25/3/15: IMF on Ireland: Risk Assessment and Growth Outlook 2015-2016

In the previous post covering IMF latest research on Ireland, I looked at the IMF point of view relating to the distortions to our National Accounts and growth figures induced by the tax-optimising MNCs.

Here, let's take a look at the key Article IV conclusions.

All of the IMF assessment, disappointingly, still references Q1-Q3 2014 figures, even though more current data is now available. Overall, the IMF is happy with the onset of the recovery in Ireland and is full of praise on the positives.

It's assessment of the property markets is that "property markets are bouncing back rapidly from their lows but valuations do not yet appear stretched." This is pretty much in line with the latest data: see http://trueeconomics.blogspot.ie/2015/03/25315-irish-residential-property-prices.html

The fund notes that in a boom year of 2014 for Irish commercial property transactions "the volume of turnover in Irish commercial real estate in
2014 was higher than in the mid 2000s, with 37.5 percent from offshore investors." This roughly shows a share of the sales by Nama. Chart below illustrates the trend (also highlighted in my normal Irish Economy deck):

However what the cadet above fails to recognise is that even local purchases also involve, predominantly, Nama sales and are often based on REITs and other investment vehicles purchases co-funded from abroad. My estimate is that less than a third of the total volume of transactions in 2014 was down to organic domestic investment activity and, possibly, as little as 1/10th of this was likely to feed into the pipeline of value-added activities (new build, refurbishment, upgrading) in 2015. The vast majority of the purchases transactions excluding MNCs and public sector are down to "hold-and-flip" strategies consistent with vulture funds.

Decomposing the investment picture, the IMF states that "Investment is reviving but remains low by historical standards, with residential construction recovery modest to date. Investment (excluding aircraft orders and intangibles) in the year to Q3 2014 was up almost 40 percent from two years earlier, led by a rise in machinery and equipment spending."

Unfortunately, we have no idea how much of this is down to MNCs investments and how much down to domestic economy growth. Furthermore, we have no idea how much of the domestic growth is in non-agricultural sectors (remember, milk quotas abolition is triggering significant investment boom in agri-food sector, which is fine and handy).

"But the ratio of investment to GDP, at 16 percent, is still well below its 22 percent pre-boom average, primarily reflecting low construction. While house completions rose by 33 percent y/y in 2014, they remain just under one-half of estimated household formation needs. Rising house prices are making new construction more profitable, yet high costs appear to be slowing the supply response together with developers’ depleted equity and their slow transition to
using external equity financing."

All of this is not new to the readers of my blog.

The key to IMF Article IV papers, however, is not the praise for the past, but the assessment of the risks for the future. And here they are in the context of Ireland - unwelcome by the Ministers, but noted by the Fund.

While GDP growth prospects remain positive for Ireland (chart below), "growth is projected to moderate to 3½ percent in 2015 and to gradually ease to a 2½ percent pace", as "export growth is projected to revert to about 4 percent from 2015". Now, here the IMF may be too conservative - remember our 'knowledge development box' unveiled under a heavy veil of obscurity in Budget 2015? We are likely to see continued strong MNCs-led growth in 2015 on foot of that, except this time around via services side of the economy. After all, as IMF notes: "Competitiveness is strong in the services export sector, albeit driven by industries with relatively low domestic value added." Read: the Silicon Dock.

Here are the projections by the IMF across various parts of the National Accounts:

So now onto the risks: "Risks to Ireland’s growth prospects are broadly balanced within a wide range, with key sources being:

• "Financial market volatility could be triggered by a range of factors, yet Ireland’s vulnerability appears to be contained. Financial conditions are currently exceptionally favorable for both the sovereign and banks. A reassessment of sovereign risk in Europe or geopolitical developments could result in renewed volatility and spread widening. But market developments currently suggest contagion to Ireland would be contained by [ECB policies interventions]. Yet continued easy international financial conditions could lead to vulnerabilities in the medium term. For example, if the international search for yield drove up Irish commercial property prices, risks of an eventual slump in prices and construction would increase, weakening economic activity and potentially impacting domestic banks." In other words, unwinding the excesses of QE policies, globally, is likely to contain risks for the open economy, like Ireland.
• "Euro area stagnation would impede exports. Export projections are below the average growth in the past five years of 4¾ percent, implying some upside especially given recent euro depreciation. Yet Ireland is vulnerable to stagnation of the euro area, which accounts for 40 percent of exports. Over time, international action on corporate taxation could reduce Ireland’s attractiveness for some export-oriented FDI, but the authorities see limited risks in practice given other competitive advantages and as the corporate tax rate is not affected."
• "Domestic demand could sustain its recent momentum, yet concerns remain around possible weak lending in the medium term. Consumption growth may exceed the pace projected in coming years given improving property and labor market conditions. However, domestic demand recovery could in time be hindered by a weak lending revival if Basel III capital requirements became binding owing to insufficient bank profits, or if slow NPL resolution were to limit the redeployment of capital to profitable new loans." Do note that in the table listing IMF forecasts above, credit to the private sector is unlikely to return to growth until 2016 and even then, credit growth contribution will remain sluggish into 2017.

And the full risk assessment matrix:

Oh, and then there is debt. Glorious debt.

I blogged on IMF's view of the household debt earlier here: http://trueeconomics.blogspot.ie/2015/03/25315-imf-on-irish-household-debt-crisis.html and next will blog on Government debt risks, so stay tuned.

25/3/15: As Bogus Is, Bogus Does... IMF on Irish MNCs-led Growth

The IMF has published its Article IV consultation paper for Ireland and I will be blogging more on this later today. For now the top-level issue that I have been covering for some time now and that has been at the crux of the problems with irish economic 'growth' data: the role of MNCs.

My most recent post on this matter is here: http://trueeconomics.blogspot.ie/2015/03/24315-theres-no-number-left-untouched.html

IMF's Selected Issues paper published today alongside Article IV paper covers some of this in detail.

In dealing with the issues of technical challenges in estimating potential output in Ireland, the IMF states that "Irish GDP data volatility and revisions make it difficult to assess the cyclical position of the economy in the short-run. Ireland’s quarterly GDP growth data are among the most volatile of all European Union countries, more than twice the variability typically seen."

The IMF provides a handy chart:

And due to long lags in reporting final figures, as well as volatility, our GDP figures, even those reported, not just projected, are rather uncertain in their nature:

However, as IMF notes: other structural issues with the economy, besides poor reporting timing and quality and inherent volatility, further 'complicate' analysis:

"Multinational enterprises (MNE) accounting for one-quarter of Irish GDP can vary their output substantially with little change in domestic resource utilization. As shown in a recent study, MNEs represent only 2.1 percent of the number in enterprises in Ireland but slightly over half of the value added in the business economy. MNE output swings, sometimes related to sectoral idiosyncratic shocks (e.g., the “patent" cliff” in 2013...), can occur with little apparent change in
domestic resource utilization."

In other words, there is little tangible connection between output of many MNEs and the real economy. And the latest iteration of tax optimisation schemes deployed by the MNCs is not helping the matters: "The sharp increase in offshore contract manufacturing observed in 2014 is another example of such a shock. Such shocks to the productivity of the MNE sector may be best treated as shifts in potential GDP, because the result is a change in GDP without any significant change in resource tensions or slack in the
economy."

But MNCs are important for Ireland's tax base, right? Because apparently they are not that important for determining real rates of growth. Alas, the IMF has the following to say on that: "Swings in the value added of MNEs contribute substantially to variations in Irish GDP. Yet such swings are not found to have a significant effect on [government] revenues."


How big of an effect do MNCs have on the real economic growth as opposed to registered growth? IMF obliges: "The gross value added excluding the sectors dominated by MNEs behaves quite differently from aggregate GDP in some years. For example, in 2013 it grows by 3 percent at a time when official GDP data
were flat." In other words, the real, non-MNCs-led economy shrunk by roughly the amount of growth in the MNCs to result in near-zero growth across the official GDP.

However, since 2013 (over the course of 2014) a new optimisation scheme emerged as the dominant driver of manufacturing MNCs-led growth: contract manufacturing. IMF Article IV itself contains a handy box-out on that scheme, so important it is in distorting our GDP and GNP figures. Per IMF: "In 2014, multinational enterprises (MNEs) operating in Ireland made greater use of offshore
manufacturing under contract."

A handy CSO graphic illustrates what the hell IMF is talking about:

As covered in the link to my earlier blog post above, "Goods produced through contracted manufacturing agreements are treated differently in the national accounts than in customs measures of trade. As these goods do not cross the Irish border, they are not included in customs data on exports. If, however, the goods remain under the ownership of the Irish company, they are recorded as exports in the national accounts. Payments for manufacturing services and patent and royalty payments are service imports in the national accounts, offsetting in part the positive GDP impact of contracted manufacturing."

And to confirm my conclusions, here is IMF on the impact of contract manufacturing (just ONE scheme of many MNCs employ in Ireland) on Irish growth figures: "Contracted manufacturing appears to have had a significant impact on GDP growth in 2014 although it is difficult to make a precise estimate. Customs data on goods exports rose by 2.8 percent y/y in volume terms in the first nine months of 2014. In contrast, national accounts data on exports rose 12 percent in the same period. The gap between these two export measures can be attributed in part to contracted production, but could also reflect other factors like warehousing (goods produced in Ireland but stored and sold overseas) and valuation effects." Note: I cover this in more detail in my post.

"Assuming conservatively that contract manufacturing accounted for about half of the difference between customs and national accounts data, the implied gross contribution to GDP growth in the first three quarters of 2014 from contract manufacturing is 2 percentage points. However, there is a need to take into account the likelihood that service imports were higher than otherwise, but it is not possible to identify the volume of additional service imports linked to contract manufacturing."

One scheme by MNCs accounts for more than 2/5ths of the entire Irish 'miracle of growth'. Just one scheme!

And now… to the punchline:

Update: Seamus Coffey commented on the 2013 figure for domestic (real) economy cited above with an interesting point of view, also relating to the broader issue of the Contract Manufacturing: http://twishort.com/DTShc and his blogpost on the subject is here: http://economic-incentives.blogspot.ie/2015/03/the-growth-effect-of-contract.html

15/6/2012: IMF Review : Mortgages Arrears & Household Wealth

In the previous post I promised a closer look at the IMF analysis of the household wealth and mortgages in Ireland. Per Article IV consultation paper:

Mortgage arrears continued to rise as some households struggle with high indebtedness. 

• Household’s net wealth peaked in mid-2007, but has since declined by 37 percent largely due to the collapse in housing prices. 
• By 2011, households’ deleveraging efforts have reduced debt by 13 percent from its end 2008 peak. 
• Declining incomes have, however, meant the overall household debt burden has eased by only 3 percentage points to 208 percent of disposable income in 2011, although there has been some relief from lower interest rates. 
• Income declines, especially on account of the rise in unemployment, have also driven the increase in the rate of mortgage arrears on principal private residences to 10.2 percent of mortgage accounts and 13.7 percent of mortgage balances at end March 2012. 
• The share of mortgages that have been restructured—predominantly through payments of only the interest due or somewhat more—rose to 12.6 percent at end March 2012, but more than half of restructured loans are in arrears, indicating that deeper loan modifications are needed in some cases.

 More charts from the IMF:

In IMF news, rental yields are now closer to stabilization levels, but house prices are averaging 10 times average disposable per capita income, implying ca 4 times average disposable per-family income. In my view, prices will need to reach 3-3.5 times before the property market becomes affordable in the current conditions. This, however, is a longer-term target, with intermediate target being most likely even lower at 2.5 times (given credit conditions and general economic conditions). Also note, the above do not account for upcoming property taxes and for future reductions in disposable income due to tax increases.

Meanwhile credit condition remain horrible:

Chart above clearly shows that although interest costs and interest rates have declined, deleveraging did not take place. This stands in sharp contrast to the US and UK, where deleveraging of the households was more aggressively underpinned by bankruptcies and repossessions. Another issue is that declines in interest rate burden apply primarily to tracker mortgages.

Charts below highlight rapidly accelerating problems with mortgages defaults:

Chart above shows the decomposition of restructured mortgages, highlighting the extent of significant changes in the overall mortgages burden under restructuring (interest only 35%, below interest-only payments at 14%, payment moratorium at 4% and hybrid at 5%, implying that at the very least well over 50% of all restructured mortgages are not delivering on capital repayments).

15/6/2012: IMF Review of Irish Economy: Q2 2012

IMF latest outlook for Ireland. Not so cheerful reading after all. Quoting from the report:

• Growth prospects for 2012 remain modest at about ½ percent, unchanged from the fifth review. 
• Consumption is projected to decline by 1.7 percent as real household disposable income further weakens while the savings rate will likely remain elevated as households continue to reduce high debt burdens, although retail sales data for April suggest downside risks. 
• The decline in fixed investment is expected to continue, in part owing to fiscal consolidation, though at a slower pace than in 2011.  

Summary table:

Further quoting from the report [emphasis and comments mine]:

• An external recovery underpins the projected strengthening in growth in coming years, with support from a gradual revival of domestic demand, but there are significant risks. 
• Net exports are expected to continue to be the main contributor to growth in 2013–14, with support from further gains in competitiveness over time. [Albeit exports contribution to growth will effectively drop like a brick - from 4.5% in 2011 to 1.2% in 2017]
• Consistent with Ireland’s major banking crisis and ongoing fiscal consolidation, the revival in domestic demand is projected to be a protracted process, with a stabilization of demand in 2013, followed by a gradual pick up to about 2 percent growth by 2015–17. 
• Overall, growth is projected to average 2½ percent in 2013–17, which is low in relation to the scale of underutilized resources. [Re: unemployment staying very high and underinvestment continues rampant through the period].

There are, however, a range of interconnected risks to this outlook: 

• An intensification of euro area stress would heavily impact Ireland’s growth and the debt outlook through exports, and also through household and business confidence and spending, with adverse effects on financial sector health. [Not exactly 'just feta', then?]
• The gradual resumption in private consumption and investment growth starting in 2013 hinges on a combination of a bottoming out of housing prices, some pick up in lending to SMEs and the younger cohort of households with less debt [note stress on cohorts effects - supporting my continued insistence that, in effect, the current crisis and lack of Government support for deleveraging of households mean lost generation of highly indebted households], well targeted private debt restructuring over coming years, and public confidence that the crisis is being overcome, which will allow some easing in precautionary savings. [That is a motherload of 'ifs' there - all showing no sign of materializing any time soon.]
• Banks’ capitalization has been greatly strengthened, but their underlying profitability remained weak in 2011, reflecting the low quality of loan portfolios which include significant legacy assets. These factors could hinder a renewal of lending to households and SMEs including by limiting access to funding.
• Gradual recovery and slow reductions in unemployment could imply higher structural unemployment, limiting potential growth in the medium-term, and ongoing high youth unemployment could risk sustained high emigration. [Clear warning on human capital side].

In short, I can't read much of any conviction in the IMF view that the above risks will not overwhelm the economy in its current weak state.

Worse: "The structure of government debt, in particular the promissory notes, is a further challenge. ... [the] lack of burden-sharing on senior bank debt as part of the resolution process added to government debt, exacerbating the political difficulties with the annual payments of €3.1 billion due on the notes until 2023. In these circumstances, the authorities settled the payment due at end March 2012 by placing a long-term government bond with a face value of €3.5 billion with IBRC. The underlying set of transactions was complex and it is not expected that future promissory note payments can be financed in this manner. A more durable extension of the debt service schedule on promissory notes, matched by corresponding stability in the Eurosystem funding of IBRC, is needed to ensure the political sustainability of the substantial medium-term fiscal consolidation planned, and to significantly reduce market financing requirements in the medium term and thereby facilitate regaining market access."

So the 'Bad Cop' IMF is, as I always said before, still playing our side in the game against our wonderful 'European partners' who are screwing Ireland. Hmmm...

On debt: "Debt sustainability remains fragile, especially with respect to medium-term growth prospects. The debt path is projected to peak at 121 percent of GDP in 2013 and to decline to 111 percent of GDP by 2017. The upward shift in the gross debt path compared with the previous review reflects higher cash balances, which are expected to reinforce prospects for regaining access to market funding. The debt outlook remains sensitive to weaker growth, with debt rising to about 133 percent of GDP by 2017 if growth were to stagnate at 1⁄2 percent. Although the disposal of state assets and the planned sale of Irish Life could modestly lower the debt path, this may be offset to some extent in the next few years by potential outlays for restructuring the credit union sector."

Chart: 

Now, Green Jerseys love the number of 117% don't they... oops... IMF is sticking to 121%. Recall, Green Jerseys said in the past that debt < 120% is sustainable. Goodie, then...

IMF's overall review conclusions are:

• Ireland’s policy implementation has been consistently strong during the first half of the EU-IMF supported program, yet considerable challenges remain.
• The Irish economy remains weak, with real GDP broadly flat in the last three years.
• Labor market conditions may be beginning to stabilize, yet they remain adverse.
• The lack of employment opportunities is seen in the rising share of involuntary part-time employment, vacancy rates among the lowest in Europe, and the long- term unemployment share rising to 60 percent [note that this fully corresponds to my estimates and analysis of the 'broader' unemployment figures for Ireland - something that the Government comprehensively ignores.]
• Inflation continues to rise and is now closer to the euro area average [with energy accounting for three quarters of the increase and core inflation (mostly transport and insurance) contributing the remainder - in other words, IMF is noticing our Government's valiant efforts to gouge consumers by hiking state-controlled prices.]
• The current account was broadly balanced at 0.1 percent of GDP in 2011, and the unwinding of competitiveness losses continues. [Good news, but although a continued gradual decline in Ireland’s market share in goods exports suggests further improvements may be needed]
• Bank funding pressures appear to be easing as the overall level of deposits in the banking system has stabilized
• Mortgages - see follow up post, but core conclusion is that household deleveraging is simply not happening fast enough (see my forthcoming Sunday Times article on this)
• The PCAR banks are highly capitalized but report low profitability mostly due to weak loan quality [As warned in my Sunday Times columns]
• Exchequer situation - see follow up post but headline conclusion is: 
  Final data confirm the 2011 general government deficit was well within the program ceiling and Fiscal developments in the first four months of 2012 were in line with expectations.

Economics 16/7/10: IMF Article IV CP on Ireland: part 3

This is the third post on the IMF's Article IV consultation paper for Ireland. (The first two posts is available here and here).

V. THE FISCAL OUTLOOK AND CONSOLIDATION AGENDA

35. To counter the deteriorating fiscal position, the authorities moved early to make substantial, balanced, and lasting consolidation efforts. As the fiscal situation deteriorated and a large structural deficit emerged, the authorities acted repeatedly to take additional measures and raise the ambition of their fiscal consolidation goals. This was achieved in a remarkably socially-cohesive manner and represented a balance of economic and social considerations. The strong upfront measures are expected to yield a net adjustment of 5½ percent of GDP over 2009–10.

[The Fund is generally positive on the measures taken so far. However, in the chart at the bottom of page 22, the report shows the overall contribution to fiscal imbalances across various categories of spending and receipts. Picture 1 reproduces, with added details, the IMF analysis. Several things that are not covered by the Fund analysis stand out as significant omissions, most likely politically motivated. First, there is a very substantial role played by the continued deterioration in transfers (social welfare, health etc) which the Fund glances over. Second, public sector wages bill continues to represent further downward pressures on fiscal deficit despite the measures taken in 2009.
Third, noted (to the IMF credit) in the footnote on the following page, banks supports are likely to exert additional pressures in years to come. Per IMF: “A re-classification of a capital injection (2½ percent of GDP) as a capital transfer raised the 2009 deficit to 14¼ percent of GDP. In the first half of 2010, the government issued promissory notes worth 8½ percent of GDP to increase capital in one bank and two building societies. If these injections are considered capital transfers, the 2010 deficit would increase by this amount. As it would represent a once-off adjustment, it would not impact on the trajectory of the deficit for 2011. The further possible capital injection of 5 percent of GDP would add correspondingly to the 2010 deficit.”

Clearly, the Fund is not interested in making any predictions about the markets reaction to such an one-off adjustment. But one must wonder, if the Irish deficit shoots past 20% of GDP mark, even on one-off measures – what will our bond yields be at? And if 2011 brings about more capital injections into the banks, how long can these ‘one-off’ measures continue to hammer our deficits before someone, somewhere screams ‘The Irish Exchequer has no clothes!”]

[In the box-out on page 23, the IMF states:]

When adjusting for the impact of asset prices, the Irish structural deficit reached 8 percent in 2007, spiking to 12 percent of GDP in 2008. Spain and the U.K. also experienced sharp but smaller increases in structural deficits. However, after fiscal adjustment of 5½ percent of GDP, the Irish structural deficit is expected to decline to 8½ percent of GDP in 2010, while discretionary fiscal stimulus has raised the structural deficits in Spain and the U.K.

[Two things worth mentioning here. One: if the Bearded Ones of the Siptu/Ictu alphabet soup economics have their way, what would our structural deficit look like today? 8.5% is a hefty number. Recall that structural deficits won’t go away once economy is back on long term growth path. Second: at 8.5%, structural (long-term) sustainability of our Exchequer finances would require a combined reduction in expenditure, plus increases of taxation (assuming 50:50 split between the two) of roughly speaking a further €6.5 billion cut in spending and €6.5 increase in tax revenues. Given that roughly 700,000 households pay income, stamps & CGT taxes in this country, that would mean an annual tax bill increase of a whooping €9,300 per household. Does the Fund or the Government, or even the Bearded Ones think this is feasible?]

36. The 2010 budget adheres to the consolidation track, but risks remain. The authorities project the 2010 deficit to be 11½ percent of GDP. Because of lower nominal 2009 GDP than assumed in the 2010 budget and a weaker growth projection, staff projects lower revenues, leading to a deficit of 11.9 percent of GDP in 2010. The accounting treatment of the government’s equity injections into the troubled banks is still being determined but could raise the 2010 headline deficit substantially. The authorities noted that the associated fiscal outlays have already been incorporated into the official debt figures.

[Here is an interesting one. So banks-related outlays are in the debt figures already, but they are not in the deficit figures yet. How can Brian Cowen sit with a straight face in front of CNN cameras and tell the world that fiscal consolidation is working if Ireland Inc is heading for a deficit in 2010 that is vastly in excess of the deficit in 2009? And if he can, then why is DofF already factoring in the banks numbers into official debt? Gosh, it does begin to appear that we can’t even do a banana republic thing right.]


37. The remaining sovereign financing need in 2010 is limited. The average maturity of Irish treasury bonds is high—at 7½ years—and the rollover need is therefore limited. [That’s the good news…] For 2010, about three quarters of the planned government bond issuance (€20 billion) had been obtained as of June. The annual financing needs in 2011–12 are projected at about the 2010 level. The authorities maintain sizeable cash balances, financed by short-term debt, which could act as a buffer against any temporary difficulties in issuing long-term debt.

[Two things jump out: one the annual financing requirements for 2011 and 2012 are around €20 billion each. Which really means that the Government is not planning any substantial reductions in overall size of its expenditure. The con game of taking spending out of one pocket and shifting it into another pocket, while calling its transition from hand to hand a ‘saving’ will keep going on through the next elections… This explains why, for all our talk of ‘taking the pain’ the Government expenditure stubbornly keeps climbing up. Second, there is a quick sighting of the substantial additional costs of our overspending habits here. Short-term buffers kept by the DofF in order to insure ourselves against the possible tightness of the normal borrowing channels are ‘substantial’ per IMF. These buffers are subject to the higher risk of rising interest rates and also have no productive role in financing public spending. The costs of funding these buffers is a pure insurance premium we have to pay on top of standard borrowing costs in order to keep on rolling the vast social welfare/public spending machine we have created.]


38. Staff supports the appropriately ambitious fiscal consolidation plan through 2014 but cautioned that the required adjustment may be larger than projected by the authorities. The consolidation plan, outlined in the December 2009 Stability Programme Update, aims to reduce the deficit to below 3 percent of GDP by 2014. The plan envisages fiscal adjustment of 4½ percent of GDP over 2011–14, of which about 1 percent of GDP represents reductions in capital expenditures. The staff’s macroeconomic projections imply that the required medium-term adjustment could be larger than projected by the authorities. Starting from a higher projected deficit in 2010 and based on less optimistic macroeconomic projections, staff estimates that the adjustment need over 2011–14 would be 6½ percent of GDP, 2 percentage points of GDP higher than the authorities do.

[Quite a nasty turn for the ‘authorities’ here. The Fund clearly has little faith that the Irish Government can reach the set target of 3% by 2014. In fact, the IMF now projects that Irish Government deficits will be 5.9% of GDP in 2014 (driven by macroeconomic and target differences between DofF projections and IMF forecasts), with our debt to GDP ratio reaching 97.7% ex-banks supports in 2010 (5% of GDP additional to 8.5% announced in March) and 2011 (by my estimates around 5% of GDP). Worse than that – 5.2% of GDP will be our structural deficit in 2014 – a massive 88% of the total deficit.

A little footnote to the table on page 24 gives explanation: “The difference between the fiscal projections of the Department of Finance and the IMF staff is due in part to assumptions of lower growth on the part of the IMF staff. The IMF staff’s baseline fiscal projections for 2011–12 incorporate the adjustment efforts announced by the authorities in their December 2009 Stability Programme Update, although 2/3 of these measures remain to be specified. For the remainder of the period, the IMF staff’s projections do not incorporate the further adjustments efforts outlined in the Stability Programme Update.”

In other words, folks, in IMF terms, these projections include what has been promised but is not specified. And furthermore, the IMF doesn’t really believe anything this Government has set out to do beyond 2012 elections. They rightly suspect that any commitment of FF/Greens made before 2012 will face a serious uphill battle in implementation should the coalition fall apart.]

Economics 15/7/10: IMF Article IV CP on Ireland: part 2

This is the second post on the IMF's Article IV consultation paper for Ireland. (The first post is available here).

Several issues, previously stressed by this blog have made their way into Article IV – a good sign for those who read these pages regularly, and bad news for the Government. Emphasis is mine, throughout.

21. Given the sharp increase in leverage, this will be a drag on the pace of recovery. In order to achieve the required internal devaluation, some fall in Irish prices is necessary. However, in the transition to lower price levels, deflation will slow the pace of recovery. The debt of households and businesses, fueled by the low real interest rates before the crisis and with unchanged nominal values, has now to be repaid in an environment of falling prices, higher real interest rates, and low GDP growth rates. These factors lead staff to conclude that the normally-sharp bounce back to close the output gap after a large output decline will be muted on account of the deflationary drag.

[Let’s revisit the above comment of mine about the shocking state of economics understanding amongst the Irish ‘authorities’ (see the first blog post on Article IV paper). If the Irish authorities disagreement with the IMF on deflation is correct, then surely the state can drive up inflation in sectors it controls to the full extent of inducing deflation of our debt. No need to worry about, as the IMF does, about the adverse effects of deflation on debt sustainability. Alas, the IMF is much more sophisticated in its analysis. The Fund understands that in order to deflate our debt, Ireland will need inflation in capital goods and consumer goods. Not in state-controlled and economically unproductive services and sectors, such as health, public services, public transport, energy, etc. Inflation, you see, is not the same across all goods and services, contrary to what our economics bureaucrats might think.]

[Page 15 of the report shows two very good charts, similar to what I’ve been posting before. Irish households’ debt roughly, per IMF estimate, is ca 215% of our net disposable income, while Irish corporates’ debt (ex banks and financial corporations) is ca 160% of our GDP. Now, recall that our corporates are our GNP, which is roughly 24% below GDP. By both measures we are more leveraged than Spain and Portugal! We are, per these charts, darn close to being insolvent as an economy. But of course, there is not a peep from the IMF about Government programmes for addressing this core problem. For a good reason – there isn’t such a programme. Instead we have denials from all official sources that debt insolvency might be even an issue here.]

22. As banks emerge from the worst phase of the crisis, they remain weak. While capital ratios of the eurozone banks have risen since the crisis, they have declined for the large Irish banks. Banks’ reliance on wholesale funding—and, hence, high loan-to-deposit ratios—has yet to be corrected significantly. The ratio of nonperforming loans (NPLs) to all loans increased from ¾ percent at end-2007 to 9 percent at end-2009 and can only be expected to increase further, particularly if rescheduled loans fall into arrears. In the meantime, the ability to provision for these NPLs has declined sharply.

[Now, let me see. We, the taxpayers, have been taken to cleaners by the bank rescue measures. Something almost the size of our annual national income has been committed by the Government to underwrite the banks – from the implicit expected liability on the Guarantee to the explicit cash injections. Just this week our Taoiseach has gone as far as tell the banks: “Burn cash away, should you need more, we’ll give you as much as you need”. And for all that, the banks “remain weak”.

And notice the IMF statement on expected losses on loans. We are now beyond 9% (as of the end of 2009) and closer to 12% by the end of H1 2010. Recall that our Nama and Government assumed just 9 months ago – in October 2009 – that the banks losses will be on par with those experienced in the UK in the early 1990s – aka 10%. We are past this number already and the banks ‘remain weak’. In what book do these outcomes constitute a successful policy response? Stage three of the banking crisis, per IMF warning, is looming if ‘rescheduled loans fall into arrears’. In other words, all the toxic loans on the banks books back in 2007-2008 that were rapidly re-negotiated by the end of 2008, many of these ‘new’ loans come to the end of the repayment holidays and interest only periods and fall due for recovery around the end of 2010-2011. When these loans tank – and there is really no reason for them not to – the arrears will shoot up. Ask yourselves the following questions – are those billions committed to BofI and AIB and Nama taking into account those possible defaults? Not really. Why? Because for now, until the recovery begins, these are performing loans! So in real terms, the banks are not just ‘weak’ as the IMF says. They are potentially gravely sick.]


[But just how gravely ill are the banks? The IMF says the following:] 23. Liquidity pressures remain serious. The authorities estimate that over €70 billion (44 percent of GDP [or 55% of our annual national income]) of banks’ obligations will mature by September this year. …Irish banks have also been heavy users of ECB liquidity facilities. The stock of retail bank deposits has been either flat or declining.

[This is pretty dire, if you ask me. As noted by me on many occasions before, our banks are close to being the most over-leveraged in the entire developed world. So they are in the poor state when it comes to solvency issues. As the IMF above states, and many other sources – from BIS to many Irish observers, including myself – confirm: Irish banks are also illiquid. That’s like a patient who is brain dead and has no pulse. Dare to call that a corpse? I am no medical specialist, but something tells me that some shock therapy – Significant bondholders haircuts? National cash for equity swaps on massive scales? Debt for equity conversions with deeper haircuts on lenders? – is needed here.]

[But do recall that by now every Government Minister and almost every Governing Coalition TD have gone out on the record telling us that Nama will restore credit flows in the economy. Of course, people like myself, Brian Lucey, Karl Whelan, Peter Mathews, and a number of other observers were saying that this won’t happen. The IMF has said the same before. This time around on page 17 the state: “…staff analysis was cautionary regarding the ability of the banks to lend for a recovery.” And then on pages 18-19: “deleveraging to reduce the loan-to-deposit ratio and banks’ risk aversion will likely constrain lending and the pace of economic recovery, at least in 2010–11. Higher than expected losses, uncertainties in global regulatory trends, and renewed financial market tensions—that may restrict access to funding—create downside risks. In this environment, targets for SME lending, which have been imposed on two major banks in 2010–11, could have adverse effects on credit quality and hence require strong prudential safeguards, as the nonperforming loans of this sector have grown rapidly.”]

[Oh, my goodness, is that the IMF warning that politically motivated targets the Government has imposed on the banks for lending out in this economy might be… hmm… damaging to the banks objective of repairing their balancesheets? Indeed the Fund is concerned. As should be Irish taxpayers. After all, the taxpayers have been repeatedly and routinely deceived by the official statements as to the expected outcomes of Nama and banks recapitalizations despite having been warned by independent economists and bankers that their claims concerning restored credit flows will not materialise. Anyone to take responsibility for that?]

28. … Governance of NAMA is strengthened by its independent board. However, given the government’s large presence in the property market, implementing the provisions for the oversight of NAMA’s operations, is vital.

[Clearly, the IMF is concerned that outside of the main board of Nama, the structure itself is not provided with sufficient oversight, transparency and/or accountability. This is not surprising. Core Nama decisions-making committees are rigged up so as to exclude all and any external independent participation. Nama operations will have a limited and not subject to FOI ‘oversight’ only ex post the operational decisions are implemented. Nama strategy and decisions will not be subject to ex ante or contemporaneous oversight of anyone, save for Nama staff itself.

[It is also interesting to note that the IMF report makes absolutely no references to specific policies aimed at restructuring banking operations in the main two Irish banks. Paragraph 31 does attempt to pay lip-service to Government efforts to “reshape the system” but it so miserably fails to note a single implemented ‘reshaping’ measure adopted that it makes it clear that there has been no meaningful change in the ways Irish banks operate. This contrasts with more robust actions on the regulatory reforms side – paragraph 32.]


[Paragraph 34 is the ill-fated section of the report mistakenly identified by the Irish press as an endorsement of the idea of banks levy:] 34. To complement regulatory safeguards, and to reduce and meet the costs of future crises, a financial stability charge could be contemplated.

Such a charge would have two elements. A risk-adjusted levy, tied to a credible resolution mechanism, would provide resources for a resolution fund to be used for future crises. A financial activities tax, levied on the profits and remuneration (of senior executives) would represent a fair contribution from the sector to general revenues but also serve the purpose of reducing the sector’s size and, hence, its systemic risk. Such tax measures remain controversial but are being contemplated in a number of other countries. The authorities noted that Ireland would be guided by the evolving international practice and these initiatives may need to be deferred until more normal conditions apply.

[So let us summarize the argument here: the levies can be contemplated (not a ringing endorsement by the Fund of the idea) and their introduction will lead to a reduced size of the banking sector in the economy.

The latter, of course, would reduce banks’ ability and willingness to supply credit, thus limiting leveraged investment and growth. Now, that might be a fine objective to set for the future, but… how does it square off with the fact that we already have too constrained of a credit supply in the economy which, per earlier IMF statements, is choking off the recovery? Do you sense a contradiction here? I do.

Irish Times folks don’t. Actually, they can't even exactly reflect what the report says. Hence in today’s paper: “The Government should introduce a tax on senior bankers’ pay and bank profits to help reduce the risks the financial sector poses to the economy, according to the International Monetary Fund (IMF).” I failed to notice where the IMF says the Government ‘should introduce a levy’…

More from Irish Times: “It notes, however, that implementation of such measures may need to be deferred until more normal financial conditions apply.” Opps… it was the authorities – as in Irish authorities, not the Fund staff – who stated this to the IMF, as the above quote from the report itself clearly states.

In short, there is no ‘should’ to the banks levy, just ‘could’… which of course may mean that the Irish Government also could do a number of other things, some palatable in a civilized society, some not. Could does not equate to should, unless you are on a preaching podium, such as the Irish Times.]


More to follow, so stay tuned...

Economics 15/7/10: IMF Article IV CP on Ireland: part 1

Amended (hat tip to Paul MacDonnell & Mack)

IMF Article IV consultation paper on Ireland. Several issues, previously stressed by this blog have made their way into Article IV – a good sign for those who read these pages regularly, and bad news for the Government. Emphasis is mine, throughout.


This is the first post of several on the Article IV consultation paper for Ireland:

2. …the path from crisis to stability and recovery is a narrow one. With some reversal in the earlier loss of competitiveness and improvements in the global economy, exports will lead the recovery. But spillovers to the domestic economy will be limited because of exports’ heavy reliance on imports, their tendency to employ capital-intensive processes, and the sizeable repatriation of profits generated by multinational exporters.

[This is bang on with my assessment of the earlier Government noises about the exports-led recovery]

Moreover, the unwinding of home-grown imbalances from the boom years—arising from rapid credit growth, inflated property prices, and high wage and price levels—will create deflationary tendencies that act as a drag on growth. Banks remain a source of downside risks from higher than expected losses, uncertainties in global regulatory trends, and continued financial market tensions that restrict access to funding.

[Note the assessment of the banking sector problems – especially lack of available credit – this will come handy later on when I highlight the self-contradictory nature of the IMF assessment of the banks levy. This is an issue raised as central to the IMF Article IV analysis in today’s Irish Times, which missed the point that the IMF does not actually call for the banks levy, but stresses that it is a controversial measure that will lead to further reduction in credit.]

[So in brief, the opening part of the IMF report does not bode well for the Government claims that we are on a road to recovery. And crucially, it does not put much credit in our Government’s claims that the recessionary adjustments have led to restoration of Ireland’s competitiveness. It also cuts across majority of our economics commentators and some MNC leaders. In contrast, I have always stressed the fact that by most metrics, our competitiveness ‘improvements’ have been either totally invisible or tentative at best.]

3. Along the long-haul path to normalcy, retaining policy credibility will require demonstrated commitment and active risk management. The appropriately ambitious fiscal consolidation plan demands years of tight budgetary control. Likewise, the weaning of the banking sector from public support and its eventual return to good health will proceed at only a measured pace.

[The IMF folks have to be wondering what the hell has happened to our Government commitment when Brian Cowen negotiated the Croke Park deal that effectively prevents any meaningful reforms of our public spending into 2014. That was some ‘demonstrated commitment and active risk management’.]

In the interim, unforeseen fiscal demands may occur. In this context, at times heavily bunched banks’ funding needs and episodes of market volatility could generate unwelcome pressures and disruption. With limited fiscal resources for dealing with contingencies, maintaining a steady policy course will require mechanisms for oversight and transparency, and high-quality communication to minimize risks and sustain the political consensus and market confidence.

[We have seen this all before – in a number of IMF previous statements. What the Fund is saying here is very clear – given the distortionary nature of our banks guarantee scheme and Nama, the Exchequer remains heavily exposed to the moral hazard problem on the banks side. In this environment, one needs a vigilant Exchequer, willing to impose severe pain on the banks in order to keep them in line and prevent future over-loading of publicly guaranteed liabilities. The IMF doesn’t openly claim we don’t have one, but we really do know that we do not. The IMF instead insists on the need for proper checks and balances in the system in order to at the very least cushion the adverse impact of banks perverse incentives to pile on publicly guaranteed debts. But the IMF does not realise (or at least does not acknowledge) that Ireland’s Government and the Dail operate effectively without any real checks and balances. How else can a democratic country run on regular unscheduled appearances of the Minister for Finance to announce another round of banks funding with no real debate, real votes, real accounts given?]


6. The economy is projected to resume growth in 2010. Short-term indicators present a mixed picture of prospects. After a sharp rise in January, industrial production has pulled back. Goods exports are recovering from a weak performance in the second half of 2009. Sentiment measures have also shown improvement, but they incorrectly predicted a much stronger 2009:Q4 and do not as yet reflect the recent financial market tensions. Recent unemployment data were disappointing.

[Errr… we’v turned the corner, as Brian Cowen keeps repeating on international news channels]

Consequently, likely outcomes are in a larger than usual zone of uncertainty. Even as the economy recovers through the year, staff projects the GDP for 2010 to be ½ percent lower than in 2009, but with a q4-on-q4 increase of about 2 percent.

[In other words, April 2010 forecast remains untouched by the IMF. The Fund sees, apparently no ‘turn around’ that would require it to raise their forecasts. More importantly, the IMF also shows 2011 and 2012 projections for growth. Thus, DofF predicted in its SPU 2010 GDP growth of 3.3% in 2011 and a whooping 4.5% growth in 2012. IMF in contrast expects growth of 2.3% in 2011 and 2.5% in 2012. That’s a massive difference on DofF. And should IMF forecasts come true, Ireland Inc will require even more cuts in deficits in years ahead.]


8. The high and persistent unemployment reflects ongoing structural changes. The headline [unemployment] rate is likely to peak this year at 13¾ percent before declining to a still high 9½ percent by 2015. In addition to the cyclical component, the large increase in unemployment reflects significant structural changes with the unwinding of the boom years. The sharpest decrease in employment has occurred in construction and manufacturing. Some of these lost jobs may never come back, especially as the duration of unemployment increases, with the attendant depreciation of human capital and future growth prospects.

[Oh, and the IMF doesn’t hold much trust in Fas’ ability to retrain all those construction and manufacturing workers with relatively low skills and education into ‘knowledge economy’ workers? I wonder why… The key phrase here is ‘structural unemployment’ – the phrase that implies that no return to growth at the level of long term economic potential will ever reduce that portion of unemployment.]

Persistent unemployment may become a policy challenge going forward, and the younger generation could face discouragement and loss of human capital.

[Again, current policies do absolutely nothing to address this issue. We are facing education cuts, education grants for the unemployed are basically unavailable in real terms.]


10. The pace of recovery remains constrained by continuing imbalances. …By staff’s estimates, the potential growth rate will rise gradually to about 2½ percent by 2015 as the internal imbalances—arising from rapid credit growth, overvalued property prices, and high price and wage levels—are corrected.

[Again, nothing new here for the readers of this blog. I have been on the record for some time now saying that long term growth for Ireland should be around (and below) 2%. In my view, IMF estimate of potential GDP growth of 2.5% by 2015 is pretty much bang on with my view. Potential GDP is the trend line. If the trend line is 2-2.5%, while the economy experiences a long term structural underperformance, then long term growth average of 1.5-2% is highly probable. And this is exactly my estimate for Ireland 2010-2020.]

The analysis cautions that the Irish economy may be in a regime with the relatively-modest potential growth and the high unemployment reinforcing each other. The authorities recognize these dislocations but are more optimistic about the medium-term growth prospects. They judge that the traditional flexibility and international openness of the Irish labor market will provide a self-correcting mechanism towards more robust growth.

[This is really a damning statement. It contains two important things. First, the explicit statement that Irish Government is excessively optimistic in its forecasts and is basically ignoring the risk of twin shocks of unemployment and low growth capacity, despite being aware of them. Second, the IMF put it on the record that the entire long term Government recovery programme is based on the hope that large enough number of Irish people will emigrate to sufficiently reduce the labour force and unemployment. This is really equivalent to a country Government wishing for a natural disaster or a plague in order to reduce economic pressures through Malthusian per capita wealth model.]


13. Even before the crisis hit, the rapid rise of Irish wage levels and increasing global competition had diminished traditional Irish advantages. The departure of Dell, …to Poland in early 2009 was symbolic of a loss of edge in low-end manufacturing [amazing, Dell operates in High tech Manufacturing sector. To call its operations in Europe ‘low-end’ is most likely an honest admission by the IMF that what was going on in its Ireland facilities was nothing more than a 'screwdriver' assembly of imported components - aka a transfer pricing 'manufacturing']. Ireland’s share of the value of global and European manufactured exports, which had risen sharply between 1995 and 2001, fell steadily thereafter. In recent years, export growth has been sustained, though at lower levels than in the 1990s, by the repositioning of Ireland as a service exporter and “knowledge hub.”

[So we were not competitive up until now. Nothing new here, but a good reminder. Again, the bit about ‘knowledge hub’ is puzzling – Ireland doesn’t register on the international radar in terms of exporters of education services or healthcare. We do not export patents produced domestically. We do not ship much of indigenous software or biotech/pharma formulas. What ‘knowledge hub’ are we talking about that accounts for our services exports? Full 90+% of our services exports are MNCs, not indigenous firms.]


14. The recent decline in unit labor costs from their high levels will need to be sustained to close the competitiveness gap and make a material difference to growth prospects. …the high Irish price and wage levels will require a period of “internal devaluation” over the next few years to support export growth. …For now, however, unit labor costs have fallen primarily because of improvements in labor productivity. [Oh, sounds so great – we became more productive… err.. not really:] …the productivity increase reflects mainly compositional shifts in the labor force as the relatively-unproductive construction industry has contracted. Thus staff was concerned that productivity increases may not continue and, hence, the decline in unit labor costs to competitive levels is not yet assured. The authorities expect wage compression to continue on account of continuing weakness in and flexibility of the Irish labor market.

[Great, Mr Cowen’s plan to ship unemployed out of the country, while cutting wages for those remaining behind is working, then… Really, folks, this is IMF’s admission (in polite society terms) of our comprehensive failure to drive up productivity! On a side note – I have been running regularly updated posts on Irish competitiveness indicators based on data from CSO, ECB and CB, so stay tuned for more… And another side note, the IMF do not say anything explicitly about public sector wages, but on page 12 they show a chart that highlights the fact that wages in the public sector and industry (also dominated by unions contracts) have driven up wages across the entire economy in Q3 2009 relative to Q3 2008.]


16. Even with faster growth, the spillover from exports to the domestic economy will remain limited. An increase in Ireland’s exports, being highly correlated with an increase in imports, generates a much smaller increase in domestic value-added. Moreover, foreigners have large claims on the value-added generated in the export activity, as demonstrated by high correlation between the change in net trade and the change in income outflow on account of direct investment—the exceptions being the crisis years when imports fell for domestic reasons. Finally, Irish exporting activity has traditionally been relatively capital intensive, becoming more so with the downscaling of lower-skilled electronic assembly.

[In other words, the GDP/GNP gap is real and it matters to the economy, from the point of view of the IMF. I’ve said this all along. But the Government continues to insist that it collects tax on the gap as MNCs repatriate profits from Ireland. This is the joke that passes for our economic analysis. Tax we collect on profit earnings of MNCs is 12.5% after net deductions on transfer pricing through internal company billings etc. The same profits earned by domestic firms are recycled into the economy in form of dividends, wages, investment etc. Which means that while Exchequer earns at most 12.5% on MNCs profits, it earns multiples of that on profits from the domestic firms. This difference is further amplified by the fact that, as IMF also point out, MNCs are less labour intensive in production and returns on labour are taxed at much higher rates of income tax than returns on capital. It is frustrating to have to point these simple things out again and again in the face of denials from the official commentariate.]


18. The decline in prices reflects the high Irish price levels prior to the crisis and the collapse in domestic demand. Despite Ireland’s extensive trade relationships with the U.K., the depreciation of the British pound relative to the euro does not, in staff’s view, appear to be a primary source of the price decline. Irish import prices seem to have fallen after goods prices. Rather, Irish price levels were substantially higher than eurozone price levels prior to the crisis, mainly reflecting higher services prices but also higher goods prices (possibly because of the domestic distribution component).

[Finally, someone of IMF’s authority has confirmed what myself and a handful of other economists were saying for years – public sector-driven inflation (services such as education, health, sectors such as energy and transport) plus our Governments staunch resistance to introducing meaningful competition into retail and logistics (the Wal-Mart or Ikea effect) – are the core culprits in our prices being out of touch with our trading partners. Has anyone heard any discussion of reforming these bottlenecked areas of Ireland Inc’s economy from the Government? I haven’t. In fact, price inflation continues in state-dominated sectors. In the preceding paragraph, the IMF states that: “The annual pace of price decline was 2½ percent in April, but moderated to 1.9 percent in May, largely due to higher energy costs.” Guess who sets prices for energy in Ireland? Bingo – the Irish state.]

Ireland is currently among the most vulnerable nations to continued deflation. An index, capturing deflationary pressure based on indicators such as GDP growth, the output gap, the real exchange rate, equity prices, housing prices, credit growth, and monetary aggregates, suggests that Irish deflation is likely to persist into next year. After a 1.8 percent decline in prices this year, staff projects a further fall of 0.5 percent in 2011. The authorities expect inflation to turn positive next year. They view staff’s focus on domestic demand as unduly influenced by the experience of larger economies and, noting recent month-on-month price increases, emphasize that in Ireland’s small open-economy setting, exchange rate movements and short-run energy and food price increases would prevent further deflation.

[Again, the backward thinking of our ‘authorities’ is fully reflected in the above paragraph. The IMF staff concerns that deflation will continue are based on their view that Ireland is at a risk of continued slump in consumer demand and investment activities. The disagreement from our ‘authorities’ suggests that they think that charging higher food prices, gauging consumers on energy prices and raising the cost of living in areas where the demand is relatively price inelastic will be the good news going forward. This suggests that our ‘authorities’ really have no clue how economy operates in the real world. Shocking! But more on this in a second…]