Economics 8/10/10: We are not Ireland

I just had to reproduce this statement in full (hat tip to Brian Lucey)... the link to the source is here.

LONDON, Nov 8 (Reuters) - Greek Finance Minister George Papaconstantinou on Monday argued that his country was not suffering the same banking problems as Ireland. Speaking in London he also said that he expected the country's deficit would be 5.5 percentage points lower by the end of the year. "Greece is not Ireland, it doesn't have banking stability problems," he said in a speech.


Well, I'd say Minister Lenihan could have said 'We are not Greece, we don't have a liquidity crisis... yet'... but then he won't be really far from his usual rhetorical corner. For another Reuters story tonight showed that we are heading for a possible liquidity crunch:

"LONDON, Nov 8 (Reuters) - A widening in bid/offer spreads on Irish and Portuguese sovereign bonds this month is possibly an even bigger worry than the rising premium these bonds offer over German Bunds or widening credit default spreads.

Liquidity is the grease in the wheels of financial markets and if there is a reduction in liquidity then this will show up in the way prices move and in bid/offer spreads.

While the bid/offer spread on the Irish 10-year cash bond is not as wide as it was before the European Central Bank said in May it was prepared to buy government bonds in the secondary market, it has definitely broken higher.

Since the ECB's May announcement, the bid/offer spread had largely stayed below 30 basis points. However, it has now widened to 40 basis points.

Ignoring such price action in its early stages can be risky since it could lead to a vicious spiral. This is what happened with Greek debt in March when a widening in bid/offer spreads was ignored, leading to a significant deterioration in the supply/demand dynamics.

Those holding long positions became increasingly keen to dump their holdings while those who might have potentially taken on new long positions refrained for fear of catching the proverbial falling knife.

What has been of concern over the last few sessions is that the widening in bid/offer spreads has also started to shift to the medium- to short-end of the yield curve.

There has even been an acceleration in the widening in the bid/offer spreads for two-year and five-year Irish sovereign debt.

This widening has continued even though the latest data shows the European Central Bank resumed its government bond buying programme after a three-week pause.

That suggests the ECB needs to step up its intervention beyond the 711 million euros it spent last week if it is to meet its aim of ensuring "depth and liquidity in those market segments which are dysfunctional".

Unless there is a marked escalation in the ECB's bond purchases, contagion-related risks suggest the potential for a further widening in Spanish yield spreads against Bunds. Against this backdrop, investors might prefer to focus on the relative value trade of a widening in the 10-year Spain/Italy yield spread."

Ouch!

Economics 25/9/10: Accounting for our exports

Quarterly national Accounts offer a rich set of data. Listening to all the talk about turnarounds and Government policies, I wondered -

• We know that Irish Government has little to do with our exports, which are largely determined by demand outside Ireland over which our leaders have no control;
• Exports have been performing strongly over the recession
• Exports, net of imports enter both GDP and GNP figures

So a natural question from my point of view was: "Absent net exports, how badly was our economy hit by the Great Recession?"

Here are the charts, taking our GDP and GNP (seasonally adjusted, expressed in current market prices) and subtracting net exports (exports less imports).
And same in terms of year on year growth rates:
Now, let's put together our growth rates for GDP and GNP ex-net Exports and standard GDP and GNP growth rates (gross of net exports, expressed as before in current market prices, with seasonal adjustments):
To me, this paints a pretty clear picture. Given that the Government has provided virtually no supports for our exporters, the gap between each solid line and each dashed line shows the true extent of net exports contribution to growth in GDP and GNP. And this gap also shows that the economy more directly controlled by the Government has been tanking at a much steeper rate than the economy which includes our exporting firms.

Let's put a cumulative figure to this same picture:
So in those parts of Irish economy where our Leaders had a say (red) we have suffered a decline in domestic income of cumulative 34.35% since 2007. In economy which includes the part which our Leaders have very little control over, the decline was 23.7%. One wonders if there is any truth whatsoever to the leadership claims on economic policy front we've been hearing in recent days?..

Economics 30/05/2010: A gargantuan task ahead

As the Government continues to insist that the worst is over for Ireland Inc, let us consider some headline numbers on the structure of our public spending.

The figures reported below refer to 2008 comparisons, so they omit most of the horrific fall-out from the current economic crisis. as such, these comparisons relate more to the structural imbalances our state is running, not to the recessionary effects. This is worth keeping in mind, for it means that the differences between Ireland and other states reported below, as well as the adjustments required for us to reach sustainable long term equilibrium on spending and taxation sides will have to be put in place no matter what happens to our economy in years to come. It is also worth keeping in mind because the figures reported below underestimate the extent of our post-2008 imbalances compared to other countries that had experienced much less pronounced crisis over 2009.

All data is taken from the publicly available sources - the IMF and CSO - so the Government and our tax-and-spend crowd of Unions-led economists are fully aware of these. Plausible deniability does not apply, therefore, when it comes to our Government pronouncements about its policies and the current position of the Irish economy on international competitiveness scale.

Chart above plots Ireland's position vis-a-vis its peers in the developed world in terms of the overall size of the primary (non-capital) share of public expenditure in the economy. Two facts worth highlighting here:

• Ireland's Government spending as a share of our real economic income (GNP) is the second highest of all countries in the group, and is well in excess of the average for small open market economies (SOME). It is in excess of Germany (Berlin) and well ahead of the US (Boston).
  
• By this metric, Ireland simply does not qualify as a 'market' economy, as domestic private sector accounts here for less than 47% of GNP! In the USSR of the 1980's, private economy (black market) accounted for around 40% of the total GNP. Get the comparison?

Chart above shows that Irish public sector is clearly one of the most lavishly paid one in the entire developed world. In fact, our public sector wages and earnings swallow over 14.4% of our national income, making Ireland's PS workers the 5th highest paid (on aggregate) in the advanced world. The gap between Irish public sector earnings bill and that for the average SOME is a massive 4.47% of our GNP. Roughly speaking Irish public sector wages bill contains a roughly speaking 48% premium relative to the PS counterparts in similar economies around the world. Clearly, even the reductions in overall take home pay imposed on PS in Budgets 2009-2010 has not erased this premium, especially when one recognizes that since 2008 our GNP has contracted almost in line with the decline in PS pay.

Chart above maps Ireland relative to the US (Boston) and Germany (Berlin) to show just how absurd the whole notion of Ireland Inc being positioned between Boston and Berlin is in the real world. In reality, just one parameter - Social Benefits as a share of GDP/GNP - marks our relative position as being between Boston and Berlin. In every other parameter, we are a basket case of excessive public spending and taxation relative to both the US and Germany.

With the above data in mind, what adjustments in the budgetary positions will be required to bring Ireland into the exact position of being between US and Germany to reflect our stated competitive benefit of being an economy that can facilitate trade and investment flows between the two giants - the EU and US?
To restore our competitive balance we need:

• A cut of €23 billion in gross annual primary spending by the state (current expenditure) - some 14.7% of our GNP. Not €3bn as Brian Lenihan is doing, or €3.5bn as An Bord Snip Nua was suggesting. A whooping €23 billion, folks!
• The cut above cannot come from the capital budget side - where most of the cuts so far took place. It has to be cut from the current expenditure. The reason for this is simple - capital spending is one-off item of expenditure and it is associated, in theory, with a net positive return on investment. Current spending is permanent and yields no financial return.
  
• The cuts must include at the very least a €9.3bn reduction in the wages and pensions bill in the public sector (5.9% of GNP or almost 44% cut in the total PS wages bill, achievable through both reductions in numbers employed and wages paid and pensions benefits entitlements).
• Social benefits, at least in the long run, actually are in line with us being smack between Boston and Berlin, so no adjustment is needed here in the short term (given further deterioration in the fiscal position in Ireland since 2008, I would actually recommend a temporary cut here. Also, longer term reforms, to change the structure of welfare benefits and state pensions must be enacted, but for the reasons different from the budgetary considerations).
• Instead of raising tax revenue, Irish Government should engage in a dramatic reduction of tax burden on the economy. Generally, total tax take in the Irish economy exceeds the average Boston-Berlin position by 6.5% of GNP, requiring a reduction in overall tax burden of €10.3bn on 2008 numbers.
• This reduction in the tax burden should include a cut in personal income tax, CGT and personal gains/profits taxes of 2.1% of GNP or €3.3bn.

There is absolutely no ground for our Government and policy leaders' claims that Ireland is strongly positioned between the low(er) tax US and high(er) tax Germany as a competitive destination for exports and investment arbitrage. In fact, due to the Government-own policies, fiscal and tax imbalances created in this economy mean that we are, at a macroeconomic level, grossly uncompetitive relative to

• both the EU and the US,
  
• as well as relative to our main competitors world wide - the small open market economies.

Economics 27/04/2010: Greece & Ireland - tied by the risk of contagion

As the Greek, Portuguese, Italian and Irish bonds are melting in the markets' gaze at the countries fundamentals, one quick reference number is worth repeating. Per Chapter 1 of the latest Global Financial Stability Report from the IMF (linked here), the overall risk of contagion from a systemic crisis in one Euro area country to another (as measured by the percentage point contribution to total distress probability) for Greece was:

Contagion from Greece to:
October 2008-March 2009

• Portugal = 9.8%
  
• Italy = 9.9%
  
• Ireland = 12.5% (highest of all Euro area countries)
  
• Spain = 9.0% (in line with the Euro area total)
  
• Euro area as a whole = 8.8%

October 2009-February 2010

• Portugal = 23.6% (in line with the Euro area total) - up 13.8 pps
  
• Italy = 24.2% - up 14.3pps
  
• Ireland = 31.3% (highest of all Euro area countries) - up 18.8 pps
  
• Spain = 23.9% (in line with the Euro area total) - up 14.9 pps
  
• Euro area as a whole = 21.4% - up 12.6 pps
  

So spot the odd one here. As the crisis evolved, despite our Government's talk about 'Ireland turning the corner' and 'doing the right thing', our economy became actually closer and closer linked to Greece. More so than any other member of the PIIGS club. Some achievement that is...

Now, spot the similarity in responses to the crisis in Greece (here) and Ireland (here) and tell me - are we really that much better off in terms of macro fundamentals than Greece, especially given that Greek policymakers are at the very least not held hostage to a Social Partnership in which the likes of Tasc-informed Unions have a direct say?

Economics 08/02/2010: Nama v IMF revelations

Fair play to the Irish Times' Simon Carswell (here) for unearthing through FOI request that IMF note which back in April last year told the Irish Government that Nama will not restore lending in the economy.

This, of course, is the old news to many of us. You can search this blog for 'restore credit' and other key words and see posts going back to April 2009 with exactly the same analysis. Outside of this blog, I warned on the matter in my columns in Business & Finance and in the Sunday Times, in articles in Irish Mail, Irish Independent, Irish Times, in numerous appearances on BBC, Bloomberg, RTE, TV3, Newstalk, TodayFM and so on. Even in the likes of Wall Street Journal and numerous international print outfits. Several other analysts - namely Professors Brian Lucey and Karl Whelan, banking specialist Peter Mathews, economist Ronan Lyons and others - all have done so as well.

But what is new is the fact that this IMF opinion was known to the Government and its advisers who, having buried it from public view, have gone out on a prolonged PR campaign, in effect liberally treating the truth about Nama. Ditto for NTMA and Nama officials. That public representatives and officials engaged in such an act is a betrayal of public trust. It is, simply put, a deception of public opinion.

Quote from Irish Times: "Speaking at the publication of the Nama legislation last September, Mr Lenihan said Nama would “strengthen and improve” the funding positions of the banks “so that they can lend to viable businesses and households”. Taoiseach Brian Cowen had said the Government’s objective in restructuring the banks was to generate “more access to credit for Irish business at this critical time”"

But there is more to Simon's article (my emphasis):

"In an internal e-mail dated June 6th, 2009, ...senior department [of Finance] official Kevin Cardiff warned against making public any official estimate for the losses faced by the banks, saying that the department had not made this information public. “We naturally shared with the IMF team our informal views on the range of possibilities, but would be uneasy about seeing these formalised,” said Mr Cardiff, who has since been appointed secretary general of the department."

This is uncomfortably close to an admission that the DofF willingly withheld crucial information about Nama from the official communications in order to avoid this information being disclosed publicly through future FOI requests. Again, I am not a conspiracy theorist, but what else does one need in terms of proof that the Government and its officials knowingly engaged in acts of public deception when they were making claims about

• Nama's expected impact on credit supply;
• Nama's expected costs and losses.

Tellingly, IMF estimated that Irish banks will face losses of up to €35 billion and that the DofF was informed by them of this figure. If you look at my posts on Nama Trust, expected Nama losses and the cost of nationalizing the banks - my estimates from early 2009 on consistently show that the at risk assets of Irish banks covered by Nama are around €32-37 billion - bang on in line with IMF's estimate. Again, I wasn't the only person providing these estimates.

The Government, Nama, NTMA, DofF and the Central Bank - all have elected to completely ignore all independent analysis that has been performed by myself, Brian Lucey, Karl Whelan, Peter Mathews and others. And yet, not a week goes by since September 2009 in which the Government is forced to admit that we were right in our estimates and forecasts.

While the Government continues to spend hundreds of thousands of our euros on PR spin doctors and 'advisers'. At the same time, the entire staff and executive structure of Nama have been loaded with either 'quiet men' of 'I have no interest in defending taxpayers' type or outright 'yes men' for the Government.

Let me reproduce here few quotes that a reader posted in his reply to one of my earlier blog posts:

"The government did an "A1" job in their spin on NAMA, they persuaded the shareholders into voting for NAMA so that the banks would avoid nationalisation. Blindfold nationalisation is inevitable. Memorable brainwashing quotes:

• "NAMA is the only game in town"
• "there is no easy way out"
• "We need NAMA to get credit flowing into the economy"
• "Ireland is getting "NAMA Money" from the EU"
  
• "There will be no more 100% nationalisations"

And so on...

Disgraceful, really!

Do send me other quotes from public officials that you feel might have been outright deceiving in nature and I will post them on the blog!

Wake up calls for Irish Government

My new article in Business&Finance magazine:

Last week two international reports provided an interesting analysis of Irish policies to date and highlighted some scepticism amongst the international analysts as to the ability of our Government to lead the necessary reforms.

First, caught up in the media feeding frenzy, the IMF Article IV Consultation Paper has raised some serious questions about NAMA. Second, much unnoticed by Irish media, the EU Commission report on public finances in the Euro area have provided an in-depth look at Irish fiscal position relative to our peers.

Let us start with the IMF’s analysis, focusing on the major area of the Fund’s oncerns that received little cover in the media. Our policymakers were quick to present the IMF statement that NAMA can be a break-even proposition for the taxpayers as a major endorsement of the Government plan.

Here is what the IMF report actually did say on the topic: “If well managed, the distressed assets acquired by NAMA could, over time, produce a recovery value to compensate for the initial fiscal outlays.” In other words, the IMF is benchmarking NAMA ‘success’ solely against a possibility for earning zero return on initial public investment. The IMF is simply unconcerned here with the associated costs, such as the cost of bonds financing, NAMA management and the cost of post-NAMA recapitalization of the banks. Yet, these costs are non-trivial from the point of view of expected taxpayers’ losses due to NAMA.

Using the balance sheet model for NAMA developed by Professor Brian Lucey and myself, table below provides estimated discount rates that would achieve break-even for the taxpayers on total costs of creating and operating our bad loans bank.
* All in billion 2009 Euro, assumed inflation: 3% pa, 15-year horizon
** ca 33% of the total value of bonds issued, plus the face value of loans purchased into NAMA
*** Ex-operating cost of €20mln pa (rising at 2% pa from 2010)

Even under optimistic scenarios of 10% impairment on loans, and assuming current cost of financing Irish bonds of 5.9% (consistent with last week’s syndicated bond issue) for 2009-2014, and moderate bond finance costs for 2010-2024, the discount on assets purchased by NAMA required to achieve zero loss on NAMA-associated public outlays ranges between 27% and 50%. Higher impairment charges (12-15%) and/or financing costs raise the required break-even discount above 60%.

In other words, there is no reasonably probable scenario whereby NAMA will end up breaking even on total taxpayers outlays in real terms. Perhaps this is precisely the reason as to why the Government has to date produced not a single estimate for expected costs and returns under NAMA, despite making numerous unfounded claims that it will not result in significant taxpayers losses.

In fact, the IMF report was rather clear in its critical assessment of the Irish authorities lack of proper cost-benefit analysis of this undertaking. “The authorities did not formally produce any estimate for aggregate bank losses. …Staff noted that losses are likely to extend beyond the property-development sector as the economy weakens and the design of NAMA should incorporate that possibility.”

Furthermore, “the debt to be incurred to support the financial sector remains uncertain,” says the IMF. “If the losses suffered by banks are about 20 percent of GDP, as estimated by staff, then bank recapitalization needs could be around 12-15 percent of GDP.” These numbers correspond to the two most extreme scenarios presented above. But the IMF Report also states that in such an eventuality “assets would be acquired against this debt...” Injecting €21-25bn in public funds would do the shareholders in Irish banks will be a de facto nationalization – a scenario consistent with IMF staff estimates, yet denied by the Government.

One day before the IMF report, the 300-pages strong EU Commission paper, titled Public Finances in the EMU, 2009 put forward the picture of Irish Exchequer presiding over the worst performing (fiscally) economy in the entire EU.

The diplomatic Commission said in its report that the scale of the downturn was unexpected by the Irish authorities, “with the end-2007 update of the [Government] stability programme expecting real GDP growth of +3% in 2008, while the Commission services’ interim …forecast estimated growth at -2% in 2008”. Irish “deficit was not considered temporary”, suggesting that the EU Commission disagrees with the Government view that most of our troubles are cyclical.

As per credibility of our Exchequer plans to bring the deficits under control by 2013, Commission said that “the January 2009 addendum to the [Government] stability programme targeted a deficit …below 3% of GDP in 2013, based on yet to be specified consolidation measures. In view of the above, the Commission concluded that the deficit criterion in the Treaty was not fulfilled.” In other words, Brussels does not believe that our plans to reduce the deficit in line with the EU rules by 2013 are credible and, therefore, we are now in a full breach of the EU Treaties.

Just to make it more clear the Commission provides a graphic illustration as to how far off we really are in delivering on the 2013 targets. Like IMF in its report last week, the Commission data shows that whilst the Government has proposed a ca 2.75% of GDP contraction in its deficit in 2009-2010, the required rate of reductions should be more than 3 times greater – at ca 8.5% of GDP.

Using the change in the current level of the structural deficit required to make sure that the discounted value of future structural balances covers the current level of debt as the indicator for long-term sustainability of current Government policies, the Commission puts Ireland in the highest category of fiscal instability risk – one of only two Euro-zone countries (alongside Spain) in the group. At the same time, we came out as the most impaired country in the Euro area in overall assessment of our fiscal position.

The IMF and EU Commission papers do agree on another point. Both state that the start of the fiscal crisis we experience today predates the current crisis by at least 4 years. At the same time, clear downward trend in our fiscal stability was visible, according to the EU Commission back in 2003.

There are some serious discrepancies between the Commission and the Government assessments of the ongoing budgetary consolidation process. According to the Commission spring 2009 forecast, “the deficit is projected to widen further to 12% of GDP in 2009, the highest in the euro area.” The deficit target set out by the Government in April 2009 is 10.75% (up from 6.5% in budgeted for in October 2008). “The projected deterioration of the deficit would take place despite successive consolidation efforts since mid-2008, …with an estimated overall net deficit reducing effect of around 4% of GDP in 2009.” Thus, the EU does not buy into the Department of Finance estimate that the total consolidation to date yields 5% of GDP reduction in the deficit, as table below illustrates.

And in contrast with the Government’s rosy projections of 9% deficit for 2010, the Commission projects the deficit to widen to 15.6% of GDP on a no-policy-change basis. “The difference to the authorities’ target …is mainly due to different projections for the 2009 budgetary outcome and ...the non-inclusion of the indications for the budgetary measures for 2010 presented in the April supplementary budget.” Once again the Commission appears to be sceptical about the willingness of this Government to actually follow through with the targets set out in April.
Thus, in major reports published in one week, two international bodies gave a rather forceful negative assessment of the current Government plans for dealing with the banking and fiscal crises. And yet, the Fitzgaraldo of self-congratulatory remarks from Irish public officials pushes on – ever deeper into the denial of our bleak fiscal reality.


Box-Out:
All last week we have been hearing about the IMF endorsing Irish Government ‘austerity measures’ aimed at bringing under control our runaway train of public spending. Rhetoric aside, real numbers suggest that at least in one area – that of public sector employment – months after setting itself some modest targets for public workforce reductions, the Government is nowhere near delivering the real progress. Chart below, taken from the latest Quarterly Household National Survey data released last week, clearly illustrates the prevalence of past trends in overall employment.
While private economy employment shows catastrophic collapse in total numbers working in industry, construction, wholesale and retail services, basic repairs, accommodation and food services, administrative and support services and professional and technical support services, the same data shows precipitous rise in employment numbers across all three broadly defined public sectors.

Subsequently, the chart below shows an even more disconcerting trend.
In addition to by-now customary steady and precipitous rise in unemployment, we are also experiencing rapid withdrawals from the labour force participation as more and more people are falling into our deep welfare trap or undertake an emigration option. This trend – of collapsing employment and rising unemployment – now poised to threaten our long-term demographic dividend, or the expected higher returns to younger labour force that many of Irish policy makers and analysts close to the Government circles are so keen on referring to in their rosy forecasts.

Well, of course the public sector is rolling in the dough as we are taking a pay cut: