Monday, January 18, 2010

Economics 18/01/2010: Sunday Times 03/01/2010

A friend just highlighted to me that I have not posted my articles for Sunday Times since late 2009. In the next few post, I will correct for this omission.

First, unedited version of January 3, 2010. Note the box-out - covering very interesting development on Nama.

Over the last few weeks, a new consensus has emerged on the direction for Ireland in the New Year. Caught in the headlights of the Government PR blitz post-Budget 2010, the media and our quasi-governmental economic commentariate (Quagec) have firmly forgotten the simple fact that the bottom of the economic canyon we find ourselves in will require much more than a wishful New year’s resolution on behalf of the Exchequer. It requires a miracle of decoupling from our Euro zone’s sick twin – Greece – in real economic terms to restore full confidence in this economy.

Throughout 2009, our policymakers grumbled that Ireland was unfairly treated by international markets. As our CDS and bonds spreads were moving in tandem with those of Greece, the sop story from our Quagec was: “Ireland has a better starting position in terms of lower debt burden and it has taken the necessary pain. We are much closer to Berlin than to Athens.”

This, of course, was nothing more than economic gibberish dressed up to sound impressive. Past performance is no guarantee of future returns. It is the prospect of the future that is driving our risk valuations instead.

So what are the New Year’s prospects for our fundamentals?

The Greek Government is aiming for a 2010 deficit of 8.7% of GDP, although Greek parliament has approved budgetary estimate of 9.7%.

Ireland’s Exchequer deficit in 2010 is likely to reach 11.6% of GDP or nearly 15% of GNP, given the prospect for another year of a widening GDP/GNP gap. These stratospherically high numbers do not account for the cost of recapitalising the banks and for Nama. Should even a half of the estimated banks recapitalization costs hit the Exchequer in 2010, our public deficit is likely to exceed that of Greece by 3.7 percentage points in terms of GDP and up to 7 percentage points in terms of GNP.

Behind these headline figures there are other multiple reasons for the deterioration in our fiscal position in 2010.

Rising unemployment will persist through the first half of 2010, imposing new burdens on our already mammoth social welfare bill. These costs will be multiplied by the ongoing and accelerating process of unemployment benefits claimants transitioning onto full social welfare benefits as their supplementary savings and redundancy payments are exhausted.

Irish Exchequer, unlike its Greek counterpart, will be facing a multi-billion euro claim in terms of recapitalizing the banks. This bill is expected to reach above €10 billion for the six guaranteed institutions on top of the costs of Nama.

In 2009 Ireland-based multinational companies have booked massive transfer pricing profits through their Irish operations. 2010 might this activity collapsing. Over 2010, the US and Asia-Pacific region are expected to re-enter the economic growth cycle. Traditionally, this involves a restart of investment cycle. This, in turn, means that the firms will place much lower importance on maximising tax efficiencies via their off-shore operations. The risks for Ireland Inc here are slower inward investment and lower tax revenues, with many of the jobs pre-announced by the IDA in its recent report potentially delayed.

Looking forward, 2013-2014 will see Irish deficits still exceeding those in Greece, even if the New Year’s resolutions by Minister Lenihan are delivered on target. The latter, of course, is doubtful.

Firstly, all Budget 2010 measures announced by the Exchequer are gross, not net, implying that no more than roughly 80% of these can be achieved in real terms once second order effects and automatic stabilizers are counted in. Secondly, Government public sector pay reductions are now coming into doubt with Irish public servants facing a real pay cut of no more than 3-4% for top grade officials.

Getting back to the real economy. For 2010 our officials are forecasting a 1.3% decline in GDP and a 1.7% fall in GNP. The risk here is to further downside. Should Ireland-based MNCs divert their activities to investing in rebuilding their productive capacity in world’s faster growing economies, the GDP might fall by another 0.1-0.2 percentage points. Should housing prices decline another 8-10% as my estimates suggest, the wealth effect alone will shave off 0.1% from our annual output. Unless consumer spending improves substantially, we might be looking at 2010 producing a fall in GDP to the tune of 1.5-1.7% and a decline in GNP of around 1.8-2%.

But what can be the driver of consumer spending increases in 2010? Sky-high taxes and a promise of more taxation rises in 2011 delivered by Minister Lenihan on the Budget Day? Or a hope for continued historically low cost of borrowing?

Don’t hold your breath for the latter. Starting with the first month of Nama operations – which might come as early as February – Irish banks will be increasing the cost of adjustable rate mortgages. The unfortunate souls who hold these loans will end up paying 50-75 basis points more over the course of 2010, regardless of what the ECB might do.

With the ECB widely expected to raise rates in the second half of the year, we might be heading for 2010 ending with mortgage rates priced at around 100 basis points higher than they are today. A new wave of mortgage defaults will be in the making.

Once again, the Greeks are hardly at the races when compared to Ireland’s house prices collapse, or to our stock market crisis to date, or even to our expected mortgage defaults yet to hit the banks in 2010-2011.

The real indicator of stability of our economy compared to that of Greece is the extent of non-financial sectors debts. In Ireland, this figure currently stands at over €1.16 trillion (roughly $570 billion ex-IFSC). Comparable figure for the Greek economy is $35.4 billion – 16 times lower than for Ireland. Irish total gross debt (inclusive of IFSC) was $2,387 billion in Q2 2009 – some 430% the size of the Greek.

All of this goes to prove two things. Firstly, throughout 2009, rational investors operating in fully functioning bond markets were correct in discounting Ireland alongside Greece as the two weakest economies in the Euro area. Secondly, no matter what you might hear in weeks to come from our Quangec, we far from having passed our hardest tests in the current crisis.


On Christmas eve, while the national news outlets were unrolling their festive medley of jolly carols and light entertainment, the Department of Finance has published a 2-page document, titled Nama (Designation of Eligible Bank Assets) Regulations 2009. The document’s objective was to define the assets eligible for transfer to Nama. Article 2 (a)-(d) state that Nama will be allowed to purchase at our, taxpayers, expense virtually any type of assets (short of credit card debts, but not personal loans or car loans) that are secured against some sort of development land asset. This covers pretty much every credit instrument known to man – from a plain vanilla loan to a structured credit agreement, all the way to a complex derivative contract. Even loans secured against equity shares in the undertaking to develop land, regardless of whether such an undertaking was primarily involved in property development or engaged in this activity as a side-show, will be eligible for taxpayers’ purchase. Undertakings that are eligible for such a treatment include not only plcs and established private businesses, but also opaque private partnerships and ‘over-night’ syndicates.

Take for example the infamous Glass Bottle site in Ringsend. The new edict means that the loans extended to developers and the investors engaged in a partnership, plus all the loans secured against the shares in the partnership and other concerned undertakings linked to the partnership, all and any other loans extended to anyone else who pledged as security any asset related to the site or its developers or investors are all eligible for the transfer.

In other words, the latest legal installment to Nama operational statues makes the state-financed bad bank a target for unceremonious dumping of all forms of toxic risky instruments from the banks balance sheet, regardless of claims seniority. And that, in turn, implies that Nama might end up holding conflicting security seniorities against itself. Good luck untangling that.

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