Wednesday, October 10, 2012

10/10/2012: Irish Real Economic Debt - Busting Records

Last night I came across the latest data from the IMF on the overall levels of indebtedness and leverage across a number of countries. Here's the original data:

Much can be taken out of the above. For the purpose of discussion below, I define real economic debt as a sum of household, non-financial corporate and government debts, excluding financial firms' debts. This real economic debt is liability of the Irish economy: households, private enterprises and public sector providers of goods and services.

First up, total debt levels:

Ireland's total real economic debt runs at a staggering 524% of our GDP and 650% of our GNP. In fact, I use 24% GDP/GNP gap as a basis for adjustment which is significantly less than the current gap, but is consistent with 2011-2012 (to-date) average. Put into perspective:

  • Our economy's overall indebtedness is 1.73 time higher than the euro area levels in GDP terms and if GNP is used as a basis it is 2.14 times higher
  • Our real economic debt is 14.4% ahead of that of Japan (second most indebted country on the list) if GDP is used and is 41.9% ahead of Japanese debt if GNP is used.

Our real economic debt can be decomposed into the following three components contributions:

In other words, the above chart clearly shows that Ireland's core debt overhang arises not from the Government finances, but from accumulation of liabilities on the side of the companies. More than that:

  • Ireland's Government debt levels are 25.5% ahead of the euro area
  • Ireland's Household debt levels are 64.8% above the euro area
  • Ireland's corporate debt levels are at 209% of the euro area levels.
Thus, with the Government policy firmly focused on taxing households to save own balancesheet, we have a perverse situation that the economy is dealing with debt overhang in Government debt that is more benign than the debt overhangs in the sectors the Government is obliterating. Households faced with increased taxation to pay for Government debts and deficits implies lower spending on goods and services and lower ability to repay household debt. Thus higher taxes on households (direct and indirect, including aggressive extraction of income via semi-states' charges) imply growing burden of the debt overhang in the private sectors (firms and households).

Adding financial debts to the overall real economic debt in the economy forces Ireland into a truly unprecedented position vis-a-vis other countries in the sample. (Note - adjustment for IFSC is mine).

Using the bounds for debt of 90% (consistent with upper range for Checchetti, Mohanty and Zampolli (2011) and Reinhart, Reinhart & Rogoff (2012)), the levels of cumulated real economy debts that are consistent with reducing future long-term potential growth in the economy are taken to be 270% of GDP. Hence:


In the above, the larger the size of the bubble, the greater is the drag on future economic growth from debt. The further to the right on the chart the bubble is located, the greater is the problem associated with Government debt (as opposed to other forms of debt). What the above shows is that Ireland's debt crisis is truly unique in size, but it also shows that the most acute crisis is not in the Government debt, but in private sectors debt.

Now, at 4.5% per annum cost of funding overall debt, irish economy interest rate bill on the above levels of real economic indebtedness runs at ca 29.2% of our GNP. Do the comparative here - interest rate bill equivalent to the total annual output of the Irish Industry (that's right - all of our Industrial output in 2011 amounted to less than 29.3% of our GNP. This is deemed to be 'long-term sustainable'... right...

Note: In my presentation at a private dinner event yesterday I referenced by earlier estimate of the total economic debt in Ireland at 420% of GDP. My 2011 estimate was ca 400% GDP. These figures have been published by me in the Sunday Times and also correspond closely to the 2010 figures cited by Minister Noonan in the Dail and made public here on this blog. They also were confirmed by Peter Mathews TD. My estimates were based on publicly available data which is less complete than data available to the IMF.
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