Thursday, June 24, 2010

Economics 24/06/2010: IMF statement on Irish fiscal policies

IMF released today its Concluding Statement for the 2010 Article IV Consultation from May 31, 2010.

1. Through assertive steps to deal with the most potent sources of vulnerability,

Irish policymakers have gained significant credibility.

2. Along the complex and long-haul path to normalcy, retaining policy credibility will require active risk management. The appropriately ambitious fiscal consolidation plan demands years of tight budgetary control. Likewise, the weaning of the banking sector from public support and its eventual return to good health will proceed at only a measured pace. In the interim, unforeseen fiscal demands may occur. …With limited fiscal resources for dealing with contingencies, maintaining a steady policy course will require mechanisms for oversight and transparency, and high quality communication to minimize risks and sustain the political consensus and market confidence.

[The really significant bit here is the IMF voicing their position that “maintaining a steady policy course will require mechanisms for oversight and transparency, and high quality communication”. In a diplomatic world of IMF’s statements, neutered by the ‘consultative’ bargaining with the Government, this is likely to mean the following: “Ireland has no mechanism for transparency and oversight (enter Nama). Ireland has no quality communications mechanism, with the preference given to ‘hit-and-run’ announcements of successive cash injections into the banks preceded by no policy debates, and followed by meek Dail talking shops in which discordant voices of fiscally and financially unqualified opposition and backbenchers bicker over minutiae, missing the big picture.”]

3. Ireland is likely to emerge from its output contraction into a period of relatively modest growth potential and high unemployment. Current Irish and global conditions make forecasts subject to much uncertainty. Various indicators point to a return to economic growth during this year, but following its earlier steep fall, GDP in 2010 is projected to be about 1/2 percent lower than in 2009. As the post-crisis dislocations are undone, annual growth rates should rise gradually to about 3.5 percent by 2015. After peaking around 13.5 percent this year and, absent additional policy measures, a sizeable structural component will likely keep unemployment at around 9 percent in 2015.

[Now, these numbers fly in the face of our budgetary projections – see table from the Budget 2010 estimates submitted to the EU Commission. And they imply much more significant challenge on fiscal consolidation side than what the Government has been aiming for.]

4. The improved global outlook will help, but to a limited extent. With some reversal in the earlier loss of competitiveness and improvements in the global economy, exports will lead the recovery. But spillovers to the domestic economy will be limited because of exports’ heavy reliance on imports, their tendency to employ capital-intensive processes, and the sizeable repatriation of profits generated by multinational exporters.

[I’ve been saying this for some time now. Exports will not get us out of this corner. More importantly, since our exports rely on inputs imports so heavily, we are staring at the situation where positive effects from the weaker euro on exports will be offset by the negative effects of rising cost of imported inputs. Also notice – this statement clearly puts IMF at odds with the Government, in so far as the IMF is explicitly stating here that for fiscal balance, it is Irish GNP, not GDP that matters most. Again, good to see another one of my long term concerns validated.]

5. Moreover, home-grown imbalances from the boom years will act as a drag on growth. The unwinding of these imbalances—arising from rapid credit growth, inflated property prices, and high wage and price levels—will limit the upside potential.

Financial sector weakness, fall in real estate prices, and high unemployment could continue to reinforce each other.

[In other words, as I have recently pointed out in the press and on the blog – the twin credit and asset markets crisis is likely to last long time. Years in fact. And this really blows apart the entire Nama strategy of getting the transferred loans back to the par with 10% (or was it not 5% before that?) appreciation in property values.]

But deleveraging to reduce the loan-to-deposit ratio and banks’ risk aversion will constrain lending and the pace of economic recovery, at least in 2010–11. Higher than expected losses, uncertainties in global regulatory trends, and renewed financial market tensions—that may restrict access to funding—create downside risks. In this environment, the targets for SME lending need to be combined with strong prudential safeguards as the non-performing loans of this sector have grown rapidly.

[So unlike the Irish Government, IMF sees banks deleveraging impacting adversely the real economy, higher margins pushing homeowners deeper into insolvency, higher banks charges and banking costs destroying operating capital capacity in the economy, etc. All the things we’ve been warning the Government about – Karl Whelan, Peter Mathews, Brian Lucey, myself – but to which our policymakers paid no attention whatsoever.]

7. Three restructuring priorities deserve attention:

NAMA should schedule an orderly disposal of the property assets acquired aimed to reduce the large overhang of property in state hands, restart market transactions and, thus, help normalize the property market. Oversight of NAMA operations, which is provided for in the legislation, is desirable.

[Thank you, IMF, for supporting exactly the criticism that myself and others have been levying against Nama. Nama needs transparency, oversight, clear business plan. Unfortunately, the legislation does not provide for proper oversight. Nama is an insider-run institution with no meaningful oversight capacity given to anyone, save for the Minister for Finance. Of course, the IMF is saying this indirectly. If the legislation did provide oversight systems sufficient enough, why is the IMF concerned about the need for oversight of Nama operations?]

Mindful of the moral hazard risks, narrowly-targeted support measures for vulnerable homeowners would limit the economic and social fallout of the crisis. …This process will be aided by an overdue shift to a more efficient and balanced personal insolvency regime.

[Again, everything here is a repeat of what we, the critics of the Government approach to the crisis, have been saying for months now. Including the need for reforming our atavistic bankruptcy laws (the calls that have been falling on Government’s deaf ears for some months now) and the need for a support package for homeowners in negative equity and distress (the calls that the Government is responding to by preparing to introduce new taxes on the same homeowners already stretched financially).]

10. Looking ahead, substantial challenges remain. Following the already sizeable consolidation in 2009 and 2010, further consolidation measures, although not as large as that already achieved, of at least 4.5 percent of GDP are required to reach the 2014 target. If GDP growth outcomes are weaker than those currently foreseen by the authorities—a clear possibility within the current range of scenarios—the additional effort needed may even be greater. Staying on target is critical to retain the hard-earned credibility. But the risk of “consolidation fatigue” and, hence, a fraying of the necessary social cohesion cannot be ruled out. For this reason, greater specificity on further proposed measures is necessary. Sustainable expenditure savings will be central, including through efficiencies in public services. Broadening the tax base for revenue enhancement will also be necessary.

[This is clearly the heaviest-edited section of the statement from the point of view of ‘consultative’ additions added by the Government. The language clearly states that the IMF does not believe Government current plans for reducing the deficit to 3% target by 2014. Just month and a half ago, IMF showed its estimates of Government deficit and they are clearly above 5% mark in 2015. Yet, a month ago the Government already had in place plans to further reduce the deficit by 4.5% before 2014. So either the IMF is saying that the Government will require a fiscal adjustment of 4.5% on top of previously announced 4.5% - to the total of 8.8% of GDP or roughly speaking €14.5 billion in total between now and 2014, or their numbers do not add up – per link above.

The really important stuff in this statement is just what risks concern the IMF. The risk of ‘consolidation fatigue’ – referring most likely to the Croke Park deal that effectively shut down any new savings in the public sector wage bill through 2014 would be one. The risk of the Government falling off the target – the risk reinforced by the continued delusionary rhetoric emanating from the ‘turnaround is upon us’ crowd. The risk of weaker growth than forecasted in the Budgetary estimates (table above).

Note that the IMF insists on central role in the adjustment to be played by ‘sustainable expenditure savings’. This is certainly divergent from the approach adopted so far, with tax measures and capital spending cuts (one-offs) being responsible for the lion’s share of fiscal adjustments.]

[On the net, the IMF is clearly seriously concerned about the ability of the Government to achieve meaningful consolidation of the budgets. On the day when Irish Government 10-year bond yields hit 5.38%, this concern means that means that IMF polite wording is just catching up with the bond markets’ clear and loud vote of low confidence in Ireland’s ability to match its tough rhetoric with equally resolute actions.]

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