On a note continuing yesterday's post - someone (hat tip to Patrick) brought to my attention Dolmen's note on the prospects for 2010, which I personally found to be of an excellent quality. The strategy is backed by serious arguments linked up with fundamentals, unlike the stuff coming out of some other stockbrokers here. The note is available here, but a couple of highlights are below:
"With stronger growth in economies such as the US and Europe compared to Ireland, 2010 will provide a good opportunity for Irish investors to increase the international diversification in their portfolios." You bet. For anyone wearing Green Jersey, my suggestion would be to look no further than IMF forecasts for growth (I plan to publish a comparative note on Ireland v Small Open Economies later this week).
Dolmen guys forecast US economy to grow at 3.5% in terms of GDP, a forecast that - despite having some risks to the downside - is reasonable in my view. Eurozone, held back by 'weaker economies' of Spain and Italy is expected to expand by 1.50%, the UK - by 1.30%, and Ireland, hmmm... Dolmen think +0.25%, my feeling +/-0.5% in GDP and up to -1.25% in GNP terms. Good luck to anyone who believes Irish equities are oversold on these comparatives. To me - they are overbought!
Dolmen predicate their Irish forecast as follows: "Ireland should see a reversal of the two years of negative GDP in 2010. The move away from negative growth will be welcome, but we estimate a slight increase of 0.25% in GDP for next year. The last three budgets have taken 7.4% of GDP out of the economy and with a further 1.8% to follow next year, there remains considerable challenges facing our economy." Correct.
But look beyond the Budget 2011 - Nama will remove some €4-5 billion annually through its operations, stalling the entire property market (due to increased uncertainty concerning supply of commercial and residential properties to the market) and doing nothing to restart credit cycle in the economy (don't take my word on this - look at the banks chiefs' statements).
Unemployment will continue to rise until second half of 2010, when massive scale withdrawals from the labour force and substantial emigration from Ireland will start reducing (artificially) the numbers unemployed. Numbers in employment will not rise, save for the wasteful state-subsidised 'jobs creation'. This means precautionary savings will stay with us, and deleveraging will remain anemic for consumers.
Corporate profitability will remain subdued - Dolmen expect 0.5% deflation in Ireland for 2010, as compared with 2% inflation in the US and the UK and 1.1% inflation for the Eurozone as a whole. Good luck to those stockbrokers who think profitability can be rebuilt with falling prices.
Interest rates gap will close up with US rates expected to rise to 0.75-1% by the end of 2010 from 0% currently, UK rates exected to increase from 0.5% in december 2009 to 1% in 2010, while the Eurozone rates are expected to stagnate at 1%. Now, I personally think the ECB will hike to 1.25-1.50 by the end of 2010. This is significant as far as FX rates for the euro are concerned. If the gap closes, euro will devalue somewhat against the sterling and the USD, implying some boost to exports. But if the gap remains where it is today (roughly), there is little momentum, bar for differences in the growth rates, to devalue the euro.
US and UK bond yields will push away - slightly - from the Eurozone averages, implying that demand for dollar and sterling will be weker (and add to this a bit of the moderation in demand for US Treasuries from China and the BRICs in general). Again, this restricts the scope for euro devaluation.
Dolmen make a call on the USD and sterling vis-a-vis the euro, but I am not that comfortable doing the same.
On Irish property markets: "In Ireland, the problems facing the commercial property sector have not improved. When compared to other Euro-Zone cities, Dublin property yields increased the most in Q3. Vacancy rates are also the highest in the sample of Euro-Zone cities... Any improvement in the sector is dependent on the outcome of NAMA and with the possibility that a number of properties may come to the market in the next year, together with the large level of unoccupied offices, the outlook for Irish commercial property looks bleak for 2010." Dead right!
Lastly, if you want to see what I mean by weaker earnings outlook for Ireland Inc on the back of our weak economy - see the end of Dolmen's note with yeild estimates for Irish equities. Marvelous - this does really support the idea of 10% growth for property markets and 100% increase in banks shares that Bloxham chief has predicted for us. I wouldn't hold my breath for that kind of a ride...
Showing posts with label Irish economy 2010 forecast. Show all posts
Showing posts with label Irish economy 2010 forecast. Show all posts
Monday, January 11, 2010
Saturday, January 2, 2010
Economics 02/01/2010: Irish Economy 2010
In the spirit of a fellow economist who posted his published views on 2010 prognosis for Ireland Inc, here is my take on the future, as published in the current edition of Business & Finance magazine. Note: this is an unedited version.
With the Budget 2010 behind us, January beacons as the month that will make or break our hopes for seeing a recovery next year.
Despite all Government pronouncements, the real issues faced by this country in 2009 reached much deeper than the three Super Challenges of the year. Neither Lisbon, nor Nama (until it is finalised) and especially not Budget 2010 will have as lasting an impact on this economy as the job never taken up – the nitty-gritty of managing our economic freefall.
Throughout 2009, our leadership has resorted to the management strategy known as the ‘sandwich’ technique. This involves delivering the requisite bad news sandwiched between quasi-plausible platitudes. Thus, throughout 2009 the Government has sought to soften the news with some ‘positive thinking’ sloganeering and move from one blockbuster campaign to another. In the mean time, taxation burden explosion and general sense of uncertainty have weighted heavily on our economic psyche.
The Budget 2010 speech by Minister Lenihan, peppered with pronouncements of the ending of the recession and exhortations that ‘The worst is now over’ continued the trend. With such modus operandi, deep and necessary reforms simply cannot take place. And predictably they did not take place.
Instead of admitting that unemployment is here to stay and that it will be our younger workers who will be on the dole the longest, Brian Cowen and his side-kicks applied selective filters pronouncing the imminent end of the recession back in May 2009. Bottoming out claims stretched into June, followed by a promise of a ‘positive growth’ quarter before Christmas.
What the country needed most – exports credits and currency risk supports, tax cuts to stimulate jobs creation and a reform of the banking sector to allow deleveraging of the households croaking under the mountain of debts – never took place. Not once have we heard of the need to stimulate entrepreneurship. Not once in the entire year have we been offered a vision to attract new start up companies into Ireland.
Instead, the country received a hefty dose of PR-speak on ‘knowledge economy’ while mothballing new investment in ICT, IT and venture capital funding. Money not spent on real economy went right over the heads of tens of thousands unemployed workers straight to the white elephant of Fas training schemes.
The problem is that amidst this marketing blitz from the Government, the real numbers suggest that the country is far from reaching the bottom of a recession and that we are heading into the period of protracted stagnation with growth bouncing along a flat trend line.
Take the Exchequer returns. A year ago, Exchequer revenue stood at €41 billion. This year the figure has fallen to €34.6 billion – down almost 15.5% in 12 months. Next year, things will ‘stabilize’ at around €34.25 billion, which will remain largely intact into 2012.
2009 Exchequer returns were artificially inflated by two major factors: transfer pricing by multinationals and redundancy payments that were made in late 2008-early 2009. These factors are unlikely to replay in 2010, because our MNCs will be heading into a new investment cycle elsewhere, with much lower incentives to push transfer pricing through Ireland, while the redundancy payments for the next wave of layoffs will be much slimmer. This suggests that some €1 billion worth of income tax and circa €110 million worth of corporate tax receipts factored into the latest Department of Finance projections are not going to materialise.
And this is before we account for the expected declines in 2009 self-employment tax revenues. Over 2009 VAT receipts fell to €10,368 million, down 20.5%. But retail sales contracted by 15% in value. This suggests that up to a quarter of the decrease in VAT payments came from somewhere else, namely – from the depressed business activity. Doing a simple back of envelope calculation suggests that VAT-related activity has fallen some €15bn (roughly in line with our GNP declines), implying the associated decline in corporate tax revenue of some €150-200 million into 2010.
Table below shows estimated 2010 balance sheet for the Government post-Budget 2010. Assuming the Government delivers planned €4 billion in cuts, the Exchequer deficit in 2010 is likely to be in the region of 10.4% (by Department of Finance estimates, adjusting for net savings) and 14.5% (using my projections). And my scenario assumes that only €4 billion worth of expected 2010 banks recapitalization funding will come directly from the Exchequer, with some €5.7-8.4 billion in additional funds financed through new Nama bonds. Department of Finance naively assumes no new recapitalization demands from the banks during 2010.
These figures compound the crisis of 2009. In other words, while the Exchequer deficit might be indeed stabilising in size in 2010, new debt burden is growing. Far from being closer to solvency, we are getting deeper into dependency of borrowing to maintain our public spending.
By various estimates, structural deficit was between 8% and 9% of 2009 GDP. Given that raising tax burden on current net contributors to the Exchequer is simply not feasible, correcting for this will require reducing our public expenditure by some €10-12 billion more in 2010-2011. Every year we delay the remaining adjustment will cost us additional €500 million in financing costs, shaving off 0.3% of our annual GDP. None of this is factored into Department of Finance projections.
As bad as things might be on the deficit front, at the very least we have an idea as to what measures must be taken to address the problem. Things are more complicated when it comes to unemployment. The latest data for Live Register shows that the number of those claiming jobless benefits is again on the rise, following a decline in October 2009. The rate of increases is much slower than in Q1 2009, but this is neither here nor there for two reasons.
First, our army of unemployed is growing much faster than the Live Register suggests because at least 3,800 people are currently due to rejoin Live Register from seasonal part time employment, while 30,300 people on Fas’ full-time training and community employment schemes have little chance of getting a real job any time soon. Factor these in and Live Register-implied unemployment rises to 13.5%, or just 42,535 shy of the half a million mark.
Second, the real unemployment, as opposed to the statistical measure, has already reached this level due to the fact that we are seeing increases in long term unemployment translating into social welfare dependency. The more the Government talks about cutting unemployment benefits, the greater will be the incentives for moving off unemployment to welfare.
And our welfare trap is a potent one. In a note published a week before Budget day, Department of Finance provided an estimate of the replacement rates for various types of welfare recipients in Ireland. Under Department assumptions (which covered rent relief, child benefit, main benefit and some additional payments), majority of categories of welfare recipients received benefits in excess of 60% of the average industrial earnings which currently stands at €33,634 per annum. Once costs of child care and health subsidies are added, all but two categories of recipients earned more than 70% of the average industrial earnings and three categories in excess of 100%. If you also recognise that working today requires payment for transport and food – the two costs vastly lower for those on the dole, all categories of social welfare recipients examined by the Department of Finance earn more than 70% of the average industrial earnings.
It is a simple mathematical conclusion that every person moving from Live Register to the generous embrace of social welfare adds to the financial woes of the state. Budget 2010 has done nothing to address this problem in real terms, while it did strengthen the incentives for transitioning to the dole from unemployment benefits by imposing a shallower cut to social welfare than to jobs seekers allowance.
All in, we can expect this process to continue working through the labour markets in 2010 as well, with employment falling toward 1,750,000-1,800,000 mark and unemployment rising officially to 13.5-14% - the rise arrested by outward migration, transitions to welfare and artificial Fas programmes ‘jobs’ supports.
The risks to the economy are to the downside with the biggest threat of another unemployment spike in Q1 2010 coming from the battered retail and business services sectors. From cars showrooms to Christmas sales counters, Irish retail sector is holding on to a hope of a half-decent holiday sales season. Should this fail to materialise, a wave of layoffs is going to take place in early 2010 as businesses shut doors for good unable to withstand another 11 months of decimated revenues.
The prospect of rising interest rates hangs over the services sector as a double edged sword.
On one hand, inversion of the interest rate curve upward will spell rising cost of doing business as higher borrowing costs will outpace any rise in ECB benchmark rate. In addition, margins rebuilding and high demand for capital will also imply rises in rates charged by the banks regardless of what ECB might do in 2010.
But in addition to borrowing costs, the retail and broader services sector will also be witnessing deeper retrenchment of consumers who will face the need to maintain high precautionary savings at the time of rising mortgages costs and real effective tax rates.
Over the last 11 months, retail sales have fallen by 26.5% in volume, excluding price adjustments. Another 10% or so contraction in demand will see wholesale and retail sectors shrinking by roughly half from 140,000 employees in Q4 2008 to ca 70,000 in Q4 2010.
And the yin-and-yang Budget is not helping this either. While excise duties on alcohol have been brought down and Vat increase of 2009 was clawed back, the increases in transport costs due to carbon levy will eat up any stimulus that could have been theoretically delivered by other measures.
All of the major economic indicators are therefore continuing to point South with little real evidence that the economy is going to return to robust growth any time soon. If confirmed, further slowdown in 2010 will mean that Irish economy will be traveling down recessionary curve for some 30-33 months by the time the Minister for Finance gets to the next round of public sector expenditure cuts. Lacking any serious policies aiming to get us out of this mess, this is a bleak prospect we will have to look forward to in 2010.
Yet, as our exporters experience shows Ireland Inc is more than capable of turning around. What such a prospect needs today is exactly what this column has advocated since July 2008. A rapid and significant cut in our deficits by ca €10 billion in 2010, followed by redirecting Nama-bound cash to deleveraging household budgets, re-capitalization of the banks through equity purchase to guarantee a capital investment and deleveraging stimulus to the tune of €40-45 billion in 2010. Redirecting existent targeted tax relief to a general cut in employer PRSI and income tax levies with a revenue-neutral effect completes the picture.
We need real reforms. Power costs, water rates, local authority charges and other state-induced costs must be cut by 25-40% through consolidation of local authorities and forceful changes to the way our power utilities operate. Airports levies and charges must be slashed to stimulate travel and to alleviate pressure on our middle classes who are straining under the weight of the state burden.
Short of getting down and dirty with far-reaching reforms, Government sloganeering about ‘taking the pain’ will be about as effective as showing reruns of the ER to a heart attack patient.
With the Budget 2010 behind us, January beacons as the month that will make or break our hopes for seeing a recovery next year.
Despite all Government pronouncements, the real issues faced by this country in 2009 reached much deeper than the three Super Challenges of the year. Neither Lisbon, nor Nama (until it is finalised) and especially not Budget 2010 will have as lasting an impact on this economy as the job never taken up – the nitty-gritty of managing our economic freefall.
Throughout 2009, our leadership has resorted to the management strategy known as the ‘sandwich’ technique. This involves delivering the requisite bad news sandwiched between quasi-plausible platitudes. Thus, throughout 2009 the Government has sought to soften the news with some ‘positive thinking’ sloganeering and move from one blockbuster campaign to another. In the mean time, taxation burden explosion and general sense of uncertainty have weighted heavily on our economic psyche.
The Budget 2010 speech by Minister Lenihan, peppered with pronouncements of the ending of the recession and exhortations that ‘The worst is now over’ continued the trend. With such modus operandi, deep and necessary reforms simply cannot take place. And predictably they did not take place.
Instead of admitting that unemployment is here to stay and that it will be our younger workers who will be on the dole the longest, Brian Cowen and his side-kicks applied selective filters pronouncing the imminent end of the recession back in May 2009. Bottoming out claims stretched into June, followed by a promise of a ‘positive growth’ quarter before Christmas.
What the country needed most – exports credits and currency risk supports, tax cuts to stimulate jobs creation and a reform of the banking sector to allow deleveraging of the households croaking under the mountain of debts – never took place. Not once have we heard of the need to stimulate entrepreneurship. Not once in the entire year have we been offered a vision to attract new start up companies into Ireland.
Instead, the country received a hefty dose of PR-speak on ‘knowledge economy’ while mothballing new investment in ICT, IT and venture capital funding. Money not spent on real economy went right over the heads of tens of thousands unemployed workers straight to the white elephant of Fas training schemes.
The problem is that amidst this marketing blitz from the Government, the real numbers suggest that the country is far from reaching the bottom of a recession and that we are heading into the period of protracted stagnation with growth bouncing along a flat trend line.
Take the Exchequer returns. A year ago, Exchequer revenue stood at €41 billion. This year the figure has fallen to €34.6 billion – down almost 15.5% in 12 months. Next year, things will ‘stabilize’ at around €34.25 billion, which will remain largely intact into 2012.
2009 Exchequer returns were artificially inflated by two major factors: transfer pricing by multinationals and redundancy payments that were made in late 2008-early 2009. These factors are unlikely to replay in 2010, because our MNCs will be heading into a new investment cycle elsewhere, with much lower incentives to push transfer pricing through Ireland, while the redundancy payments for the next wave of layoffs will be much slimmer. This suggests that some €1 billion worth of income tax and circa €110 million worth of corporate tax receipts factored into the latest Department of Finance projections are not going to materialise.
And this is before we account for the expected declines in 2009 self-employment tax revenues. Over 2009 VAT receipts fell to €10,368 million, down 20.5%. But retail sales contracted by 15% in value. This suggests that up to a quarter of the decrease in VAT payments came from somewhere else, namely – from the depressed business activity. Doing a simple back of envelope calculation suggests that VAT-related activity has fallen some €15bn (roughly in line with our GNP declines), implying the associated decline in corporate tax revenue of some €150-200 million into 2010.
Table below shows estimated 2010 balance sheet for the Government post-Budget 2010. Assuming the Government delivers planned €4 billion in cuts, the Exchequer deficit in 2010 is likely to be in the region of 10.4% (by Department of Finance estimates, adjusting for net savings) and 14.5% (using my projections). And my scenario assumes that only €4 billion worth of expected 2010 banks recapitalization funding will come directly from the Exchequer, with some €5.7-8.4 billion in additional funds financed through new Nama bonds. Department of Finance naively assumes no new recapitalization demands from the banks during 2010.
These figures compound the crisis of 2009. In other words, while the Exchequer deficit might be indeed stabilising in size in 2010, new debt burden is growing. Far from being closer to solvency, we are getting deeper into dependency of borrowing to maintain our public spending.
By various estimates, structural deficit was between 8% and 9% of 2009 GDP. Given that raising tax burden on current net contributors to the Exchequer is simply not feasible, correcting for this will require reducing our public expenditure by some €10-12 billion more in 2010-2011. Every year we delay the remaining adjustment will cost us additional €500 million in financing costs, shaving off 0.3% of our annual GDP. None of this is factored into Department of Finance projections.
As bad as things might be on the deficit front, at the very least we have an idea as to what measures must be taken to address the problem. Things are more complicated when it comes to unemployment. The latest data for Live Register shows that the number of those claiming jobless benefits is again on the rise, following a decline in October 2009. The rate of increases is much slower than in Q1 2009, but this is neither here nor there for two reasons.
First, our army of unemployed is growing much faster than the Live Register suggests because at least 3,800 people are currently due to rejoin Live Register from seasonal part time employment, while 30,300 people on Fas’ full-time training and community employment schemes have little chance of getting a real job any time soon. Factor these in and Live Register-implied unemployment rises to 13.5%, or just 42,535 shy of the half a million mark.
Second, the real unemployment, as opposed to the statistical measure, has already reached this level due to the fact that we are seeing increases in long term unemployment translating into social welfare dependency. The more the Government talks about cutting unemployment benefits, the greater will be the incentives for moving off unemployment to welfare.
And our welfare trap is a potent one. In a note published a week before Budget day, Department of Finance provided an estimate of the replacement rates for various types of welfare recipients in Ireland. Under Department assumptions (which covered rent relief, child benefit, main benefit and some additional payments), majority of categories of welfare recipients received benefits in excess of 60% of the average industrial earnings which currently stands at €33,634 per annum. Once costs of child care and health subsidies are added, all but two categories of recipients earned more than 70% of the average industrial earnings and three categories in excess of 100%. If you also recognise that working today requires payment for transport and food – the two costs vastly lower for those on the dole, all categories of social welfare recipients examined by the Department of Finance earn more than 70% of the average industrial earnings.
It is a simple mathematical conclusion that every person moving from Live Register to the generous embrace of social welfare adds to the financial woes of the state. Budget 2010 has done nothing to address this problem in real terms, while it did strengthen the incentives for transitioning to the dole from unemployment benefits by imposing a shallower cut to social welfare than to jobs seekers allowance.
All in, we can expect this process to continue working through the labour markets in 2010 as well, with employment falling toward 1,750,000-1,800,000 mark and unemployment rising officially to 13.5-14% - the rise arrested by outward migration, transitions to welfare and artificial Fas programmes ‘jobs’ supports.
The risks to the economy are to the downside with the biggest threat of another unemployment spike in Q1 2010 coming from the battered retail and business services sectors. From cars showrooms to Christmas sales counters, Irish retail sector is holding on to a hope of a half-decent holiday sales season. Should this fail to materialise, a wave of layoffs is going to take place in early 2010 as businesses shut doors for good unable to withstand another 11 months of decimated revenues.
The prospect of rising interest rates hangs over the services sector as a double edged sword.
On one hand, inversion of the interest rate curve upward will spell rising cost of doing business as higher borrowing costs will outpace any rise in ECB benchmark rate. In addition, margins rebuilding and high demand for capital will also imply rises in rates charged by the banks regardless of what ECB might do in 2010.
But in addition to borrowing costs, the retail and broader services sector will also be witnessing deeper retrenchment of consumers who will face the need to maintain high precautionary savings at the time of rising mortgages costs and real effective tax rates.
Over the last 11 months, retail sales have fallen by 26.5% in volume, excluding price adjustments. Another 10% or so contraction in demand will see wholesale and retail sectors shrinking by roughly half from 140,000 employees in Q4 2008 to ca 70,000 in Q4 2010.
And the yin-and-yang Budget is not helping this either. While excise duties on alcohol have been brought down and Vat increase of 2009 was clawed back, the increases in transport costs due to carbon levy will eat up any stimulus that could have been theoretically delivered by other measures.
All of the major economic indicators are therefore continuing to point South with little real evidence that the economy is going to return to robust growth any time soon. If confirmed, further slowdown in 2010 will mean that Irish economy will be traveling down recessionary curve for some 30-33 months by the time the Minister for Finance gets to the next round of public sector expenditure cuts. Lacking any serious policies aiming to get us out of this mess, this is a bleak prospect we will have to look forward to in 2010.
Yet, as our exporters experience shows Ireland Inc is more than capable of turning around. What such a prospect needs today is exactly what this column has advocated since July 2008. A rapid and significant cut in our deficits by ca €10 billion in 2010, followed by redirecting Nama-bound cash to deleveraging household budgets, re-capitalization of the banks through equity purchase to guarantee a capital investment and deleveraging stimulus to the tune of €40-45 billion in 2010. Redirecting existent targeted tax relief to a general cut in employer PRSI and income tax levies with a revenue-neutral effect completes the picture.
We need real reforms. Power costs, water rates, local authority charges and other state-induced costs must be cut by 25-40% through consolidation of local authorities and forceful changes to the way our power utilities operate. Airports levies and charges must be slashed to stimulate travel and to alleviate pressure on our middle classes who are straining under the weight of the state burden.
Short of getting down and dirty with far-reaching reforms, Government sloganeering about ‘taking the pain’ will be about as effective as showing reruns of the ER to a heart attack patient.
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