tax increases on ordinary families and consumers who already face higher taxes (income and VAT), rising unemployment, falling wages and upwardly mobile public services costs. If anyone thought that a near tripling in personal bankruptcies in 2008 was a sign of a serious problem, wait until our Government's efforts to 'stabilize' the economy take a massive bite out of ordinary incomes.

No FAS-led "Jobs Fair" would be able to mop up even one tenth of the unemployment created by these Government-induced 'income adjustments'. FAS spends ca 7 times the average annual wage per each job created. At this rate 85,000 jobs that the Department of Finance forecasts to be lost in 2009 will take a cool €20bn 'Job Fair' to replace. And 85,000 is the number not counting in the jobs lost by the rapidly evaporating foreign migrants.

Finally, don't be fooled by the lofty ideals of reforming taxation and pensions. The official brief has only one stated purpose for such reforms – to raise more revenue out of the private sector economy to pay for more spending. Public sector's favorite folly is to tie us all into a mandatory pension scheme and then take away tax incentives to save.

Not to help up to 250,000 homeowners who will be stuck in the negative equity by the end of 2009, nor to aid families crippled by childcare costs or healthcare bills. Most certainly – not to give an inch back to the pensioners and savers whose funds have been devastated by the collapsed market.

Our only hope is that a handful of economically literate Partners might stand their ground in these absurd talks. Otherwise, as a fellow panelist of mine exclaimed at a recent radio discussion concerning our economic future, "We all will be truly screwed…" By those who are supposed to serve us, I might add.

Corporate wipe-out and homeowners

Figures released by ICC Information today show that 21% of trading companies in Ireland have a ‘Negative Net Worth’. In other words, their balance sheet liabilities exceed the value of their assets. Net worth is composed primarily of all the money that has been invested since company inception, as well as retained earnings for the duration of its operation.

“A total of 28,513 trading companies in Ireland have a negative net worth according to their latest filed accounts. Not surprisingly the largest number of these were in the ‘Construction’ sector with 17.2%. However, in terms of actual monetary value ‘Leasing and Renting’ were top with a total negative net worth of over €7 billion.”

This is a scary sign of corporate debt overload, but it is also a sign of the unsustainable nature of many business models, especially those that emerged in 2003-2007 period of construction boom, based on cheap credit, over-supply of liquidity and overly optimistic valuations of demand.

This goes to the heart of debate about credit supply to Irish corporates.

Majority of these companies should not be rescued by cheaper fresh lending, as their businesses are no longer sustainable in the environment of much slower growth.

However, there is a second argument to be made against increasing the pressure on the banks to lend. Currently, some 140,000 households are in negative equity – with the value of their mortgages exceeding the value of their homes. Factoring in the down payments, stamp duty and closing costs, I would estimate that some 180,000 Irish households are actually in the negative equity territory, implying an insolvency risk rate of ca 9% for homeowners.

Large scale corporate bailouts and credit extensions will inevitably come at the expense of consumers and homeowners. Will this drive homeowners insolvency rates to 21% on par with the corporates? Imagine the number of financially bankrupt families in excess of 315,000…

Market view

US dividends are being cut at a record pace (see here) and this is a welcomed news as it marks the beginning of a turning point in the market. I do not mean the turning point for an upward swing in equity prices, at least not yet. I mean a turning point from the relentlessly accelerating down trend and into a flattening section of the U-curve.

Here is the logic - corporate profits are lagged at the very least one-to-two quarters from real demand. This suggests that an accelerating fall in the dividends reflects the economic reality of Q3-Q4 2008. Assuming the real side of the US economy is going to start settling into the bottom section of the U-shape correction sometime in February-March, the current reporting season will be pricing exactly this forecast. Any pick up in growth from the low figures of December-January will be a bonus point to Q2 dividends.

Regardless of such a pick up, equity markets downgrades in the next few weeks will bring share prices down to reflect dividend cuts.

This will set the stage for the next move. End of Q2 is likely to see some upturn in the US economy. Real GDP growth is likely to stay negative in annual terms, but the latter part of Q2 will be marked by a rise in growth from the lows of Q1.

Equity markets will lead this trend with a potential rally in late Q1 - early Q2. Dividend cuts anticipations for Q2 will already be priced in by then, so aggressive cost cutting measures - implying lower sensitivity of Q2 profits to any further economic slowdown in Q1 2009 - will provide some additional potential mid-Q2 boost to the share prices.

A late Q1-early Q2 rally will be a payoff to today's realism...

Tuesday, January 27, 2009

Global trade protectionism: politics at its worst

To start with, here is a great quote from Jagdish Bhagwati - courtesy of the Cato Institute's Center for Trade Policy Studies:

"[L]abour union lobbies and their political friends have decided that the ideal defence against competition from the poor countries is to raise their cost of production by forcing their standards up, claiming that competition with countries with lower standards is “unfair”. “Free but fair trade” becomes an exercise in insidious protectionism that few recognise as such."
"Obama and Trade: An Alarm Sounds," Financial Times. January 9, 2009.

Lest anyone thought that one party controlling the Congress and the White House is such a handy idea, there is a welcome package for the EU's exporters being prepared by the Democrats.

According to the reports in today's press, President Obama's much-awaited $825bn stimulus package will include a “Buy America” clause - the American Steel First Act. The act will ensure that only US-made steel will be used in $64 billion of federally financed infrastructure projects.

Clearly, Anyone-but-the-Republicans EU leadership is going to see some nasty surprises from the new Administration - if not courtesy of Mr Obama himself, then certainly thanks to the good old protectionist traditional Democrats that Europeans love so much.

The initiative has already secured the House of Representatives Appropriations Committee blessing and is about to trigger a new Steel War with Europe. The EU Commission is already making noises about taking the US to WTO. The US, of course, signed and ratified the WTO's Government Procurement Agreement which requires it to grant fair access to its federally financed projects to all competitors.

If course, some EU states themselves are toying with 'Buy Domestic' types of rescue packages. France, usually the leader of the protectionist pack despite being economically open when it comes to French sales and investments abroad has squeezed in a €6bn aid package for its automakers that includes a commitment for them to purchase on French-made components.

In the UK, plans to give state aid to car makers are also reportedly to include assurances from the comapnies not to use funds outside the country.

A similar €4bn package of aid to Saab and Volvo in Sweden also came with the same strings attached.

And then there is a decision to reintroduce dairy export subsidies by the EU's Agricultural Commissioner, Mariann Fischer Boel. The measure is not only protectionist, but came despite the EU commitment in November 2008 not to introduce new trade barriers in order to allow the troubled Doha Round of global trade talks to be finalised with some face-saving dignity for the WTO.

So maybe in the end Mr Obama is an EU-like President?

Of course, the developing nations are also moving in quickly to shut some of their markets to foreign competition, but this is hardly a reasonable ground for EU and US to start erecting their own trade barriers. History offers a somber reminder: passage of the 1930 Smoot-Hawley Tariff Act in the US triggered a wave of tariff increases across the world. Within a year, average foodstuffs tariffs went up 53% in France, 60% in Austria, 66% in Italy, 75% in Yugoslavia, 80% plus in Czechoslovakia, Germany, Romania and Spain and more than doubled in Bulgaria, Finland and Poland. We all know what that led the world...

Euro Area GDP forecast - Update I

Last month I predicted that the forward looking barometer of economic activity in the Euro-area, the €-coin indicator published by CEPR and Banca d’Italia will register a small temporary correction from its historically low level of -0.15% (growth of Euro-area GDP forecast) in December 2008. I also forecast that the Euro-coin indicator will follow the downward path in February back to -0.15% reading.Alas, I was too optimistic. Today’s Euro-coin data shows that the measure of economic activity in the Euro-area has fallen once again, this time to -0.21% in January 2009. This changes both my original forecast for February 2009 Euro-coin indicator and for Q1 2009 GDP growth rate in the Eurozone.

My new forecasts are:
  • Eurozone GDP Growth rate: -0.8% in Q1 2009
  • Euro-coin: -0.17-0.25 February-March 2009, with expected value of -0.22.

Monday, January 26, 2009

Irish policy & rising jobs losses

750 job losses at First Active, over 2,800 jobs losses last week alone... we are in a meltdown mode by all possible means and the social partnership, the government and most of the opposition are clearly out of depth on what needs to be done.

I said 'most of the opposition' because there are pieces and bits of forward thinking still coming through in a handful of statements issued by FG and Labour. However, these do not, as of yet, represent a credible and effective platform for a policy response.

Here is a statement from
Fine Gael Enterprise Spokesman Leo Varadkar TD issued today:

"Fine Gael has called on the Government to waive PRSI payments in 2009 for companies taking on new employees, declare war on red tape, launch an immediate review of overpriced electricity and gas charges, and impose a freeze on local authority charges and Government levies. The Government must also scrap the damaging VAT hike in the Budget, and overhaul FÁS into a rapid reaction agency which can provide public works schemes for the unemployed.”

Good beginnings of a policy here, but take a deeper look:
  • Waiving PRSI payments in 2009 for companies taking on new employees is, in effect, a subsidy for jobs creation, not for jobs retention. On the margin, it is an incentive to create lower-end jobs, but it will do nothing to preserve thousands of financial services jobs;
  • Declaring war on red tape is simply sloganeering. Most of our red tape comes from Brussels and the Irish Government has no say on this. Instead, culling the army of quangoes that mushroomed in recent years and rebating the savings back to the taxpayers might help;
  • Reviewing energy prices - a good idea, but beware: it will spell an end to the Green Party agenda of subsidising wind and other alternatives via minimum price guarantees. I personally have no problem with this, though;
  • Freezing local charges and levies - at current levels - will do nothing more than provide an injection of a vitamins potion to a dying patient. We need a wholesale reform of the local authorities structure to lead in cutting - dramatically - these costs;
  • VAT increases must be scrapped, and in fact, a cut in the VAT rate should be implemented, but the main problem is in declining after-tax incomes, not in rising consumption expenditure;
  • Overhauling Fas into some sort of a lean, mean jobs-creation machine ignores the basic problem with this organisation - no state body can 'create' jobs. The best Fas can do is take money from the taxpayers and spend this money on token training programmes. The efficiency of such programmes to date has been €250K spent per job added. Even if Mr Varadkar manages to cut this by 2/3rds, it will still be more than €2.40 spent per €1 in average wages added. You might as well pay the unemployed that €1 in welfare and burn the remainder €1.40 in a fireplace. At the very least you'll get some heat - more than what you'll get out of 'overhauled' Fas. For a real solution to the Fas problem - see the second bullet point above.
This brings us to the issue of what should be done. The main problems, as I have pointed on numerous occasions, faced by our economy are:
  1. Public sector insolvency;
  2. Households' and companies' indebtedness; and
  3. Uncompetitive domestic economy dragging down exports growth with it.

All three require a small number of resolute measures.

Public Sector: cut the spending (capital and current) by ca 10-15% and use one half of that to plug the deficit hole, while the other half should be rebated to the households to pay down homeowners' and pensions' deficits;

Households' balancesheets: the above will address, in part, the issue of precautionary savings demand and repair household balancesheets. More, though will be required to restore demand for credit, so use banks recapitalisation scheme to raise equity in the banks and rebate this equity back to the households via a voucher-like scheme;

Companies balancesheets: Many of the domestic Irish companies struggling today are, frankly, insolvent and incapable of operating as an ongoing concern in the environment where growth is slower than 4% per annum. These must be allowed to fail. As there is no better mechanism to sort the sick from the healthy than the market, the State should resist the desire to 'repair' companies' balancesheets. Instead, the state should enact emergency cuts in local authorities budgets and cut local authorities charges and tax cuts to consumers to stimulate demand (see below). One policy on business side to be enacted should involve a PRSI tax cut and the introduction of the full credit for private health insurance purchases against the health levy contributions.

Local Authorities & Quangoes/Regulatory Authorities (RA): Within 4 months, the Government should produce the first draft of a local authorities reforms package cutting the number of local authorities down to 4 - GDA, North East & Midlands, West and South. The savings to be achieved in this reform should be set at a minimum 50% of the combined budgets of the current authorities being pulled. A comprehensive review of the Quangoes and Regulators must be carried out by a non-political independent panel working in a transparent, open manner, reporting by April 1 2009. The objective should be to:
  • completely and effectively separate regulatory authorities from their respective sectors and the Government;
  • introduce effective RAs oversight by the Dail;
  • reduce the number of quangoes by at least 75% and the number of RAs by at least 30%, with corresponding reductions in staff and budgets; and so on.

Domestic economy reforms:

(1) Tax policies:
  • cut VAT back to 17% across the board,
  • cut CGT to 15%,
  • replace stamp duty with a land-value tax (or a variant of such) phased along some amortization schedule for stamp duty paid by the existent homeowners;
(2) Structural reforms
  • dissolve the Social Partnership;
  • privatise - via a public voucher system for disbursement of state shares - all semi-state enterprises (those state enterprises that hold more than 50% market share in their respective sectors - e.g ESB, CIE, DAA, VHI, etc) must be broken up in the process of privatisation;
  • beef-up the Competition Authority with direct enforcement and prosecution powers;
  • reform CBFSAI to detach it completely from the Department of Finance.
This is, by any measure, only a partial list of priorities. In fact, if anyone wants to add to the list, feel free to email your suggestions to me.

Eurzone's growing pain

Willem Buiter's post makes a timely and an obvious point that the new stage of the global financial crisis is beginning to pull Eurozone monetary structures apart. Buiter starts the argument by describing a rising tide of financial protectionism:

“Consequently, we have seen two forms of re-nationalisation of banking and finance. The first form of nationalisation has been the taking into partial or complete public ownership of banks and other financial institutions deemed too systemically important (too big, to interconnected or too politically connected) to fail. This has happened virtually everywhere... More examples will follow. The second form of re-nationalisation of banking and finance is the restriction of access to the fiscal and financial resources of the nation state just to those banks and other financial entities that have a significant presence in that nation state.”

Buiter points to the lack of coherent single fiscal policy platform for the EU as the underlying cause for these developments. In particular, he stresses that the Eurozone has common monetary policy, but national regulatory environments and fiscal polices, all pulling in different directions at the time of the crisis.

“The Eurozone is in a bit of a pickle here, because although it has a central bank with supposed uniform access to its resources for all Eurozone banks, regulation and supervision remain national and fiscal bail-outs (recapitalisation by the state, guarantees, insurance, loans or whatever provided by the sovereign) definitely remain national. When the central bank acts as market maker of last resort, as the Banca d’Italia is now doing in the Italian interbank market, it takes on significant credit risk which requires a fiscal back-up - the Italian Treasury. But that undermines the principle of equal treatment of banking institutions across the Eurozone...”

• either a “supranational fiscal authority with its own tax and borrowing powers, accountable to the European Parliament …and the Council...” or
• “…a pan-Eurozone fund, fully pre-funded and containing, say, 2 or 3 trillion euro to begin with. This Eurofund could be managed by the European Commission, subject to parliamentary oversight and control by the European Parliament and the Council. The fund could be drawn upon to provide financial assistance to systemically important troubled banks in the Eurozone, according to guidelines agreed by the EC, the EP, the Council and the ECB. …the fund [is] to raise its resources through the issuance of bonds that would be guaranteed jointly and severally by all Eurozone member states.

Of course, there are other solutions, which Buiter omits for obvious political reasons. These include:
1. Doing nothing, threatening a disorderly collapse of the Euro, should the current crisis continue to deepen; or
2. Partially re-introducing parallel national currencies to run alongside the Euro.

The last option is a milder version of a ‘nuclear’ first option, but desperate times do call for desperate measures.

The two solutions Buiter proposes are about as realistic as Salvador Dali’s landscapes:

• A common fiscal policy is a complete non-starter at this time.
• While a joint EU15-wide fund would be welcomed by the EU officials – ever hungry to get more power – underwriting such a fund (in excess of 32% of the Eurozone 2008 GDP) will be crippling for national governments, especially at the time when their own finances are under immense pressure from banks bailouts and fiscal stimuli.

In addition, the ages old concern of Germany and other states that the fund will be abused by the less fiscally prudent states, e.g Italy, Spain and France, constrains its feasibility, while strained sovereign debt markets are constraining the feasibility of raising such amount of money to capitalize the fund.

In this framework, unless the current downturn is reversed in the next 3-6 months, it is clear that an evolutionary process of fiscal policy responses and monetary policy constraints across the Eurozone will be creating more incentives for Balkanization of the Euro. Short of lapsing into oblivious denial of the reality, it is only a matter of managing this process that the ECB can be concerned with at this moment in time.

Saturday, January 24, 2009

Public Sector: A Feast Amidst the Plague: Update I

Here is another interesting observation concerning Public Sector earnings.

The figure below clearly shows that wages in the lowest earning categories of public sector fall within 1 standard deviation of the total public sector wage (i.e the average). This disputes an argument that there is any significant degree of heterogeneity in pay within our public sector.

Statistically, this shows that not a single category of workers in the Public Sector (identified by their respective sub-sectors of employment) earn less than the overall Public Sector average.

Indeed, this data (taken from the CSO - see here) proves that within the public sector, the so-called 'low paid' areas or professions enjoy a relatively average rate of pay, with the average itself being artificially inflated by the higher earning categories. In other words, there is no pleading relative poverty for any sub-sector of the public sector employment.

PS: Did anyone notice an apparently bizarre logic our public sector trade unions have taken to in arguing against any cuts in public sector wages?

Well, they are arguing that such a cut would be deflationary
(in case you have not noticed, deflation is a new evil). Thus, their argument goes, to rescue our economy out of the current crisis, one should stick to the excessive wage increases granted to the public sector employees under the last Social Partnership deal. But hold on, weren't the same trade unions also arguing that high inflation in the past made it imperative to raise wages paid to the public sector employees?

In other words, ICTU/SIPTU and the rest of them are having it both ways: inflation or deflation, they'll have a pay rise in the name of the nation's economic health...

Have a cake, eat it, and get the rest of us to pay for both?

Friday, January 23, 2009

Public Sector: A Feast Amidst the Plague

According to the latest CSO figures (here):
Average weekly earnings in the Public Sector (excluding Health) rose by 2.9% in the year to September 2008. The index of average earnings …rose by 3.6% for the same period. Average weekly earnings rose by 1.7% in the year to June 2008 while the index of average earnings rose by 2.5% for the same period.

Oh, no, I am not making this up. Here is an illustration from CSO's release:Only a month-and-a-half after Mr Lenihan thundered first about saving €440mln in 2008 (he actually ended the year overspending €370mln rather than saving a penny) and €2bn in 2009 (we know where that promise is going) and a month before he launched his ‘patriotic’ tax increases in Budget 2009, according to CSO:
• Public sector wages were still climbing up, while
• Public sector employment… well, shall we let CSO speak on this:
A total of 258,200 people were employed in the Public Sector (ex Health) in September 2008 compared to 251,100 in September 2007 [a rise of 7,100]. In the year to September 2008 employment in the Education sector increased from 93,500 to 97,900, a rise of 4,400. Overall employment in the Public Sector was 369,100 in September 2008, an increase of 5,200 compared with September 2007. Employment in the Health Sector decreased from 112,800 in September 2007 to 110,800 in September 2008, a decrease of 2,000.

Chart illustrates…
All sub-sectors of public employment are up! While the rest of the economy is buckling under the weight of a severe recession.

Oh, dear, who can now take our Brian-Brian-Mary Trio seriously?

PS: to our previous post (here):
According to CSO release today, retail sales volumes fell by 1.2% m-o-m in November, with the annual rate of decline of 8.1% (exacerbating a 7.5% decline in October). The last time the annual rate fell to these levels was in February 1984. November core sales (ex-motor) volumes fell by 1.9% m-o-m, and by 7.8% y-o-y.
Car sales were down 11% y-o-y. Overall, core retail sales have now fallen - in y-o-y terms - at a rate not seen since April 1975. Consumers are clearly boycotting Brian-Brian-Mary policies and spending only on bare necessities at home, preferring to take their Euros to Northern Ireland, the UK, the Continent, the US or anywhere else where they are welcomed. In doing so, they indeed fulfill their real (ass opposed to Lenihaenesque) patriotic duty of serving their families' needs!

PPS: a fellow economist (hat tip to Brian) just asked (rhetorically) if these figures mean that we might register and unadjusted decline in December retail sails. My view - quite possibly. And January sales, and February sales, and so on, well into a -4.5-6% fall in retail sales for 2009! Laffer Curve is merciless - raise taxes, see revenue evaporate. Brian-Brian-Mary should have been sent to Economics 101 before they were allowed to run the country!

Thursday, January 22, 2009

Living in the world of delirium

Irish Times today reports that "the Cabinet will today continue its discussions on ways to achieve a €2 billion reduction in costs."

Take a step back:

National deficit for 2009 is projected by the Department of Finance to reach 10.5% of GDP in 2009 before any adjustments (i.e Bord Snip cuts and Mr Lenihan's 'patriotism' tokens from July) are taken. That is, assuming a 4% drop in GDP in 2008 levels, a cool €18.9bn. Now, add €5bn in April bonds redemption due and the cost of banks recapitalization, as estimated by the Government - we are potentially €33.9bn in a hole. From there on, its anyone's guess what the cost of operating the nationalized bank(s) and other ancillary spend items might be, but let's be 'patriotic' and stop at that €33.9bn figure.

The Government is now 'working hard' to get €2bn through the door - the same €2bn that Lenihan demanded in savings for 2009 back in July 2008! Six months later, he is still at it.

In other words, and here the Irish Times is naturally silent, this Government cannot get even a lousy €2bn in savings out of ca €34bn that it will need! And they have audacity to talk about 'national sacrifices'?

Forget Sean Fitzpatrick's loans, forget incompetent bankers who could not get risk/return relationships right in their lending decisions - the real scandal is the fact that this Government is playing us all for their willing milking cows. There is no national recovery plan! There is no willingness to take tough decisions! Hell, there is not even a realisation of the true extent of the problems we face! There is an incompetent, cronyist Government-by-appeasement that is clearly banking on borrowing and taxing its way through the recession to avoid angering its main constituency - the public sector unions.

And now, run through the Irish Times again (here):

No one on the Times team connected the dots from the gutless, incompetent governance to the economically illiterate and morally insulting Budget 2009 to the news that Superquinn will axe 400 jobs and shut its store in Dundalk. And yet this connection is there for anyone to see.

In 2002-2007, the current FF Government (for there is no real change save for Charlie McCreevy's and Bertie's departures) squandered away billions of our money to pay off its own constituencies. All of this waste has gone up to fuel business costs increases across the country that left Ireland in a position of being completely uncompetitive relative to our, already uncompetitive, neighbour - the NI. Mr Cowen presided over this gratuitous mismanagement of public finances as the Minister of the Exchequer. Mr Lenihan was on the sidelines of economic policymaking, but he did not seemed to have minded what was going on around him. Ms Coughlan was at the coalface of the FF-led welfare banquet as a minister for agriculture, although she was wasting billions of European taxpayers money there.

The same Trio has passed the Budget 2009 income tax levies and has raised VAT – wiping out thousands of jobs in this economy. The same Trio is now presiding over a charade process that is supposed to bring the state budget under control and resuscitate economy.

The end game? We will end up being forced to accept worthless 'National Recovery Bonds' in a way of pay, as our taxes will rise to 25% & 50% range by Q3 2009, our savings wiped out to pay the army of inefficient and over-paid state workers.

Wednesday, January 21, 2009

Update: Mushroom Cloud III

Here is an updated chart...

After talking to a couple of fellow economists - both admittedly gloomier than myself - I came to a conclusion that Brian Lenihan simply must face the nation on what is holding him back from putting forward a real rescue plan for Ireland's bettered economy:
  • is it the internal opposition by the Cabinet to do anything that will potentially anger public sector trade unions, or
  • is it his own Department inability to provide logistical support for a credible and effective plan?
It is now clear, despite a recent 'consensus' amongst the Government-fed economists, that the country needs rapid and significant cuts in public spending, a tax stimulus (across income tax, VAT and payroll tax) and a round of privatizations (carried out in voucher form to transfer ownership of state enterprises to the public, improving private households' balance sheets). These must be enacted before the end of February. In the medium term, we need a dramatic reform of the stamp duty on property (moving in the direction of a land value taxation system), a long-term reform package for public services and a political reforms pack to include reduction and consolidation of local authorities, reduction of the number of TDs and the size of the Cabinet and an overhaul of our Byzantine system of Departments and Quangoes.

Given the above chart, we have no longer the luxury of time to wait for various Committees and Commissions' reports - it is time to act now!

A View From the Musroom Cloud III

As another day of carnage ensues, there are several new and old issues worth giving a thought to:

(1) Recall S&P ratings update (here): now that Irish 10-year spreads, predictably, are pushing beyond 300bps spread on German bund, what service did S&P provide to the bonds buyers who subscribed to the latest Irish issue of 5-year bonds on the back of AAA rating? The yields, as I have predicted (see here and here) on our bonds have moved in above the Greeks' leaving a wave of devastation behind in the balance sheets of those who bought into this paper on the back of S&P's ratings;

(2) Despite Mr Lenihan's assurances to the contrary on last night's Prime Time, the government is appearing to run thin on actual liquidity (in addition to running thin on any ideas). Do the maths. Mr Lenihan (who was, it must be said, trying to do his best in answering tough questions and did solicit some real compassion from this observer for being, evidently, under immense pressure both inside the Cabinet and in the wider world) stated that banks recapitalization requirements were ca €10bn in 2009.

Now, we know this figure was hammered out but the incompetent risk-pricing non-entities in the Department of Finance on the basis of the following assumptions:
(a) BofI and AIB raising some €2-3bn of their own funding,
(b) Anglo's depositors staying put (saying nothing about other banks' depositors),
(c) shares valuations for the three banks at twice above current, and
(d) no skeletons in the closets when it comes to loan books.

All four of these assumptions have now been challenged. So why is Mr Lenihan sticking to this figure? Is it because he has nothing new coming in with the morning briefing papers from our civil service mandarins?

Some commentators estimate the state exposure under recapitalization/guarantee schemes at €30bn. I would put the figure at a more modest €16-18bn. This would leave Mr Lenihan with just €2-4bn reserve to finance, in 2009 alone:
  • a 10% deficit (ca €8bn in borrowing in excess of already acquired funds);
  • a 'stimulus' package (ca €2bn);
  • state credit pumping operations (via Anglo) (ca €5bn); and
  • €5bn worth of maturing bonds...
In other words, no matter how you spin things, we are in the hole for, in the better case scenario, €16-18bn in 2009. Can the Minister really look straight into the voters eyes (as he did last night) and tell us - 'It's ok, folks, we'll just tap the credit markets for that. We have low sovereign debt'?

(3) David McWilliams brought back the specter of external rescue yesterday (here) with Ireland using a threat to leave the Euro if the ECB/EU Commission to get some funds. I am not sure this is going to be necessary. It is more likely that the Government will tap ECB/EUC for money under the argument that Ireland is yet to have a second Lisbon vote and that denying it emergency aid will be detrimental to the cause of getting us to vote Lisbon in. The funds will arrive in a combination of a straight ECB loan, acceptance of state paper as a collateral for more borrowing, some mixture of the 'knowledge' economy and capital spending investment assistance from the EUC and support for dwindling multinational employment in the likes of Limerick. Saving the face publicly, however, will not fool the debt markets and the yields will go further up.

(4) And while we are on the subject of the Euro - imagine our current Gang of Three running the monetary policy and managing our currency if we were to exit the common currency area? Close your eyes and watch Mary Coughlan trying to compute a three-party FX arbitrage parity, while Brian Cowen discusses a helicopter drop of money with Mr Hurley... Frightening!

(5) More from the bond markets - as our 10-year spreads moved above 300 bps, our short and medium term paper (6-24 months) breached 290bps last night. This suggests a temporary compression in the time structure of the bonds, implying that our 5 year yields will be climbing up and up and up in days to come.

(6) On the positive side, we have the latest comprehensive Government programme for dealing with this crisis (hat tip to Brian, courtesy of the source) in line with our closest competitor for being the worst performing economy in Europe, Latvia (here):

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.

Mushroom Cloud II

No words needed... (Hat tip to an anonymous reader pointing to July 9 event)

Watching a mushroom-shaped cloud rising

Sadly, my quick prediction last night has turned into a reality - bleaker than I could have anticipated. As, at the time of writing, FTSE EUROTOP100 index is trading in the green territory, ISEQ-FINANCIAL is over 34% in the red, with AIB down 41.5%, and BofI and IL&P both down 27%.

We are now safe to assume that the Anglo Irish Bank, taken over by the state last week, was on the verge of becoming a moneyless institution. That despite the tough talk from Mr Lenihan about freezing some deposits, all sizeable corporate deposits have now left the bank's vaults. That the Exchequer downside from the bank 'rescue' is going to be in excess of €10bn, prompting his yesterday's remark that the other banks are now effectively on their own, and in effect admitting that the Exchequer itself may be now out of money, if commitments to date were to be honoured!

All of this has not been lost to international investors, who are currently dumping anything they might still have in the form of Irish banks shares. The surprising thing for now is that Irish bonds yields appear to be holding.

The question, however, is: for how long. If the Black Monday is not reversed, and unless the Government comes out in public with the actually believable statement on its current financial position (including a detailed and credible forecast as to how it plans to manage its exponentially increasing commitments for 2009), Irish yields will rise and prices will fall.

Whatever you do, I would think thrice before switching into Irish bonds... they are far from being a safe harbour...

Will mayhem begin?

This is an unusual post for this blog - short and an attempt to 'call' the market - but given the comments, reportedly, given on RTE today by Mr Lenihan, I would venture to attempt to predict this week's start of trading (6 hours 30 min from now). With the Government once again faltering at the banks recapitalization policy and talking gibberish (with RTE reporting that "Brian Lenihan said each bank had to take responsibility for its own bad debts"), it is difficult to see how we can avoid another deep meltdown in the markets. I hope I am wrong, but today might be the first Black Monday of 2009... Stay safe, ye all who trade today!

Sunday, January 18, 2009

Irish credit II

Here are the facts in support of Irish credit ratings downgrade (for those impatient to get the actual downgrade forecast, see Table 2 at the bottom of this post) taken directly from the IMF’s latest Global Financial Stability Report published in October 2008.

These facts suggest that:
(a) the problem of Ireland’s high risk of sovereign and economic insolvency is not new –by the end of 2007 Ireland has emerged as the most financially exposed country in the developed world, to the total silence of Irish Government, Regulators and other domestic financial services authorities; and
(b) our sovereign ratings have are failing to reflect this risk, despite the fact that the data was available to all rating agencies for some time.

Our financial health ca January 2008...
Ireland ranks last out of the entire group of countries/ regions covered in the report in terms of its overall capital markets/financial stability (see table below). The countries/regions reported by the IMF include: the EU, Euro area, Canada, US, Japan, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, the UK, a general set of all emerging economies. Report parameters are given in IMF’s Table 3 in absolute terms.

Table 1 below ranks Ireland, and its two European competitors for the title of the worst-off (in terms of financial stability) Italy and Greece, across these same IMF-selected parameters.

Table 1: Ranking for Selected Indicators on the Size of the Capital Markets, 2007, expressed as % of country GDP/GNP
Sources: IMF GFS Report October 2008, and author own calculations.

Figures below plot the data that led to the above table results.

Figure 1: Total Reserves, % of GDP/GNPSources for Figures 1-7: IMF GFS Report October 2008, and author own calculations.

Figure 1 above shows total economies’ reserves (net of gold) as a percentage of GDP (and GNP for Ireland). Technically, ceteris paribus, higher levels of reserves relative to the economy size imply higher levels of solvency. Notice that this data is for 2007 – the year when Ireland was still in a relatively benign economic environment. In 2007 Ireland’s total reserves stood at a level almost 6 times below the EU27 average. Out of all main global financial centers selected by the IMF only Greece and Luxembourg showed weaker reserves base than Ireland.

Of course, we knew this already, as most of our wealth was trapped in the deteriorating housing markets. But the rating agencies failed to see this as a serious threat, preferring to focus disproportionately on the deceptively low public debt levels in this country. The irony that the state has managed to drive down its debt at the expense of economic stability (by taxing businesses and consumers to produce a ‘savings’ piggy bank for the public sector) and by imperiling our financial stability (by re-directing private financial flows and diverting investment into property and other state-incentivised schemes), was totally missed by the likes of S&P and Fitch.

Figure 2: Stock Market Capitalization, % of GDP/GNP
As the above figure shows, our stock market capitalization as the percentage of GDP/GNP ranked the second lowest in the world in 2007. Italy was the only country with a relative weight of the stock markets capitalization in its economy falling below that of Ireland. This parameter reflects, indirectly, the overall mammoth share of debt (as opposed to equity) on our corporate balance sheets and the effects of Irish economy’s dependence on leveraging and housing markets.

Figure 3: Debt securities as % of GDP
Figure 3 above shows how extreme were the levels of Irish debt liabilities in 2007, with the country leading the world in terms of private debt share of GDP. In the figure 4 below, the two sources of debt are combined to show that Ireland (as a share of GNP) has achieved a dubious distinction of becoming world’s most debt-ridden country by the end of 2007 – a point also missed by the rating agencies.

Figure 4: Total Debt Securities Outstanding, as % of GDP/GNP
Figure 5: Bank Assets as % of GDP/GNPWhen it comes to the financial system assets side of the balance sheet, Irish banking assets appeared to be relatively healthy in 2007 (Figure 5), although this does not include any correction for these assets quality. However two factors must be kept in mind:
(1) to date, Ireland has been leading the EU in terms of commercial bankruptcies (up 250% on 2007) and in terms of housing and commercial real estate crises, implying mid-term impairment charges for Irish banking system well in excess of those in other European countries;
(2) as the following two figures show, our assets cushion (non-bank assets as % of the total debt) and reserves cushion (total reserves as % of the total debt) were both thin, despite the fact that we are faced with an unprecedented (by global comparisons) total debt mountain.

Poor protection buffers: still the ‘old’ news

Figure 6: Assets CushionFigure 7: Reserves Cushion
It is worth mentioning that our Assets cushion (Figure 6) is artificially inflated by the still high property valuations of 2007. Correcting for 2008 commercial and residential property contractions, Ireland's non-bank assets to GDP or GNP stand at the lowest level in the entire developed countries sub-sample. Of course, as far as our reserves to GDP ratio goes - the fact is that our banking sector reserves stood at a critically low levels even in 2007 invites two observations:
(1) reserve requirement ratios are the prerogative of Irish Central Bank and Financial Regulator - with domestic regulators having full access to the powerful policy lever of raising these requirements. Both did absolutely nothing;
(2) the IMF figure for reserves includes state own reserves (NPRF), implying that the real problem of the banking sector reserves crisis we are currently experiencing is even worse than the official figures suggest.

Given a precipitous fall in Irish shares, property and economic growth – all registering declines well in excess of other European countries – we are now facing the assets and reserves cushions that are critically low, warranting a significant downgrade on our credit ratings.

Ireland’s comparatives (2008-2009) and ratings forecast
Comparing our financial position to that of the peer countries, Table 2 below shows that our current credit fundamentals are woefully out of line with other AAA rated countries in Europe. In fact, even disregarding the realities of our economic slowdown and fiscal challenges facing the country in 2009, comparative analysis of financial stability fundamentals for Ireland suggest that our true ratings should be below those of Greece or Italy.

Table 2: Assets, Reserves and Ratings
Sources: Fitch, S&P and IMF data, author own forecasts

The above results show that Ireland is well over-due a downgrade on its sovereign debt to bring us in line with our relative peers – Italy, Greece and (correcting for Eurzone membership) Iceland. But Table 2 above (see forecasts for financial stability parameters marked in blue) also shows that taking into account our economic and fiscal prospects for 2009, the downgrade currently overdue can actually be much deeper than the one forecasted herein.

Current environment: even more room for downgrades
One cannot ignore the extent of the economic and fiscal deterioration in Ireland to-date. We are facing an officially projected deficit that is unprecedented in the entire EU27. And the official forecast, as I argued before (here) is by all means an underestimate of the fiscal black hole we are heading for.

Even with An Bord Snip delivering significant – ca 10% - cuts in pubic spending (at least half of which is already factored into the Department of Finance forecasts), and even assuming the Government has the guts to implement such changes, Ireland is likely to find itself in ca 10% deficit in 2009.

This alone should trigger our ratings to be downgraded below AA- and our bonds yields to head closer to 6-6.5% for a 10-year paper. Of course, Ireland cannot at this time issue 10-year paper, implying that our borrowings for the foreseeable future will be short-term. Should the downturn extend through 2013, or alternatively, should the post-downturn growth fail to reach above 3%, Ireland will be in a serious trouble when redemptions on 2008-2009 debt issues come knocking on the door.

But the fiscal challenge is not the only one. Ireland’s economic contraction is likely to reach 4.5-5% (GDP terms) in 2009, implying that we will continue to lead the EU in terms of recessionary pressures. Such a scenario also warrants a downgrade of our ratings to AA-/BBB+.

Last, but not least, the Irish Government has underwritten some €450bn worth of debts and obligations on the domestic banks’ books, plus an open-ended commitment to supply capital to the banks. The nationalization of Anglo alone is likely to add something to the tune of €7-10bn to 2009 liabilities of the Exchequer and some economists estimated last week that this liability can easily reach €15-30bn.

Now, do the math. The Government boasts of holding some €20bn in liquid reserves, including surplus 2008 borrowings. Of these, Anglo commitment will eat through, say €7bn, previous capital commitments alongside the underwriting of the equity placements for AIB and BofI – another €5bn, the Exchequer deficit, assuming An Board Snip delivers real savings, will take up the rest. This leaves Ireland Inc naked for 2009 – no stimulus, no cushion for error, no buffers for any bank or building society default and, even more crucially, no deficit financing for 2010 should the sovereign debt markets get tougher throughout the year.

In these conditions, it is highly likely Ireland will push 10-year yields well beyond 350-400bps spread on German bonds and despite Mr Cowen's protestations to the contrary, find itself begging for funds from external donors. IMF or ECB or both - the acronyms are semantic: either one will part with its money only on extremely strict conditions...