Tuesday, September 30, 2014

30/9/2014: Have Irish Retail Sales 'regained growth momentum' in August?

Yesterday, CSO released latest data on Retail Sales in Ireland for August 2014, prompting some media reports that the data is showing the "retail recovery gaining momentum".

Here is the actual data for core retail sales (ex-motors):

  • Value of retail sales rose 0.1% m/m in August, down from 0.2% growth in July. This implies loss of the momentum in value of sales, not a gain.
  • Volume of retail sales rose 0.29% m/m in August, up on -0.1 loss in July, implying regaining of the momentum m/m in volume of sales.
  • Value of retail sales rose 2.22% y/y in August after posting 1.22% gain in July, implying some improved momentum y/y.
  • Volume of retail sales rose 3.64% y/y in August after posting a rise of 3.21% in July, again implying some improved momentum y/y.
  • 3mo average through August 2014 rose 1.9% for value of sales compared to the same period a year ago and 3.6% for volume of sales. Both rates of growth were lower than those recorded for the 3mo period through May 2014, representing a slowdown in the momentum, not a gain.
All of the above evidence suggests that retail sales are bouncing along the established trend and are not consistent with a claim that there has been sustained gains in retail recovery in August. Charts below illustrate this conclusion:

Chart above shows that Volume of retail sales index is trending along with established long-term trend. A gain in momentum would imply the index pushing steeper up relative to trend. Value of sales index is now running at a flatter upward momentum than long term trend implies. This supports the view that retail sales recovery has lost recovery momentum (but did not lose recovery overall) in Value terms and is running at zero change to the momentum (which is still positive) in Volume terms.

The conclusion above is confirmed by looking at /y/y growth rates in both series: since April 2014 jump in retail sales, both Volume and Value growth rates have fallen. Value growth has continued to trend down after May and Volume growth trended down from June.

Once again, we have positive growth in the series, but the momentum in this growth is either zero or negative, certainly not positive.

Monday, September 29, 2014

29/9/2014: Russian Economy Briefing for IRBA

Earlier today I gave a brief presentation on the topic of the Recent Developments in Russian Economy. Here are my speaking notes:

Economic growth in Russia was running at +0.8% y/y in Q2 2014 versus 0.9% y/y in Q1 2014.

At the same time, GDP shrank 0.2% y/y in July 2014 and 0% y/y in August 2014.

Taken against the consensus forecast for growth at 0.5% for the full year 2014, this suggests geo-political risks-induced slowdown in the economy of some 0.3-0.4% to-date.

Russia's economic outlook for 2014 and 2015-2015 continues to trend down, driven by two core factors:
  1. Geopolitical risks of the Ukrainian conflict, and
  2. Structural weaknesses in the economy.

The first factor is responsible for the expected actual output growth falling below down-trending potential output growth in 2014 and 2015.

The second factor is driving down potential output growth in 2015-2016 and beyond.

How dramatic were the growth forecasts revisions so far?

Take IMF: IMF is about to publish its October World Economic Outlook forecasts revisions.

In October 2013, IMF forecast real GDP growth in Russia to run at 3.0% in 2014, 3.5% in 2015 and 3.5% in 2016. So 3.5% average over 2015-2016.

In April 2014, IMF forecasts were running at 1.33% in 2014, 2.3% in 2015 and 2.5% in 2016, respectively. 2015-2016 average of 2.4% down 1.1 ppt on previous.

We have no forecasts for October, yet, but consider IMF's 'twin' organisation, the World Bank. The WB expect growth of around 0.5% pa on average over 2014-2016, broken down into 0.5% in 2014, 0.3% in 2015 and 0.4% in 2016. Average growth of just 0.35% in 2015-2016 down massive 3.15 ppt on a year ago!

Russian Government official forecasts are for growth of 0.5% in 2014, 1.2% in 2015 and 2% in 2016, so average 2015-2016 growth of 1.6% or 1.25 ppt above World Bank forecasts.

Taken against CIS growth rates, the official sector revisions suggest that about 1/2 of the total downside in growth expectations is down to Ukrainian crisis and the rest are structural.

Based on World Bank forecasts, slowdown in domestic investment and consumption will be the main drag on the structural side of growth.

Private sector analysts forecasts are even worse than those from the IMF and the World Bank. For example, Danske forecast for GDP growth is -0.3% in 2014, -1.9% in 2015 and +0.5% in 2016. These are driven by expected private consumption growth going from 1.2% in 2014 to -2.2% in 2015 and rising to +2.2% in 2016, Fixed investment falling 3.7% in 2014, 3% in 2015 and growing by only 0.3% in 2016.

Morgan Stanley cut its 2014 forecast for Russian economy from +0.8% growth to -1.5% recession earlier this month.

BOFIT forecast estimates growth of 0% in 2014, +0.5% in 2015 and +1.7% in 2016, or an average rate of growth of 1.1% in 2015-2016. These are more in line with official forecasts and are less gloomy than World Bank outlook and Danske outlook. I tend to err on their side, although my expectation is that 2015 growth will be above 0.5% and 2016 will be slightly shy of 1.7%, but the average of 1-1.1% for 2015-2016 looks about right, assuming no major rapid changes to the Ukrainian situation.

All in, there is huge uncertainty as to what we can expect from the Russian economy in 2015-2016.

The slowdown in investment is driven by a number of factors, such as:
  1. Capital outflows and high interest rates (in part related to the Ukrainian crisis, but also linked to stubbornly high inflation and the Central Bank move to free floating ruble). Policy interest rates currently stand at 8% and are expected to rise to 8.5% by the end of 2014-beginning of 2015. Currently, EUR/RUB exchange rate is at 50.22 and 12month forward contracts imply the rate of 53.65, while USD/Ruble rate is at 38.8 currently and 12 months forward markets pricing implies the rate of 41.18. Much of this is down to the expected revaluation of the dollar and the strong euro vis-a-vis majority of the emerging markets currencies. But some is down to expected structural weaknesses in the Russian economy. Weaker ruble implying higher cost of imported capital goods and technology.
  2. Weaknesses in the banking sector (exacerbated by the impact on the banks' access to global funding markets arising from Western sanctions) relate to continued sector consolidations (Central Bank has shut down more banks in 2014 so far than in 2010-2011 combined) and sector deleveraging (with credit supply growth falling dramatically over the last 12 months).
  3. Tight fiscal policy: Russia's draft federal budget approved by the cabinet on September 18, upholds the budget rule adopted in 2012 that says the deficit may not exceed 1% of GDP. Spending composition changed to allow higher allocations to defence and national security, as well as to boost certain sectors of the economy. Much of the spending in the latter will go to building new production or expand existing capacity to substitute for imports, especially in the defence and agriculture sectors. The measures are part of Russia’s new emphasis on economic self-sufficiency. New funding was allocated also to Crimea and the Far East region development, and to large infrastructure projects such as Moscow’s new ring road. Per BOFIT: “The government sees giant state-funded infrastructure projects as a way to revive economic growth”. But big infrastructure investments are not identical in terms of their future productive capacity as business investment in new technology and capital goods. As Brazil example shows, infrastructure uplifts based on public funding are virtually one-shot game when it comes to funding growth.

On the budgetary policy side:
  • The Government refrained from new tax hikes and shelved the proposal for sales-tax. VAT remained unchanged at 18%. This is a major net positive for domestic demand.
  • Another positive on domestic demand side, but presenting new risks on long term macroeconomic sustainability front, the new budget includes decision to raise revenue by transferring federal budget pensions contributions for 2015 into general budget, same as in 2014. Under 2002 pensions reform, Russian pension system moved from pure pay-as-you-go system to partially funded system. Under the 2002 reformed system, a share of pensions contributions collected by the federal authorities went to fund current pensions obligations, while the balance was invested in long-term instruments to help fund future pensions provisions. Since 2014 and now into 2015, the second part of contributions will be diverted to general budget.

As mentioned above, Russia is moving toward a greater degree of economic self-sufficiency in two key areas: defense industry and agriculture. While the former is likely to be a drag on general investment, the latter presents opportunities for Irish exporters and is likely to lead to some economic grains in Russia.

Russian agriculture is in a desperate need of investment. I wrote about this on my blog http://trueeconomics.blogspot.ie/2014/09/892014-russias-agrifood-sector-in-need.html on September 8th - a post that I shared with you on the IRBA Linkedin page. To summarise my findings, modernisation of Russian agriculture and food sectors will require annual investments in the region of USD10.7-11.7 billion per annum. Agriculture Ministry requested a 50% increase in annual farm subsidies from EUR4.2 billion in 2014 to EUR6.3 billion in 2015.

These investments will have to cover:
  • -       Agricultural production, especially in dairy, fisheries, beef and fruit and vegetables sectors, including staples, like potatoes;
  • Supply Chain Management and Logistics, especially in storage and transportation relating to fruit and vegetables sectors;
  • Food processing sectors, especially relating to dairy and fishing sub-sectors.

Increasing Russia’s agricultural output will take significant time, somewhere across 2-6 years, depending on a sector (http://trueeconomicslr.blogspot.ie/2014/08/2782014-russian-economy-outlook.html).

We can expect significant uplift in investment support schemes in beef and poultry sectors, as well as in pork production. So far, draft 2015 Budget provides only 20% of the funds requested for this purpose. The hope is that the bumper crop of cereals this year is going to provide off-setting breathing space for investment: Russia expects grains harvest in 2014 to hit 104-106 million tons, just shy of the all-time record of 108 million tons achieved in 2008 and well above the 84 million tons average for the last 10 years.

Overall, most acute risks to the Russian economy are geopolitical, with sanctions escalation on September 12-18th resulting in more severe pressures on the banks for funding, as well as increased pressure on oil producers. So far, the sanctions war has been escalating despite the ceasefire in Ukraine holding and this suggests that we cannot expect lifting of the sanctions before the end of 2014 even under the most optimistic scenarios.

Credit supply from euro and dollar funding has fallen to zero for all Russian companies in July 2014.

The second immediate risk is that of declines in oil prices. Russian economy is more sensitive to changes in oil prices than to gas prices and the fact that oil is currently down some 16% on its June 2014 highs and is trading closer to USD95-96/bbl presents a major threat to the economy. Should oil prices fall below USD90/bbl, federal budget will require major tightening to keep the Government within targeted 1% deficit rule.

The third risk is to the investment side from the monetary policy: stubbornly rising and high CPI - currently running at around 7.9% against CBR and Government targets of 5.5-6%, and devaluation of the ruble, plus rapid outflows of capital from Russia - all are implying future potential tightening of interest rates policy. This, if it were to pass, will push even further down the already poor investment performance.

On the positive side, even with sanctions tightening, we are seeing some recovery in producer and consumer confidence, as signaled by PMIs and consumer surveys. But the recovery is fragile and uncertain in terms of future prospects. We need to see confirmation of the stronger PMIs trend in September figures, due to be released this week.

If we are to look at the demand side for exporters into Russian markets, things are tough. Russian imports have already fallen in 2014, driven by depreciation of the ruble more than by anything else. Imports declines contributed +6.5% to Russian GDP growth in 2009, but rebounded relatively strongly in 2010 and 2011, erasing the 2009 contraction. Imports shrinkage is likely to contribute some 1% to GDP growth in 2014, 0% to 2015 growth and -0.3% in 2015, so expected rebound to the current imports drop is likely to be less swift and longer-drawn out.

Surprisingly, imports slowdown and sanctions did not hurt, to-date, bilateral trade in goods between Russia and Ireland. In the first seven months of 2014, compared to the same period of 2013, Irish exports to Russia rose from EUR397 million to EUR509 million - an uplift of 28% y/y. Our trade balance in goods with Russia improved from a surplus of EUR301 million in January-July 2013 to a surplus of EUR353 million in January-July 2014. If in 2013 exports to Russia accounted for 3.67% of our goods exports ex-EU and USA, in 2014 so far it is accounting for 4.31% of our goods exports ex-EU and USA.

Keep in mind: in national accounts, net trade (trade balance) is what counts as additive to national income and GDP. In these terms, for the first 7 months of 2014, our surplus vis-a-vis Russia (at EUR353 million) is much more to our GDP and GNP than our trade deficit with China of EUR478 million.

While we do not have detailed breakdown of July trade flows, comparing H1 2014 against H1 2013, noticeable increases in Irish exports to Russia were recorded in:
  • Coffee, tea, cocoa, spices and manufactures thereof
  • Miscellaneous edible products and preparations
  • Essential oils; perfume materials; toilet and cleansing preps
  • Chemical materials and products nes
  • Photographic apparatus; optical goods; watches and clocks
  • Miscellaneous manufactured articles 

Noticeable decreases were recorded in:
  • Live animals
  • Meat and meat preparations
  • Metalliferous ores and metal scrap
  • Organic chemicals
  • Medical and pharmaceutical products
  • Office machines and automatic data processing machines

Opportunity space for Irish exporters in Russia remains wide open in areas not impacted by sanctions, e.g. outside immediate supply of some food and agricultural products. And new opportunities should open up in the areas relating to agricultural production, food processing, storage and transportation. In addition, there is renewed scope for investment in Russia in the above areas and in areas relating to technological innovation and modernisation in a wide range of sectors.

However, to facilitate this, it would be positive if Russian authorities were to accelerate policy efforts directed at attracting foreign investors into the country, especially in areas linked to investor protection and regulatory and tax facilitation. There is also a need for assuring investors that ruble valuations are going to become less erratic and the global rates divergence is not going to precipitate dramatic further drops in currency values. Key here is Euro/Ruble pair, rather than Dollar/Ruble one. Access to trade finance and insurance are also a major bottleneck.

While over the next 1-2 years we can expect more uncertainty and risks to materialise, including the risk of significant further devaluation of the ruble valuation, taking a longer-term horizon of 5-10 years, these factors are likely to be replaced by more positive growth momentum and improved returns on foreign investment.

Sunday, September 28, 2014

28/9/2014: Political Risks and MENA Equities Valuations

A quick and accessible writeup on our (still work-in-progress) paper on "Political Risks and Financial Markets: MENA perspective" that uses data from Euromoney Country Risk surveys: http://blog.learnsignal.com/2014/09/26/political-risk-financial-markets/

28/9/2014: Euro area banks deposits: no sign of significant improvements

Courtesy of @cigolo - a nice chart summing up trends in deposits in Euro area banks from 2009 through Q2 2014:

Italy and Slovenia are two countries that managed to raise the deposit levels in their banking system from Q1 2009. Portugal suffered a decline in deposits off the peak, but stayed above 2009 levels. In every other country sampled, deposits fell from 2009 levels. Note: Ireland too suffered a decline in deposits and in fact, once we control for the reclassifications in deposits, the decline has been more dramatic than the one depicted in the chart (see details here: http://trueeconomics.blogspot.ie/2014/09/2792014-growth-just-not-in-irish.html).

Since the Cypriot bailout, and the introduction of bail-in clause for depositors, Euro area banks deposits stayed basically flat in Italy (with slight decline in trend) and Greece, rose in Slovenia, posted a shallow increase in Portugal, declined in Ireland and Spain, collapsed further in Cyprus. While there was no immediately obvious common trend, deposits pre-Cypriot bailout trend was disrupted or failed to improve in Italy, Slovenia, Cyprus, Portugal, Ireland, Spain and Greece despite numerous efforts to shore up the fallout from the bail-ins under the new systems set up for the European Banking Union.

So much for reformed banking sectors, then. Remember that funding in European banks should be shifting toward more reliance on 'organic' sources, e.g. deposits, than on interbank lending. We are yet to see this happening on any appreciable scale across the 'peripheral' economies.

Saturday, September 27, 2014

27/9/2014: Growth... just not in Irish deposits...

Here's an interesting question: when economy grows, what happens with the household deposits? The right answer is: it depends on a couple of factors:

  1. How long has economy been growing: if we have growth over a month or two, one can safely assume that households are using up cash to cover their short term debts accumulated over the course of the downturn. Indeed, Irish debts have been shrinking, not growing over the downturn - on aggregate - and growth has been ongoing for a long time now, at least in official accounts.
  2. What type of growth we are seeing: if economy grows outside the household sector, e.g. via corporate profits that do not 'trickle down' into the real economy in higher wages, etc, then deposits will not follow growth, although this effect too should be short-lived.
So what happened so far with irish households? Here's a chart:

Since Q1 2011, when the current Government came to office and promptly declared yet another economic turnaround miracle, Irish household deposits are down EUR2.08 billion or 2.23%. Worse, household deposits have been running at a flat trend since mid-2011. 

Total private sector (excluding financial firms) deposits are currently only EUR1.289 billion ahead of Q1 2011 average - a miserly increase of just 1.13%. Given Irish firms and households are still pretty much abstaining from investing in the economy, this shows the current recovery to be almost entirely concentrated in the sectors that ship profits out of Ireland with the balance of domestic growth being fully consumed by the debt servicing and repayments. 

Ah, and do note that any talk about 'rising deposits' in Irish banks that we occasionally hear from our politicians is down to one thing: inclusion of the credit unions' deposits into Central Bank statistics. As shown above, absent that, deposits still remain near crisis-period lows: household deposits today are only 1.1% above their crisis period lows, while non-financial corporates deposits are 1.22% above their crisis period lows. And as of July 2014, Irish household deposits fell in 3 months in a row. Just as growth 'accelerated'. 

Friday, September 26, 2014

26/9/2014: BBC covering Irish Fintech sector

BBC cover of Irish fintech sector successes: http://www.bbc.com/news/business-29365484 with comments from a number of people, including myself.

Related: my speech at the Enterprise Ireland annual conference this week: http://trueeconomics.blogspot.ie/2014/09/2392014-ei-conference-domestically.html

26/9/2014: Some recent links on tax inversions

Some interesting recent articles on tax inversions and Irish role as a tax-conduit to tax havens:

US Treasury new rules tightening tax inversions: http://www.treasury.gov/press-center/press-releases/Pages/jl2645.aspx

And Irish reaction to these: http://businessetc.thejournal.ie/us-tax-inversions-ireland-1685263-Sep2014/?utm_source=twitter_self and here: http://www.irishtimes.com/business/economy/us-launches-crackdown-on-overseas-tax-avoidance-1.1938583

While markets broader impact here: http://www.reuters.com/article/2014/09/23/us-usa-tax-inversion-idUSKCN0HI1WK20140923?feedType=RSS&feedName=topNews&utm_source=twitter

Here is a more detailed discussion of the net impact of the new rules, mentioning so-called 'Levin solution' http://fortune.com/2014/09/24/the-treasurys-chicken-soup-take-on-tax-inversions/

And an earlier article from Arthur Cox solicitors on the benefits of inversions into Ireland and associated restrictions: http://www.arthurcox.com/wp-content/uploads/2014/07/April2014_SpotlightOn.pdf Hilariously, the above quotes: "Ireland is a popular country for inversions because of its favorable tax regime and extensive tax treaty network."

And an official response from Ireland to US tightening is 'not our problem': http://www.irishtimes.com/business/economy/kenny-defends-us-firms-irish-presence-1.1939192#.VCKA645RJ3A.twitter

You can track previous articles and posts on Ireland's role in global tax optimisation by searching this blog for "corporate tax". 

26/9/2014: FT on Land Value Taxes

26/9/2014: 'Cartoon Economics'? You bet...

Priceless is the best way to describe financial instrumentation antics of Irish Government.

The IMF loan early 'repayment' is really a re-financing. It has its good sides and no one argues it shouldn't be done (see here: http://trueeconomics.blogspot.ie/2014/09/992014-imf-loans-deal-can-be-win-win.html) but 'repayment' this is not.

Still more of the bizarre machinations were publicised today in an Irish Times piece: http://www.irishtimes.com/business/economy/move-on-anglo-debt-set-to-boost-exchequer-earnings-1.1942119#.VCUUnz_O6bw.twitter. The idea is that those Anglo/INBS/IBRC 'shut down' bonds that are being held in the Central Bank (with interest on them payable to the CB and thus recycled back to the State, implying zero cost financing of the bonds) can be sold at a rate faster than that required by the original schedule. Which, of course, means two things:

  1. Selling these bonds today is likely to generate a capital gains return to the Exchequer, as Irish bonds are currently trading at lower yields than when issued, which means that the Government can sell these bonds and pocket the price difference over par.
  2. But,... the proverbial but, once sold, the bonds ill be paying declared coupon (interest payments) of Euribor + 263 bps to their new holders, and not to the Central Bank. Which means that new interest payments will be an addition to the already hefty interest bill of the Government. What used to be 'free funding' prior to sale will become 'Euribor+263bps' funding after. 
There is an added caveat to all of this. If the Government spends the capital gains on anything other than reduction of debt, interest costs under above pricing become net costs. In effect, we will be funding a quick-fix-drug addiction with a credit card.

Back in 2013, after the Promo Notes deal, myself and others have cautioned as to the risks associated with accelerated sales of bonds. And now this risk is upon us. And beyond all of this looms the largest question of them all: These bonds were issued to cover Irish Government liability to the ECB (Eurosystem) arising from the nationalisation of Anglo and INBS (not nationalisation, per se, but from our state assuming all liabilities of the two failed banks and refusing to burn their bondholders). So, as we all know, Ireland 'took one on the chin' for Europe. 

A symmetric response from the ECB would have been to allow us hold these bonds in perpetuity, so no repayments need to be made at all. Instead, we created these bonds with an intent of selling every year a bit of this debt into the markets to generate cash to close the liability to the ECB (in other words, to raise money to burn money to appease ECB balancesheet exercise). This 'burning' of money means two things:
  1. ECB gets accounting 'cancelation' of liability which has zero material impact on the Eurosystem regardless of whether it remains open or is closed; and
  2. Irish taxpayers have to fund the debt sold - which means more real pain and suffering for taxpayers and people of Ireland.
With the new move, we are going to accelerate (1) and (2) above and the Irish Times is cheerleading this?! 

The Irish Times misses all of the above points in its article. But one man doesn't: Diarmuid O'Flynn:

As he said, this is 'cartoon economics'...

26/9/2014: Those Fabled Euro Area Structural Reforms: Greece, Spain, Portugal & Italy

EU Commission has published some interesting research on structural reforms in Italy, Spain, Portugal and Greece (strangely, no Ireland or Cyprus).

The full paper is available here: http://ec.europa.eu/economy_finance/publications/european_economy/2014/pdf/ee5_en.pdf

But here is an interesting set of charts, showing the effect of the said 'reforms' on the economies of these 'peripheral' states.

First chart shows employment growth against productivity growth in 2001-2008 and 2008-2013:

Above clearly shows that in two 'peripheral' countries covered, namely Portugal and Spain, productivity (as measured by value added per hour worked) rose during the crisis period, while the same fell in Greece and Italy. Productivity growth accelerated over the crisis period in Portugal and Spain and de-accelerated in Italy and literally fell off the cliff in Greece. And in all four economies, hours worked collapsed.

This all means two things:

  • Firstly, jobs destruction failed to sustain growth in productivity in Italy and Greece (in other words, the two economies suffered jobs losses dispersed across all sectors of activity), while jobs destruction did sustain improved productivity for the remaining active workforce in Spain and Portugal (where jobs destruction was more concentrated in several domestic sectors, such as retail and construction). 
  • Secondly, given that all four economies developed broadly similar 'structural reforms' packages, albeit with varying degree of implementation, the above suggests that the said reforms had zero-to-negative effect on economic performance in Italy and Greece, and potentially positive effect in Spain and Portugal. This is basically equivalent to saying that reforms overall effectiveness is not anchored in the structure of reforms, but is rather being driven by something else, something more idiosyncratic. Or, alternatively, that the reforms had no discernible effect whatsoever and instead nature of jobs destruction is driving differences in productivity growth.

The second chart shows annual trajectory in hours worked against productivity growth from 2008 through 2013.

Again, the above chart shows that in all four economies, relationship between productivity growth and employment is broadly negative. The diagonal line shows two segments of the chart: above the line, jobs destruction / creation effects are dominated by productivity growth effects. Below the line, the opposite takes place. So in a summary, the chart shows that the dominant driver in every economy as jobs destruction, not productivity growth. If structural reforms are of any significant help in driving productivity of workers, one would expect at least one of the economies to perform above the diagonal line. None do.

Quite surprisingly (or may be not) EU Commission offers an entirely opposite arguments on reforms efficacy. Even in the case of Greece - a country where both employment and productivity collapsed, the Commission paper argues that "Greece made a substantial adjustment in terms of employment while productivity stopped falling down". The folks in Commission believe that once the economy is completely exhausted on the downside, the lack of further declines is a sign of 'reforms-driven improvements'. This is about as crazy as cheering the fact that a lifeless body at the bottom of the empty pool is no longer falling.

Here is the Commission own guide to the above charts:

Do tell me which of the four countries locates in 'jobless growth' (early stage of reforms and structural changes working) area? Do note that other area of "Repositioning (growth less restructuring)" - which sounds exactly what it is: mindless demolition of jobs in hope that such a move can improve the remaining average. This is the best the 'periphery' has been able to achieve so far under the watchful eye of the EU Commission boffins.

26/9/2014: Eurocoin Signals Accelerating Fall in Economic Activity

Eurocoin, euro area leading growth indicator compiled by Banca d'Italia and CEPR has fallen again in September, indicating further slowdown in growth conditions:

  • In August 2014 Eurocoin indicator stood at 0.19. In September, the indicator fell to 0.13 - its lowest reading in 12 months.
  • Growth forecast consistent with current readings for Q3 2014 are in line with y/y euro area GDP growth of 0% (range between +0.1% and -0.1%).

As usual, updating my ECB Monetary Policy Dilemma chart:

The above shows the proverbial 'growth corner' for ECB: historically low interest rates and virtually zero growth signalled by the leading indicator.

Annualised growth rates are abysmal:

Per release: the latest decline reflects continued losses in consumer and business confidence, slowdown in exports and weakening of industrial production conditions. Those tracking my analysis for previous months would note that in the past Eurocoin was supported to the upside primarily by equity markets valuations. As predicted, these effects are now becoming exhausted and as the result we are witnessing rapid declines in the leading indicator.

Thursday, September 25, 2014

25/9/2014: "We sit in the mud... and reach for the stars": ISIS and Western Policy

For the Laughs... or dead serious:

via @bill_easterly

Throw in Russia into the above equation and the 'mud' gets epic. Turgenev once said that "We sit in the mud... and reach for the stars"... it is clearly a permanent cloud cover in the US / Western politics... Or as Wislawa Szimborska wrote: "In every tragedy, an element of comedy is preserved. Comedy is just tragedy reversed."

25/9/2014: IMF Dished Out Some Bad News on Italy... here's a snapshot...

Recently IMF released Article IV consultation paper on Italy. I have missed posting this note for some days now due to extensive travel, so here it is, with slight delay.

A depressing read both in terms of current situation assessment and prospects for the medium term future. Which is hardly surprising.

Key struggles are, per IMF: "Exports have held steady, led by demand from non-EU countries, but investment continues to decline and remains 27 percent below pre-crisis levels."

Err… actually no… exports are still below pre-crisis levels by volumes, never mind price effects on value. Exports of goods and services grew by 6.2% in 2011, but then growth collapsed to 2.1% in 2012 and 0.1% in 2013. 2014 projected growth is for healthier 3.0%, and thereafter the Fund forecasts exports to continue expanding annually at just under 3.6% pa on average between 2015 and 2019. Which is handy, but not exactly 'booming'. And worse, net exports having grown by 1.5% and 2.6% in 2011 and 2012 have shown decline in the growth rates to 0.8% in 2013 and projected 0.5% in 2014. Thereafter, net contribution of external trade to GDP is forecast to grow at 0.4% in 2015 and 0.1% every year from 2016 through 2019. Again, this is weak, not strong. And keep in mind: GDP does not grow with Exports, it grows with Net Exports.

Fixed investment is, of course, still worse. In 2011 gross fixed capital formation shrunk 2.2%, followed by an outright collapse of 8% in 2012 and topped by a decline of 4.7% in 2013. Now, the Fund is projecting contraction of 1.1% in 2014, but return to growth in 2015 (+1.8%) and in 2016-2019 (average annual rate of expansion of ca 2.6%). Which means one simple thing: by the end of 2019, investment in Italy will still be 6.2% below the pre-crisis levels.

Now, the IMF can be entertaining all sorts of reforms and changes and structural adjustments, but there is one pesky problem in all of this: investment is something that the young(er) generations tend to do. And Italian young (people and firms) have no jobs and little churn in the marketplace to allow them grow, let alone invest. IMF notes low churn of firms… but misses the connection to investment. 

And, of course, it misses the Elephant in the proverbial Room: Italian families are settled with 30-40 year old sons and daughters still living on parental subsidies. Now, parents are heading for retirement (tighter cash flows) and retirement funds are heading for if not an outright bust, at least for gradual erosion in real value terms. What happens when retired parents can’t nurse their children’s gap between spending and earning?..

Things get uglier from there on. Not surprisingly, due to debt overhang already at play, credit supply remains poor and NPLs continue to strain banks balance sheets. This is holding back the entire domestic demand and is exacerbating already hefty fiscal disaster.

There is no life in the credit market and with this there is no life in the economy. Which, obviously, suggests that credit is the core source for growth. This is not that great when you consider that there are four broadly-speaking sources of investment (and capacity expansion):
  1. Organic revenues growth (exports are barely growing, domestic consumption is dead, so that's out of the window);
  2. Direct debt markets (bond markets for corporate paper, open basically only to the largest Italian corporates and no smaller firms access platforms in place, which means no real debt markets available to the economy at large);
  3. Equity (forget this one - tightly held family firms just don't do equity, preferring to cut back on production) and
  4. Banks credit (aka, debt, glorious debt).

Chart above shows the relationship between Financial Conditions Index (FCI) and economic growth. FCI breakdown is shown in chart below:

All of which confirms the above: improvements in the credit volume and credit standards are being chewed up by the ugly nominal rates charged in the banking system that is now performing worse (in terms of profitability) than its other Big Euro 4 + UK counterparts.

And the IMF notes that: "Financial conditions are closely correlated with growth and FCI shocks have a significant impact on growth. For example, a bivariate VAR under the identifying assumption that the FCI affects growth with a one-quarter lag suggests that a negative shock that raises real corporate lending rates by 260bps through a 200bps increase in nominal rates and a 60bps decline in inflation expectations (to 0.5 percent), would lower growth by a cumulative 0.4 percentage point over three quarters. As a reference, real rates have increased by around 300 bps since mid-2012." No sh*t Sherlocks, you don’t need VAR to tell you that growth in Europe = credit. It has been so since the creation of the Euro, and actually even before then.

Now, do the math: in 2013, Italian banks have posted profitability readings that are plain disastrous:

The swing between ROE for Italian banks and Spanish & French counterparts is now around 21 percentage points. While NPLs are still climbing:

But real lending rates are above those in France and below those in Spain:

Taken together, charts 4-6 show conclusively that nominal rates will have to rise AND deleveraging out of bad loans will have to either drag on for much longer, or worse (for the short run) accelerate. All of which means (back to the above IMF quote) continued drag from the financial sector on growth in quarters ahead. Everyone screams 'austerity' but really should be screaming 'deleveraging':

IMF notes: "The analysis suggests that measures to normalize corporate financial conditions would support a robust and sustained recovery, mainly through investment. Since bank lending rates account for the lion’s share of the tightening in the FCI, domestic and euro area measures to address financial fragmentation, mend corporate balance sheets, and strengthen banks’ capacity to lend would minimize the risk of a weak, creditless recovery."

This is all fine, but totally misses the problem: financial 'normalisation' in the above context is not about investment, but about investment via debt. And more debt is hardly a feasible undertaking for Italian firms and for Italian banks. Supply IS closer to demand that we think, because tight supply (banks deleveraging) is coincident with tight demand (once we control for the risks of poorly performing corporates seeking debt rollovers and refinancing).

And, of course, the IMF optimism for “domestic and euro area measures to address financial fragmentation, mend corporate balance sheets, and strengthen banks’ capacity to lend” capacity have just hit a major brick wall at the TLTROs placement last. As subsequent data showed, Italian banks just started re-loading their hoard of Government bonds instead of repairing the corporate credit system. Who could have imagined that happening, eh?

25/9/2014: Forecasting 2015-2016 Growth in the Euro Area: Pictet

Pictet's latest euro area forecasts for 2015-2016 show the full extent of the expected trend slowdown in growth (see details here: http://perspectives.pictet.com/2014/09/25/euro-area-gloomy-sentiment-threatens-recovery-hopes/)

Even dreaming up sustainable steady growth in 2015-2016, forecast growth rates are seen at around 1.5% pa on average, well out of line with the 'Golden' period of the euro so far, the H2 2003-H2 2007.  In other words, in 16 years of euro's existence, 45 quarters (or just over 11 years) is now expected to be associated with below 2% growth rates. Run by me again that tale of the 'European Century'?.. 

25/9/2014: Irish Property Prices: Scary Dynamics in Dublin, Relative Slumber Elsewhere

Latest Residential Property Prices Index for August 2014 continues to point to the same trends and risks as in previous months.

Firstly, historical level of current price levels: Measured in quarterly terms, Q3 2014 data through August 2014 points to Dublin index reading of 77.95 against 72 in Q2 2014 which brings index to the levels last seen in Q3 2010.

As dramatic as the increase from crisis period trough might appear, the series still well below where long-term activity should be, as seen in the chart below:

However, rate of price increases remains of concern in Dublin market. In August 2014, residential property prices across the nation rose 14.93% y/y, the fastest y/y growth rate since October 2006. Nationally, house prices rose 14.61% y/y in August, marking the fastest rate of increase since March 2007. Apartments prices rose 24% y/y in August 2014, marking the fastest rate of increase on record and beating previous historical high attained in July 2014.

All of this activity was down to Dublin price hikes. Excluding Dublin, property prices rose more modest 5.63% y/y in August. House prices rose 5.80% once Dublin is excluded.

Meanwhile, Dublin property prices were up 25.08% y/y in August, marking thirteenth consecutive month of double-digit y/y inflation. Dublin house prices rose 24.7% y/y in August 2014, also marking thirteenth consecutive month of double-digit y/y prices growth. Dublin apartments posted price growth of 32.63% y/y in August, for the fourteenth consecutive month of double-digit expansion.

Compare the above chart for Dublin with the same for ex-Dublin:

Over the last 24 months, cumulated growth in national residential property prices was 16.02%, with house prices rising cumulatively by 15.34% and apartments prices up 32.2%. Outside Dublin, all properties prices were up more modest 2.89% in cumulative terms over the last 24 months and house prices were up 3.11%. In Dublin, residential property prices were up 38.39% over the last 24 months, which is 13.3 times faster than ex-Dublin. Dublin house prices grew 12.2 times faster than ex-Dublin house prices, at a 24 months cumulative rate of 37.83%. Dublin apartments prices rose 46.09% in 24 months through August 2014.

So as before: there are very worrying signs in price increases in Dublin, albeit levels of prices still remain subdued compared to both historical trend and inflation-driven trend. In other words, be scared of the speed of price increases, but not of the levels of prices so far.

25/9/2014: Irish Planning Permissions Q2 2014: No Signs of Sustained Recovery, Yet...

CSO released planning permissions data for Q2 2014 (release here), so here are updated charts:

Starting from Total Number of Planning Permissions Granted: this rose in Q2 2014 to 4,149 which is up 8.24% q/q. In Q1 2014, total number of PPs granted was up massive 13.3% y/y down to anticipated changes in regulations. Year on year, Q2 2014 numbers were up 23.19% - which is significant. Alas, increases took place off a very shallow level of activity, with Q2 numbers down 76.1% on pre-crisis peak and down 4.42% on 1975-1999 minimum (lowest point in activity for that period). So current level of PPs is still lower than in any quarter between Q1 1975 and Q4 2010. On the somewhat positive side, current level is the highest since Q3 2011.

Still, as chart above shows, the post Q1 2012 trend remains flat (aka, there is no sustained recovery, yet).

Planning permissions granted for dwellings are showing even worse performance. These were up 18.64 q/q in Q1 2014 and are now down 1.8% in Q2 2014. However, y/y PPs for Dwellings are up 13.34%. The wild volatility ride continues in the series and the trend is still flat, showing no real recovery. Compared to pre-crisis peak, current activity is down 88.4% and relative to 1975-1999 minimum level of activity, Q2 2014 figures stand at the levels 40% lower than the worst point recorded in 1975-1999. This quarter marks the fifth worst quarter on record.

Chart above shows clearly that the trend has been flat since roughly Q1 2013.

Floor area underlying granted PPs is tanking, again, as illustrated in the chart below:

And with it, the average floor area per granted permission:

So here is the summary of H1 cumulative figures for 2014, compared to 2011-2012:

  • Planning Permission granted for all types of construction rose to 7,982 in H1 2014 from 6,643 in H1 2013 and 7,040 in H1 2012. But total floor area underlying these permissions fell from 1,558, 000 sq.m. in H1 2011 and 1,764,000 sq.m. in H1 2013 to 1,456,000 sq.m. in H1 2014.
  • Planning Permissions for Dwellings stood at 1,766 in H1 2014, up on 1,634 in H1 2013, but down on 1,899 in H1 2012. Total floor area associated with PPs for Dwellings stood at 563,000 sq.m. in H1 2012, rising to 727,000 sq.m. in H1 2013 and falling to 632,000 sq.m. in H1 2014.
In other words, I am failing to see any sustained upward momentum in future work pipelines for the construction sector. Backlog of past permissions might be working through the latest optimistic outlooks for the construction sector, but as far as genuine new activity goes, we are not there yet.

25/9/2014: Geopolitical Risks Weigh on Global Growth Expectations into Q1 2015

Some interesting insights into global economic conditions and expectations forward from the McKinsey Global executives survey for Q3 2014 (analysis link here):

Geopolitical Instability is still core threat to the global economy:

But it is not related directly to Ukraine. Instead, the source of key instability is MENA:

And expected impact of the risk is in North America, non-Euro area EU (presumably this has to be linked to Ukraine) and the Eurozone:

Gloom and doom overall prevail today, most significantly in North America (June-September swing in worsening expectations from 7% of respondents to 27%), Europe (from 11% of respondents to 28%):

And looking forward (6 months out), poor outlook (expected deterioration) remains in Europe (30%, a decline from 34% of respondents compared to current):

This survey supports recent revisions to global growth by a number of forecasters. 

Tuesday, September 23, 2014

23/9/2014: EI Conference: Domestically-Anchored Globally Open Entrepreneurship

Yesterday, I was asked to say a few words on the challenges and opportunities facing Ireland's economy in the near term future for the Annual Conference held by the Enterprise Ireland. Here are my comments.

"Ladies and Gentlemen,

I would like to thank you for this opportunity to speak to such a distinguished group of professionals who represent the organisation that is responsible for helping Irish indigenous enterprises to grow, develop new markets and increase their value added to the economy.

Global economic environment and Ireland

Let me start by briefly outlining the global economic environment in which Ireland operates today, focusing on both the immediate challenges and opportunities in the next 12-24 months, as well as further afield, into 2017-2020. It is worth stressing beforehand that opportunities and challenges go hand-in-hand and should not be viewed as opposing concepts. An opportunity not pursued is a challenge unmet. A challenge met is an opportunity pursued.

Firstly, analysts’ forecasts generally agree that the global economy is currently moving toward the post-crisis growth trend. The worst of the Great Recession is over, but pockets of structural weaknesses and real pain of economic displacement remain.

Our two major trading partners: the US and the UK are
Delivering rates of growth consistent with those at or slightly below the pre-crisis averages of 2.5-3%
But, this growth is still excessively reliant on monetary policy supports, rather than investment, productivity expansion, external trade growth and/or domestic consumption.
The problem of private and public debt overhang still looms, like a dark shadow, over both economies, presenting a risk of a slowdown in the rates of growth toward 2%.
These risks are even more material in the context of potential effects of the monetary policy tightening that the markets currently expect to take place some time in Q2-Q3 2015.

In the euro area, growth is showing some promise of a fragile acceleration starting with Q3-Q4 2014 and into H1 2015.
However, the rates of growth achievable in Europe remain below the already less-than-impressive pre-crisis trends.
Again, looking at consensus forecasts, we can expect growth around 1.2-1.5% in 2015, rising closer to 2% in 2016.
This assumes no significant adverse shocks from either external sources or from those originating in the euro area.
As with the US and UK, lack of investment, slow productivity growth, and debt drag on consumption represent the biggest challenges alongside fragmented financial markets and sovereign debt bubble that is putting a superficial shine on the dire state of public finances.
As with the US and the UK, growth is still reliant on monetary accommodation and is subject to significant forward risks once the accommodative stance by the ECB is reversed in time.

In the rest of the world:
Commodities dependent economies of Australia and Canada are facing significant risks of unwinding large asset bubbles and economic imbalances built up in boom years. Australia is more vulnerable here than Canada, both in terms of the extent of the bubbles in its domestic economy and its exposure to the slowdown in global demand for commodities, especially to downward pressures in demand coming from China.
Amongst BRICS, Brazil, China and Russia are facing structural pressures - all arising from different driving factors, but all substantial and extremely dangerous to regional and global growth prospects.
Brazil is in a recession and is running out of the road finding sufficient credit supply sources to continue funding public investment boom that sustained the economy.
China is facing a gradual de-acceleration of growth toward 5-5.5% per annum, in a 'good' or ‘benign’ scenario, and is nursing a substantial risk of a sudden break on growth if the investments bubble collapses rapidly.
Russia is amidst a geopolitical turmoil surrounding the Ukrainian crisis, but below these immediate concerns, structural growth slowdown is working to push post-crisis longer-term growth rates closer to 2-2.5% per annum.

Overall, we are looking at the global growth rates in the region of 3-3.5% and advanced economies growth rates around 1.5-2.5%.

Ireland’s position in the global environment currently represents an outlier. Stripping out superficial boost to growth in H1 2014 achieved primarily via reclassifications of the National Accounts, our economy is, at last, showing some changes in the previous post-crisis trend. Prior to 2014, our economic growth dynamics could be characterised as flat-lining with some short term volatility around near-zero growth trend. In more recent months, we are witnessing a gentle uplift in the flat trend, which is most certainly a heart-warming experience. Much of the positive momentum today, just as positive growth supports over recent years (since at least 2011) is down to our exports performance, especially in the indigenous sectors. This performance, strong as it may be, is only partially offsetting the negative trends in multinationals-supported exports of goods (the ‘patent cliff’) and is largely obscured in the national accounts by the superficial boom in MNCs-driven ICT services exports. Nonetheless, given much higher employment and national income intensities of indigenous exports, this domestic exports growth is one of the core drivers, in my view, of the improvements in Irish economy.

Looking beyond 2014, we are likely to see continued upward momentum in the Irish economy, albeit still at subdued rates. Growth of 2.5-3%, once we strip out changes in the National Accounts methodology is possible for 2015 and 2016, should we stay the course on fiscal consolidation and reforms, and assuming we are not heading for a new credit and real estate investment bubble. Trade prospects for Irish exporters should remain relatively robust, but rates of growth in our exports to our traditional partners are likely to come under some pressures, while our exports penetration into new markets are at the risk due to the factors mentioned above.

Global trade will suffer in the 'slow burner' global growth environment. Margins are likely to fall, growth is likely to slow down or remain capped at around 3.5%, and the process of trade regionalisation will accelerate, in part driven by higher volatility in the exchange rates, regionalisation of financial services and credit markets, and by on-going shifts in global supply chains. All of the above factors will present significant challenges for our indigenous exporters.

However, the said challenges will also present some significant opportunities for Ireland. And in the longer term, gradual unwinding of the debt overhang in the advanced economies over 2015-2020 will strengthen both the traditional trade channels from Ireland into North American and European markets, while continuing to open new channels to middle income economies of Asia-Pacific, Latin America and BRICS.

What does addressing these challenges and capturing the related opportunities require from the Irish perspective?

The key issues, both on the threat side and in terms of opportunities, over the next 2-5 years will be the following:

1) Shifting economy toward more intensive indigenous growth. Currently, shares of exports and domestic consumption supplied by domestic producers are insufficient to address the threats to Ireland's FDI-based development model. In simple terms, Ireland needs to replicate the successes in the area of FDI, delivered over recent decades with the help of IDA, in a new area, the area of driving up indigenous firms growth and creating, attracting, retaining and enabling a new economy in Ireland: economy based on high quality human capital, world class open model of entrepreneurship, and increased focus on high value added strongly differentiated activities.

2) This challenge is coincident with tax regime reforms that started with G20 and G8 push last year and will continue, in my opinion, beyond the OECD's "Action Plan on Base Erosion and Profit Shifting” that will be unveiled in 2015.

3) Parallel to these, regionalisation of trade is shifting large-volume supply chains closer and closer to end-users. This dis-favours Ireland as a basis for real activity and requires addressing this risk by increasing our product/service differentiation.

4) Related to the above, there is an urgent need to focus on increasing value added in our indigenous agricultural, manufacturing and services sectors, both for domestic markets and exports. So far, we have pursued an early stages development strategy to deliver competitiveness - a strategy of wage moderation. This is driving down domestic demand, but also capping our ability to Create, Attract, Retain and Enable a deeply integrated base of top quality human capital. The result of racing to the bottom in wages costs is holding back indigenous innovation, but also the rate of adoption of innovation and productivity growth in the MNCs and larger indigenous enterprises sectors, reducing quality of production, specialisation and supply in the public and private sectors. It is also supporting growth in wealth inequality and suppresses our economy's ability to meet future challenges mentioned earlier. Ironically, wages competitiveness is also creating huge imbalances in the stock of human capital in Ireland, promoting accumulation/concentration of human capital in firms with superficially high (tax arbitrage-supported) productivity MNCs and restricting flow of human capital to indigenous innovators.

5) A major opportunity, yet to be fully tapped, is presented by focusing on an open entrepreneurship model that favours high value added manufacturing and internationally traded services. We are still less active in the global race for entrepreneurial talent than we should be. And we are lagging in projecting Ireland as thought- and policy-leader in this space. We must make Ireland synonymous with entrepreneurship and openness, not with tax arbitrage opportunities. And we must make Ireland’s ‘brand’ visible to would-be entrepreneurs, investors and trading partners around the world.

6) Related to the point above, there are multiple opportunities open to Ireland to compete more aggressively in developing an economy based on value added through user-experience and industrial design, product and service innovation, creativity and, yes, the perennially talked-about R&D. Ireland lags in presence in the world markets in terms of recognisable brands, products, end-user services that are ambassadors for this economy's productive capacity. With exception of Ryanair, Kerry Group and a handful of others, like Dairymaster, too few of our companies have direct reach into global supply chains with offers that are differentiated sufficiently to withstand regionalisation of trade. The added risk arising from the lack of defined differentiation for our producers in the global markets is the added exposure to the exchange rates volatility and thus to the monetary policy shifts that are likely to come over the next 12-24 months. It is heartening to know that Enterprise Ireland's work has been and remains one common support base for the majority of our most successful companies. But it is depressing to know that our policies on migration, taxation, trade facilitation, R&D and enterprise investment remain focused more on FDI and the adjoining sub-sectors, such as ICT Services, and not on a consistent building up of the entrepreneurship and human capital bases here.

7) Last, but not least, we are facing a continued challenge of growing successful early stage enterprises beyond the tipping point of EUR10-15 million revenues. Scaling up of Irish indigenous firms is neither sufficiently supported nor incentivised by our tax systems, equity and debt markets or by our policy frameworks. Hence, too many of successful Irish early stage companies are prematurely terminated via sales with a resulting loss of Irish 'brand' identity in global marketplaces. This also induces unnecessary volatility in the domestic markets for skills, talent and know-how.

The above list of 7 point is by no means exhaustive, but the key, unifying point of the above opportunities and challenges is singular: Ireland needs to move to a more domestically-anchored, globally open model of enterprise based on high value added outputs generation.

More open system of entrepreneurship and a greater focus on actual productivity, higher levels of products and services innovation, design and creativity are becoming the differentiators for our competitors, like Singapore, Hong Kong, Korea, Chile, the Netherlands, Switzerland, Belgium, Sweden, Denmark, Austria and even the UK and Germany. The same drivers are also being actively embraced by the newcomers to this competition, such as UAE, Slovakia, Estonia and others.

What does the above mean in practical policy terms? 

How do the above challenges and opportunities translate into tangible actions by the Government and the enterprise support agencies, such as Enterprise Ireland?

We, economists, usually talk in terms of 'first best' policies – policies that are optimal from the point of view of economic efficiency – neglecting political and social dimensions of the policies. I do not intend to break away from this tradition. But some of the policies suggestions I put forth here are currently feasible, and more importantly, the objective of achieving a more entrepreneurship-driven and value-added growth is now simply imperative.

Firstly, we need to open up our migration system to entrepreneurs. Not just the so-called identifiable high-potential entrepreneurs, but to a wider range of entrepreneurs.
This means not only issuing more residency permits for entrepreneurs coming from abroad and issuing them faster.
It also means more actively recruiting entrepreneurs from the ranks of our foreign and domestic students and by projecting our thought leadership in this area worldwide.
And it means making entrepreneurs and human capital residency here more meaningful, more closely integrated with the open-borders policies of the EU, and more reflective of the needs of modern commerce for travel, cross-border cooperation and work.

Secondly, we need to move Ireland into the position of being extremely visible internationally in the space of creating, attracting, retaining and enabling entrepreneurs and key talent. We lack international thought leadership in this area to identify this economy and society with pro-entrepreneurial culture and ambitions and not tax arbitrage opportunities.

Thirdly, we need to enhance dramatically entrepreneurial skills training and supports.
Enterprise Ireland already does very important work here, but the scale of its programmes can and should be expanded.
To free resources for more specialist, high-level training and supports, we need to move more general training into our education system. We need to start giving our children basic entrepreneurial skills earlier in their lives and provide tangible supports for younger entrepreneurs coming out of our schools, colleges, ITs and universities.
We need to clearly and visibly position Ireland as a platform for trading into the EU and North American markets for entrepreneurs from outside the EU, not just for established MNCs. Again, positive experiences of IDA (working with the MNCs) and Enterprise Ireland (working with numerous indigenous exporters) are a great encouragement and a good foundation to build upon.
But, as mentioned already, our thought leadership in this area is still lagging. And the scale of our programmes remains too shallow and too narrow to-date to deliver a game changing shift in our entrepreneurship support systems.
To compete in global markets, we will need active programmes to coach and nurse foreign and domestic entrepreneurs and SMEs on how to access foreign markets with their goods and services.
But we will also need programmes facilitating foreign entrepreneurs integration into the Irish system: from simple supports in terms of accessing basic services here, to tax supports, to legal supports and so on.

Fourthly, we need to drastically revamp our systems for accessing development and trade finance funding. We had volumes written about this in recent years by the Irish Exporters Association and other organisations and indeed by the analysts, like myself. And the Government has reacted positively to some of the proposals, despite the funding difficulties faced by the Exchequer. But, the proverbial carriage is still stuck in the same puddle of dysfunctional banking system and equity markets.

Fifthly, we need to stop penalising self-employment and sole-proprietorship in terms of income taxation and start rewarding early stage entrepreneurial endeavours. Our current model is "Higher Tax for Lower Benefits" and it is rewarding pursuit of PAYE job security and penalises pursuit of enterprise. An alternative currently on the table is a model of "Higher Taxes for Similar Benefits" which will continue to do basically the same injustice to early stage entrepreneurs. Addressing this imbalance between risk-adjusted returns to entrepreneurship and PAYE employment we need to eliminate self-employment penalty and streamline the system of tax compliance for the self-employed.

Sixth, we need to re-couple domiciling of innovation and use of innovation at business level. This applies to the MNCs trading from here, but also to Irish firms. The levels of innovation in our economy are still insufficient. The levels of meaningful utilisation of innovation, R&D and IP in this economy are still below where we would like to see them. We need to create a favourable regime for the firms that both on-shore innovation into Ireland for IP purposes, and deploy it on the ground here. This is tricky, I admit. But it is necessary.

Seventh, growth in the value-added of exports of indigenous firms cannot be contemplated in the environment where we are promoting volumes of sales over value, as, for example, in some agricultural sector outputs. We have to relentlessly drive up margins on our goods and services by pursuing higher valuations for our goods and services, even when such a drive implies increased business and investment risks.

Once again, the above are hardly an exhaustive list of things that must be done for Ireland to succeed in increasingly more competitive global environment.

The key themes that permeate the above remain, however, the same as before: Ireland needs to move to a more domestically-anchored, internationally open model of enterprise based on high value added outputs generation.

More open system of entrepreneurship and a greater focus on actual productivity, exponentially higher levels of products and services innovation, design and creativity, and more aggressive transition of enterprises to higher value added production are becoming the real differentiators for our competitors.

We must lead them, not follow.

23/9/2014: Nationalist Revival and the end of the Age of Great Moderation

Recently, I was asked to comment on the issue of emerging nationalism in the European and Eastern European (especially Russian and Ukrainian) context. Here is a paper that was produced for the discussion: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2499254

23/9/2014: Irish factory Gate Prices: Deflation and Inflation in August

CSO's latest data on monthly factory gate prices shows that producer prices rose 0.3% in August 2014 m/m and fell 2.0% y/y, moderating a y/y drop of 2.4% recorded in July 2014.

Exports prices rose 0.4% and home sales prices were down 0.3% m/m. However, y/y exports prices are now down 2.1% and home sales prices are down 1.4%.

Noting the effects of European agricultural products trends associated with Russian counter-sanctions, dairy products prices were down 2.4% m/m and meat and meat products prices fell 0.4% m/m. Outside sanctions impact, Beverages prices rose 2.7% y/y, basic pharma products prices fell 4.5% y/y.

Capital goods prices rose 1.3% y/y and 0.3% m/m, while energy prices fell 13% y/y, petroleum fuel prices were down 2.3%.

Given moments in inputs prices and outputs prices, business margins appear to be pressured by: forex valuations (primarily driving exports prices changes to the downside) and by ongoing domestic deflation in the private sectors. Margins were supported by some decreases in the inputs costs (energy) and offset by the increases in prices of capital goods.

Chart below shows the overall downward trend in producer prices for manufacturing sectors that has been established now from roughly Q3 2012.

But never mind the above... all is rosy based on Irish PMIs readings...

Monday, September 22, 2014

22/9/2014: Where TLTROs dare to go?..

Last week I wrote about the disappointing nature of the first round of TLTROs by the ECB (http://trueeconomics.blogspot.ie/2014/09/1892014-quite-disappointing-tltro-round.html). Now, some more evidence that TLTROs are at best replacing / swapping liquidity in LTROs maturities without materially changing the nature of the banks assets holdings. Remember, the objective of TLTROs is to inject funds into corporate lending, not sustain or increase flows of funds into sovereign debt markets... which means sovereign yields should not be falling in connection to TLTROs.

So guess what's happening?

H/T for the chart to @DavidKeo

The chart above shows several things:

  1. Both Spanish and Italian yields are falling across all maturities in excess of 1 year.
  2. The margin from lending to the Spanish and Italian Governments (yield on bonds less cost of TLTRO funds) is lower across all maturities post TLTRO issue than before.
  3. Margin declines are not uniform across maturities, and generally steeper at longer maturities. 
Are the banks taking up TLTROs pushing up prices of Government debt?.. That would mean more disconnection between the monetary policy objectives and outcomes, right?..

Sunday, September 21, 2014

21/9/2014: Irish Corporate Tax Policy: Some Leadership Needed

Earlier this week I gave a comment to TheCorner.eu on the issue of Irish corporate tax reforms and challenges:

21/9/2014: Ireland's Performance: Some Gains, Some Pains

Last week I gave a quick interview to Swiss Dukascopy TV. The link is here: https://www.youtube.com/watch?v=V9Qi9r-7PSE

Here are some of my notes for the programme.

Q: Ireland’s unemployment rate fell to five-year low of 11.5 per cent. Fitch restored its A grade to the Irish economy. Noonan believes the upgrade reflects significant progress made in repairing the economy. 

Ireland has shown some significant improvements in unemployment and jobs creation areas and the economy is now growing, at least in official accounts terms, in part driven by changes to GDP and GNP accounting standards. These are well-documented and there is little point of dwelling on the figures.

However, less noticed is the fact that the latest figures for jobs market and population trends remain worrying.

Unemployment, officially, eased to 11.5% as you mentioned. But broader unemployment remains stubbornly high at 21.6% if you include underemployed, discouraged workers and all others who want a job, but cannot find one. If you add to this figure net emigration of working age adults and those who are not counted as unemployed because they are engaged in State Training Programmes, underlying ‘jobless’ rate reaches even higher. Another problem is that the declines in broader measures of unemployment from the peak are running at just about 1/2 the rate of official unemployment rate declines.

People are still dropping out of the labour force. Official Participation rate fell from 60.5% in Q2 2013 to 60% in Q2 2014. This below historical average of 60.8%. The Dependency ratio rose, albeit marginally, in H1 2014 compared to H1 2013. Over the last 3 years of the recovery, dependency ratio remained unchanged at the levels well above historical averages, some 7% above the average currently.

The problem is that the economy is generating jobs, but these jobs are either lower quality - when they cover domestic sectors of the economy and especially agriculture, or high quality jobs in the internationally-trading sectors, where employment is generally being created for younger, international workers. As the result, long-term unemployment amongst older workers is stubbornly high.

So Irish economy is an economy of two halves: one half is the economy that is saddled with high debt burdens, slow growth and in some cases, continued contraction. Another half is the economy with more robust growth. The problem is much of the latter half is imaginary economy of Services MNCs shifting profits through Ireland with little impact on the ground. The first half - the suffering one - is the real economy.

Q: Ireland has lost nearly a quarter of a million young people in five years due to emigration. This is one reason why some are skeptical about the recovery as they believe that there are still not enough jobs. Do you think we have seen enough evidence, which shows significant improvement in the labour market?

Latest emigration figures are somewhat positive for Ireland. We have recorded a decline in net emigration in 12 months through April 2014. This fell from 33,100 in 2013 to 21,400 in 2014. Much of this is down to two factors: some jobs creation in the economy is helpful, but also due to immigration increase from the countries outside the EU. This is good news. Bad news is that this is the 5th year of continued net emigration from the country, matching previous record back in the late 1980s and 1990s. In numbers terms, things are worse than then. In 5 years of 1987-1991, 133,700 Irish residents left the country, net of those arriving. In the 5 years through 2014, the number is 143,800.

So the crisis is easing, but it still is a crisis. And increasingly, people who leave today are people with decent jobs, seeking better career and pay prospects abroad, fleeing high cost of living and taxes. This means we are losing higher quality human capital.

Q: What other positive improvements in the economy are you expecting to see and do you see any downside risks remaining?

On the positive side, we are seeing continued gains in activity in core sectors of the economy. Especially encouraging are the signs of ongoing revival in manufacturing. Services, when we strip out the superficial figures from the MNCs, such as Google, Facebook, Twitter etc, are still lagging, but I would expect this to pick up too. Investment is rising - not dramatically, but with some upward support forward. Much of this down to booming local property markets in Dublin. This is ok for now, as we have a massive lag in terms of supply of housing and even commercial real estate that built up over the years of the crisis. There is a risk of a new bubble emerging in the resale property markets, but this bubble is still only a risk.  Part of investment increase is also down to reclassification of R&D spending from being counted as a business expenditure prior to Q1 2014 to now counted as business investment. However, some indicators (PMIs and imports flows in capital goods and machinery categories) are pointing to a pick up in investment.

The downside risks are banks, retail interest rates cycle (potential for higher cost of servicing existent debt pile in the real economy - a risk that is still quite some time off), credit supply shortages (credit continues to decline in the economy and now we are seeing some downward pressures on deposits too). Beyond this, there is a risk of misallocated investment - investment flowing not to entrepreneurial activity, but to re-sale property markets - something that Ireland is always at a risk of.

I suspect that Irish economy will continue to grow at higher rates than the euro area for the next 12 months. But this growth will continue to come in at levels below where we need to be to actively deleverage our private sector and public sector debts.

Q: And what are the main trends we are witnessing in the Irish bond market right now? 

There is basically no longer any connection between economic fundamentals - as opposed to monetary policy expectations - and the sovereign debt markets in the euro area. Take Credit Default Swaps markets, for example: Irish CDS are at around 53-54 mark, implying cumulative 5 year probability of default of around 4.62%. That is for a country with debt/GDP ratio of over 120% and relative to the real economic real capacity measured by GNP at around 135%. Take a look at Italy, with moderately higher public debt levels and more benign private sector debts: Italy is running at a probability of default of 8.29%.

The markets expectation is for the ECB to deploy a traditional QE on a large scale through its Assets Purchasing Programme - currently being developed.

Problem is: eurozone (and Ireland with it) is suffering from a breakdown in lending mechanism, lack of transmission of low policy rates to retail rates and credit supply. This is not going to be repaired by a traditional QE. It is, therefore, crucial that the ECB deploys a functional ABS purchases programme and scales up its TLTROs and better targets them.

Irish bond yields were, for 10 year paper, down to around 1.8 percent in August from 2.23 percent in July. Yields declines are in line with the rest of the euro area and its ‘periphery’. Has there been any significantly positive news flow to sustain these valuations? Not really. We are in a de facto sovereign bond markets bubble. It can be sustained for some months ahead, but sooner or later, monetary tightening will begin, currency valuations will change, and with this, the tide will start going out. Who will be caught without their proverbial swimming trunks on, to use Warren Buffet's analogy? All economies with significant overhang of private debt - first, second, economies with significant government debt overhang. Now do the maths: Ireland is one of the more indebted economies in the world when it comes to private debt. And we have non-benign sovereign debt levels. We simply must stay the course of continued reforms in order to prepare for the potential crunch down the road.

Overall, Ireland is clearly starting to build up growth and employment momentum, even when we control for the accounting standards changes on GDP and GNP side. But risks still remain, of course. The next few months will be crucial in defining the pre-conditions for growth over 2015-2016. A steady push for more structural reforms, especially completing the unfinished work in protected domestic sectors and developing and deploying real, sustainable and long-term productivity enhancing changes in the public sector will be vital.