17/10/2013: Budget 2014 Missing the Targets: Sunday Times, October 13

This is an unedited version of my Sunday Times column from October 13, 2013.


Recent events have led to a significant reframing of the Budget 2014. With these, the Government is now actively signaling a more accommodative stance on next year's cuts. Alas, the good news end there and the bad news begin. Any easing on austerity in 2014 will be unlikely to produce a material improvement in household budgets. In return, the Government will be placing huge hopes on robust growth returning in 2014. If this fails to materialise, lower austerity today will spell more pain in 2015. Like a dysfunctional alcoholic, unable to stop binging at closing time, we ignore tomorrow’s hangover.


A combination of the latest IMF report on the Irish economy and the outcome of the Seanad abolition referendum have settled the debate on the scale of adjustment to be taken on October 15th. Embarrassing defeat in the referendum has meant that the continuation of Taoiseach's leadership required some symbolic gesture toward the electorate. Lowering the 2014 cuts targets on October 15th can serve the purpose for a few crucial months until the New Year.

Meanwhile, ambiguity-embracing IMF lent a helping had. The IMF repeated its insistence on EUR5.1 billion combined 2014-2015 cuts in the latest assessment of the Irish economy. Yet, the IMF avoided specifying the breakdown of these adjustments between 2014 and 2015. This has given the Government confidence to argue the case in favour of partially delaying 2014 adjustment in front of the EU overseers of our budgets.

Immediately after the IMF report publication, Irish media was promptly fed the rumors that the Minister for Finance was seeking a reduction in the level of budgetary cuts. This week Minister Noonan said that the 2014 adjustment will be EUR600 million lower than EUR3.1 billion originally agreed with the Troika. The savings will amount to 0.37 percent of our GDP: a small boost for the Irish economy, but a massive splash in the PR spin terms for the Government.

With some cuts delayed to 2015, Ireland’s debt sustainability and deficit targets now hinge on the Government’s forecasts for growth materializing over the next twelve months. The risks to these are non-negligible. Last week IMF lowered Irish GDP growth forecasts for every year from 2013 through 2018. Compared to the forecasts released in June this year, October forecasts for inflation are also down. This implies that nominal growth – the source of budget deficits and debt dynamics – is expected to be even slower. If back in June this year IMF expected Irish economy to be at EUR205.8 billion by 2018, now the fund is projecting it to hit EUR201.7 billion. Cumulated forecast nominal GDP for 2013-2018 is EUR15.6 billion lower in October report than in June assessment.  Even before Minister Noonan’s latest reductions in fiscal adjustment for Budget 2014, IMF projected worsening of Irish deficits in 2014-2018.

Department of Finance forecasts, released this week and underpinning the Budget 2014 calculations are more optimistic on nominal growth, expecting higher inflation and anticipating more domestic consumption and investment than the IMF. If the Department gets its forecasts wrong, we will pay 2015 for the delays in cuts planned for the next year.



Flying on hopium of rosy growth expectations is a risky proposition for the Exchequer especially ahead of our drawing down the final tranche of the Troika funding. For this risk, the savings to be delivered in the Budget 2014 are likely to be insignificant from economy’s point of view.

Given the precarious position of the Government in public opinion polls, it is a safe bet to assume that the coalition will be putting the money to ‘work’ as an investment stimulus and a cushion against cuts to social welfare and health.

New building programmes in the more sensitive constituencies hold some serious political capital. But planning allocation of large sums to new investment is a lengthy process before construction jobs actually materialise. Growth impact of these measures in 2014 is unlikely to be significant.

But the thrust of 'savings' is likely to go to the second option. Doing as little as possible for yet another year in structurally altering the way we spend on social supports and healthcare will mean that the budgetary changes to health spending in 2014 will likely be identical to those undertaken in the past. Expect more cost shifting to private insurance, more sabre-rattling over cost overruns and more imaginary gains in productivity. Social welfare ‘cost containment’ measures will continue to rely on 'demand attrition' - the declines in demand due to unemployment benefits expiration and emigration. This means zero impact on growth in 2014.

Meanwhile, revenue side of the budgetary equation will keep pressuring the economy.

Fine Gael's side of the Coalition is promising us that the Budget will contain no new taxes. Alas, in Ireland we have a very narrow definition of both terms: 'new' and 'taxes'. In 2014 we will be facing a full annual Property Tax bill, which is expected to take out additional EUR250 from the average household income. The Budget will also likely raise charges on families to fund education and healthcare. The Irish Government is saying these are not new taxes. Anyone expected to pay them would disagree.

Last year, PRSI changes and reduction in child benefits were not identified as 'new taxes' either. These cost an average working family with two children some EUR494 per annum – an involuntary reduction in family income.

Per research note published by Grant Thornton two weeks ago, a family on EUR80,000 with two earners with two children saw their tax bill rise by 54 per cent since 2008. Their disposable income is now down a massive EUR6,132 per annum. Only a small fraction of these were officially recognised as new tax measures.

Meanwhile, the same families have also seen the costs of basic services provided by the state agencies and enterprises, or controlled by the state regulators and heavily taxed, rise dramatically over the course of the crisis. On average Irish consumer prices fell 1.6 percent between August 2008 and August 2013. Health insurance costs more than doubled over the same period, education costs inflated by 29 percent, bus fares have gone up over 46 percent, and motor tax went up 27 percent. Increases in core public services costs have taken out close to EUR3,500 annually out of the pockets of an average Irish family. These came on top of the Grant Thornton tax cost estimates cited above.

What is the opportunity cost for the families of the losses brought about by the fiscal crisis? For an average family with expected working life of 25 years, the above costs of austerity are equivalent to around EUR111,000 in foregone pensions savings. This excludes costs of the same measures continuing beyond December 31, 2013 and the new measures yet to come in 2014-2015.

The devastation of the above financial arithmetic is even more apparent when we realise that we are far from completing the full set of fiscal adjustments needed to restore our public finances to health. Medium-term Government fiscal consolidation forecasts confirmed by the IMF last week, envision total fiscal consolidation for 2014-2015 to be EUR5.1 billion. Of this, new revenue measures for 2014-2015 are to be set at EUR1.5 billion against carry forward measures of EUR0.3 billion. Current spending cuts are set at EUR3.2 billion. These adjustments translate into additional fiscal burden of EUR3,300-3,500 per annum for an ordinary family.

The hope is that the general economic recovery will mop up the household finances blood spilled by the fiscal crisis.  This rosy expectation is in turn driven by Minister Noonan’s worldview in which Irish trade partners are expected to also grow faster in years ahead. Alas, this Tuesday, IMF cut its global growth forecasts for both 2013 and 2014.


Forecasts aside, today, Ireland has run out of the road on tax hikes and revenue raising measures.

Instead of hiking tax rates, the Government is expected to widen the tax base in Budget 2014. The most efficient way for doing so would be to close loopholes on income exemptions. Less efficient, will be to lower income threshold at which upper marginal tax rate kicks in. Middle and upper-middle class families will pay in either scenario, but the costs to them will be higher in the latter.

In addition, the Government has been briefed on the potential for hiking PRSI for self-employed, while opening up access for this category of workers to social security net. Conditions for accessing cover will be so onerous, few self-employed will ever be able to qualify, but the hike will be politically acceptable. Currently, a self-employed person earning the equivalent of minimum wage pays almost six times as much tax and PRSI as an employee. Few interest groups so far have taken up a challenge of pointing this fact out.

Reality is, Ministers Noonan and Howlin have hit the brick wall. All the low-hanging fruit of marginal tax hikes and revenues extraction schemes has been picked. What's left now are two possible options. Option one: cut social welfare and health. Option two: delay adjustments and hope that comes Budget 2015 day, growth will pick up, unemployment assistance costs will fall, and Brussels will be happy enough reveling in the euro recovery to let things slip a bit on targets in Dublin. No prizes for guessing which option the Coalition will pursue comes next Tuesday.

Source: Department of Finance

BOX-OUT:

This week, the IMF published an assessment of the impact of the monetary policies deployed since 2008 by the ECB, the US Fed and the Bank of England. These unorthodox measures ranged from outright quantitative easing to lowering of the key interest rates to direct lending to the banks against riskier collateral. These monetary interventions, it has been argued in the media and by the majority of analysts, helped to ameliorate euro area sovereign crises. Per conventional wisdom, as the result of the central banks interventions, and particularly those carried out by the ECB, government bond yields and borrowing costs declined post-2011 across the euro area periphery. In addition, supporters of these policies have suggested that unconventional MPs were responsible for increasing equity funding in the real economies, thus supporting the recovery.

Rejecting the mainstream claims, the IMF researchers found that over 2008-2012 various monetary policies had zero statistical impact on the sovereign bond yields in Ireland, Portugal, and Greece. The policies have let to a moderate reduction in Italian Government bond yields, and a weak reduction in Spanish yields. In the case of Ireland, the IMF found no benefits to sovereign bond flows or prices that can be associated directly with the ECB interventions. Furthermore, ECB interventions were associated with outflows of liquidity from Irish equity funds. In contrast, Fed and Bank of England interventions resulted in net inflows of funds into Irish equities.

The paper clearly suggests that the ECB has not done enough to support recovery in sovereign debt and equity markets in the euro periphery.

4/10/2013: IMF 11th review of Ireland: Banks & Exchequer

IMF released its 11th review of Irish economy under the Extended Arrangement for funding. I covered growth-related issues arising from the IMF release here: http://trueeconomics.blogspot.ie/2013/10/4102013-imf-11th-review-of-ireland.html

Now, some other topics, namely banks and the Exchequer.

Per IMF: "Ireland is expected to return to reliance on market financing in 2014, yet further European support could make Ireland’s recovery and debt sustainability more robust. Irish banks face weak profitability that hinders their capacity to revive lending. European support to lower banks’ market funding costs could help sustain domestic demand recovery in the medium term, protecting debt sustainability and financial market confidence."

What's that about? Here are two charts:

IMF: "The recent retracement of Irish sovereign bond yields has been broadly consistent with the experience of other countries in the euro area periphery." [But wait, what about Ireland's unparalleled success in fiscal adjustments and 'best-in-class' status? Are the IMF saying that Enda did not singlehandedly deliver huge improvements in Irish bonds yields? How can this be the case, unless the Irish Government uses 'we' as denoting 'Peripheral Countries' collective in claims that the Govenment has delivered stabilisation of Government funding costs.]

"After touching record lows in early May, the 10 year yield has risen 56 basis points, to 3.98 percent as of September 11. Market tensions dissipated in July after the settlement of the political crisis in Portugal and recent turbulence in emerging markets has had limited effect on Irish bond yields. No new bond has been issued by the Irish sovereign since the €5 billion ten-year issue in mid March." The latter, of course simply means that lower supply of new bonds (lack of it since mid-March) and now the new announcement by NTMA that it will not be tapping the markets any time before official exit from Troika supports, are keeping things steady in yields terms. Otherwise… well… logic suggests, at least speculatively, they can be higher.

And on banks: "From a trough in mid-May, yields on Bank of Ireland (BoI) and Allied Irish Banks (AIB) 3 year covered bonds have edged up some 40 basis points as of September 11. Since its May 30 issuance, the yield on BoI’s 3 year senior unsecured bond has been more volatile, but overall has risen by 62 basis points, to 3.37 percent."

Bah! Two things to say about the above:

1. Banks bonds still tracing sovereign risks and that holds even for covered bonds! Not a good sign for the banking sector. The explicit guarantee is gone, so now it is don to the implicit guarantee and the state simply cannot shake off the baggage of the original 2008 Guarantee. Irish banks are still too-big-to-fail and Irish state is still a too-small-to-bail-in banks lenders.
2. For an army of bonds sales-desks analysts out there pontification on Irish economy, I am yet to see their honest analysis on what is happening with banks funding costs and sovereign funding costs. They are a bit too keen talking about the economy and too little about debt markets. Which is sort of 'your dentist is football analyst' analogy...

"Deposit rates continued to inch downward, however, and ECB borrowing by domestic banks fell from €39.6 billion at end March to €33.4 billion at end August, reflecting a paucity of new lending, further noncore asset deleveraging, modest amounts of new market funding, and a broadly stable deposit base."

So cheap funding dissipating, deposits (stable funding) still anaemic or declining… Happy times, folks. Stabilisation bites. Come back and argue that when businesses and households are croaking under the weight of interest on their debts with the above 'improvements'.

Why wait, however, let's take a look at IMF-reported 2009-2013 data:
Banks non-performing loans (vs provisions) as % of total loans: 2009=9% (4%) or 44.4% cover, 2012 = 11.3% (5.4%) or 47.8% cover, 2013 = 11.5% (4.5%) or 39.1% cover. So cover is shrinking! Meanwhile, personal lending rates have gone up (as ECB repo rate went down) from 11.1% in 2009 to 11.6% in 2013, and SVR mortgages rates have gone up from 3.3% in 2009 to 4.4% in 2013. Government bond yields are down from 4.9% in 2009 to 4.2% in 2013. What's happening folks" The state credit costs are being dumped onto mortgagees. The 'rescue' of the banks and subsequently the rescue of the state has been loaded up onto the borrowers from the banks.


On the positive side, Exchequer performance was good. Not spectacular, but fine - in line with (and slightly better than) budgetary targets:

Do note the caveats listed below the charts - it would be nice were the Irish authorities actually provided a clear, consistent and well-defined map of all one-off payments and receipts… but then the picture of the fiscal adjustment would not have been as pretty as our politicians like to claim. Still, the picture is broadly fine.

Crucially, the above is not sufficient for us to rest on our laurels. For a number of reasons, but chiefly for the reason not even mentioned in the IMF note: has anyone looked at how sustainable, over the medium (2015-2020) term the fiscal savings delivered by the Government are? I mean: we know that pay moderation agreements with public sector unions are not sustainable and even subject to automatic reversals in 2015-on, right? We also know that much of health system 'savings' are not sustainable, since these come on foot of extracting more and more cash out of ever-dwindling supply of private insurance holders. Right? What else is not sustainable? How much? What is the risk down the line? Is corporate tax revenue uplift we have seen over the last 24 months or so sustainable? Much of it seems to have come from MNCs booking more transfer pricing profits into Ireland. Is that 'sustainable'?

IMF does some 'sustainability' tests in its analysis and here is a scary chart:

Basically, note the path of the gross financing needs for Ireland through 2018. This returns us, under baseline (no new shocks) scenario back to the situation in 2018 where financing needs of the Exchequer are slightly above the needs in 2013. This is assuming GDP is growing 2.5% annually in real terms 2015-2018. And this is incorporating the 'savings' achieved from the Promissory Notes. And this is after we impose agreed target cuts of 2014-2015. We are swimming faster and faster to be thrown back, not even to stay put.

Now, tweak few assumptions:

So in Constant PB Scenario, the change is with no 2014-2015 'austerity' factored in, which is boring stuff. But the exciting stuff is the 'Historical Scenario' where things slide back to 'normal' on growth and government deficits:

 The outcome of the above in two charts:
1) Public debt explodes

2) Financing needs of the Government explode too

Care to argue now we can afford a 'stimulus'? As Harry Callahan put it: "Go on, punk, make my day!"

22/10/2012: Is Ireland a 'Special Case' in the Euro area periphery?

Since the disastrously vacuous summit last Thursday and Friday, there has been a barrage of 'Ireland is special' statements from Merkel and other political leaders. The alleged 'special' nature of Ireland compared to Greece, Portugal and Spain is, supposedly, reflected in Irish banks being successfully repaired and Irish fiscal crisis corrected to a stronger health position than that of the other peripheral countries.

I am not going to make a comment on the banking system's functionality in Ireland compared to other states. But on the fiscal front, let's take a look. Per IMF:

• In 2012 we expect to post a Government deficit of 8.30% of GDP against Greece's deficit of 7.52%, Portugal's 4.99% and Spain's 6.99%. We are 'special' in so far as we will have the highest deficit of all peripheral countries.
• In 2013, Ireland is forecast to post a Government deficit of 7.52% of GDP against Greece's 4.67%, Portugal's 4.48% and Spain's 5.67%. Once again, 'special' allegedly means the 'worst performing'.
• In 2012, Ireland's structural deficit would have fallen from 9.31% of potential GDP in 2010 to 6.15% - a decline of 3.16 ppt. For Greece, the same numbers are 12.12% to 4.53% - a decline of 7.59 ppt or more than double the rate of austerity than in Ireland. For Portugal, these numbers are  8.96% to 4.09% - a decline of 4.87 ppt of more than 50% deeper reduction than in Ireland. For Spain: 7.32% to 5.39% - a drop of 1.93 ppt or shallower than that for Ireland.
• In 2013 in terms of structural deficit, Ireland (5.38% of potential GDP deficit) will be worse off than Greece (-1.06% of potential GDP), Portugal (2.28%) and Spain (3.52%)

Now, run by me what is so 'special' about Ireland's fiscal adjustment case?

Can it be that we are 'lighter' than other peripherals on debt?

• 2010 Government debt in Ireland stood at 92.175% of GDP and this year it will be around 117.743% - up 25.255% of GDP. For Greece this was respectively 144.55% of GDP in 2010 and 170.731% in 2012 - a rise of 26.181%, marginally faster than that for Ireland. For Portugal, gross Government debt was 93.32% of GDP in 2010 and that rose to 119.066% in 2012, an increase of 25.746%. Again, not far from Ireland's. And for Spain, these numbers were 61.316% to 90.693% - a rise of 29.377%. So while Spain is clearly the worst performer in the class, Ireland, Greece and Portugal are not that far off from each other.

Wait, what about economic reforms and internal devaluations? Surely here Ireland, with its exports-focused economy is a 'special' case?

• In 2012, Ireland is expected to post a current account surplus of 1.813% of GDP, against deficits of between 0.148% and 2.909% for the other three peripheral countries. This, of course, is not the legacy of Irish reforms, but of the MNCs operating from here.
• However, in terms of current account dynamics, Ireland is not that special. Between 2010 and 2012, Greece will reduce its current account deficit by 4.294 ppt, Ireland will improve its external balance by 0.674 ppt, Portugal by 7.105 ppt and Spain by 2.278 ppt. So Ireland is the worst performing country of four in terms of current account dynamics, while the best performing in terms of current account balance.

Now, do run by me what can it possibly mean for Ireland to be a 'special' case compared to Greece, Portugal and Spain?

2/10/2012: Irish Exchequer Receipts Q3 2012

Headline figure on Tax Receipts is €26,118mln collected in Q3 2012 against profile of €25,733mln a surplus over the profile of 1.5%. However, in January-August  2012 the same surplus was 1.7% and January-June 2012 it was running at 3.1% surplus on target. In other words, target is being met, but performance is deteriorating and the Department is correct to sound cautiously here, constantly reiterating the importance of Q4 in terms of receipts delivery. The cushion as it stands at the end of September was €385 million on profile.

Year on year headline figure shows improvement in 9 months through September (up 8.4% on unadjusted basis, and up 6.2% on adjusted basis) compared to 8 months through August (7.7% on unadjusted basis and 5.2% on adjusted basis). This is the good news for the Exchequer.

On adjusted basis, tax revenues are up €1,491 mln in Q3 2012, having been up €1,063 mln in 8 months through August. This suggests that September monthly performance was pretty robust even once we adjust for the various reclassifications of tax revenues.

Now, let's try to see what is going on behind the headlines.

Adjustments - covering reclassifications of USC and delayed accounting for corporate tax receipts (carryover from 2011) - were running at €511 million in 8 months through August 2012. In Q1-Q3 2012 these were booked at €529 million - a suspiciously low differential for the whole month. I noted the same suspicion back in August. 

In addition, the Department seemingly does not account for reclassification of the Corporate Tax receipts from 2011 to 2012 in full. Instead, the Department does subtract the revenues booked in 2012 due to carry over from 2011 from 2012 figures, but it does not add these carry over amounts back into 2011 comparative Corporation Tax figure.

On non-tax revenues side, banking-related receipts are running at €2.057bn in 9 months through September 2012 against €1.643bn in the same period 2011.Semi-states dividends (another indirect tax on the economy) are at €88mln against €31mln in 2011. Pensions levies are at €11mln against €8.6mln in 2011. Adjusting for banks receipts alone (see my August note as to why such adjustments are warranted), total current receipts (tax and non-tax) are at €26,471mln in January-September 2012 against €24,455 in the same period 2011 (+8.25% y/y). 

Now, adding to these adjustments on tax revenues (explained above), total adjusted current receipts are up 6.1% y/y, not the 9.3% headlined in the exchequer figures.

Excluding the Sinking Fund transfers (deficit neutral), Capital Receipts are down at €813 mln in 9 months through September 2012 compared to €1,038mln in the same period 2011.

Let's combine all receipts ex-Sinking Fund receipts:

• Official numbers are: Total tax and Non-Tax Current and Capital Receipts amounted to €29.342bn in January-September 2012, up 8.13% on the same period 2011 (€27.136bn).
• Adjusting for Banks-related receipts and adjusting for tax revenues reclassifications, total receipts amounted to €26.755bn in 2012 and €25.655bn in 2011 (January-September periods), a rise of 4.29% y/y or €1.1bn.
• The above is still an impressive performance, given stagnant economy, but it is a far cry from what is needed to close the funding gap for the Exchequer.
• Critically, while tax performance cushion on target is getting thinner, it is still positive and is likely to stay non-negative through Q4 2012. In other words, it appears that we will deliver on targets on tax revenue side. This represents the reversal to some threats emerging in July-August.

5/9/2012: The balance of imbalance: Irish Exchequer deficit in January-August 2012

In the previous two posts I examined the Exchequer receipts and net voted expenditure for January-August 2012. Now, on to the overall balance.

In July 2012, the Exchequer deficit stood at €9.13 billion against July 2012 headline deficit of €18.89 billion. In August, cumulated 2012 deficit rose to €11.35 billion (up €2.22 billion in one month) compared to €20.43 billion in 2011 (2011 monthly rise in August was €1.54 billion).
Fact 1: Irish Exchequer deficit rose at faster pace in August 2012 than in August 2011, so in monthly changes terms, August 2012 was not an improvement on August 2011.

However, the headline figures are incorporating several factors that gold-plate our deficit performance in 2012 compared to 2011, none of which the Government is willing to actually directly separate to identify the true performance. Let's try doing this job for them:

• As mentioned earlier, €233 million on 2011 revenue side came from the one-off sale of the Bank of Ireland shares, while €251 million of corporate tax receipts booked into 2012 is really the revenue from 2011. This means the deficit in 2011 should be adjusted by -€18 million and the balance in 2012 should be adjusted by +€251 million.
• In January-August 2011 the state spent €7.6 billion on recapitalizing banks, while this year the spending was only €1.3 billion plus there was a payment of €450mln in 2012 into the ICF (Insurance Compensation Fund). This means we should adjust the Exchequer balance on 2011 side by -€7.6 billion and 2012 by -€1.75 billion.
• Promo notes 'restructuring' this year meant the net cost of the Notes booked at €25mln, against €3.1 billion in 2011. This means adjusting 2011 deficit by -€3.1 billion and 2012 deficit by €25 million.
• In 2011 revenues from the banks measures - clearly a temporary source, as the EU Commission has warned Ireland already about the future tapering off of these receipts - amounted to €1.27 billion, while in 2012 they amount to €2.06 billion.

Accounting for the above one-off and temporary measures, the underlying deficit figures are:

• 2011 January-August period: €10.98 billion or €9.71 billion if we omit accounting for banks receipts;
• 2012 January-August period: €11.88 billion or €9.82 billion if we omit accounting for banks receipts.
• Hence, January-August 2012 period deficit, comparable to that for the same period in 2011 is worse, not better, by €109-896 million depending on whether we consider windfall differences in temporary revenues from banks.

Fact 2: On comparable basis, stripping out one-off measures and temporary allocations, Irish Exchequer deficit is worse in the first 8 months of 2012 than it was in 2011.

4/9/2012: The Fog of Exchequer Receipts: August 2012

The Exchequer receipts and expenditure figures are out for August and the circus of media rehashing that way and this way the Department of Finance press releases is on full blast.

From the way you'd read it in the media outlets, tax receipts are up, targets are met, deficit is down, spending is down. The problem is that the bunch of one-off measures conceals the truth to such an extent that no real comparison is any longer feasible for year on year figures. The circus has painted the Government finances figures so thickly in a rainbow of banks recaps, shares sales receipts, tax reclassifications, tax receipts delays and re-bookings etc that the Government can say pretty much whatever it wants about its fiscal performance until, that is, the final annual figures are in. Even then, the charade with promo note in March will still have material influence on the figures, as will tax reclassifications and delayed tax receipts booking.

With this in mind, let's try and make some sense out of the latest Exchequer receipts results, first (expenditure and balance in later posts).

Take total tax receipts for January-August 2012. The official outrun is €22.076bn which is 1.7% ahead of target set in the Budget 2012. Alas, monthly receipts of €1.763bn is 7.1% short of target. In July 2012, monthly tax receipts were 0.2% below target. So:
Point 1: As a warning flag: revenues are now running increasingly below target levels.

Year on year tax receipts were down 1.7% in July on a monthly basis and were up 9% on aggregate January-July basis. Year-on-year receipts were down 5.7% in August on a monthly basis, and were up 7.7% on January-August aggregate basis.
Point 2: As another warning flag: tax receipts are now running for two months under last year's and this is even before we adjust for 2011-2012 reclassifications and delayed bookings of some receipts.

Now, the Department of Finance states in the footnote to its tax receipts analysis that: "Adjusting for delayed corporation tax receipts from December 2011 and the techncial [sic] reclassification of an element of PRSI income to income tax this year, aggregate tax revenues are an estimated 5.2% year-on-year at end-August, coproration [sic] tax is up 6.7% and income tax is up just under 10%". What does it mean? this means that by Department estimates, the two factors account for roughly €511 million in combined bookings into 2012 that are not comparable to 2011 figures.

Subtracting €511 million our of the total cumulated receipts implies tax receipts for January-August 2012 of €21.565bn which would be 0.7% below the Budget 2012 target. Thus,
Point 3: Tax receipts, on comparable basis, are running at below target, not ahead of it, albeit the difference is still materially small.

Here's what else is interesting, however, at the end of June the Department provided an estimate for the above adjustments of ca €472 million, at the of July it was €467 million and now at €511 million. Even allowing for rounding differences on percentages reported this looks rather strange to me.

On non-tax revenues:

• In 2011 the Government collected €233 million from selling its shares in Bank of Ireland. This year - nil booked on that. Which largely accounts for the capital revenues being down from €1,036 million in 2011 to €813 million in 2012.
• Again on the capital receipts side, total EU contributions to Ireland in January-August 2012 stood at €68.401 million against €43.671 million a year ago.
• Total non-tax revenue on the current line of the balancesheet is €2.403 billion in January-August 2012 and this is up 49.4% on the same period in 2011.
• Of the increase registered in 2012 compared to 2011, €487 million came from increases in clawbacks from the banks and Central Bank of Ireland remitted profits. In other words, that was roughly half a billion euros that could have gone to writing down mortgages, but instead went to the Government. €302 million more came from the Interest on Contingent Capital Notes, which is the fancy phrase to say it too came from the banks. Thus, all in, current non-tax revenues increases of €794.1 million were almost fully accounted for by the increases of €789 million in the state clawbacks out of the insolvent and semi-solvent banks that the state largely owns.

Point 4: Unless you believe that the banks conjure money out of thin air, any celebration of non-tax receipts improvements in January-August 2012 compared to 2011 is a celebration of Pyrrhic victory of the Exchequer witch craft inside our (as banks customers and mortgage holders) pockets.

Now, let's add all receipts together:

• Total Exchequer receipts in January-August 2012 stood at €25.937bn against €23.146bn in 2011. 
• The 'rise' in total Exchequer receipts of €2,791 million in 8 months of 2012 compared to the same period in 2011 includes €511 million in tax adjustments (re-labeling) and carry over from 2011, plus €789 million in new revenues clawed out of the banks. In addition, €645.7 million is booked on receipts side via the Sinking Fund transfer (which is netted out by increased expenditure).
• So far, over the 8 months of 2012, the actual net increase in total (tax, non-tax current and non-tax capital) receipts is ca €845 million, or 3.7%.

Point 5: Disregarding expenditure effects (to be discussed later), Irish Exchequer has managed to hike its policy-controlled receipts by 3.7% y/y over the January-August period. Better than nothing, but a massive cry from the headline figure of 7.7% increase in total tax receipts and 12% rise in total receipts.

16/1/2012: Irish Bailout Redux - Sunday Times 15/01/2012

Several articles in the press yesterday on why Ireland will require / need a second 'bailout' - here's an excellent piece from Namawinelake and here's a piece from Colm McCarthy.

This is an unedited version of my Sunday Times (January 15, 2012) article on the same topic.

In May 2011, as Greece was sliding toward the second bailout, I conjectured that within 24 months, Ireland and Portugal will both require additional bailout packages as well. This week, my prediction has been echoed by the Chief Economist of the Citi, William Buiter.

According to Buiter, the costs of borrowing in the markets are currently prohibitive and the expiration of the €67.5 billion loans deal with the Torika, scheduled for 2014 will see Ireland once again unable to borrow to cover remaining deficits and refinancing maturing bonds. Ireland should secure additional funding as a back up, to avoid seeking it later “in a state of near panic”.

Buiter’s suggestion represents nothing more than a prudent planning-ahead exercise. In addition to Buiter’s original rationale for securing new lending, Ireland is facing significant fiscal and economic challenges that will make it nearly impossible for the State to finance its fiscal adjustment path through private borrowing in 2014-2016.

Speaking to the RTE, Buiter said that although Ireland’s situation was different from that of Greece, the economy remains under severe stress from banking sector bailouts. Addressing this stress should involve restructuring of the promissory notes issued by the state to IBRC, as the Government was hoping to do in recent months. But it also requires anchoring our longer-term fiscal adjustment path to predictable and stable sources of funding at a cost that can be carried by the weakened economy.

The Government will do well to listen to these early warnings to avoid repeating mistakes of their predecessors.

On November 18, 2011, Carlo Cottarelli, IMF Director of Fiscal Affairs Department gave a presentation in the London School of Economics, titled Challenges of Budgetary and Financial Crises in Europe. In it, Mr Cottarelli provided three important insights into the expected dynamics for debt and deficits that have material impact on Ireland.

Firstly, he showed that to achieve the ‘golden rule’ debt to GDP ratio of 60% of GDP by 2030, Ireland will be required to run extremely high primary surpluses in years to come. Only Greece and Japan will have to shoulder greater pain than us over the next 19 years to get public debt overhang down to a safety level.

Secondly, amongst all PIIGS, Ireland has the highest proportion of outstanding public debt held by non-residents (84%), implying the highest cost of restructuring such debt. The runner up is Greece with 65%. In general, bond yields are positively correlated with the proportion of debt held by non-residents.

Thirdly, Cottarelli presented a model estimating the relationship between the observed bond yields and the underlying macroeconomic and fiscal fundamentals that looked at 31 countries. This model can be recalibrated to see what yields on Irish debt can be consistent with market funding under IMF growth projections for Ireland. Using headline IMF forecasts from December 2011, 2014-2016 yields for Ireland are expected to range between 4.7% and 6.5%. Incorporating some downside risks to growth and other macroeconomic parameters, Irish yields can be expected to range between 5.3% and 7.0%.

Even in 5.5-6% average yields range, financing Irish bonds rollovers in the market in 2014-2016 will be prohibitively costly as at the above yields, Ireland's debt dynamics will no longer be consistent with the rates of decline in debt/GDP ratio planned for under the Troika agreement. This, in turn, means that the markets will be unlikely to provide financing in volumes, sufficient to cover debt rollovers. Thus, Ireland will either require new bridging loans from the Troika or will have to extract even greater primary surpluses out of the economy, diverting more funds to cover debt repayments and risking derailing any recovery we might see by then.

What Butier statement this week does not consider, however, are the potential downside risks to the Irish fiscal stability projections. These risks are material and can be broadly divided into external and internal.

Per external risks, the latest CMA Global Sovereign Risk Report for Q4 2011, released this week, shows Ireland as the 6^th riskiest country in the world with estimated probability of sovereign default of 46.4% and credit ratings of ccc+. Despite stable performance of our bonds in Q4 2011, CMA credit ratings for Ireland have deteriorated, compared to Q3 2011. And, our 5 year mid-point CDS spreads are now at around 747 bps – more than seven times ahead of Germany. This highlights the effect of a moderate slowdown in euro zone growth on our bonds performance.

Even absent the above risks, Irish debt dynamics can be significantly improved by significantly extending preferential interest rates obtained under the Troika agreement to cover post-2014 rollovers and adjustments. Based on IMF projections from December 2011, such a move can secure savings of some €9 billion or almost 5% of our forecast 2016 GDP in years 2014-2016 alone (see chart).

CHART

Chart source: IMF Country Report 11/356, December 2011 and author own calculations

Looking into the next 5 years, there is a risk of significant increase in inflationary pressures once the growth momentum returns to the Euro area. A rise in the bund rates can also take place due to deterioration in the German fiscal position or due to Germany assuming greater role in the risk-sharing arrangements within the euro area. Lastly, German and all other bonds yields can also rise when risk-on switch takes place in post-recessionary period, drawing significant amounts of liquidity out of the global bond markets. All of these will adversely impact German bunds, but also Irish bonds.

On the domestic front, we should be providing a precautionary cover for the risk of a more protracted slowdown in the Irish economy especially if accompanied by sticky unemployment. The risk of deterioration in Irish primary balances due to structural slowdown in the rate of growth in Irish exports (potentially due to strengthening of the euro in 2013-2016 period or significant adverse effect of the patent cliff on pharma exports) is another one worth considering well before it materializes. Lastly, there is the ever-growing risk that the markets will simply refuse to fund the vast rollovers of debt which is currently being increasingly warehoused outside the normal markets in the vaults of the Central Banks and on the books of the Troika.

Overall, Ireland should form a multi-pronged strategic approach to fiscal debt adjustment. Recognizing future risks, the Government should aggressively pursue the agenda of restructuring the promissory notes issued to the IBRC with an aim of driving down notes yield down to ECB repo rate and push for ECB acceptance of burden sharing imposition on IBRC bondholders to reduce the principal amount of the promissory notes. Pursuit of longer-term objective of forcing the ECB to accept a writedown on the banks debts accumulated through the Emergency Liquidity Assistance lines at the Central Bank of Ireland is another key policy target. Lastly, Ireland needs to secure significant lines of credit with the EU at preferential rates for post-2014 period with longer-term maturity than currently envisaged under the Troika deal.

Given the general conditions across the Eurozone today, the last priority should be pursued as early as possible. In other words, there’s no better time to do the right things than now.

Box-out:

The latest EU-wide statistics for Retail sales for November 2011 released this week present an interesting reading. Retail sector turnover index, taking into account adjustments for working days, shows Irish retail activity has contracted by 0.4% in November 2011 year on year. Overall activity is now down 5.2% on same period 2008, but is up 7.9% on 2005. For all the Irish retail sector woes, here’s an interesting comparative. Euro area retail sales turnover is now down 2.5% year on year and 1.6% on 2005. In terms of overall contraction in turnover, Ireland is ranked 15^th in EU27 in terms of the rate of contraction relative to November 2010 and November 2008 and 12^th in terms of contraction relative to 2005. Not exactly a catastrophic decline. Once set against significant losses in retail sector employment since 2008, these numbers suggest that to a large extent jobs losses in the sector were driven by lack of efficiencies in the sector at the peak of the Celtic Tiger, as well as by declines in revenues.

13/1/2012: The need for political reforms

An interesting paper from the World Bank (linked here), by Torgler, Benno, titled "Tax Morale and Compliance: Review of Evidence and Case Studies for Europe" (December 1, 2011). World Bank Policy Research Working Paper Series, 2011 (World Bank Policy research Working Paper 5922) presents an overview of the literature on tax morale and tax compliance. Perhaps unsurprisingly, it finds that accountability, democratic governance, efficient and transparent legal structures, and crucially, "trust within the society" are important in enforcing tax compliance and tax morale.

Which offers an interesting point for observation: in 2011, trust in Irish system of government as measured by the Edelman Trust Barometer stood at 20%, against the average of 52% for 23 countries surveyed in the report, making Ireland the lowest ranked country in the study. 


But things are even worse than the above number suggests: 

• Ireland ranks lowest 23rd in terms of average trust measures across four institutions of government, media, business and NGOs
• The above result is driven by: high trust in NGOs at 53%, although this is still below global trust in NGOs at 61%, high trust in business at 46% against global trust in business at 56%, low trust in media at 38% and abysmally low trust in government.

So may be, just may be, folks, in order to improve our fiscal performance we need deep political and leadership changes at least as much as tax increases and spending cuts? Perhaps, one of the problems with Irish fiscal crisis response to date is that the current Government and its predecessor are not doing enough to make Ireland's elites more accountable, more transparent, and better governed? There's an old Russian saying that every fish rots from the head (although Chinese, British and other nations claim the origin of this phrase as well).

20/12/2011: IMF IV Review of Ireland Programme: part 3

In the previous two posts I covered the IMF analysis of mortgages arrears and budgetary dynamics. Here, let's focus on IMF forward-looking analysis for 2012.

"Given the strong growth in the first half, real GDP growth has been revised up to 1.1 percent
in 2011 from 0.4 percent in the most recent WEO projection. However, nominal GDP would
be essentially flat in 2011 given a projected 1 percent decline in the GDP deflator owing to a
deterioration in the terms of trade." [You can read this as follows: we repay debt out of nominal GDP. Which is flat. Thus our capacity to repay our debts in 2011 remains identical to that in 2010. Another year, and not any closer to the elusive - and utterly unattainable, of course - goal of paying down our total debts.]

"Further deceleration in external trade prevents any growth pick-up in the baseline in 2012. Growth projected for key trading partners—the euro area, the U.S. and the U.K. account for 80 percent of exports—has been revised down from 2 percent at the Third Review to 1½ percent currently (export-weighted). The non-cyclicality of pharmaceutical exports and recent improvements in competitiveness help mitigate the impact of lower demand, nonetheless, projected Irish export growth in 2012 has been revised down from 5¼ percent to 3¾ percent. Domestic demand will continue to contract, leaving GDP growth at 1 percent in 2012, down from 1.9 percent at the previous review. Low growth allows only a small reduction in unemployment in 2012. Inflation would remain low at about 1 percent in 2012, as higher indirect tax rates broadly offset the impact of weaker international price pressures." [So, in a summary: if pharma exports remain as they are - no patent cliff effects etc - we will grow at 1% in 2012, unemployment will decline slightly solely due to exits from the labor force and emigration, and high taxes will hammer domestic demand, thus driving down inflation. Did I hear 'stagnation' said anywhere?]

"Overall, growth is expected to average 2¾ percent over 2013–15, but the unemployment rate may remain in double-digits through 2016, risking the development of sizeable structural unemployment." [In other words, the growth rate IMF builds in assumes 2012 growth of 1.0%, 2013 growth of 2.3%, 2014 of 2.7% and 2015 of 3%. Department of Finance projects growth of 1.3-1.6% for 2012 (+0.3-0.6% on IMF), 2.4% in 2013 (+0.1% on IMF), and 3% in 2014 and 2015. Cumulative departure over 2012-2015 between IMF forecasts and DofF/Budget 2012 forecasts is, therefore, at 0.75-1.08 percent. If anything, were the IMF to be correct in their assumptions, Ireland will need some additional cuts of 0.02-0.03% of 2015 GDP - €172-204mln. If, however, the IMF itself is over-optimistic and Irish GDP growth were to come in at 2.5% average for the 2013-2015 period instead of 2.75%, the shortfall on targets will be as high as €293mln. And that's just the growth estimates effects.]

Importantly, the IMF revised its previous forecasts for 2015 deficit of 2.9% in line with the Government plans. However, debt/GDP ratio remains projected to peak at 118.1% in 2013 and this reflects adjustments for the €3.72bn 'Cardiff error'.

"Debt-to-GDP is projected to peak at 118 percent in 2013, in line with the previous review. The debt path is lowered by a correction to the end-2010 general government debt level and the reduced interest rate on EU loans, but this is offset by lower projections for nominal GDP. Potential privatization receipts could lower debt prospects, while outlays to restructure the credit union sector could raise debt prospects, but such outlays are expected to be manageable. External developments affecting growth and the prospective interest rates on market financing are the key sources of risk to debt sustainability."[The assumption is that projected cost of credit unions losses covers will be €500-1,000mln only.]

But don't worry - Government revenues are going to be very transparent. Per IMF analysis, in effect, the entire revenue adjustment forward will be carried through income taxes:

Perhaps a telling thing about the report is that the entire 'growth policies' section of the review is given less space than the reforms of the credit unions. What is given, however, is bizarrely thin on ideas and impact.

Most of the 'measures' referenced reflect focus on Employment Regulation Orders (EROs) or Registered Employment Agreements (REA) review - a measure that is likely to produce some labour cost reductions in the construction sector and perhaps some other labor intensive, lower-wage sectors. However, it is simply naive to believe that labor costs hold back jobs creation in retail, hospitality and construction. Instead, market structure, lack of consumer demand, Nama - for construction, banks credit availability and, above all, devastated personal incomes of those still working (via taxes hits and earnings declines) are the main drivers for lack of jobs creation in these sector. Review of wage setting mechanisms might be a high enough priority, but it is not the highest by any possible means.

Apart from that, IMF Megaminds have nothing else to say about jobs creation.

In the next post, I will focus on the IMF review of risks with respect to fiscal consolidation and growth.

20/12/2011: IMF IV Review of Ireland Programme: part 2

This continues my review of the IMF's 4th review of Ireland. The previous post (here) covered the findings concerning mortgages arrears and property markets.


"Budget execution remains on track despite weakness in revenues linked to domestic demand. ...Excluding net banking sector support costs, the January–October Exchequer primary deficit was €12.1 billion, 0.8 percentage points of GDP narrower than the authorities’ profile after allowing for the impact of the Jobs Initiative introduced in May 2011." [In other words, folks, allowing for pensions levy hit]

"The smaller deficit primarily reflects tight expenditure control; net current spending undershot budgetary allocation by 1.6 percent (0.4 percent of GDP), while capital spending was below profile by 17.2 percent (0.8 percent of GDP)." [This further shows that the smallest positive impact on deficit was derived from the largest area of expenditure - current spending, with capital spending cuts acting as the main driver, once again, of budgetary adjustment. This, of course, has been highlighted by me on numerous occasions.]

"Overall revenues remained on track, with shortfalls in taxes such as VAT due to weak domestic demand offset by higher than budgeted non-tax revenues, such as bank guarantee fees." [That's right, folks, one-off hits on income and wealth are 'compensating' for tax revenues fall-off in income tax, VAT and corporation tax. Again, keep in mind that IMF analysis is based on data that excludes the largest revenue generating month of November.]

But here's an interesting note: "The cumulative Exchequer primary balance through end-September 2011 was -€18.3 billion, above the adjusted target of -€20.2 billion. Central government net debt was €111.7 billion, below the adjusted indicative target of €115.9 billion" [One might ask the following question, is that target of €115.9bn - set in December 2010 - reflects the €3.6bn error found in Q3 2011? If not, then, of course, our 'outperformance of the target shrinks to a virtually irrelevant €500mln which, itself, can be fully covered by capital expenditure shortfall on the target mentioned above. In other words, when all is factored in, are we really outperforming the target set, or are we simply overestimating the target and ignoring expected spending?]

The IMF catches up to that:
"Program ceilings for fiscal indicators at end-2011 are expected to be observed. Although spending will pick up toward year-end, and a funding need of 0.2 percent of GDP is expected in relation to the failure of a private insurance company, the end-December performance criterion is projected to be achieved."
[In other words, the State will have to cover €300mln of Quinn Insurance losses in 2011 and then another €400mln of same in 2012. Alas, due to the accounting trick, since these losses will be recovered by the State through an insurance levy - to be paid by the completely innocent dopes (aka, us, consumers of insurance products in Ireland), the whole thing is not counted as Government debt, even though the State will be borrowing these funds.]

"Similarly, the general government deficit is projected at 10.3 percent of GDP, within the European Council’s ceiling of 10.6 percent of GDP. The 2011 consolidation package of €5.3 billion (3.4 percent of GDP) is expected to reduce the primary deficit to 6.7 percent of GDP, representing a €3.1 billion (2 percent of GDP) year-on-year reduction." [Now, note the maths - 6.7% primary deficit remains to be closed before we can begin net debt repayments. Last year, we've closed - and that is based on pre-November 2011 pretty disastrous numbers - 2%, so 2/9th down, 7/9th still to go, roughly-speaking]

Crucially: "The realized increase in the primary balance will thus likely amount to only about three-fifths of the consolidation effort, which reflects the adverse impact of the contraction in domestic demand and the rise in unemployment, highlighting the challenge of implementing large fiscal consolidations when growth is weak." [Here's what this means - due to the adverse effects of lower growth and higher unemployment, some 40% of this year's adjustment has gone on fighting the rising tide of economic crisis, not on structural rebalancing of fiscal deficit. In other words, if this situation of fiscal targets set against unrealistic expectations for growth were to continue in 2012 and through 2015, we will get a deficit to GDP ratio of closer to 5.5-6% not 2.9% as envisaged. Now, think about this in the following terms - Budget 2012 assumes growth of 1.3% next year - although I have some questions as to whether that is indeed the number, given that a day before the Budget 2012 was published, the Department of Finance quoted the figure of 1.6% - and the expectations of ESRI, OECD, the EU Commission and the IMF are now for 0.9-1%... hmmm... realistic expectations, targets and outcomes risks are now pretty clear...]

As is, the IMF report shows progress achieved. But it also raises a number of questions:

• Is this progress - 2% adjustment of which 2/5ths are simply gone to cover lost ground - sufficient?
• Is this progress sustainable (see next post)?
• Is this progress being achieved through structural reforms (current spending cuts and sustainable revenue raising) or through capital expenditure cuts and one-off tax measures?

The following post will cover the IMF analysis of the future outlook for the Irish economy.

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 1/8/10: California's lesson for IRL?

Last week the State of California declared official emergency in relation to its fiscal shortfall. The problem, you see, is that torn between various vested interests, California's legislature is unable to approve a new budget for 2011. The State deficit is currently running at $19bn, which represents 22% of the general budget fund. As a part of emergency declaration, Governor Schwarzenegger ordered three days off without pay per month beginning in August for tens of thousands of state employees to preserve the state's cash to pay its debt, and for essential services. Now, 3 days out of each month represents roughly speaking a 14% straight cut across all lines of wages, pensions liabilities, overtime etc. A bit more dramatic than Irish Government 2-year old programme of cutting PS pay by an average of 5-7%.

May be the depth of California's crisis is that much (say 2.5 times?) deeper than the fiscal crisis in Ireland?

Well, let's compare, shall we? To do so, I took budgetary projections (latest available) for California and Ireland and put them side by side. I computed the extent of expected and planned deficits in both locations as a share of the net Government expenditure.
It turns out that in its state of emergency, 'insolvent' California is not 2-3 times worse off than Ireland. It is the 'turning the corner' Ireland that looks 1.5 times worse off than California. And not just now - all the way through the next 4 years.

So California - its Governor and Legislature - are at the very least trying to work through the summer to hammer out some sort of a resolution. Our own legislators and Government are out to enjoy a spot of recreation. And why not, you may ask, if the economy has finally turned the corner... err... sort of... for the 15th time since May 2009 that is...

Economics 15/12/2009: Denmark cuts 2010 deficit by almost 50%

An interesting way of dealing with deficits: Denmark shows the way to lower taxes and deferred tax liabilities, while restructuring public expenditure away from direct spending to more pro-business, growth oriented spending. Read the details here.

Another interesting key fact: "The general government budget balance is estimated to decrease by DKK 154bn from 2008 to 2010. This corresponds to a reduction of 8.9 per cent of GDP of which one third reflects the loosening of fiscal policy... Measured by the fiscal effect fiscal policy is estimated to stimulate economic activity by 1.0 per cent of GDP in 2009."

So run this by me again? Cut balance by 8.9%, of which roughly 3% of GDP goes to fiscal spending to generate growth of ca 1%. suggested multiplier? Lowly 30cents on the euro... or rather DKK... not exactly a big bang for a buck, given that over 5 years interest alone would eat up some 15.8 cents out of this amount.

Another crucial bit: "The deficit on the central government net balance, which is essential for the central government debt, is estimated at DKK 141½bn in 2009 and 74½bn in 2010." Implied cut in deficit 2009 to 2010 is 49.6%. Irish Government approach to the cuts (see my estimates here) is to cut 15.2% of the deficit (if no banks recapitalization is taken into the account) or under 1% reduction (if banks recapitalization is factored in at €4 billion in 2010). DofF own rosy projections imply a cut in the deficit of 29.7%, which is still shallower than Denmark's.

So, the Siptunomics is not what Denmark subscribes to when it comes to fiscal discipline.