Friday, July 16, 2010

Economics 16/7/10: IMF Article IV CP on Ireland: part 3

This is the third post on the IMF's Article IV consultation paper for Ireland. (The first two posts is available here and here).

V. THE FISCAL OUTLOOK AND CONSOLIDATION AGENDA

35. To counter the deteriorating fiscal position, the authorities moved early to make substantial, balanced, and lasting consolidation efforts. As the fiscal situation deteriorated and a large structural deficit emerged, the authorities acted repeatedly to take additional measures and raise the ambition of their fiscal consolidation goals. This was achieved in a remarkably socially-cohesive manner and represented a balance of economic and social considerations. The strong upfront measures are expected to yield a net adjustment of 5½ percent of GDP over 2009–10.

[The Fund is generally positive on the measures taken so far. However, in the chart at the bottom of page 22, the report shows the overall contribution to fiscal imbalances across various categories of spending and receipts. Picture 1 reproduces, with added details, the IMF analysis. Several things that are not covered by the Fund analysis stand out as significant omissions, most likely politically motivated. First, there is a very substantial role played by the continued deterioration in transfers (social welfare, health etc) which the Fund glances over. Second, public sector wages bill continues to represent further downward pressures on fiscal deficit despite the measures taken in 2009.
Third, noted (to the IMF credit) in the footnote on the following page, banks supports are likely to exert additional pressures in years to come. Per IMF: “A re-classification of a capital injection (2½ percent of GDP) as a capital transfer raised the 2009 deficit to 14¼ percent of GDP. In the first half of 2010, the government issued promissory notes worth 8½ percent of GDP to increase capital in one bank and two building societies. If these injections are considered capital transfers, the 2010 deficit would increase by this amount. As it would represent a once-off adjustment, it would not impact on the trajectory of the deficit for 2011. The further possible capital injection of 5 percent of GDP would add correspondingly to the 2010 deficit.”

Clearly, the Fund is not interested in making any predictions about the markets reaction to such an one-off adjustment. But one must wonder, if the Irish deficit shoots past 20% of GDP mark, even on one-off measures – what will our bond yields be at? And if 2011 brings about more capital injections into the banks, how long can these ‘one-off’ measures continue to hammer our deficits before someone, somewhere screams ‘The Irish Exchequer has no clothes!”]

[In the box-out on page 23, the IMF states:]

When adjusting for the impact of asset prices, the Irish structural deficit reached 8 percent in 2007, spiking to 12 percent of GDP in 2008. Spain and the U.K. also experienced sharp but smaller increases in structural deficits. However, after fiscal adjustment of 5½ percent of GDP, the Irish structural deficit is expected to decline to 8½ percent of GDP in 2010, while discretionary fiscal stimulus has raised the structural deficits in Spain and the U.K.

[Two things worth mentioning here. One: if the Bearded Ones of the Siptu/Ictu alphabet soup economics have their way, what would our structural deficit look like today? 8.5% is a hefty number. Recall that structural deficits won’t go away once economy is back on long term growth path. Second: at 8.5%, structural (long-term) sustainability of our Exchequer finances would require a combined reduction in expenditure, plus increases of taxation (assuming 50:50 split between the two) of roughly speaking a further €6.5 billion cut in spending and €6.5 increase in tax revenues. Given that roughly 700,000 households pay income, stamps & CGT taxes in this country, that would mean an annual tax bill increase of a whooping €9,300 per household. Does the Fund or the Government, or even the Bearded Ones think this is feasible?]

36. The 2010 budget adheres to the consolidation track, but risks remain. The authorities project the 2010 deficit to be 11½ percent of GDP. Because of lower nominal 2009 GDP than assumed in the 2010 budget and a weaker growth projection, staff projects lower revenues, leading to a deficit of 11.9 percent of GDP in 2010. The accounting treatment of the government’s equity injections into the troubled banks is still being determined but could raise the 2010 headline deficit substantially. The authorities noted that the associated fiscal outlays have already been incorporated into the official debt figures.

[Here is an interesting one. So banks-related outlays are in the debt figures already, but they are not in the deficit figures yet. How can Brian Cowen sit with a straight face in front of CNN cameras and tell the world that fiscal consolidation is working if Ireland Inc is heading for a deficit in 2010 that is vastly in excess of the deficit in 2009? And if he can, then why is DofF already factoring in the banks numbers into official debt? Gosh, it does begin to appear that we can’t even do a banana republic thing right.]


37. The remaining sovereign financing need in 2010 is limited. The average maturity of Irish treasury bonds is high—at 7½ years—and the rollover need is therefore limited. [That’s the good news…] For 2010, about three quarters of the planned government bond issuance (€20 billion) had been obtained as of June. The annual financing needs in 2011–12 are projected at about the 2010 level. The authorities maintain sizeable cash balances, financed by short-term debt, which could act as a buffer against any temporary difficulties in issuing long-term debt.

[Two things jump out: one the annual financing requirements for 2011 and 2012 are around €20 billion each. Which really means that the Government is not planning any substantial reductions in overall size of its expenditure. The con game of taking spending out of one pocket and shifting it into another pocket, while calling its transition from hand to hand a ‘saving’ will keep going on through the next elections… This explains why, for all our talk of ‘taking the pain’ the Government expenditure stubbornly keeps climbing up. Second, there is a quick sighting of the substantial additional costs of our overspending habits here. Short-term buffers kept by the DofF in order to insure ourselves against the possible tightness of the normal borrowing channels are ‘substantial’ per IMF. These buffers are subject to the higher risk of rising interest rates and also have no productive role in financing public spending. The costs of funding these buffers is a pure insurance premium we have to pay on top of standard borrowing costs in order to keep on rolling the vast social welfare/public spending machine we have created.]


38. Staff supports the appropriately ambitious fiscal consolidation plan through 2014 but cautioned that the required adjustment may be larger than projected by the authorities. The consolidation plan, outlined in the December 2009 Stability Programme Update, aims to reduce the deficit to below 3 percent of GDP by 2014. The plan envisages fiscal adjustment of 4½ percent of GDP over 2011–14, of which about 1 percent of GDP represents reductions in capital expenditures. The staff’s macroeconomic projections imply that the required medium-term adjustment could be larger than projected by the authorities. Starting from a higher projected deficit in 2010 and based on less optimistic macroeconomic projections, staff estimates that the adjustment need over 2011–14 would be 6½ percent of GDP, 2 percentage points of GDP higher than the authorities do.

[Quite a nasty turn for the ‘authorities’ here. The Fund clearly has little faith that the Irish Government can reach the set target of 3% by 2014. In fact, the IMF now projects that Irish Government deficits will be 5.9% of GDP in 2014 (driven by macroeconomic and target differences between DofF projections and IMF forecasts), with our debt to GDP ratio reaching 97.7% ex-banks supports in 2010 (5% of GDP additional to 8.5% announced in March) and 2011 (by my estimates around 5% of GDP). Worse than that – 5.2% of GDP will be our structural deficit in 2014 – a massive 88% of the total deficit.

A little footnote to the table on page 24 gives explanation: “The difference between the fiscal projections of the Department of Finance and the IMF staff is due in part to assumptions of lower growth on the part of the IMF staff. The IMF staff’s baseline fiscal projections for 2011–12 incorporate the adjustment efforts announced by the authorities in their December 2009 Stability Programme Update, although 2/3 of these measures remain to be specified. For the remainder of the period, the IMF staff’s projections do not incorporate the further adjustments efforts outlined in the Stability Programme Update.”

In other words, folks, in IMF terms, these projections include what has been promised but is not specified. And furthermore, the IMF doesn’t really believe anything this Government has set out to do beyond 2012 elections. They rightly suspect that any commitment of FF/Greens made before 2012 will face a serious uphill battle in implementation should the coalition fall apart.]
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