12/7/2013: IMF Report on Malta: A Warning for Ireland

IMF Report on Malta is out, with, as expected, much of attention given to the risks of erosion of the tax advantages that form one of the core drivers for Malta's growth. This, of course, is of interest to other European jurisdictions, including Ireland.

IMF opens the report with a statement that Malta (emphasis in italics is mine) "has maintained macroeconomic stability in the face of a major crisis in Europe. Low reliance on external finance by the government and domestic banks, solid fundamentals, and a sound banking system have contributed to this resilience. However, recent events in Europe have heightened financial stability risks. In the longer term, Malta’s attractiveness as a financial and business location could be adversely affected by regulatory and tax reforms at the European level. "

"The Maltese economy has greatly benefitted from a business-friendly tax regime… Although these gains are hard to quantify, the large increase experienced in financial services [parallels to our IFSC anyone?] and other niche activities [in Malta's case: online gambling. In Ireland's: all IP-linked tax arbitrage, e.g. Google et al] since 2004 are likely related to Malta’s accession to the EU [which means Ireland is hardly unique here], its macroeconomic stability [which Ireland spectacularly does not have], and relatively favorable tax regime [bingo!]. Over the last ten years, more than half of the growth in value added is explained by the growth in financial services, ancillary activities (legal, accounting, and consulting), remote gaming, and ICT [wait, wait… but Dublin?… replace remote gaming with pharma - worse]. These sectors alone account for a quarter of total value added and 12 percent of employment [err… even more in Ireland and growing, again - replace remote gaming with gaming and… worse in the case of Ireland]. It is possible that greater fiscal integration of EU member states and a potential harmonization of tax rates could erode some of these benefits, with consequences on employment, output and fiscal revenues."

The risk is medium in size, medium/low in probability of materialisation and medium term - per IMF:

And thus, the report states that "The authorities were also of the view that an EU-wide tax harmonization would not happen in the short or medium term." However, let me ask you a simple question - how often does the IMF directly and bluntly pointing actual risks to the euro area states? After they have fully materialised, only. Hence, IMF stating the politically-sensitive and structurally important risk is 'medium/low' in likelihood and 'medium' in expected impact is as stern of a warning as one might expect. At any rate, of 6 main risks faced by the Maltese economy, the risk of tax regime changes is ranked joint 3rd with the risk of Protracted period of slower European growth, Significant declines in real estate prices, and ahead of the risk of Global oil shock triggered by geopolitical events.


Why such downplaying of the risks?

"Malta has been an important international banking centre in the past 25 years. A special offshore regime for banks (and other non-bank institutions) was promoted since the late
1980s. Like in several other European jurisdictions (Cyprus, Ireland, Luxembourg, or Switzerland), the main incentives offered to foreign investors at that time included exemptions from various regulations imposed on onshore banks and a favorable fiscal treatment."

How bad?

"The separate offshore supervisory framework was eliminated in 2002. As part of the planned accession into the EU, Malta was required to amend its financial policies to treat local businesses the same as international companies. In the mid-1990s, Malta started abolishing its offshore banking. In 2002, the legal amendments to the Banking Law removed an offshore banking option. Since then, all banks operate under the same regulatory and fiscal frameworks."

Spotting a picture of Dublin's IFSC, yet?..

"However, Malta maintained a substantial tax incentive for attracting foreign investors
in its banking and other businesses. This was achieved through tax refunds based on the
dividends that a local bank distributes to its shareholders. While the headline corporate income tax rate in Malta is 35 percent, the application of a tax refund system positions Malta as the country with one of the lowest effective tax in the EU, which ranges between 0 and 12 percent. The quantum of the tax refund depends on the nature of income and is generally equal to 6/7th of the underlying tax (35 percent), resulting in a 30 percent tax refund of the taxable profits."

Of course, Ireland does not provide such refunds - instead we have a Mega 'Refund' System called Double-Irish.

"In addition, the EU accession in 2004 and the euro adoption in 2008 boosted international banking and non-bank financial sector activities in Malta. Several large banking groups from various countries around the world (Australia, Germany, Saudi Arabia, etc) established their presence in Malta since the mid-2000s. The EU and euro area memberships inspired confidence; the former also allowed non-EU investors an easy access to European markets, while the latter facilitated transactions for EU-based investors. The availability of skilled people and the use of English as the official language also contributed to making Malta an attractive place for doing business by the multinational banks."

You have to laugh reading the above, as you can just replace Malta with Ireland there and nail the regular IDA presentations…

"As a result, the internationally-active banks have become large compared to the size
of the Maltese economy. As of October 2012, there were 13 non-core domestic banks and
8 international banks, with assets of respectively €5.3 billion (80 percent of GDP) and €33.1 billion (500 percent of GDP). The majority of these banks are subsidiaries of EU banks offering a range of services to non-residents that include trade finance, investment banking, and group funding operations."

"Unlike some other EU countries with a big international financial centre (for example,
Cyprus or Ireland), Malta has not experienced any deleveraging pressures in recent years. As a result, measured by the total bank assets to GDP ratio, Malta now ranks higher than Cyprus or Ireland, and is second only to Luxembourg among all EU countries."

Problem, Roger, is that the above statement is pretty much bonkers. Ireland has deleveraged not tax-sensitive international banking sector, but tax incentives-insensitive domestic sector. Cyprus 'deleveraged' deposits. So from the truth-in-analysis point of view, one should look at the compatible assets and liabilities at risk of tax regime changes. And that is much harder, as a large part of Irish internal assets and liabilities is really IFSC, while part of Malta's external assets and liabilities is domestic economy.

All in - the risk is real. This is why IMF (having downplayed it to medium) still posits it as the fifth most significant in overall terms.

Ireland should be seriously concerned.

Note: I wrote about the threats to Ireland from tax policy harmonisation most recently here: http://trueeconomics.blogspot.ie/2013/07/272013-sunday-times-june-23-2013-g8-and.html
And I wrote about Malta's tax dilemma and IMF analysis of it before, here: http://trueeconomics.blogspot.ie/2013/05/1552013-what-imf-assessment-of-malta.html

Economics 23/05/2010: To Infinity & Beyond

As a harbinger of good news I bring to you all... Ah, what the hell, here is the announcement:
And actually this is the good news - Infinity is the leading international finance academic/practitioner conference in Ireland and it is great to see it back in town this year. It is a truly international venue (as in actually attracting real, not invited & paid-for, experts and speakers, with real - not imaginary or self-appointed - clout in global finance) and it carries hundreds of latest research papers with the focus on different areas of international finance.

Few notes of worth:

• Patrick Honohan will open the proceedings - Patrick, of course, has spoken at Infinity before, in his academic capacity, reviewing papers and presenting them. Two years ago he launched a session that introduced the book myself, together with Sharon Jackson and Colm Kearney edited and co-authored on the issue of Global Debt problems. He will, undoubtedly, engage with the audience of peers this time around.
• Bill Megginson, the University of Oklahoma will present on “The Value of Investment Banking Relationships: Evidence from the Collapse of Lehman Brothers”. We should ask him few questions as to his view of the Irish Government claims that Lehmans' collapse was responsible for our gravely ill banking sector, instead of the homemade hash of senile lending practices.
  
• Simon Stevenson, Director, Center for Real Estate Finance, City University London; Derek Brawn, Property Economist and Author; Peter Matthews, Banking Consultant and myself will be talking about Real Estate Finance - so expect myself and Peter getting stuck into long term effects of Nama on this vital (for Ireland Inc) sector, while Simon - one of the world's preeminent and prolific researchers in the area (and a good friend and co-author) - will be on hand to tie it all into international markets framework. Simon, by the way, has really first class knowledge of Irish markets as well - just one example of his recent work includes the paper that James Young and myself co-authored with him on property auctions in Ireland, forthcoming in the Journal of Housing Economics (number one venue for academic research in the field of property).
  
• Edward J Kane, Boston College, USA will speak about the “Post-Crisis Financial Reform as Denial and Coverup” - a salient topic given the current state of regulatory reforms proposals coming out of the EU. Judging by the strong title, this is not going to be one of them placid academic discourses on how to find a "balancing act" or "resolve the problems of injustice and equity in financial services"...
  
• On a practitioner interface side: “Investments in the Post-Crisis World” a roundtable organised by CFA Ireland and moderated by Aleksander Sevic of Trinity College Dublin, will be dealing with: “An Update on Latest Trends in Fund Offerings” by David Hammond, CFA, Bridge Consulting; “Major Challenges in Allocations to Irish and Emerging Markets’ Equities, Liquidity Risk and Product Innovation: The Perspective of a Pension Fund Trust” by Stephanie Condra, CFA, Invesco Pension Consultants; “An Update on Current Issues in the EU Government Bond Market” by Catherine McLaughlin, CFA, Irish Life;
  
• For those interested in CDS bond spreads - the hot potato in today's media and politicos discussions - Brian Lucey will be presenting a paper (in which yours truly is one of the co-authors) "CDS Bond Spreads among the PIIGS 2006-2010"

Ok, enough of praise singing - couple of links: programme for Infinity is available here. I intend to blog and twitter on it during the proceedings. I also intend to do one or two interviews with top participants - hopefully might convince Business & Finance to run something on this.


Finally, in a note of custom for this blog - Infinity is a fully self-financed conference, built on work of Brian Lucey, Linda Sorinton and others in TCD School of Business, excellent researchers like Elaine Hutson of UCD and many others. Many involved are co-authors in academic life, so all discussions are frank, open and usually free of agendas. Infinity has no reliance on subsidies of any sort. Unlike many other 'specialist' or 'futurist' conferences out there, richly sprinkled across Irish calendars. So no taxpayers funds will be harmed in the preparation of this event - an example of real academic sustainability!

Economics 14/11/2009: Irish Insitituional Accounts 2008

CSO is not the quickest of institutions when it comes to timely release of data, so when it comes to Institutional Accounts, all we have to go for now is 2008 end of year data released earlier this week. Here is my take on it.
Chart above shows broad GDP composition. The decline in GDP in 2008 is pronounced and it is relatively clear that Non-Financial Corporations lead the way in driving down our gross domestic product. To see this in more details, consider the decomposition below:
Absent real growth in private sectors, public sector becomes more pronounced. In other words, as overall economy decline, public spending picks up in relative terms. Everything else is tanking. Not surprising, really. But in percentage terms, this is throwing some additional insights (below):Now, the story of our economic downturn is very much in full view - productive part of domestic economy (non-financial corporations and households and financial sector) is in deep retreat. Non-productive public deficit financing of state consumption is swinging into positive. Also, note that household contribution fall off is pretty much in line with financial sector fall off. This is indicative of the fact that (as I have argued consistently before) our financial crisis was not caused by external forces of credit crunch, but by internal mountains of bad debts accumulated by corporates and households.

Another point from above is just how dire are the conditions in non-financial corporate sector. Only a fool would believe that this precipitous collapse in the relative share of GDP accruing to non-financial companies in Ireland can be repaired by injection of more debt into the system.
Chart above shows that Net National Income (NNI=GNI-depreciation, GNI=GDP+net receipts from abroad of wages and salaries and of property income), which by its definition nets out along with depreciation some of the effects of transfer pricing has fared pretty much in line with GDP. Interestingly, households contribution to NNI is in excess of their contribution to GNP, suggesting lower depreciation and potentially rising inflows of income from abroad when it comes to Irish households. It also reflects the outflow of foreign workers (either out of Ireland or onto unemployment benefits), reducing income outflow out of the country. General Government line shows clearly that net income multiplier of government spending is negative - which is logical when you consider the fact that the Government borrows from abroad to finance current spending at home.
Percentage contributions to NNI are equally revealing of the fact that Government spending cannot be seen as income-additive when it comes to net income accruing to this country. Remember - per earlier slides, Government spending was a positive contributor to GDP, but a negative contributor to NNI.
Gross operating surplus in the economy fell in 2008 across all private sectors and rose for Government sector. Why? Because while talking about the need to correct deficit, to cut spending and to take tough measures necessary to rebuild exchequer finances, our leaders were all too keen to actually pre-borrow as much as possible before 2009 hit. 'Do as I say, not as I do' is the motto...And thus net savings collapsed for Irish Exchequer as net borrowing soared. In contrast, households - scared first by rising joblessness and tanking stock markets and collapsed house prices, then by Leni's VAT measures and Government's inability to act - have moved early on into precautionary savings. Good for them - Irish non-financial corporations, in contrast decided to cut their savings - a sign of debt overhang in a recession. This means that overall, Irish corporations will emerge from this crisis with no spare cash to sustain restart of capital investment. This might be a good thing, given that over the last 10 years, most of Irish corporate 'investment' involved buying up competitors' firms at peak market valuations in a hope that if you make your company bigger, it will grow faster.

External balance has improved, but underlying it, trade flows to and from Ireland have come under pressure:
To nobody's surprise, net worth fell off the cliff in 2008 for the entire economy, although household savings allowed for a rise in their net worth position. 2008 marked the first year in modern history when Irish households net worth exceeded that of the Irish Government. Just think about it: the state dependent on taxpayers has had higher net worth than those who financed it... Spot anything here? How about 'fairness' idea our political leaders love waving around.Net lending positions (above) are also self-explanatory. But here is an interesting angle on CSO's data:
While Government share of GDP rose, its share of Net National Income declined. Even more dramatically, Government share of net disposable income fell even faster than that of NNI. Why? Because as Government deficit went through the roof, net disposable income fell -4.66% which is even faster than GDP (-4.18%). How? One word: Taxes!

Daily Economics 22/04/09: IMF's GFSR

IMF's Global Financial Stability Report (available here) is a lengthy read worthy of attention, both for its finance world-view and a diplomatically correct version of the 'Office' comedy. Subtle language turns tell more of a story of IMF's desperation from looking at APIIGS' incompetent macroeconomic management than the direct phrases. That said, there is little in the report, aside from two tests of financial contagion, that is either new or forward-looking.

"The United States, United Kingdom, and Ireland face some of the largest potential costs of financial stabilization given the scale of mortgage defaults."

Emphasis on the word 'mortgage' is mine, of course, added precisely because the IMF concern has not been, to date, echoed by many Irish economists or banks. In fact, all Irish banks currently assume that mortgage defaults will not happen. Instead, policymakers (via NAMA and debt issuance), bankers (via impairment charges and recapitalization funding) and economists (via RTE / Irish Times opinion pages) have been preoccupied with 'toxic' assets (development loans). Poor households have largely been left out of the 'They deserve help too' circle. The Government actually is so confident that mortgage defaults will not be a problem, that it is taxing households into the recession. As I have noted before, this presents a problem - should inflationary pressures rise, interest rates will regain upward momentum and Ireland will be plunged into a mortgages implosion.

How costly are Lenihan's commitments?
Moving on, two illustrations from the IMF report are worth putting together: First, the sheer size of the so-called 'costless' (Brian Lenihan's grasp of economics), guarantees written by Ireland Inc on our banks:Second, the real-world cost of these guarantees...I've identified this link between the throwaway promises Irish Government has been issuing since September and the cost of our debt before. It is nice to see IMF finally saying the same: "Figure 1.37 highlights that the spread on the issues guaranteed by sovereigns perceived as less capable of backing their guarantee is wider than for those that are deemed well able to stand behind their promises, such as the United States and France."
But here is another proof of the link between Brian Lenihan's guarantees and the cost of these to you and me:
Note the coincident timing: September 2008, and spreads on Government debt shooting through the roof to reach banks bonds spreads and trending from there on side-by-side to Anglo's Nationalization (another spike), then to recapitalization (a slight decline)...

Go long, not short...
The IMF advises the Governments to switch debt issuance to longer term maturities. Exactly the opposite is the strategy adopted by the Irish Government that has launched increasing quantities of new 3-9mo bonds into the markets. "...Authorities should take the opportunity of the currently low level of real long-term yields to lengthen the maturity of issuance where possible to reduce their refinancing risk," says the IMF, implying in simple terms that you shouldn't really pile on short term debt at the time of a prolonged crisis.

For all its faults, even the IMF knows that you can't run the country on the back of credit card debt. But Brian, Brian & Mary wouldn't have a clue, would they? All their experience relates to managing a cash cow for the public sector unions that is our public purse.

Shock scenarios
More interesting stuff is in the IMF's modeling of financial shocks: Scenario 1 (pure credit shock with no fire sale of assets - more like a situation in the US in recent months) v Scenario 2(credit shock with fire sale of assets - a more relevant case scenario for the likes of AIB). Here are the results of the latter test:
In scenario 2, Australia shows 7 double-digit responses to shocks to other countries' financial systems, Austria, Italy, Portugal, Sweden & UK 6; Canada, Japan, Spain & US 5; France 8; Belgium, Germany & Ireland 9; The Netherlands 12; Switzerland 13. This hardly supports an assertion that we are driven by external markets crises in our own financial sector to any exceptional degree. Yes, we are less exposed than Switzerland and the Netherlands, but we are way more exposed than the many other countries.

The table below (it is the same table that was reported by me in December 2008) shows that we have the second highest (after Luxembourg) ratio of Bonds, Equities and Banks Assets to GDP in the world - a whooping 900%!

Furthermore, Table 23 provides some amazing evidence: Banks Capital to Assets in Ireland stood at only 4.1% in 2008, down from the high of 5.2% in 2003. Only Belgium and The Netherlands have managed to get lower ratio in 2008. Irish Central Bank actually provided these figures to the IMF and yet the CB has managed to do precious nothing to correct the steadily deteriorating capital ratios throughout 2003-2008 period. This, presumably is why we pay our CB Governor a higher salary than the one awarded to his boss, the ECB Chief.

So the 'comedy' part now being played in Dublin has a simple scenario that IMF, with its diplomatic mission, will not reveal to us, but that is visible to a naked eye though the prism of the IMF report:

1. Incompetent state regulators (CBFSAI and more) get golden parachutes for damaging the financial services sector and the economy;
2. Incompetent and greedy politicos are shielding their unions', banks' and developers' cronies from risk and pain caused by (1);
3. The ordinary people and businesses of Ireland are paying for (1) and (2).

And the markets still show willingness to powder this charade with 110% bids cover on Irish Government bonds? For how long?

Daily Economics 31/03/2009

Irish external debt stats for Q4 2008 are out and, guess what, things are looking worse than before. Here is the CSO table:
Now, the Gross External Debt itself is up for the year as a whole: from €1.579 trillion (yes, trillion) in Q1 2008 to €1.661 trillion in Q4 2008. But look closer to the details (see chart below for illustration):

• Gen Government Debt is obviously up - we are borrowing sh***t loads of money. But, GG short-term liabilities are also taking off, which confirms my argument: we are increasingly borrowing short, frontloading future deficits. This is before we factor in the Q1 2009 seriously aggressive short-term debt raising.
  
• Monetary authorities debt is going ballistic - all of this is in short term liabilities.
• Monetary financial institutions (financial sector etc) is declining overall, but slowly, and the short-term debt is rising - gain, trouble ahead refinancing this 'oxygen'.
• Other sectors - the real economy - debt is up and short-term liabilities are also up.
  

So, despite CSO's brave claims - the title of today's note is Ireland’s External Debt decreases to €1.66 trillion at end December - in reality, the debt mountain is still growing (in yearly comparisons) and the nasty short-term debt overloads are getting heavier.

Now, think, what will happen if the Government was successful in restarting banks lending?

Per one of the readers comments, here is the table with actual nominal increases in various debt headlines.

Boardrooms in denial: McKinsey study & Ireland Inc

McKinsey has done some homework and published impressive findings on the issue of corporate leadership in the current downturn. You can get the article here, if you have access to the Quarterly, but below are some main findings.

"While half of board members describe their boards as effective in managing the crisis, just over a third say their boards have not been effective; 14 percent aren’t sure how to rate their boards’ effectiveness. At the personal level, roughly half of corporate directors say their boards’ chairs haven’t met the demands of the crisis, and a nearly equal percentage of board chairs believe the same about their board members. Though most boards have implemented various changes to their procedures in response to the crisis, 62 percent say their boards need to change even more." Chart below (courtesy of McKinsey) illustrates.Now, we all by now can be counted as the slaves of 'innovation' fad - the trend in modern management and policy to label every strategy change an 'innovation', but what McKinsey data shows, strategy is still the king when it comes to responding to changing environments.

"Innovative strategies are the key when corporate directors evaluate their boards’ responses. Among the group who say their boards have been effective in responding to the crisis, 60 percent credit the development of new strategies to manage risk and take advantage of new opportunities (chart below). That same area of management is most frequently cited as lacking among respondents at companies with ineffective boards. (This finding is consistent with the results of another recent survey, in which executives said support for innovation should be the overall focus of governments’ actions in response to the crisis.) Other areas that have been addressed by many effective boards are financing and operational needs; at unsuccessful companies, respondents say their boards have been particularly ineffective at tackling talent management and restructuring."
So let me ask you this question. Since November 2008 I spent inordinate amount of time and effort trying to convince some of our top organizations and companies - amongst hardest hit by the current uncertainty in the markets - to set up some formal research function to evaluate various strategic responses to the crisis that they can adopt. The structures I have been proposing are pretty much in line with those summarized by the McKinsey below:
Not a single Irish corporate took up my challenge. Majority of our corporate leaders are sitting on their hands, in words of Leonard Cohen 'Waiting for the miracle to come". But don't take my word for it - here is hard data on the issue.

Here is the truth - 'miracle' ain't coming, folks. Wake up and smell the roses - if you your board/CEO assessments of counterparty contributions is anywhere close to what McKinsey reports, you are screwed. Your corporate structure is rotten from the head down and you need to do an independent appraisal of it from the head down. Waiting around for 'miracles' is not going to do it.

Irish Boardrooms in Denial

This is an unedited version of the article published in Business&Finance Magazine, February 26, 2009, pages 30-31

Almost a year ago, I warned in this column that Irish companies are going to face a tough recession, with rising bad debts, tighter payments collections and accelerating rate of insolvencies. A recession that is likely to last through 2009 and a good half of 2010. Figures for 2008 show us on track to fulfil these predictions with more than doubling of the number of corporate insolvencies in one year. By all possible indications, 2009 is going to be even tougher than the already abysmal 2008. And yet, when it comes to a realistic assessment of business conditions there is a strange sense of denial of reality taking hold in Irish boardrooms.

First consider recent evidence. Two weeks ago, CSO recorded the first drop in industrial output in Ireland since 1982. A combination of collapsed construction sector activity, decimated domestic consumer spending and ever-shrinking global demand, exacerbated by the overvalued Euro all have contributed to this trend. Even more significantly, these forces’ impact on Irish producers, exporters and service providers is getting stronger by the day.

Exporters under pressure
2008 slowdown in output was primarily due to traditional sectors of the economy – down 4.7% in y-o-y terms, with multinational companies expanding their production by an anaemic 1.7%. There is little hope that this latter trend will not continue through 2009 and into a good part of 2010. More ominously, December figures show broadly based collapse in industrial activity with output contracting by more than 10% m-o-m in both multinational sector and amongst domestic companies. 26 out of 29 broader industry categories recorded contractions in output. Figure below highlights this, while removing some of the seasonal volatility.
Source: CSO

This is broadly in line with international experience. Last week figures showed that in 2008 Europe posted its biggest trade deficit in 10 years – a whooping €32.1bn. This marked a deterioration in the trade balance to the tune of €48bn in y-o-y terms. According to the majority of the analysts, coming months will see severe recessionary pressures for eurozone exporters. Irish exports are particularly vulnerable, given the falling consumer demand and business investment activity in the US and UK, as well as in the emerging countries. Exports to the UK, the main destination for the region’s products, dropped 3 percent in the 11 months through November 2008. Exports to the US, the second-biggest buyer of euro area goods, fell 5 percent. In the case of Ireland, the two countries account for more than 36% of the goods exports flow by value and some 50% of all Irish trade is linked to either the Dollar or Pound Sterling.

The end result – our core industrial exports are facing a decline, as illustrated in the figure below, precisely at the time of already collapsed domestic consumption. Our services exports are also facing decline with financial services and tourism struggling to stay afloat, while broader business services exports are feeling the same pressures of currency overvaluation and high cost of credit as our goods trade.Source: CSO

The expectations are that the 2008 growth sectors – ICT and pharma – might be also hard hit by a slowdown in global demand this year. In particular, ICT is sensitive to households and business investment demand. Lack of new investment in plant and equipment, software and operating systems in the US and across Europe is taking its toll on the likes of Dell, Intel and smaller hardware and software suppliers. By all estimates, this sector is not going to see a significant recovery until the earliest second half of 2009. Dell alone accounts for some 6.5% of Irish exports.

At the same time, pharma sector is likely to face mounting cost pressures in the US, a significant decline in demand for higher-end drugs from the emerging economies, plus a stronger generics competition. A recent study by the International Pharmaceutical Policy Council has shown that traditional pharma and bio-pharma sectors are facing significant cuts in research spending and employment, with recession undercutting public and private spending on universities-affiliated research. In the mean time, last week, Israel-based Teva Pharmaceutical Industries Ltd., the world's largest maker of generic drugs, said it expects the deepening global recession to spur demand for generics – bad news for the likes of Big Pharma that dominate Ireland’s exports statistics. In other words, even the so-called ‘recession-proof’ pharma companies are starting to feel the heat.

Yet to face the music
Which brings us back to the corporate boardrooms perceptions of the near term future. Last week’s InterTradeIreland Quarterly Business Monitor sheds some light here.

A comprehensive survey of some 1,000 companies north and south of the border has revealed that businesses are more pragmatic in their assessment of the past than they are about the future. In other words, Irish companies are feeling the pain, but are potentially deluding themselves into believing that the first half of 2009 will turn out to be economically stronger than the consensus forecast predicts.

In terms of the current conditions, roughly four out of five businesses indicated that they have experienced an adverse impact on trading conditions in recent months. This is hardly surprising, given that the biggest problems reported by business leaders were impacting their core parameters: tighter cash flow (68%) and decline in demand (66%). Some 87% of businesses noted a fall-off in consumer spending. 61% of the Republic of Ireland businesses saw a fall in turnover as opposed to 44% in the North.

Nonetheless, when asked which policies the Government can undertake to help business,
• 27% cited the need for improving access to borrowing (most likely indicative of the severe pressures on debt-laden businesses to raise new credit and roll over maturing short-term debt),
• 9% called for reduced levels of VAT and 7% for reduced taxation,
• 7% named assistance for SMEs, and 6% identified financial assistance for distressed companies.
The low numbers supporting consumer confidence improving tax reductions measures suggests that majority of businesses are not perceiving the current downturn to be demand-driven. Instead, there seem to be a much stronger conviction that the recession is a function of the credit cycle. Yet, 61% of business in the South (as opposed to 44% of those in the North) reported declining turnover.

Do the companies underestimate the extent of the collapse in consumer confidence at home, demand for exports abroad and the extent of their exposure to debt markets? Judging by the main policy priorities listed above, the answer is yes. The same answer is supported by the fact that few companies so far have taken significant cost-cutting measures. Only 30% of the Republic of Ireland companies (19% in the North) have reduced their workforce to the end of 2008. This is reflective of the fact that just 18% of businesses expected the downturn to have a severe adverse impact on their business in the next 12 months. Majority (63%) still think that this recession will be a moderate and short-lasting one.

And this is despite the fact that forecasters virtually unanimously predict 2009 to be worse than 2008 when it comes to trading conditions. For example, McKinsey Global Economic Conditions Survey last month has shown that 71% of global businesses expected general conditions to worsen in Q1 2009.

Chart below shows that Irish business leaders pessimism about the future has increased only marginally between the end of 2007 and the end of last year, despite the rapid deterioration in Irish economic conditions.

Potential Impact of Economic Downturn, 12 months forward
Source: InterTradeIreland, 2009

Optimism amongst businesses, although having abated in 2008, remains relatively high. Only 39% of all Irish businesses anticipate a decrease in turnover in Q1 2009 as opposed to 52% of global businesses in McKinsey survey. Similarly, for profitability – only 35% of Irish businesses expect a decline in profitability in Q1 2009, against 67% for the global sample.

Thus, only 14% of businesses across the island (18% in the Republic of Ireland) expected more layoffs and redundancies in Q1 2009. This is well below 29% of the global sample firms that were planning layoffs for this quarter.

In short, consistent with the findings on employment, turnover and profitability, the Intertrade Ireland results suggest that Irish businesses, both sides of the border, expect a mild recession to last no longer than 6-8 months. At the same time, global business leaders expect “a battered but resilient economy …[that] implies a recession of 18 months or so”, much in tune with the forecasts by the EU, IMF and the OECD. One side of the sea is clearly foolin itself here…

Box-out: IFSC Liabilities

A research note from the Davy Stockbrokers last week attempted to clarify the issue of the banking sector liabilities in Ireland. According to the Bank for International Settlements data, in Q3 2008 banking liabilities of the Irish-owned banks totaled €575bn, or 309% of GDP – the third-highest in the euro area. The Irish government has guaranteed €440bn (or 237% of GDP) of this. At the same time, the liabilities of all financial institutions resident in Ireland were €1,424bn, or 839% of GDP. But €849bn of that “…is not in any way a liability of the Irish government,” says the Davy note.

Well, sort of. €849bn might not be a liability under the Government guarantee scheme (although it remains to be seen how the foreign banks deposits and loans by and to Irish residents will be treated in the case of default) but from the economy’s point of view – some share of the €849bn debt represents a potential risk exposure for the state.

Here is how. Recall the good old days when our country leaders trotted the globe telling everyone that IFSC is a flagship of our knowledge-based modern economy? How come we now conveniently shrug off any liability inherent in having IFSC on our soil? IFSC is an asset to Ireland: a major contributor to the exchequer, a large employer of Irish workers and a significant purchaser of associated business services, including the services of the stockbrokers.

Now, imagine if excess debt exposure of IFSC-based companies was to drive them out of business. Where would that leave the State, not to mention the economy? A rough guess – ca €700mln in Exchequer revenue, plus the returns from employment of ca 20,000 people, plus commercial rents returns and VAT returns due to business activity. The total state take from the IFSC can easily exceed €1.5bn. If the risk of losing this dough is not a liability for the Irish state, what is?

Davy is correct in the strict sense of listing the actual figures. However, ignoring the IFSC-held liabilities creates an illusion that somehow Ireland Inc is independent of what is happening in the Docklands and beyond. It is not. Just as in good times we reaped the benefits of the IFSc, we must, at the time of challenges acknowledge its liabilities as being at least in part our own.