05/10/2011: Tax receipts for September

Tax receipts for September released yesterday show predictable evolution along the trend established in recent months - the trend of broadly matching the targets, but continuing to surprise on the downside in some core categories. In other words, no signs of recovery here, folks.

Here are the details.

Income tax came in at €9,254mln (this, of course, includes USC, rendering annual comparisons virtually meaningless). Compared to the target, Income tax receipts were up €147mln or 1.6%. Year on year Income tax came in at +25.7%, much of which is due to levies and USC, making multi-annual comparisons even less meaningful. Annual target for the category envisions an uplift of 25.3%yoy so we are slightly ahead of that for now.

The bright-ish spot that is Income tax is offset by the continued fall off in VAT. Through September 2011, VAT receipts stood at €7,994mln down on the target of €8,294mln (-3.6% or €300mln shortfall). Year on year VAT receipts are down 2.04% or -€167mln. VAT receipts are now down 7.7% on comparable period of 2009 and mark the worst year-to-date for 2007-present period.

Corporation tax - the Big White Hope of the 'exports-led recovery' is below target at €2,054mln (do notice that Government's Great Hope is less than 1/4 of the income tax as far as contribution to the overall Exchequer balance goes). Target was €2,085mln, so the shortfall now stands at -1.5% or €31mln. Corporation tax performance through September 2011 is now at the worst levels in 2007-present period despite all the record activities in exporting sectors, which again puts the boot into the Government's claims that exports-led recovery will restore our economy to health.

Excise tax is also underperforming the target, coming in at €3,229mln or €77mln (-2.3%) below the target. Excise tax revenues are also below 2010 levels by some 1.4% so far, implying that through September, 2011 is the worst year since 2007 in terms of excise tax collection.

In terms of smaller taxes:

• Stamps came in at surprisingly high levels of €1,124mln in 9 months through September, up €384mln or 51.9% on the target. This builds on gains in July and, most likely, represents incidental returns from one-off activities, such as €457mln expropriation of private pension funds via the FG/LP levy (HT to Jerry Moriarty of http://www.iapf.ie)
• Capital taxes are below target and posting the worst year so far for the entire 2007-present period.

Overall tax returns are now at €24.098bn, up 0.7% or €160mln on the taget and 8.7% on 2010 performance, with virtually all the yoy gains achieved due to USC reclassifying health levy into tax revenue, plus through increases in tax burden on households.

Relative to overall annual target, 0.7% increase on target through September 2011 and 8.7% increase yoy in outrun to-date are contrasted by the annual target set at 9.9% over 2010 outrun, so we do have to step up tax returns performance in months to come dramatically to deliver on the annual target.

More on the tax burden distribution in the subsequent post.

To conclude - tax receipts show no signs of substantive change in the overall Exchequer position on 2010 broadly confirming that 'exports-led recovery' thesis for restoring Irish economy to health, at the present, remains invalid.

12/09/2011: IMF admits failures in debt risk forecasting frameworks

In the analysis published just minutes ago, the IMF ("Modernizing the Framework for Fiscal Policy and Public Debt Sustainability Analysis" by the Fiscal Affairs Department and the Strategy, Policy, and Review Department, dated for internal use from August 5, 2011) implicitly admits deep errors in the methodology for analyzing public debt dynamics. Given the magnitude of errors reported by the IMF (see table summary below), the entire exercise puts the boot into the EU-led attacks on the Big 3 ratings agencies - it turns out that the wise and uncompromisable IMF was not much good at dealing with fiscal sustainability risks either.

Here are the core conclusions: "Modernizing the framework for fiscal policy and public debt sustainability analysis (DSA) has become necessary... [This paper] proposes to move to a risk-based approach to DSAs for all market-access countries, where the depth and extent of analysis would be commensurate with concerns regarding sustainability..."

DSA could be improved, according to the IMF report, through a greater focus on:

• Realism of baseline assumptions: "Close scrutiny of assumptions underlying the baseline scenario (primary fiscal balance, interest rate, and growth rate) would be expected particularly if a large fiscal adjustment is required to ensure sustainability. This analysis should be based on a combination of country-specific information and cross-country experience." (Note that in Ireland's case such analysis would probably require, in my view, using GNP metrics in place of GDP).
• Level of public debt as one of the triggers for further analysis: "Although a DSA is a multifaceted exercise, the paper emphasizes that not only the trend but also the level of the debt-to-GDP ratio is a key indicator in this framework. [Apparently, before the level of debt didn't matter much, just the rate of growth in debt - the deficit - was deemed to be important] The paper does not find a sound basis for integrating specific sustainability thresholds into the DSA framework. However, based on recent empirical evidence, it suggests that a reference point for public debt of 60 percent of GDP be used flexibly to trigger deeper analysis for market-access countries: the presence of other vulnerabilities (see below) would call for in-depth analysis even for countries where debt is below the reference point." [So, now, folks, no formal debt bounds, but 60% is the point of concern. Of course, by that metric, IMF would have to do country-specific analysis for ALL euro area states]
• Analysis of fiscal risks: "Sensitivity analysis in DSAs should be primarily based on country-specific risks and vulnerabilities. The assessment of the impact of shocks could be improved by developing full-fledged alternative scenarios, allowing for interaction among key variables..." [Another interesting point, apparently the existent frameworks fail to consider interacting risks and second order effects. That is like doing earthquake loss projections without considering possibility of a tsunami.]
• Vulnerabilities associated with the debt profile: IMF proposes "to integrate the assessment of debt structure and liquidity issues into the DSA." [Again, apparently, no liquidity risk other than maturity profile analysis is built into current frameworks]
• Coverage of fiscal balance and public debt: "It should be as broad as possible, with particular attention to entities that present significant fiscal risks, including state owned enterprises, public-private partnerships, and pension and health care programs." [It appears that the IMF is gearing toward more in-depth analysis of the unfunded state liabilities, such as longer-term liabilities relating to pensions and health expenditure, as well as more explicitly focusing on unfunded contractual liabilities, such as specific contractual exposures on state pensions. If that is indeed the case, then there is some hope we will see more light shed on the murky waters of forthcoming sovereign exposures that are currently outside the realm of exposures priced in the market.]

Now, several interesting factoids on sovereign debt forecasts and sustainability as per IMF paper.

Here's the summary of IMF own assessment of its forecasting powers when it comes to Ireland: "The 2007 Article IV staff report included a public DSA, which showed that government net debt (defined as gross debt minus the assets of the National Pensions Reserve Fund and the Social Insurance Fund) was low and declining. In the baseline scenario, net debt was projected to fall from 12 percent of GDP in 2006 to 6 percent of GDP by 2012. The medium-term debt position was judged to be resilient to a variety of shocks. The worst outcome-a rise in net debt to 16 percent of GDP in 2012-occurred in a growth shock scenario. Staff identified age-related spending pressures as the most significant threat to the long-run debt outlook. The report noted that, although banks had large exposures to the property market, stress tests suggested that cushions were adequate to cover a range of shocks. Net debt to GDP subsequently increased nearly fivefold from 2007 to 2010, owing to a sharp GDP contraction and large fiscal deficits linked mainly to bank recapitalization costs."

No comment needed on the above. The IMF has clearly missed all possible macroeconomic risks faced by the Irish economy back in 2007.

On Greece: "In the 2007 Article IV staff report, staff indicated that fiscal consolidation should be sustained over the medium term given a high level of public debt and projected increases in pension and health care costs related to population aging. ...In the baseline scenario, public debt to GDP was projected to fall from 93 percent in 2007 to 72 percent in 2013. All but one bound test showed debt on a declining path over the medium term. In the growth shock scenario, debt was projected to rise to 98 percent of GDP by 2013. Two years later, staff warned that public debt could rise to 115 percent of GDP by 2010-even after factoring in fiscal consolidation measures implemented by the authorities-and recommended further adjustment to place public debt on a declining path."

So another miss, then, for IMF.

Here's the summary table on these and other forecast errors:

Next, take a look at a handy summary of debt sustainability thresholds literature surveyed by the IMF (largely - sourced from IMF own work):
So for the Advanced Economies (AE), debt thresholds range from 80-150 percent of GDP, the range so wide, it make absolutely no sense. Nor does it present any applicable information. By the lower bound, every euro area country is in trouble, by the upper bound, Greece is the only one that is facing the music. Longer term sustainability bound is a bit narrower - from 50% to 75%, with maximum sustainable debt levels of 183-192%.

And, for the last bit, off-balance sheet unfunded liabilities and actual debt levels chart:
Here's an interesting thing. Consider NPV of pension and health spending that Ireland is at - in excess of aging economies of Italy, Japan and close to shrinking in population Germany. One does have to ask the question: why the hell does the younger economy of Ireland spend so much on age-linked services and funds?

Another thing to notice in the above is that there appears to be virtually no identifiable strong statistical relationship between debt levels and pensions & health expenditures. This clearly suggests that the bulk of age-related spending looking forward is yet to be factored into deficits and debt levels. Good luck with getting that financed through the bond markets, I would add.

06/01/2011: Exchequer Returns - part 3

In parts 1 and 2 (here and here) I've dealt with some longer term issues relating to the general Exchequer performance figures. In the following two posts I will update specific expenditure (current post) and tax receipts (next post) data.

First, total expenditure:
Two things worth noting here:

• Up until November, total spending side of Exchequer returns was performing relatively strongly, with year on year savings of 4.22%. These savings were significantly reduced in December, with full year savings performance of just 1.55% on 2009.
• The reductions in 2010 have been achieved solely on the back of capital expenditure cuts. Year on year, current spending rose by €261mln or 0.6% in 2010, while capital spending was cut by 14.3% or €990mln
  

You can see the dynamics of reductions over the year in the following two charts:
Combined savings by each department head per quarter end:
Feel free to interpret the above, but what interested me much more is just how stable are the Government's spending priorities over time. To see this, I plotted annual shares of each department head as a percentage of total spend (note - this exercise is not a perfect comparison as departments' responsibilities have changed over time).
The chart above suggests strongly to me that the Government, despite all the criticism it deserves in managing the crisis, has so far elected to cut largely discretionary spending. This is a rational response to the early stages of the crisis, but it is clearly insufficient to deliver stabilization of public finances, let alone their restoration to health.

06/01/2011: Exchequer Returns - Part 2

In Part 1 (here) I raised couple of specific points concerning the latest official claims over Irish Exchequer returns for December. Here, I follow up on the first point raised earlier and then post on longer term trends in Government spending, including my forecasts for fiscal performance in 2011-2014.

First, relating to the point raised in yesterday's post: Minister Lenihan stated that
"On the spending side, overall net voted expenditure at €46.4 billion was over €700 million below the level recorded in 2009, reflecting the ongoing tight control of public spending. While day-to-day spending was marginally ahead of target in the year, this is due to a shortfall in Departmental receipts rather than overruns in spending."

As I outlined earlier, I beg to disagree with the Minister on the claim of 'tight control'. Let me add to the reasons for my disagreement:

• The Exchequer Returns show that the Government had an overall budget deficit of €18,745m in 2010,
  
• On the surface, this appears to be ,896m lower than the deficit in 2009, which stood at €24,641m.
  
• However, deficit 2009 included a €3bn payment to the National Pensions Reserve Fund as part of the banks recapitalization plus a €4bn re-capitalization injection into Anglo Irish Bank
  
• Deficit 2010 does not include bank recapitalization measures.

This implies that the Exchequer deficit was:

• 2010 = €18,745m
• 2009 = €17,641m

And thus Minister Lenihan's tightly controlled public spending measures in 2010 have managed to increase Government deficit by €1,104m on 2009 levels.


Next, let's take a look at the annual data for Irish Exchequer over the recent years, incorporating latest release.

First, receipts v expenditure over time - for 1983-2011 and on with my forecasts. All data is annual:
Notice that with exception of 3 points - all observations fall to the right and below the 45 degree blue line. Also notice that the trend over time has been toward greater excess expenditure. Overall, however, 'when I have it, I spend it' relationship really does hold - the RSq is high 0.9413.

Latest figures show that in 2010 the Government has savaged capital investment side of its balancesheet and failed to curb current spending. This too is consistent with long term trends:
The age of Brian Cowen 'stimulus' (remember - he did say that we are going to have recession stimulus in the form of large capital investment) is now over and, despite Minister Lenihan's claims that we are not in the 1980s... guess what - 2010 we landed right into pre-1989 era.

Lastly, on to forecasts for the future:
Above chart clearly shows why I am with the IMF on the deficit outlook for 2014, and not with the Government. Apart from slightly higher total expenditure outlook than that of DofF, I expect slightly lower tax take and non-tax returns, but then I also expect the remaining costs of banks and subsequent increased interest repayment burdens to come due in 2011-2014 as well.

Economics 5/12/10: Default, debt and 'Rescue of Ireland' deal

Today's Sunday Independent article on inevitability of default, with comprehensive figures on the impact of the IMF/ECB/EU deal for ordinary Irish households and the levels of our indebtedness. Link here.

Economics 5/12/10: Links to recent articles on irish economy

Here is the link to my article in Saturday Irish Independent on the topic of FG and Labor 'alternative' Budget 2011 proposals: here.

Here is the link to another article from Saturday, this one from the Irish Examiner on the topic of banks debt default as an option for Ireland: here.

Economics 17/11/10: The road we traveled

Amidst this crisis, it is worth taking a look back at the road that we have traveled on our way to the current predicament. It is fashionable today to make claims that the past - the recent past in fact - has been a place of greater fiscal responsibility, the age of 'sustainable' public finances. But is the claim true? Have lost our way all of a sudden around 2005-2007, or have we always been traveling along the same route.

Here are few charts looking back to 1983...
In absolute levels terms, spending and tax receipts have clearly grown dramatically over the years. These are nominal figures, of course. But notice that total expenditure line almost invariably exceeds total receipts levels. The chart also shows pretty dramatic changes that took place since 2007.


Now, let's take a look at the decomposition of the Exchequer balance sheet:
Clearly, gross current spending has been a core of the overall Exchequer financing. The most dramatic departure from 'investment' focus toward current spending focus took place around the turn of the century. Looking at the comparatives across the shares of GNP taken up by capital and current spending shows this even more dramatically. If during 1985-2000 period current expenditure declined as a share of GNP, capital spending first fell (through 1988) then stagnated (through 1997), and then rose through 2002. Capital spending stagnated in the boom years of 2003-2007 and then rose again (due to contraction in GNP) through 2009. However, from 2006 through today, current spending went through the roof.

Another interesting feature of the chart above is that during the current crisis there was not a single year when the current expenditure declined - either in terms of absolute level of spending or in terms of spending relative to GNP.

Total government spending both in levels and as a share of GNP is expected to fall this year for the first time since the beginning of the crisis. This, of course, is driven solely by the decline in capital spending, as charts above indicate.

Now, let us plot primary Exchequer balances - the difference between the total receipts and expenditure.
In broad terms, over the long run, Irish Exchequer has been historically on a non-sustainable path. In only 3 years since 1983 did our total receipts cover total expenditure: 1999, 2000 and 2006.

It is worth noting that we are, despite what Minister Lenihan says, firmly back into the 1980s territory:

• Our current expenditure will stand around 48.7% of GNP this year - a level consistent with 1986-1987 average
• Our capital expenditure as the share of GNP is now 5.7% - the level also attained in 1986
• Our total government expenditure stands at 54.4% this year - the level close to the one last seen in 1986 (54.7%)
• In 2008 our balance was -9.8% which was between 1986 and 1987 levels of balance
• In 2009-2010 we have posted worse deficits than in any other year recorded in the abvoe charts.

So what about good cop - bad cop game of blame going across the Dail isles?
It turns out that on average annual basis, Brian Cowen leads the recent history team of profligate Taoisigh with a whopping (albeit obviously crisis-related) average annual shortfall of €26.5bn so far. Together - Bertie & Cowen come distant second with €5.5bn in annual shortfalls. But overall, there is not a single Toiseach in the modern history of Ireland who managed to balance the books at the primary level. Hardly a sign of any fiscal 'golden age' in the past.

Economics 6/11/10: Private sector response to DofF estimates

Yesterday’s morning note from Eurointelligence.com – a politically neutral economics site read: “A really bad day for European peripheral bond markets, as market participants realise that the Irish recovery plan is a pile of baloney, based on wishful thinking and unrealistic forecasts (which are shocking also believed by private sector forecasters in Ireland). The assumption is essentially that the crisis has no real GDP effect. This is the Irish government’s official forecast for the growth, inflation and unemployment for the next four years, contained in the Irish budget plan."

Summary here:

Their analysis is illustrated by a chart from Calculated Risk showing scary dynamics:


But the ‘happy-to-parrot DofF’ quasi-official analysts of IRL Inc took a different view of the numbers. So was Eurointelligence right in being sarcastic about ‘private sector forecasters’ misfiring in their enthusiasm for DofF numbers?

Per one ‘research note’ Irish deficit problems are attributable, at least this year, to things like ‘decrease in GDP’ (apparently, something no one could have foreseen). And palatable comparisons are being made between the UK adjustments planned ahead (less than 6% of GDP over next 5 years) and Irish adjustments envisioned by DofF (9.5% of GDP through 2014), without actually bothering to check what’s happening between Euro and Sterling lately, or possibly worse – without understanding the relationship between currency value and deficits.

One of our most cheerleading ‘analysts’ remarked that markets “may take some consolation from the depth of next year's adjustment, which is at the high end of expectations” obviously confusing their own sales pitch to the clients with the market view. Markets promptly corrected this by bidding up our bond yields.

Defending DofF ‘forecasts’ was done on a reference to a single figure that almost matches this broker’s view and a claim that we can’t really tell much about their realism because there isn’t enough detail provided by DofF. It sounds like an argument that famines are caused by the lack of food. The entire point of the DofF 'forecasts' was to provide certainty. The fact that the Department failed to do so escaped the broker.

Funny thing – the same broker lauded the details provided on interest payments from the recapitalization promissory notes. “The general government balance will reflect no promissory interest charge until 2013, when the charge will be €1.75bn for two years, reducing thereafter. Alleviating uncertainty around these charges is a positive but also reinforces the reality of a challenging fiscal situation.” Alleviating uncertainty? Did anyone notice the fact that DofF is projecting forward 4.7% interest rate – the average for 2009 – despite the fact that the entire universe expects ECB rates to rise by 2013? You’d expect the brokers to understand that no yield curve in this world remains flat for 5 years. Then again, may be this is not something our official ‘economists’ are aware of.

Another broker produced an equally priceless analysis: “The revised forecast [of 1.75% real growth next year] is below the median projection of 2.0% growth in the latest Reuters monthly Irish economists’ poll.” Oh, mighty, that wouldn’t be the same economists’ poll that missed the Great Recession and predicted soft landing for the property markets, failed to detect the beginning of collapse in Exchequer revenues and spot a market crash. Oh, and just in case you still doubt the powers of the Reuters ‘Irish economists’ poll’ – the poll covers only the 'economists' who thought Irish banks shares back in 2007 were not overvalued and Anglo was a great little bank besieged by bad short-sellers…

About the only research note on Irish Government announcement that didn’t cause a severe tooth-ache like reaction when I read them was NCB’s note.

The prize for the least readable (and least informative) commentary goes to Goodbody’s note, which spots a host of typos, grammatical errors, confusion and absolutely ludicrous assertions that “recent bond market jitters have been caused by factors outside of Ireland’s control, namely the fear that some European nations are considering a mechanism for restructuring of euro-area member’s sovereign debt at some stage in the future.” I mean what can you make of an ‘economics’ analysis that claims that ‘factors outside’ country control can override the fact that we have 32% deficit this year?! To me, it looks like a worldview which would miss a nuclear blast for a match strike.

Economics 4/11/10: Early DofF Estimates for Budget 2011

DofF has published some preliminary projections for Budget 2011 tonight, titled "Information Note
on the Economic and Budgetary Outlook 2011 – 2014 (in advance of the publication of the Government’s Four-Year Budgetary Plan)". Catchy, isn't it?

Here's my high-level read through:

1) pages 2-3 (note DofF couldn't even number actual pages in the document) present some rosy scenarios concerning growth. Most notably, DofF doesn't seem to think that Dollar is going to devalue against the Euro significantly in 2011. As if QE2 will have no effect or will be offset, under DofF expectations by a QETrichet. This is non-trivial, of course. Price of oil is expected to rise by 10.4% over 2011, but dollar will devalue by just 3.7% and sterling by 2.3%. Absent robust demand growth (per DofF-mentioned global slowdown) what would drive oil up at a rate more than 4 times dollar devaluation? This is non-trivial - any devaluation of sterling and dollar will impact adversely our exports and will increase our imports bills, chipping at GDP and GNP from both ends.

2) "in overall terms, real GDP is projected to increase by 1¾% next year (GNP by 1%). This takes account of budgetary adjustments amounting to €6 billion, which are estimated to reduce the rate of growth by somewhere in the region of 1½ - 2 percentage points. Nominal GDP is set to grow by 2.5% in 2011, implying a GDP price deflator of ¾%." Errr... ok, I can buy into low inflation, but... folks - DofF is talking tough budget. which will mean inflation on state-controlled sectors is going to be rampant. To keep total inflation at just 0.75%, you have to get either a strong revaluation of the euro (ain't there, as we've seen in (1)) or a strong deflation in the private sectors (possible, but if so, what would that do to Exchequer returns and to domestic activity? Interestingly, DofF refer to HICP, not CPI when they talk about moderate inflation of 3/4%. Of course, they wouldn't dare touch upon the prospects of our banks skinning their customers (err... also shareholders, rescuers etc) with mortgage costs hikes.

3) Now, consider that 1.75% growth in real GDP and 1% growth in GNP. Where, exactly will this come from? IMF projection for WEO October 2010 (before Government latest adjustment in deficit announcement) factored in 2.277% growth in constant prices GDP for 2011. DoF says that the reduction in Government consumption will amount to 1.2-2% point in the rate of growth. This is, I assume, before factoring in second order effects of higher taxation measures - just a brutal cut. So IMF, less DofF estimate leads to growth rate of 0.227-1.077%, which is less than what DofF assumes. Of course, that range - with a mid-point of 0.652% still does not capture the adverse effects of increased taxes and other charges, which - if we are to take €6bn headline figure for deficit reductions, applying 1.2-2% of GDP net adjustment on expected Government consumption side and factoring in stabilizers of 20% implies that DofF is aiming to get well in excess of €1.9-3bn in new revenues in 2011. Of these, maximum of €1.1-1.2 billion can be expected to arise from DofF forecast growth, leaving €0.8-1.9bn to be raised from tax increases and other charges. Apart from being optimistic, it does look to me like DofF didn't factor the effects of this into their growth projections.

4) About the only realistic assumption that DofF makes is that investment will contract by far less next year than in 2010. The reason is simple - stuff is going to start falling apart in private sector, so companies will have to replace some of the capital stock sooner or later. I can tell from here whether investment will fall 6% (as DofF assume) or 10%, but I doubt there is much upside from DofF assumption. The problem is that if you expect investment goods decline to be reversed on plant and machinery side (continuing to allow for investment to fall further on housing and construction sides) you are going to get an increase in imports, as we import much of equipment we use. So I suspect imports are going to rise more than 2.75% that DofF factored into their estimates.

5) I also think DofF are too optimistic on the employment contraction side. The Department assumes -0.25% change in overall employment levels in the Republic. I would say that several longer term trends are going to push this deeper into the red: pharma sector restructuring, continued shutting down of MNCs-led manufacturing, declines in public contracts etc.

6) All of the above is crucial, as per Table 3 we can see that even with the €6bn taken out, 2011 Exchequer balance will be exactly the same as in 2010: €19.25bn deficit in cash terms. In other words, folks - of the total €6bn in cuts almost €3.1bn will go to cover... errr... you've guessed it - BANKS! another €1.25bn to cover interest on the BANKS rescue notes (net under Non-voted expenditure). More bizarre, unless you understand our Government's logic, which escapes me - our Current Expenditure will not fall next year at all. Instead it will rise from €47.25bn in 2010 to €49.75bn in 2011, while Current Revenue will fall by €500mln, leaving our Current Budget Balance at -€16.25bn - deeper than -€13.5bn achieved this year. Under this arithmetic, the only way this Government can claim that it will be on any track in the general direction of 3% deficit by 2014 is by building in some mighty optimistic assumptions on growth side, plus projecting no further demands for funding from the banks.

7) Now, let me touch upon the last part of the concluding sentence in (6) above. Oh, boy. The Government, therefore is reliant on €31bn in promisory notes to cover the entire rescue of the banking sector. Yet, not reflected in any of DofF estimates, AIB's latest failure to raise requisite capital is likely to cost this Government additional €2bn on top of already promised funds. Toss into the mix expected losses for 2011-2012 on all banks balancesheets, and you get pretty quickly into high figures. Let's suppose that the whole banking sector will cost the state ca €60bn (this is well below my estimate of 67-70bn, Peter Mathews' estimate of 66.5bn, etc). The state will be on the hook for some €29bn more in 'promisory' notes. Suppose none are redeemed and no new borrowing against them takes place. The gross cost per annum of these notes will be roughly at least what DofF estimated for €31bn or €150mln in 2011, while the borrowing requirement for the state will have to go up by €2.9billion annually (if structured as previous promisory notes).

Overall, I have significant doubts that the numbers presented in these early estimates will survive the test of reality. However, the Department of Finance seemed to have gotten slightly more realistic in these estimates, when compared to the stuff produced a year ago. It remains to be seen if the learning curve is steep enough to get them to reach full realism by the Budget 2011 day.

Economics 31/10/10: €15bn in cuts will not be enough

This is an unedited version of my article in yesterday's Irish Examiner.

The last three days have seen dramatic volatility and extreme upward pressures on Irish, as well as Greek and Portuguese Government bonds. Briefly, early on Thursday morning, Irish 10 year bonds have set a new all-time record with yields reaching North of 7.07%. Much of these changes have been driven by the budgetary news from all three countries.

First, Greece and Portugal have shown the signs of increasing uncertainty about projected tax revenues and ability to deliver on ambitious austerity programmes.

Then, Ireland came into the line of fire.

Back in December 2009, the Government outlined a plan for piecemeal cuts in deficits over 2011-2014 that added up to a gross value of €6.5 billion (with at least €3 billion in tax measures). This was supposed to get us from having to borrow €18.8 billion in 2010 to a deficit of ca €9 billion in 2014. All courtesy of robust economic growth of more than 4% per annum penned into the Department of Finance rosy assumptions for 2011-2014.

This week, the Minister for Finance had to come down from the lofty heights of the “now you see the deficit, now your don’t” estimates by his Department. Courtesy of continuously expanding unemployment, declining tax revenues, plus ever-growing interest bills on Government debts, the headline gross savings target for 2011-2014 has been increased to €15 billion.

Dramatic as it might be, this figure is still far from being realistic – the fact that did not escape the bond vigilantes and some analysts. More than that, it represents the very conservative ethos of the Department of Finance and the Government that got us into a situation where three years into the crisis Ireland is still light years away from actually doing anything serious about correcting its fiscal position.

Let me explain.

First of all, take the actual announced plans for cuts in public spending. Over two months ago I have argued in the media that to get us onto the track toward reaching the goal of 3% to GDP deficit ratio, we need ca €7 billion in cuts in 2011, followed by €5 billion in 2012. The grand total of gross deficit reductions from now through 2014 adjusting for the effects of these cuts on our GDP and unemployment, plus steeper cost of financing Government debt, excluding new demand for funding from the banks is not the €15 billion, but €19-20 billion. In other words, once fiscal stabilizers (automatic clawbacks on Government spending) are added in, to achieve 3% target requires more than 33% deeper cuts than Minister Lenihan announced this Wednesday.

The markets know this. Just as they know that given the Government record to date there is very little chance that even €15 billion in cuts will be delivered. This mistrust in Government’s capacity to actually administer its own prescription is manifested most explicitly by the Croke Park agreement that effectively put one third of the current public expenditure out of reach of Mr Lenihan’s axe. It is further highlighted by the fact that this Government has failed to
substantially reduce public spending bills from 2008 through today. Back in 2008, net government spending stood at €55.7 billion. This year, we are likely to post a reduction of just €2.4 billion on 2008, all of which is accounted for by cuts in capital investment programmes.

Third, the markets also understand long-term implications of deficits. Even if the Irish Government manages to bring 2014 deficit close to 3% target, our Sovereign debt will grow by over €5 billion in that year. At this pace, Irish Exchequer is likely to be on the hook for a debt to GDP ratio of 125% by the end of 2014 reaching over 140% if expected additional banks liabilities materialise in 2011-2014. And all of this after we account for Mr Lenihan’s €15 billion cuts planned for 2011-2014.

Fourth, Government budgetary arithmetic falls further apart when one considers economics of the proposed deficit reduction measures. So far, the Government has planned for €3 billion increase in taxes on top of tax revenues gains due to rosy economy growth expectations between now and 2014. €15 billion target announcement raises this most likely 2-fold.

I have severe doubts that this economy has capacity left for tax revenue increases. Signs are, households are struggling with personal debts and their disposable after-tax incomes are barely sufficient to cover day-to-day spending. Credit card debts and utilities arrears are rising, savings are falling – all of which points to growing stress. Weakening sterling is pushing more retail sales out into the North just in time for Christmas shopping season. Cash economy – judging by
anecdotal evidence and corporate tax revenue in light of booming exports sectors – is expanding. The tax base is shrinking due to unemployment, underemployment and falling earnings.

Again, any rational investor will look at this as the evidence that the Government has run out of capacity to tax itself out of the fiscal corner.

But wait, this is only half of the story. The other half relates to the banking side of consumer affairs. In 2011 we can expect significant increases in mortgages costs as Irish banks once more go rummaging through the proverbial couch in search for a new injection of pennies. Bank of Ireland’s bond placing this week, with a yield of 5.4%, suggests a bleak future for lending markets. Any increases in mortgages costs will hike Government expenditure (by raising the cost of interest subsidies), hammer revenues (by reducing household consumption) and trigger new demands from banks for capital (to cover defaulting mortgages).

None of which, of course, appears to be attracting much attention from the Upper Merrion Street. At least judging by the budgetary projections released so far. At the same time, these numbers are impacting our long term growth potential and increasing the probability that Ireland, in the end, will have to restructure its public debt.

This week, similarly brutal arithmetic concerning Greek fiscal situation has prompted Professor Nouriel Roubini to make a dire prediction of the inevitable default by Greece on its Sovereign debt. Given Minister Lenihan’s recent statements and his boss’ staunch unwillingness to scrap the Croke Park agreement, it is hard to see how the forthcoming budgetary framework for 2011-2014 can get us out a similar predicament.

Economics 29/9/10: IMF or EFSF hypotheticals

Hypothetical discussion of options for external assistance for Ireland in today's Irish Examiner - here, text link - here, associated publicity - here.

Economics 16/9/10: Why a rescue package for Ireland might not be a bad idea

This is an edited version of my article in today's edition of the Irish Examiner.

Two weeks into September and the crisis in our sovereign bond markets continues unabated. Ireland Government bonds are trading at above 6% mark and given the perilous state of the Irish banks, plus the path of the future public deficits, as projected by the IMF, Ireland Inc is now facing a distinct possibility of our interest bill on public debt alone reaching in excess of 6% of GDP by 2015. [Note: by now, the magic number is 6.12% as of opening of the markets today].

Sounds like a small number? Here are a couple of perspectives. At the current cost of deficit financing, our Exchequer interest bill in 2009 was 1.7% of GDP or €2.8 billion. Within 5 years the interest bill can be expected to reach over €12 billion, based on the Government own projections for growth. By this estimate, some 30% of our expected 2015 tax receipts will go to pay just the financing costs of the current policies.

It is precisely this arithmetic that prompted the Financial Times this Monday to question not only the solvency of the Irish banking sector, but the solvency of the Irish economy. The very same inescapable logic of numbers prompted me to conjecture in the early days of 2009 that our fiscal and banks consolidation policies will lead to the need for an external rescue package for Ireland.

This external rescue package is now available, fully funded and cheaper (financially-speaking) to access than the direct bond markets. It is called the European Financial Stability Fund (EFSF). More than money alone, it offers this country a chance to finally embark on real reforms needed to restore our economy to some sort of a functional order.

The EFSF was set up to provide medium term financing at a discounted rate of ca 5% per annum for countries that find themselves in a difficulty of borrowing from the international markets. With effective yields on our bonds at 6.05% and rising – we qualify.

The EFSF requires that member states availing of European cash address the structural (in other terms – long term) deficit problems that got them into trouble in the first place. In Ireland’s case this is both salient and welcomed.

It is salient because, despite what we are being told by our policymakers, our problems are structural.

Banks demands for capital from the Exchequer – a big boost to Irish deficit last year and this – are neither temporary, nor dominant causes of our deficits. In the medium term, we face continued demands for cash from the banks. By my estimates, total losses by the Irish banks are likely to add up to €52-55 billion (ex-Nama) over the next three-four years. These can be broken down to €36-39 billion that will be needed in the end for the zombie Anglo, €6bn for equally dead INBS, at least €8 billion for AIB and up to €2 billion for the ‘healthiest’ of all – Bank of Ireland. These demands will come in over the next 24 months and face an upside risk should ECB begin aggressively ramp up interest rates in 2011-2012.

No economy can withstand a contraction in its GDP on this scale. Least of all, the one still running 5-7% of GDP structural deficits over the next 4 years. In 2009, banks demands for Exchequer funds managed to lift our deficit from 11.9% to 14.6%. This year, absent banks bailouts, our deficit will still reach around 11.3%. Only 3.3% of that due to the recessionary or temporary effects. In 2011, IMF estimates our structural deficit alone to be 7% and 5.9% in 2014.

Which brings us to the point that the use of the EFSF funds should also be a welcomed opportunity for Ireland.

A drawdown on EFSF funding will automatically trigger a rigorous review of our fiscal plans through 2015 by the European and, more importantly, IMF analysts. This is long overdue, as our own authorities have time and again proven that they are unable to face the reality of our runaway train of fiscal spending.

Since 2008 in virtually every pre-Budget debate, Minister Lenihan has been promising not to levy new taxes that will threaten jobs and incomes of the ordinary people of Ireland. In every one of his budgets he did exactly the opposite. Under the EFSF, the IMF will do what this Government is unwilling to do – force us to reform our tax system to broaden the tax base, increase the share of taxes contributions by the corporate sector and start shifting the proportional burden of taxation away from ordinary families.

Minister Lenihan has repeatedly promised reforms of spending. In every budget these reforms fell short of what was needed, while the capital investment was made to bear full force of the cuts. Drawing cash from the EFSF will make Mr Lenihan scrap the sweetheart Croke Park deal and start reforming current spending. Politically unacceptable, but realistically unavoidable, deep cuts to social welfare, public sector employment and wages, quangoes, and wasteful subsidies will become a feasible reality.

Starting with December 2009, the Irish Government faced numerous calls from within and outside this state (headed by the EU Commission and the IMF) to provide clarity on its plans to achieve the Stability and Growth Pact criteria of 3% deficit to GDP ratio by 2014-2015. The Government has failed to do this. Drawing funds from the EFSF will help us bring clarity as to the size and scope of fiscal adjustment we will have to take over the next 5 years.

Lastly, the EFSF conditions will include a robust change in the way we are dealing with the banks. Gone will be the unworkable Government strategy of shoving bad loans under the rug via Nama and drip-recapitalizations. These, most likely, will be replaced by haircuts on bond holders and equity purchases by the State.

Contrary to what the Government ‘analysts’ say, drawing down EFSF funds will not shut Ireland from the bond markets. Instead, swift and robust restoration of fiscal responsibility and more a more orderly exit of the exchequer from banks liabilities are likely to provide for a significant improvement in the overall markets perception of Ireland. After all, bond investors need assurances that we will not default on our debt obligations in the future. Only a strong prospect for growth and recovery can provide such an assurance. Ministerial press releases and Nama statements are no longer enough.

Economics 2/9/10: Exchequer results - expenditure

So if there was no miracle happening on the receipts side, what was Minister Lenihan having in mind while drumming about the improvements in the fiscal position? Perhaps it was a dramatic turnaround on the Exchequer spending side?

Let's take a look at the year on year performance across all departments (2 charts below):
Looks like all departments are performing well in cutting back spending, save for Social Welfare and the department of Communications, Energy and Natural Resources. However, even a cursory glance suggests that something is amiss. In particular, it is pretty clear that the cuts are primarily happening on the capital side.

What the above charts do not tell us is that there is an interesting dynamic structure emerging to the cuts. This is highlighted in the next chart:
Notice the following in the chart above:

• Capital spending cuts overall have clearly dominated current spending cuts - for example, in August the ratio of capital spending cuts to current spending cuts stood at -34% for the former and -1.6% for the latter;
• Capital spending cuts are finally starting to decline in magnitude, having peaked in June at 36% and having declined to -34% in August. It looks like the state is finally beginning to spend - though still anemically - on the few capital projects it promised to deliver this year.
• Current spending cuts became shallower and shallower as the year progressed. In January 2010 current spending was 11.9% below the same period of 2009. In 5 months to May it fell to -5% compared to 5 months to May 2009. In August it is down only 1.6% on the same period of 2009.

Predictably, cuts in the net cumulative voted expenditure are also getting shallower and shallower:
So far we are down 5.8% on 2009. But this is not exactly a massive achievement, given the trends underlying cuts to date.

Another problem is that given the Croke Park agreement, there is a clear reason as to why the current spending cuts are getting weaker.

Either way - just as with receipts, I am not seeing any improvements anywhere in these numbers. If anything - Government spending is way too slow to adjust and is adjusting so far in a wrong direction.

Economics 2/9/10: Exchequer results - tax receipts

So folks, with some trepidation - given the ambitious statements concerning yet another 'turnings of the corner' by Minister Lenihan in today's 'Voice of the Irish Civil Services Gazette' (err... commonly known as The Irish Times) - I awaited the August Exchequer results.

The surprise, I must say, is all my, at least on the tax take side. Things have improved... dramatically... by what I would described as a 'nil change'. In other words, there is no improvement on the tax side.
Total tax take is now moving deeper down relative to 2009 and is nowhere near 'turning around'. It is not even stabilizing on the downward trajectory. Year-on-year total tax take is down 9%. End of July the same figure was 8.2%. Oops...

Income tax and Vat two mega tax heads:
The two are 8.2% and 6.4% behind January-August figures for 2009. A slight improvement on the gap in 7 months to July (8.4% and 6.9% respectively), but not that much of an improvement.

Corporate and excise taxes:
Corporate tax take is now on a trend of erasing the surplus on 2008 accumulated since June. This is bad, folks. In 7 months to July 2010, corporate tax receipts were 13.8% behind 2009 figure. In 8 months to August 2010 these are a massive 24.1% behind. As far as excise tax goes - receipts in 7 months to July 2010 were -3.3% behind corresponding period for 2009, by August 2010 8-months cumulative receipts gap to 2009 period shrunk to 2.7%. Good weather and more partying at home (instead of taking vacations) means booze is being consumed, while euro weakness relative to 2009 means we are buying more of it at home instead of N Ireland.

Next the 'Celtic Tiger Taxes', aka Stamps:
No sign of a serious improvement on abysmal 2009 here either. Poor showing continues with receipts down 18.2% on 2009 in seven months to July and down 11.1% on the first 8 months of the year in August. Let's see what happens in the big boost month of September.

Capital gains:
CGT was down on 2009 in the first 7 months of the year by 44.1% and down on the first 8 months of the year by 42.6%. Marginal gain in relative performance is clearly not enough to bring us even close to the extremely poor performance of 2009.

Summarizing year on year changes in all tax heads:
And to entertain our 'official analysts' favorite pass time: performance relative to targets
One noticeable and real change in monthly returns is the share of the burden that befalls our ordinary incomes:
Table below summarizes:
Nothing really to add to this except this: Minister Lenihan clearly thinks we are seeing improvements on the fiscal side. I see continuously increasing burden of Minister Lenihan's deficits on the ordinary taxpayers and consumers. In my economics books, this is bound to add pressure on Irish growth. Severe pressure.

Economics 05/06/2010: Economics of Fiscal Stimulus

This is an unedited version of my article for June-July issue of the Village Magazine.

Weeks into a new round of ‘talks’ over the public sector reforms and Ireland’s Policy Kindergarten squad is getting more agitated by the issue of cuts in the Government expenditure. The logic of their arguments, led by the likes of Tasc, the Irish Times, and an army of Unions-employed ‘economists’, is perverse: “In order to get the economy back on track, we need to borrow more and spend on public services and wages.”

There are three basic arguments why stimulating Irish economy though increased public spending won’t work in the current conditions even in theory, let alone in practice. These are: the structural nature of the fiscal crisis we face, the size of the debt we face, and the lack of evidence that stimulus can work in a country like Ireland.

Structural deficits

Economists distinguish two types of deficits: cyclical and structural. The first type of deficits occurs when a temporary economic slowdown leads to an unforeseen decline in revenue and acceleration of certain components of spending (e.g. unemployment insurance and social welfare). By its definition, the cyclical deficit will be automatically corrected once economy returns to its long term growth path.

In contrast, structural deficits are those that arise independently of the short term changes in economic growth. They are the outcome of unsustainable increases in permanent spending and/or decline in the long term growth potential that might arise from a severe crisis.

In the case of Ireland, both of the latter factors are at play. Various estimates of the extent of structural deficits carried out by the likes of IMF, OECD, the European Commission, ESRI and independent analysts range between one half and two thirds of the 2009 General Government deficit, or 7-9.5% of GDP.

Reckless expansion of Government spending in the period of 2001-2007 is the greatest cause of these – not the collapse of our tax revenue. In the mean time, our economy’s long-term growth rate has declined from the debt-and-housing-fueled 4.5% per annum to a Belgium-like 1.8% per annum.

In 2000, General Government Structural Balance stood at roughly -0.5% of GDP. By 2008 this has fallen to almost -11% courtesy of a massive build up in permanent staff increases in the public sector, rises in welfare rates, explosion in health spending and creation of a gargantuan army of quangoes and supervisory organizations.

Forget, for a second, that majority of these expenditures represented pure waste, delivering nothing more than top jobs for friends of the ruling class, plus scores of jobs for public and quasi-public sector workers. Between 1981 and today Ireland has recorded not a single year in which Government structural balance was positive. Windfall stamps, VAT and capital gains tax receipts over 2001-2007 have masked this reality, as Goldman Sachs structured derivatives masked the reality of Greek deficits.

We are not getting any better

Over the recent months, the Government has been eager to ‘talk up’ our major selling points. Ireland, it goes, is a country with stabilized public finances and low debt to GDP ratio.

Last month, Eurostat exposed the lie behind the ‘stabilized public finances’ story. It turns out our Government has decided to sweep under the carpet billions of cash it borrowed in 2009 to recapitalize Anglo. Courtesy of this, our deficit for 2009 was revised to a whooping 14.3% of GDP – topping that of Greece.

But Irish General Government deficit this year is expected to come in between 11.7% and over 12% of GDP, depending on who is doing the forecasting – Department of Finance or ESRI. And this is before we factor in March 2010 statement by the Minister for Finance, promising over €10 billion for the banks this year. This means that, as the rest of the world is coming out of the recession, our fiscal deficit for 2010 is expected to either match or exceed the revised level achieved in 2009. Some stabilization.

Irish Government debt is expected to reach 78-82% of GDP by the end of 2010 – on par with Eurozone’s second sickest economy, Portugal. With Nama and banks recapitalizations factored in, Irish taxpayers will be in a debt hole equal to between 117% and 122% of GDP by 2011 and to 137% by 2014. At the point of the Greek debt crisis implosion last year, Greece had second highest debt to GDP ratio in the EU at 117%, after Italy with a massive 119%.

In totality, current crisis management approach by the Irish State is going to cost every Irish taxpayer in excess of €117,000 in added tax liability. Neither Iceland nor Greece come close.

Economy on steroids

Still think that we should be stimulating this economy through more borrowing?

Take a look at the private sector debts. In terms of external debt liabilities, Ireland is in the league of its own amongst the advanced economies. Our overall debts currently are in excess of the critically high liabilities of the HIPCs to which we are sending intergovernmental aid. And rising: in Q3 2009, our external debt liabilities stood at a whooping USD 2.4 trillion, up 10.8% on Q3 2007. Of these, roughly 45% accrue to the domestic economy – more than 6 times our annual national income.

Ireland’s share of the world debt is greater than that of Japan and more than double that of all BRICs combined, once IFSC companies are included. Over the next 5 years, the entire Irish economy will be paying out around €206,000 per each taxpayer in interest on this debt. Adding more debt to this pile is simply unimaginable at any stage, let alone when the cost of borrowing is high and rising.

These figures show that the main cause of the current crisis is not the lack of liquidity in the system, but an old-fashioned problem of insolvency.

This problem is directly related to the actions of the Irish state. Over the last decade, there was a nearly 90% correlation between the average increases in the Irish tax revenues plus the rate of economic growth and the expenditure growth on capital and current spending sides. In effect, courtesy of the ‘Boom is getting boomier’ Ahearn/Cowen team Ireland had two bubbles inflating next to each other – a private sector borrowing bubble and a public sector spending one. Government’s exuberant optimism, cheered on by the Social Partners – the direct beneficiaries of this ‘fiscal policy on steroids’ approach – explains why during Brian Cowen’s tenure in the Department of Finance, Irish structural deficit doubled on his predecessor’s already hefty increases.

But what went on behind the glossy Exchequer reports was the old-fashioned pyramid scheme. Some got rich. Temporarily, we had an army of politically connected developers and bankers stalking the halls of premier cars dealerships and property auction rooms.

Permanently, an entire class of public employees reaped massive dividends in terms of shares in privatized enterprises that cumulated in their pension plans. Current claims that because the values of some of these payoffs have declined over time (often due to the intransigent nature of the unions in the semi-state companies, staunchly resisting change and productivity enhancing reforms) is irrelevant here. Prior to their privatization, these companies were called 'public' assets. Creation of any, no matter small or large, private gains to their employees out of the companies' privatizations or securititization through pensions funds liabilities of their assets in favor of employees, therefore, is nothing more than an arbitrary, unions-imposed grab of the public asset.

Benchmarking, lavish pensions and jobs security – also paid out of the economy leverage (just think of the NPRF - explicitly created to by-pass the illegal, under the EU rules, taxation of economy for provisioning for future public sector pensions liabilities) – was a cherry on top of the cake. Public companies management got dramatically increased pay and a permanent indemnity against competition through a regulatory system that was all but a client of their semi-state companies.

From our hospital consultants to our lawyers, academics and other professionals – a large army of state-protected, often non-competitive internationally professional elites collected state-subsidised pay so much in excess of their real productivity that we became the subject of diplomats’ jokes.

Our state’s response to this was telling. Just as the country was borrowing its way into insolvency, our Government gave billions to aid developing nations. That was the price our leaders chose to pay to feel themselves adequate standing next to Angela Merkel and Nicolas Sarkozy at the EU summits. Incidentally, as the country today is borrowing heavily to cover its basic bills, Brian Cowen still sends hundreds of millions of our cash to aid foreign states and has recently decided to commit over €1,000 million – full year worth of the money he clawed out of the ordinary families through income levies – to the Greek bailout package.

Economics on Steroids

Still think more state-centred economy is the solution to our problem? Irish economists, primarily those affiliated with the Unions are keen on talking about the ‘positive multiplier’ effect of deficit-financed stimulus. Sadly for them, there is no conclusive evidence that borrowing at 5 percent amidst double-digit deficits and ‘investing’ in public services does any good for the economy.

Firstly, one has to disregard any evidence on fiscal stimulus efficiency coming out of the larger states, like the US, where imports component of public and private expenditure is much smaller than in Ireland. The US estimates of the fiscal stimulus multiplier also reflect a substantially lower cost of borrowing. Even if Ireland were to replicate US-estimated fiscal stimulus effects, higher cost of our borrowing will mean that the net stimulus to Irish economy will be zero on average.

Second, international evidence shows that for a small open economy, like Ireland, the total fiscal multiplier effect starts with a negative -0.05% effect on economic growth at the moment of stimulus and in the long run (over 6 years) reaches a negative -0.07-0.31%. Add the cost of financing to this and the long-term effect of deficit financed stimulus for Ireland will be around -2.3% annually.

Third, no one on the Left has a faintest idea what the new spending should be used for. Simply giving borrowed cash to pay the wage bill in the public sector would be unacceptable by any ethical standards. Any investment that is bound to make sense would have to focus on our business centre – Dublin, where infrastructure deficit is acute and potential demand is present. Alas, this will not resolve the problem of collapsed regional economies. Pumping more cash into the ‘knowledge economy’ absent actual knowledge infrastructure of entrepreneurship, private finance, skills and without a proven track record of exporting potential, is adventurist even at the times of plenty.

In short, the idea that expanded deficit financing will support any sort of real recovery in the economy is equivalent to arguing that pumping steroids into a heart attack patient can help him run a marathon.


Ireland needs severe rethinking and reforms of the grossly inefficient and ethically non-sustainable spending and management practices of our public sectors. It should start with significant rationalization of expenditure first and then progress to a more deeply rooted revision of the public sector objectives and ethos.

Ireland also needs a significant deleveraging of what is a basically insolvent economic structure. This too requires, amongst other things, a significant reduction in overall public spending. Far from ‘borrow to spend’ policies advocated by the Left, we need ‘cut to save’ policies that can, with time, yield a permanent increase in the national savings rate, productive private investment and improved returns on education and skills. Otherwise, we might as well give our college graduates a one-way ticket out of Ireland with their degrees, courtesy of Tasc and the Unions.