Economics 29/06/2009:

IMF Report last week highlighted some pretty nasty sides to our policies of the past, present and the future. For those of you who missed my Sunday Times article this week, here is the unedited version:


“They who delight to be flattered, pay for their folly by a late repentance,” said Phaedrus of Macedonia some 2000 years ago. No matter how much our Ministers herald this week’s IMF report as ‘being supportive’ of the Government policies, these words can be a leitmotif for the international organization’s view of our economy.

The IMF clearly states that the bulk of our economic problems was predictable and stems from our own policies choices.

Structural deficit, notes the report reached 12.5% of GDP back in 2008. Now, even following the savagery of April supplementary budget, the deficit remains at 11% of GDP for 2009.

Profligate in spending, Irish authorities project deficits of 10.75% of GDP in 2009 and 2010 falling to 2.5% of GDP by 2013. IMF projects – as a benign scenario - deficits of 11.75% in 2009 and 12.75% in 2010, and 4% in 2013. Bang-on in line with my forecasts published in January 2009. And this is before we factor in our ongoing short-term borrowing binge and the costs of NAMA.

IMF staff’s baseline scenario implies “stronger expenditure consolidation than currently projected by the authorities”. Read: Minister Lenihan is off the mark in his fiscal consolidation exercise. Over 2009-2014 primary expenditures will have to be brought down by a whooping 9.5% of GDP – a cut of some €16.2bn against additional revenue raising of €4.3bn. A note: An Bord Snip is toiling overtime to reportedly cut just €4bn.

The balance between new taxes and spending cuts that the IMF suggests is so out of line with the Government approach two Budgets and two policy documents issued to date that it is impossible to interpret the Report as anything more than a motivational platitude that a senior scholar would accord to a not-too-bright student attempting a difficult proof. That Minister Lenihan failed to notice this irony is truly remarkable.

The IMF has a right to be critical of our policies. The Fund has been at the forefront of warning the Government about the problems we facing today. Annually, in Article IV Consultation Papers of 2003-2007 Fund analysts said that Ireland must focus on reforming grossly inefficient public services, stabilizing tax revenues, and deflating the property and public spending bubbles. Time and again the Government presented the IMF polite warnings as the marks of its approval of our policies. Cheers were sounded at numerous press conferences and nothing was done to address specific risk factors.

In its 2004 paper the Fund noted, that “Increases in public sector employment ...gradually inched up from a low of 3.7 percent in January 2001 to 4.8 percent by July 2003. Domestic demand was supported by the ECB’s easing of monetary policy and an expansionary fiscal policy.” Later, the Fund told the Government that “progress in improving public expenditure efficiency, controlling public sector wages, and increasing domestic competition has been limited.”

Throwing good money after bad to ‘improve’ public services as the Government preferred to do was never sustainable for the IMF: “the size of government [in Ireland] is not small in comparison with other OECD countries when compared to GNP, the more relevant measure of domestic economic activity.”

Bertie Ahearne’s response to this was to declare himself the last standing socialist in Europe and accelerate spending growth, triggering a wave of public sector waste. By 2007, Ireland became the country with one of the most generous welfare systems in the OECD.

“The ongoing rise in debt levels over the past decade has placed Ireland above the average of household debt-to-income ratio for Euro area countries, only surpassed by the Netherlands and Luxembourg,” said IMF in 2006.

Neither CBFSAI nor the Department of Finance stepped in to reign in this activity, despite IMF warnings. No tightening in reserve ratios or regulatory restrictions on excessive and risky loans took place. Capital to risk-weighted assets ratio has fallen from 14% in 2003 to 12% in 2005 for domestic banks. Contingent and off-balance sheet accounts have risen from 538% of total assets to 879%. Annual credit growth to private sector ballooned doubled to 29%. Today, the Government continues to promote our low public debt with no references to the private sector indebtedness.

In 2007 the IMF warned about the risks to our fiscal sanity: between 2003 and 2006, Irish real GDP grew by 22%, while real primary public spending rose 27%. Unfunded forward expenditure commitments have swallowed all existent and expected future primary surpluses.

Not surprisingly, this week, the IMF found that cyclical public deficit (the deficit that can be attributed to the world-wide recession) accounts for less than 30% of our total shortfall – in line with my own analysis published in August 2008. We are, as a nation, borrowing tens of billions of euros in order to pay grotesquely over-paid public sector employees their wages.

Perhaps the most perverted reading of the report by the Government concerned the IMF assessment of NAMA. Far from being an unguarded endorsement of the Government strategy, the report is tactfully telling our leaders to start thinking about the basics.

Per IMF, the main risks to NAMA are with pricing of the loans, post-NAMA recapitalization, narrowness of its remit and potential lack of flexibility. Protection of taxpayers’ funds is a serious concern. All these issues were raised by a number of critics of the Government approach to NAMA over the recent months. None have been addressed by the Government.

Crucially, the IMF sees a room for considering nationalization of the banks with shareholders taking full hit on their asset values. The IMF suggests that such nationalization can be triggered by either insolvency of the bank or by cash flow constraints. Given that the IMF estimates that some €34bn of the loans can end up in the rubbish bin, the cash-flow constraints that can trigger nationalization may apply to all major banks in Ireland. This is hardly comforting to the Government that categorically ruled out nationalizing well before it got to do the sums on NAMA itself.

Interestingly, a much over-looked sentence inserted in just two places in the report states: “A number of Directors considered that, for bank restructuring, other [than NAMA] options including a greater equity interest by the government should not be ruled out.” Given the current market valuations, any ‘equity interest by the government’ in our ailing banks would spell an outright nationalization to have any meaningful impact on the financial institutions. This hardly constitutes the IMF endorsement of the Government strategy.

On potential for NAMA success, the IMF says that “if well managed, the distressed assets acquired by NAMA could, over time, produce a recovery value to compensate for the initial fiscal outlays.” Note that the Fund says nothing about recouping the cost of final outlays: bond financing, managing NAMA, inflation or recapitalization post-NAMA. These lines of expenditure are likely to yield tens of billions in taxpayers’ losses.

In short, IMF report, even after rounds of ‘consultations’ inputs and delays by our officials, presents a picture of Ireland as a country that is yet to address the grave and domestically rooted policy disasters it faces – 22 months after the onset of the crisis. Hardly an endorsement we can be proud about.

Box-Out:
Another week, another bond offer from Ireland Inc. Last week, NTMA has sold a syndicated bond offer worth €6bn, with a whooping 5.9% annual coupon. The good news: it was a large issue and the maturity date for the new paper was 2019 – well away from 2012 and 2014 dates in previous two syndicated issues of this year. The bad news was the cost of the latest borrowing to the taxpayers. If the first €4bn bond raised this year was pricing each €1 in borrowed funds at €1.25, once expected inflation is factored in, the latest offer will cost us over €2.31 per each €1 borrowed. Not exactly a deal of a century. Another interesting feature of the syndicated bond offers to date is that the demand from banks, including Irish banks, remains very strong, covering more than 50% in all three placements despite continued problems in the banking sector. Funds allocations into Irish bonds rose steadily from 10% in the earlier offer to 26% in the latest placement. This can suggest two possible things. Either the fund managers re-discovering genuine interest in Irish paper or there is some sort of parking facility arrangement between the dealers and the issuer to store-up bonds for future use in NAMA-related transactions. Of course, one can only speculate…


And here are few quotes from earlier IMF reports on Ireland that did not make it into the article:

In its 2004 Article 4 Consultation Paper the Fund noted, in relation to the 2000-2003 period that: “The substantial contribution of multinationals to Irish output and associated profit flows creates significant differences between measures of output, and the recent cycles in GDP and GNP have not been synchronized. ...Increases in public sector employment ...gradually inched up from a low of 3.7 percent in January 2001 to 4.8 percent by July 2003. Domestic demand was supported by the ECB’s easing of monetary policy and an expansionary fiscal policy.”

Thus, the IMF was diplomatically telling the Government that by 2003 Ireland was running overheated housing markets, slowing productive sectors and unsustainable expansion in the public sector employment and spending. Per IMF “...steps toward improving efficiency in public transportation have been met with resistance by public sector unions,” clearly identifying the main obstacle to the path of public sector reforms in Ireland.

The Fund had also serious criticism of the rising levels of public spending in Ireland. Preserving the emphasis placed by the IMF itself, Article 4 document told the Government that “the size of government is not small in comparison with other OECD countries when compared to GNP, the more relevant measure of domestic economic activity in Ireland. Lower tax rates in Ireland as compared to the EU reflect favorable demographics, prudent fiscal policies that have delivered lower debt and debt-servicing costs, smaller defense requirements and lower unemployment-related social spending.”

2006 Article IV paper identified “several macro-risks and challenges facing the authorities. As the housing market has boomed, household debt to GDP ratios have continued to rise, raising some concerns about credit risks. Further, a significant slowdown in economic growth, while seen as highly unlikely in the near term, would have adverse consequences for banks’ non-performing loans.”

Government response to this was extending a range of property tax incentives schemes and encouraging banks lending. No tightening in reserve ratios or regulatory restrictions on excessive and risky loans took place. Indeed by 2005, regular capital to risk-weighted assets ratio has fallen from 15% in 2003 to 13.6% in 2005 for all banks, and from 13.9% to 12% for domestic banks. Contingent and off-balance sheet accounts as a percentage of total assets have risen from 538% to 879%. This deterioration in the quality of our financial systems took place against the backdrop of rapidly rising lending with annual credit growth to private sector balooning from 15% pa in 2003 to 28.8% in 2005.

In 2006 and later in 2007 the IMF staff “suggested broadening the tax base by phasing out the remaining property based incentive schemes, reducing mortgage interest tax relief, or introducing a property tax.” Despite agreeing with the staff, Irish Government has gone into 2007 election year with double digit growth in current expenditure and massive handouts to the pressure groups. The tax base was not only left unreformed, but new tax measures were introduced that pushed the state deeper into dependency of property tax revenues.

In September 2007 the IMF took a look at the quality of Irish Government targets delivery. Table A.1 of the report contains an often neglected line specifying the rising disconnect between the policymakers’ rethoric and the actual outrun. Between 2003 and 2006, Irish primariy surpluses rose from 1.1% to 3.4%. Over the same period of time, real GDP grew by 21.8%, while real primary public spending rose 27%.