21/10/2014: Of Statistics: Ireland and ESA2010

Eurostat released a handy note showing revisions to euro area debt and deficit figures that arose as the result of conversion to ESA2010 methodology (yes, yes, that infamous inclusion of illicit trade and re-classification of R&D spending as investment, and much more).

You can read the full note here: http://epp.eurostat.ec.europa.eu/portal/page/portal/government_finance_statistics/documents/Revisions-gov-deficit-debt-2010-2013.pdf

And the effects are:

Government deficit revisions:

Click on chart to enlarge

One clear outlier in the entire EU28 is... Ireland. We had the largest, by far, downward revision in our deficit/GDP ratio of some 1.5 percentage points, pushing our deficit down from 7.2% of GDP (ESA95) to 5.7% of GDP (ESA2010) overnight. No austerity, just accounting.

We were similarly 'fortunate' on the debt calculations side:

Click on chart to enlarge

While revised actual debt levels rose, under new rules, the revised debt/GDP ratio fell due to GDP push up under the new rules. Lucky charms...

Per note, relating to deficit revisions: "Ireland (-3.1pp for 2010, -0.1pp for 2011, -0.1pp for 2012 and +1.0pp for 2013): the 2010 and 2011 deficits were  revised mainly for other reasons (than ESA 2010 introduction) and the 2012 and 2013 deficits mainly due to  introduction of ESA 2010. The deficit for 2010 was increased mainly due to reclassification of the capital injection  to AIB and the deficit for 2011 due to various reasons such as an adjustment to accrual calculation for PRSI,  health contribution and National Training Levy. The revisions in the deficit for 2012 and 2013 are mainly due to  the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central government. " 

Per note, relating to debt revisions: "Ireland (+12.2pp for 2011, +10.3pp for 2012 and +7.2pp for 2013): the revisions in the debt are mainly due to  introduction of ESA 2010: the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central  government as it became a government controlled financial defeasance structure in 2011."

So our actual debt rose. But our debt/GDP and deficit/GDP ratios fell:

Enron would be proud...

22/3/2014: Mind the Gap... Primary Balances Gap...

Here's a chart from Pictet showing precisely why all the austerity has been the case of too-little-to-date when it comes to stabilising debt ratios across the euro area:

And do note 'best in the lot' country of Ireland against the 'laggard' Italy... One wonders, how Messrs Kenny & Noonan are going to plug that gap while delivering tax cuts and jobs programmes?..

28/5/2013: EU Looks Into Bending Rules... Again...

Spiegel [http://www.spiegel.de/wirtschaft/soziales/vorschlag-der-eu-kommission-deutschland-kaempft-um-den-sparkurs-a-902198.html] reports that the EU Commission, as a part of a planned shift in the policy focus from austerity to structural reforms, will consider altering accounting rules per classification of fiscal deficits. The idea is that member states will be allowed to exempting certain types of government spending from the deficit calculations.

How this will work? Ok, insolvent state, like, say Greece, can borrow (somewhere) EUR X billion to use as a backing for its 50% share in matching EU Structural funds, thus raising EUR 2X billion for investment. The EU will then allow Greek Government to classify EUR X billion borrowings as aquarium fish and not deficit nor debt.

So
(1) EU thinks it is a grand idea to hide even more debt and deficit under the proverbial rug of 'accounting rules' bent to suit EU; and
(2) EU thinks that 'structural funds' deployment will be sufficient to 'stimulate' euro area economies out of structural balance sheet recession.

I suggest they (a) read up on why honesty and transparency matter in fiscal accounting and (b) read up on what happened in Japan where a stimulus ca 100 times larger than 'structural funds' one was applied to no avail.

Then again, the EU might also change the rules on reading, so the inconvenient reality does never interfere with the dreamy Enronising…

10/12/20111: Euro summit twin tests: deficits and structural deficits

In the wake of the European summit, it's worth taking a look at historical and projected future performance of the member states of the Euro area based on the parameters for fiscal sustainability.

First, consider historical performance of the Euro area member states based on the 3% Government deficit criteria. Charts summarize:

And a plot of all instances when Euro member states have fallen outside the 3% deficit sustainability criteria:

Let's summarize the above evidence:

As can be seen from the above, by the 3% deficit criteria, between 2000 and forecasted 2016,  only two states will have been in full compliance with the fiscal rule: Luxembourg and Estonia. Only two more state, Austria and the Netherlands, will see probability of falling outside the sustainability criteria below 30%. Seven Euro area states will have probability of not satisfying this criteria in excess of 50%. It is also evident, based on the IMF forecasts, that Ireland, Spain, Cyprus, Slovenia Belgium, Greece and France will have an uphill battle satisfying this criteria between 2012 and 2016. Ireland is by far the worst performing state in terms of required future adjustments with cumulative reductions required of 27.7% of GDP, followed by Spain with 21.8%.

Now, let us consider the 0.5% of potential GDP bound for structural deficits:

To summarize the above:

As shown above, with exception of Finland, no member state of the Euro area has been in compliance with this rule since 2000 through (forecast) 2016. The numbers for expected future adjustments required under this rule for 2012-2016 are horrific. Spain is the worst off country under this criteria, followed by Ireland, Cyprus and Slovenia. Things are also gloomy as the future adjustments go for all other countries, save Germany and, irony has it, Italy (due to the country lack of any growth potential), Netherlands and Portugal (same case as Italy).

In short, there is no real evidence that the Euro area can deliver on the targets set without

1. Running a truly depressionary level of fiscal adjustments over the next decade; 
2. Raising dramatically levels of sustained growth over and above current potential capacity in a large number of countries, but especially in Italy, Portugal and Greece, and
3. Exercising the levels of discipline that the Euro member states have not exhibited in their recent history.

5/12/2011: Two 'Austerity' charts

In previous two posts we covered Exchequer revenues and balance. Here is an interesting follow-up chart showing the dramatic swing in spending priorities of the Irish state:

And a neat chart summarizing the extent of our and indeed global 'austerity' (this one is courtesy of the OECD):

Pretty darn clear, no?

13/11/2011: Euro area - history of insolvency

Nouriel Roubini makes a very compelling argument as to the nature of the Euro area crisis - the nature revealed by unsustainable economic model based on running excessive external deficits and accumulating debt (see his blogpost here).

I have frequently referenced this problem to a deeper underlying force - the propensity of the European social democratic models to spend beyond their means. As the Euro area economies pursued populist agendas of 'social' services and subsidies expansion throughout the 1990s and 2000s, some (indeed majority) of the European economies stagnated, implying diminished capacity to sustain subsidies transfers within the vested interests-run Union. Thus, current account deficits - mask both Government and private sectors imbalances (with Governments in effect pumping the private economy with steroids of debt and cheap interest rates to extract tax rents that can be used to finance political largesse).

To see this, look no further than the links between Current Account deficits (external imbalances across entire economy - public and private) and Government deficits (fiscal imbalances), as well as Structural deficits (fiscal imbalances corrected for recessionary impacts).

Chart below shows cumulated current account deficits for 12 years since 2000 as well as cumulated structural deficits.

The striking feature of this chart is that over 12 years horizon, only 6 countries of the Euro area have managed to post a cumulative external surplus, while only one country (Finland) has managed to live within its means both in terms of external balance and fiscal balance. Any wonder that Finns are so opposed to the idea of 'burden sharing' that will see their surpluses transferred to the profligate states?

Another striking feature of the graph is that, contrary to Mr Roubini's assertion, France too was running dual external and fiscal deficits. Albeit, its deficit on current account side was small. Germany - another paragon of 'stability' run structural deficits on the fiscal side - i.e. spent beyond its means when it comes to Government expenditure outside that needed to correct for recessionary imbalances. Ditto for the Netherlands.

Ireland - our engine of 'exports-led growth' - is, alas, firmly NOT an engine of external balances. Cumulated current account deficit for the country is -19.5% of GDP. Any hopes for reversing 12 years of that experience, folks, will require re-wiring of our economy, preferences, political and institutional structures etc. Good luck getting there before the whole house of cards comes tumbling down.

In fact, deficits are sticky - hard to reverse. Past deficit experience, it turns out, shapes much of the future achievement, as illustrated in the chart below.

Once you are insolvent for a decade (1990s) you are likely to remain insolvent for the next decade too (2000s). And, hence, the headwinds against us (Ireland) reversing that and moving into strong surpluses on current account in years ahead are strong. Not that they can't be overcome. If we look at transition from 1990s external balance position to 2000s position, the following holds:

• Finland and the Netherlands stand out as the only 2 countries that managed to improve their surpluses on the current account side between 1990s and 2000s averages
• France, Belgium and Luxembourg are 3 countries that managed to retain surpluses, but weakened their performance between 1990s and 2000s
• Malta was the only country that managed to reduce its external deficits between 1990s and 2000s in terms of averages
• Portugal, Greece, estonia, Cyprus, Slovak Republic, Sapin, Ireland, Slovenia and Italy all saw average deficits of the 1990s deepening in the 2000s
• Only two economies - Austria and Germany have managed to reverse previous deficits (in the 1990s) to surpluses in the 2000s. 

That means that, historically, a chance of reversing average current account deficit in the previous decade to a surplus in the next decade is 2/17 or less than 12%. not an impossible feat, but an unlikely one.

And current account deficits do appear to relate closely to the General Government deficits and Structural fiscal deficits as the two charts below show (note of caution - the equations estimated below are imprecise, of course, due to small sample).

At last, a table to summarize:

Yep, insolvency - of the deepest (across all three measures) variety is the domain of 10 out of 17 member states when it comes to the last 12 years of Euro area history. Another 5 member states are insolvent by two out of three criteria. Lastly, only two member states - Finland and Luxembourg - were actually fully solvent since 2000.

That, folks, makes for a rather spectacular failure of the Euro area institutional design.

31/10/2011: Europe's latest blunder

This is an unedited version of my article in October 30, 2011 edition of Sunday Times.

This week was a fruitful and productive one for Europe’s leaders. Not because the battered euro block has finally produced a feasible and effective solution to the raging debt, fiscal and banking crises sweeping across the common area, but because they spent the entire week doing what they do best: holding meetings and issuing communiqués.

The latest plan, unveiled this Wednesday, shows once again that the EU remains incapable of actually doing what needs to be done.

The real European disease is debt. Too much debt. Based on the latest IMF forecasts and statistics from the Bank for International Settlements by the end of 2011, combined public, household and non-financial corporate debts will reach 280% of GDP in the US. In France, the Netherlands, Sweden and Belgium, this number will be closer to 330-335%, in Italy – 314%, in Greece – 290%, in Portugal 375%, in Spain 360%, and in Ireland a whooping 415%.

The composition of these debts, and in particular the weight of public sector debts in total non-financial debt overhang, may differ, but the end result is the same for all of the above. Per August 2011 research paper from the Bank for International Settlements, combined private sector debt in excess of ca 250% of GDP results in a long term (aka permanent) reduction in future growth rates. This reduction, in turn, puts under pressure the ability of the indebted states to repay their obligations.

Further compounding the problem, European banking systems have become addicted to Government bonds as a form of capital. In the past, this addiction was actively encouraged by the Governments, regulators and the ECB. With the latest proposals in place, we are likely to see even more Government/EFSF debt piling into the banks in the long term.

Having ignored basic risk management rules, banks across the Euro area are now fully contaminated with their exposures to sovereign bonds that are about as bad – from the risk perspective – as the adjustable rate mortgage borrowers in the US. Based on the second set of stress tests carried by the European Banking Authority this summer, Greek haircut of 75%, as suggested by the IMF, against the core tier 1 requirement of 9% will imply a capital shortfall of €180 billion. Failing to recognize this, the EU plan unveiled on Wednesday calls for just €100 billion recapitalization under a 50% haircut.

This, of course is far too little too late for Greece and for Europe overall. To bring public debt to GDP levels back to the point of fiscal stabilization (under 100% of GDP) will require ca 20% write-down in Portugal, 40% in Italy, and 30% in Ireland. Europe’s problem is at least €730 billion-strong. It can become bigger yet if – as can be expected – Greece fails once again to deliver on prescribed fiscal adjustment measures and/or the write-downs trigger CDS calls and/or the credit contraction triggers by the measures leads to a new recession. All in, Euro area needs closer to €820-850 billion in funding in the form of both rights placements, assets disposal, and government capital supports.

Now, factor in the second order effects of the above numbers onto the real economy.

Injecting €820 billion in new capital or, equivalently, providing some €1 trillion in fresh capital and bonds guarantees as envisaged under the EFSF proposals being readied by the European officials will increase broad money supply by 10%. This is consistent with long term ECB rates rising to well above their previous historical peak of 4.75% - triple the current rate. European banks trying to raise new capital and deleveraging foreign assets will saturate equity markets across Europe with capital demand. Reduced banking sector competition, pressures on the margins and higher funding costs will push retail rates into double-digit territory.

For European companies – more addicted to debt financing than their US counterparts and now competing for scarce equity investors against their European banks – this will mean a virtual shutting down of credit supply. Starved of domestic credit, European multinationals will aggressively divest out of the Continent and pursue jobs and investment growth in places where capital is more abundant – the US and Asia.

As Paul Krugman recently said, “The bitter truth is that it’s looking more and more as if the euro system is doomed. And the even more bitter truth is that given the way that system has been performing, Europe might be better off if it collapses sooner rather than later.”

Sadly, Krugman is correct. European cure proposals to the crises are worse than the disease itself and the Wednesday’s proposals for dealing with the crisis are case in point.

Firstly, banks recapitalizations – first via private equity raising and bond-to-equity conversions, then via sovereign/EFSF funding – risks extending the recapitalization procedures into the second half of 2012 and simultaneously increase the risk premia on banks funding. In other words, credit crunch is likely to get worse and last longer. Most likely, this will require additional guarantees to ensure the funding market does not collapse in the process. The ECB balance sheet exposure to peripheral banks and sovereign debts – currently at €590 billion, up from €444 billion back in June 2011 – will become impossible to unwind.

Secondly, the insurance option for sovereign bonds issuance is likely to be insufficient in cover and, coupled with greater seniority accorded to EFSF debt can lead to a rise in yields on Government bonds. This, in turn, will amplify pressure on countries, such as Spain and Italy which are facing demand for new bonds issuance and existent debt roll over of some €1.3-1.5 trillion over 2012-2014.

Thirdly, leveraging EFSF to some €1 trillion via creation of an SPIV (Special Purpose Investment Vehicle) will create a nightmarishly complex sovereign debt structure.

Under leverage EFSF option, a country borrowing from the fund €1 billion will receive only a small fraction of the money directly from the fund itself, with the balance being borrowed from international lenders that may include IMF. In order to secure such lending, the EFSF will require seniority for international lenders over and above any other sovereign debt issued by the borrowing state. This will de facto prevent the EFSF borrower from raising new funding in the capital markets in the future.

In all of this, Ireland is but a small- albeit a high risk – player with the power to influence some of the EU decisions, especially those that matter most. Alongside the EFSF reforms and banks recapitalizations, the EU will require stronger fiscal and sovereign debt oversight measures, and ultimately closer integration.

The Irish Government should make it clear from the earliest date possible that Ireland’s participation in this process is conditional on three measures. First, Irish banks debts to the euro system should be written down to the tune of €60-70 billion, allowing for clawing back some of the funds injected into banks as capital and providing a stronger cushion for a households’ debt writeoff. Second, we should demand that the debt-for-equity swaps explicitly encouraged as the means for recapitalization of the euro area banks in Wednesday agreement be applied to Irish banks. These swaps can be used to further reduce previously committed funds and reverse some of the debt accumulated by the Exchequer (on and off its balancesheet). Third, Irish Government should make it unequivocally clear that we will veto any tax harmonization in the future.

On the net, European solutions unveiled this Wednesday are simply not going to work. In Q1 2012 the latest recapitalization of Euro area banks and Greece will run out of steam. Next time around, this will happen in the environment of slower growth and possibly a full-blown recession with Spain, Italy and Portugal all running into deeper fiscal troubles. The real price of Europe’s serial failures to deal with the crisis will be the real economy of the euro zone.

Box-out:

This week’s CSO-compiled Residential Property Price Index (RPPI) had posted another 1.49 percent monthly fall in house prices nationwide. Exactly four years ago, at the peak of residential property valuations, RPPI stood at 130.5. At the end of September this year, the index was just 72.8 or 44 percent below the peak. The misery of falling prices is now impacting not only hundreds of thousands of negative equity mortgage holders, but even the all-mighty Nama. Nama referenced its original valuations of the assets it took over from the banks to November 30, 2009. Since then, residential prices in the nation have fallen 29.5% and apartments prices (the category of property more frequently related to Nama loans) have fallen 33.9%. All in, Nama will now require a 35% uplift on its assets (55% for apartments) to break even, not including the organization’s gargantuan costs of managing its assets.