Sunday, June 16, 2013

16/6/2013: NPRF, Stimulus & Futility of Policy: Sunday Times June 9, 2013

This is an unedited version of my Sunday Times article from June 9, 2013.

With the coalition mulling over the idea of investment 'stimulus', there are only two questions everyone in the Leinster House should be asking: Where is the money coming from? and Is there value for money in these investments?

Since the beginning of this crisis, the State piggy bank, aka the National Pensions Reserve Fund (NPRF) has been as rich of a target for Government raids as the taxpayers pockets. Back in 2007, NPRF assets were valued at EUR21,153 million with almost 94% of these, or EUR19,817 million, held in liquid financial instruments, such as cash, listed equities and bonds. Q1 2013 data shows that the fund discretionary portfolio (portfolio of assets excluding government-mandated 'investments' in AIB and Bank of Ireland) has declined to EUR6,449 million with only EUR4,243 million of this held in relatively liquid assets that can be meaningfully used to fund any stimulus.

The reason for the NPRF’s disastrous demise has nothing to do with the fund management or strategy - both of which were relatively good, compared to some of Ireland's 'leading' private sector asset managers. The cause of the precipitous 79% drop in liquid assets held by the NPRF was the banking sector collapse and the Government decision alongside the Troika to waste some EUR20,700 million of NPRF funds to 'invest' in two pillar banks equity stakes, with EUR16,000 million of this sunk into the black hole of AIB. As of Q1 2013, the NPRF 'investments' in the banks were valued at EUR8,800 million. This, accounting for dividends paid and disposals made to-date, implies a loss of some 47% of the original investment outlay.

The sheer absurdity of the use of the NPRF to fund every possible twist and turn of the State financial crisis is magnified by the latest Government plans. The exchequer returns through May 2013 released this week show clearly that as in previous years, the heaviest burden of spending cuts by the public sector is once again falling onto the capital expenditure side. January-May current voted spending is running 1.6% ahead of the target, with capital spending outstripping targeted cuts by 12.6%. Now, the same state that has been for years slashing voted capital expenditures is angling to raise a capital investment stimulus by raiding the remaining liquid NPRF funds.

The key issue with NPRF asset holdings is that even theoretically liquid funds will have to be leveraged in order to raise cash for any meaningfully sizeable Government investment. Leveraging NPRF funds via Public-Private partnership-type schemes can yield, realistically speaking, around EUR8-10 billion of total funding for the proposed seven years-long investment envelope, or just about 8% of the cumulated gross domestic capital formation taken at the 2011-2012 running levels.

Use of NPRF funds to finance economic stimulus while the state continues to borrow cash for day-to-day management of unsustainable deficits is of a dubious virtue to begin with. The costs of leveraging the NPRF funds will add further pain to the economics of stimulating investment in the environment of already high levels of government and private sector indebtedness. Worse than that, leveraging NPRF will either increase the Government debt and deficits or put a hefty new cost onto the taxpayers and users of services funded via the stimulus. In effect, the very attractiveness to the Government of the leveraged finance via NPRF is that such funding for capital programmes will most likely be off the official balancesheet of the State. This, however, means that it will also become a direct cost to consumers and, possibly, also to the taxpayers.

Let me explain the last point in greater detail. In 2012, Irish Government spent 3.7% of the country GDP or EUR6,133 million on paying interest on its debts implying an average effective interest rate of 3.19%. With the markets in a relative calm, our latest issue of Government bonds on March 20 this year saw NTMA raising EUR5 billion in 10-year debt at 3.9% annual coupon. This is the benchmark rate for any long-term lending in the country.

Even assuming the markets conditions will not change in the wake of a significant leveraging of funds from the NPRF, current cost of funds to the State is well in excess of recent returns earned by the NPRF on its liquid assets portfolio. In Q1 2013, NPRF delivered annualised rate for return of 2.8% on its discretionary portfolio and over 2000-2011 period, compounded returns earned by the NPRF run at 3.23% per annum.

Now, consider the second question posited above. Much of the public investment in infrastructure and general economic activities, as detailed in September 2011 Strategic Investment Fund (SIF) initiative issued by the current Government requires heavy involvement of the Private Sector co-funding. Quoting NPRF annual report for 2011, under  the SIF, "investment on a commercial basis from the NPRF will be channeled towards productive investment into sectors of strategic importance to the Irish economy (including infrastructure, water, venture capital and provision of long-term capital to the SME sector) and matching commercial investment from private investors would be sought." In other words, we are already leveraging the state finances for previous rounds of stimuli.

Private co-investment requires two things to succeed: sovereign assurances and preferential treatment to reduce overall levels of risk, plus annual return well in excess of sovereign debt returns. In other words, in any PPP and joint co-investment scheme, the State must assure premium return to the co-investing private sector agents.

If the State investments were to be financed at a sovereign cost of funding absent any negative effects on Government bond yields from increased borrowings, the underlying returns on public investments through the 'stimulus' scheme, based on a 50:50 split with private funding, would have to be yielding well in excess of 7-8% per annum. These returns will have to come either from the users of services backed by the PPP investments or from the taxpayers via minimum return guarantees.

Do the math: we can borrow at 3.9% in the markets or we can borrow at 7-8% via PPPs. The only difference is that under the latter arrangement, Minister Noonan can pretend that we didn’t borrow at all, as most of the money to repay the PPP investments will simply come out of the economy directly, instead of via the Exchequer.

That is the hope that is driving the Government to use NPRF instead of its own funds to fund capital spending. This hope, however, is based on rather thin analysis of the economic realities of the PPPs.

It is worth noting that between 1999 and the end of 2011, the total volume of PPP-based investments in Ireland, both committed and allocated, was just over EUR6.4 billion - or a fraction of the hoped-for amount of funds currently under the discussion for the next stage stimulus on foot of NPRF assets. This excludes EUR2.25 billion stimulus announced in July 2012 by the Government, which is not producing much of a desired effect of a stimulus on the economy so far.

Setting aside the issues of financial returns feasibility, it is highly doubtful that this level of investment can be economically efficiently deployed in the economy. And this is on foot of rather poor PPPs performance documented for pre-crisis period, as was highlighted in a number of studies on the subject. Several reports found that the final PPP deals involving capital funding for schools, water infrastrcture and transport programmes returned final costs well above the costs of direct procurement. Severe cost transfers to the state from the PPP projects have been found in the cases of major roads contracts in Ireland, including Clonee-Kells project and Limerick Tunnel project.

An in-depth research note on the problems inherent in PPP funded capital investments in Ireland published by the NERI Institute in January 2013 concluded that "it is striking that after thirteen years of procurement under PPP, there has been no official in-depth analysis of the experience to date. Yet PPP is now a major part of the current governments plan to stimulate the economy. The absence of any publicly available body of evidence in support of this plan represents a major shortcoming in terms of the formation of economic policy."

In contrast to the pre-crisis periods, current business, investment and economic environment in Ireland is characterised by high levels of debt overhang in the private sector, involuntary entrepreneurship, falling rates of growth in global demand for indigenous exports out of Ireland, stagnant or declining real assets valuations and a number of other factors significantly increasing the risk of any new investment. In other words, any new stimulus will have to come at the time when investment opportunities are thinner on the ground and risks associated with such investments are higher.

All of the risks associated with PPP-funded projects, thus, are only exacerbated in the current economic environment.

Instead of first attempting to fix the problems with the core financing schemes, the Government is setting out to drive more forcefully into the troubled waters of privately co-funded schemes. Previously announced stimuli, ranging from capital investment supports to stamp duty and R&D tax incentives, to the 2011-2012 announcements of similar PPP-based leveraged capital investment programmes have been insufficient to stimulate the domestic economy out of its structural collapse. This time around, the Government is attempting to up the ante by increasing the amounts of funds it aims to pump into the economy. The hope, obviously, is that doing more of the same on an increasing scale will yield a different outcome.

More likely, the outcome will be a further debasing of the consumers’ disposable incomes via higher taxation and higher cost of services, in exchange for wiping out completely the NPRF – our only remaining cushion against any potential future risks. Doubling-up when losing repeatedly in the economic policy roulette is not a good idea.  Doubling-up using granny’s pension cheques might be outright reckless.


Back in April this year, the IMF stole the headlines in Ireland after pointing that combined unemployment and underemployment rate in Ireland stood at a staggering 23%. However, the only really surprising thing about the IMF statement was that this data was already reported by the CSO before. In fact, CSO reports quarterly broader unemployment statistics since Q1 1998. Last week, CSO database showed that in Q1 2013, the broadest measure of unemployment – the measure that includes unemployed, discouraged workers and underemployed workers – has hit 25%, rising from 23.7% in Q1 2011 when the current Government took office. However, the above measure is still incomplete, as it excludes those workers who are drawing unemployment supports but are classified as participants in state training programmes, e.g. JobBridge. Adding these workers to the broader measure referenced by the IMF, Irish broad unemployment rate in Q1 2013 stood at a massive 29% - a historical high for the metric and up 2.7 percentage points on Q1 2011.

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