2/7/2012: 16 issues with ESM 'deal'

This is the second post for this blog on the latest Euro area ‘deal’ struck early morning last Friday – the ‘deal’ that is thin on details (see statement here http://trueeconomics.blogspot.ie/2012/06/2962012-deal-preliminary-reaction.html) and even thinner on actual commitments (as in ‘new commitments’ not ‘repeated old commitments’).

(1) The core ‘commitment’ in the deal is the possibility that – once “effective single supervisory mechanism is established” (which may or may not take long – depending on whether the already existent EBA structure can be seen as ‘effective’ and whether it can be enhanced with real supervisory powers to oversee EA17 states, who are yet to agree such enhancements and such oversight) “the ESM could, following a regular decision, have the possibility to recapitalize banks directly” (so on top of establishing a common supervisory structure and endowing it with sufficient powers, the member states are yet to endow ESM with ‘regular decision’ powers to recap banks).

Assuming that such possibility is indeed delivered upon, this would allow banks recapitalizations via ESM instead of directly via sovereign funds and thus will – for accounting purposes – prevent banking debt being counted directly as Government debt. This is the positive and it is a significant positive, for Europe.

However, it has limitations, although it also delivers some potential positives. A mixed bag overall for Europe.

(2) Irish experience shows that – with Nama debt not officially counted as Exchequer debt, while Promissory Notes to IBRC and interest on them is counted as such. Both are fully backed by Government and both have economic implications, but only one (Promo Notes) has implication for sovereign finances. In other words, removing for accounting purposes debt off Government balancesheet does not remove the costs and burdens of this debt off the balancesheet of the economy as a whole. What this means is that the ‘deal’ does not share responsibility for debt across the Euro zone, as long as there remain Government guarantees. Instead it spreads debt into the economy (as banking system will still have to repay them), putting taxpayers into the second line of fire.

Incidentally, Nama – that vehicle which absorbed some of the banks bailouts – is highly unlikely to be featured in any potential/theoretical/rumoured/alleged retroactive restructuring of the banks-related sovereign debt.

This also means that the deal does not fully break the link of contagion from banks bad debts to Government balancesheet, but makes this link more opaque.

(3) There is no retrospection in the deal, although the Irish Government claims there is. We hope there can be such retrospection, but it is difficult to see how that can be delivered given that

a) Retrospection would open ESM to some €200 billion worth already committed Governments’ funds from the peripheral and other states (including Germany), effectively erasing 40% of ESM capacity before it gets to lend to any new states (e.g. Italy and Spain).

b) Retrospection in any case would not apply to non-debt funds committed by the Irish state (some €21 billion in NPRF cash paid in already).

c) Retrospection could challenge some of the requirements for conditionality (as it cannot be covered by any new conditions) and any potential requirements for collateralization (see below).

The Irish Government is so convinced that retrospective deal is possible, it has set the target of 17% of GDP for debt writedown (see: http://www.irishtimes.com/newspaper/breaking/2012/0702/breaking4.html) which will require a restructuring of €34 billion and if achieved will be a significant help to the Exchequer, although doubtful in value to the economy at large.

(4) The deal clearly states that the banks bailouts will be subject to the "appropriate conditionality, including compliance with state aid rules, which should be institution-specific, sector-specific or economy-wide and would be formalized in a Memorandum of Understanding." In other words, the conditions will not be universal for all states, but will be granular – specific to individual environments. Render onto… comes to mind, and the Caesar – Italy, Spain, any other large member state, is not the same as Ireland, Cyprus, Portugal, Greece et al.

(5) The ESM itself is, at this stage, still not set up and, more importantly, has not raised any funds. When operational it will have capacity to raise €500bn which is highly unlikely to be sufficient to cover sovereigns’ own needs, let alone underwrite any significant banks bailouts. If current EFSF participants were allowed to roll into ESM their banks’ exposures along with Spain, the ESM will have to allocate some €200 billion or so of funds to existent programmes, leaving €300 billion or so to fund other banks bailouts that might arise and fund Exchequers’ needs outside banks bailouts. Thus, ESM will be faced with a dilemma – either it acts as a somewhat credible banks bailout fund or a somewhat credible support for Government bonds. So far, under any of the existent proposals, it cannot do both. Were such proposals to be put in place in the future (e.g. leveraging via ‘banking license’ etc – explicitly excluded from the ‘deal’), the ESM will have to balloon well past €1 trillion mark.

Absent such proposals for ESM structure, the ‘deal’ says that ESM will be allowed to directly intervene in the markets to purchase Government debt. This is not new – in fact it was always supposed to do so.

(6) ESM structure remains unchanged under the deal, so the fund will go to the funding markets with a backing of collective guarantees of the member states. The internal backing of credit flows within ESM is that of the guarantees by the borrowing states to the fund – same as in the EFSF – except absent subordination. This can mean two things:

a) ESM will have to pay more for borrowing in the markets, and

b) ESM might face severe difficulties, similar to those experienced by the EFSF, in raising funds.

The things are getting so tight with the ESM (even before it is launched) that within the ESM set-up, the combined "guarantees" by the peripheral states borrowers from the EFSF/ESM plus Italy to ESM creditors are proportionately in excess of the guarantee provided by Germany.

However, on the positive side here, removal of subordination clause from ESM lending affirms to private lenders to national Governments the equal treatment of their bonds with supra-national ESM debt. In the long run, therefore, this should reduce risk premia for those member states still capable of tapping the private markets for debt. Thus, making things harder for ESM might make things easier for Germany & Co.

(7) ESM structure of guarantees is itself a troubling scheme. When Spain receives the bailout funding, its share of ESM funding and guarantees will be reallocated to other member states. Germany’s share will move from 29% to 33%, Italy’s share from 19% to 22%, France’s from 22% to 25% and so on. Two weaker Euro area states – Italy and Belgium – will become larger guarantors of ESM. And France, which wants effectively to expand ESM and to grow the overall euro area debt pile to finance own agenda. More fun? Unwilling participants to the scheme – Finland, Austria, the Netherlands – all are getting more ‘voting’ power in the ESM too. Which, of course, should make the whole ESM proposition even more risky in the eyes of external investors.

(8) ESM structure under the ‘deal’ is reinforced by the compulsion of the borrower state to comply with strict and specific conditions. To maintain credibility, therefore, ESM will require these conditions to be at least as stringent as those imposed under the EFSF (Troika) deals. The problem, alas, is that no country, save Ireland, to-date has been able to comply with the previous conditions and the entire mess we are in today was triggered (not caused) by Greece and Spain refusing to comply with these conditions.

This means that either ESM will have to offer its own funders much lesser security (higher risk of borrowers from ESM not being able to deliver internal adjustment programmes necessary for repayment of ESM funds) or it will have to avoid buying Spanish and Greek debts. Alternatively, the ESM lending will have to come with even stricter conditions to compensate for the lack of subordination, which is clearly unviable in current political environment.

(9) To secure ESM funding, the member state applying for the funds will be required to sign an agreed Memorandum of Understanding (as with Troika) which then will have to be approved by other member states. In the past, Finland, the Netherlands, Austria and Slovakia, not to mention Germany, have opposed to some conditions that would have allowed easier access to ESM funds. Specifically, some countries on the list have demanded use of collateral to secure lending even with assumed (under previous ESM plans) and actual (under EFSF) super-seniority conditions. What these and other countries might demand from the ESM funding recipient state is, thus, completely unclear and uncertain. The same applies to ESM lending to the banks, with an added caveat – conditions for banks will have to be even more strict.

We are now, therefore, facing a possibility that the collateral for loans debate can be reignited.

(10) Pretty much everyone agrees that the only lasting resolution to the crisis will have to arrive via ECB. Yet, to-date, ECB has been reluctant to engage even with the crisis spinning out of control. If the latest agreement de facto injects more funds in support of the banking and sovereign balancesheets, the current deal can actually result in even lower willingness of ECB to engage. In other words, the ECB might play a wait-and-see game, allowing the ESM to become fully engaged and only thereafter, assuming the crisis remains acute, stepping in. In other words, instead of deploying monetary policy upfront, we might see Euro area first increase its overall level of indebtedness via ESM and only after that move for the aggressive deployment of the monetary policy. As we know, this has happened in Japan and it has shown the weakness of the monetary policy at the time of elevated debt crisis.

(11) On a positive side, we must recognize that the deal explicitly recognized two things:

a) Germany no longer holds total power over the Euro area decisions,

b) A Euro area state should not be forced to accept bankruptcy level debts in order to underwrite banking system solvency (although there is yet to be a realisation on the side of same happening to the economy)

(12) Also on a positive side, it appears that likely outcome of common supervision regime will include deposits guarantee and banks insolvency resolution regime. Both are net positives and both are consistent with my long-held views on what should be done to repair Euro area banking system. Alas, the resolution regime will have to come ex post already adopted measures, so it is unlikely to make material difference to the banking system we currently have.

(13) A unified banking supervision itself might be a tight spot. Suppose it is set up. And suppose it is functional. In this case, any Euro area banking regulator will be faced with a problem – banks under his/her supervision holding massive and increasing exposures to the sovereign debt of their own governments, some of which are in ESM. There is a clear-cut case here to be made that this situation cannot be sustained. However, should the Euro area regulator move to curtail, say Italian or Spanish banks buying more of their Governments debts, there will be effectively an end to these countries participation in the funding markets and a larger call on ESM. Alternatively, should the regulator ignore the problem of accumulating risks, the regulatory system itself can be undermined.

(14) The deal – and especially the path that it took to arrive at – is the example of European policy brinkmanship, not cooperation. All accounts show that the meeting was broken by Mario Monti with support of Rajoy and that Hollande provided back up. There is absolutely no argument to make that any other member state was explicitly on their side, although most likely Ireland and Portugal were only happy to ride on the coattails of the opposition. Either way, the whole process of deriving the deal was not a cooperative solution, but a stand-off. This is not a break from the established pattern of past summits. But equally ominously, the latest success of brinkmanship is underpinned not by the change in the Euro area leaders’ positions, but by changes in the electoral landscape in Europe, with opposition to the status quo growing on the side of the ‘rebels’ in Greece (Syriza), Italy (Five Star), France (recent lections shift toward more extreme parties support), Finland (the True Finns), Germany and so on.

(15) In the end, ESM will not resolve the problem of too much debt accumulated on the shoulders of European sovereigns and dysfunctional banking system. The economies involved – Spain, Ireland, Greece, Portugal, Cyprus, and potentially Italy – are simply incapable of repaying these debts (please, do consider that even under the rosy Irish Government scenarios – the best performer in the group – Government debt reductions envisioned post 2014 are minor and mostly driven by economic growth, not repayment of actual debts). With this, the ESM can become a perpetual lender, with the requirement to continue raising funds well past the envisioned 10-15 years period. Any cyclical recession before then or after will derail repayments and the ESM debt will have to simply rise, risking a debt spiral that we are experiencing today replaying at some point in the future. Not a pretty thought and certainly a risk that the ‘game changer’ of the ‘deal’ might end up being the ‘end-game’ losing move.

(16) The deal does provide some room for ECB to claim that now there is a realistic progression toward more centralized oversight over banking sector and thus it can engage more actively in monetary easing. The signal to watch for is the ECB 1% repo rate, which can be lowered, implicitly signalling ECB willingness to long-term tolerate inflation over 2%. Thereafter, 4% inflation becomes feasible and ECB can start priming the pump. In turn, devaluation of the euro will compensate German economy by boosting exports and will put even more pressure on internal devaluations in peripheral states (imports costs up, exports largely non-existent to benefit from cheaper euro, etc).

Today’s PMI figures showing broad euro zone-wide and sharp contraction in activity in June should make the ECB move this Thursday a ‘no-brainer’.

29/6/2012: The 'deal' - preliminary reaction

Overnight statement from the EA [emphasis mine]:

"We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution- specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding. 

The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.

We urge the rapid conclusion of the Memorandum of Understanding attached to the financial support to Spain for recapitalisation of its banking sector. We reaffirm that the financial assistance will be provided by the EFSF until the ESM becomes available, and that it will then be transferred to the ESM, without gaining seniority status.


We affirm our strong commitment to do what is necessary to ensure the financial stability of the euro area, in particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets for Member States respecting their Country Specific Recommendations and their other commitments including their respective timelines, under the European Semester, the Stability and Growth Pact and the Macroeconomic Imbalances Procedure. These conditions should be reflected in a Memorandum of Understanding. We welcome that the ECB has agreed to serve as an agent to EFSF/ESM in conducting market operations in an effective and efficient manner.
We task the Eurogroup to implement these decisions by 9 July 2012."

I note that there is NO retrospection in the above - a negative for Ireland. So far we have a statement from some Irish Government members not present at the summit who claim there is retrospective applicability, but as far as I am aware, this is NOT confirmed in any documentary evidence.

I also note that transfers to ESM from EFSF will be carried out "without gaining seniority status" de jure, although it will most likely still be de facto super-senior debt - a positive for Ireland.

It is worth noting furthermore that countries entering ESM without first obtaining funding via EFSF might be able to avoid facing a Troika-imposed set of conditionalities, but will be required to comply only with the internal EU rules (see here). This, however, does not seem to apply to countries like Ireland who will enter ESM from EFSF and, potentially (based on reading of the official statement) to countries that have obtained funding not solely for the purpose of recapitalizing their banks 9again, precluding Ireland from softening of conditionalities).

Per Enda Kenny (via RTE):

• Ireland's government debt (not only banks-related) will be 're-engineered' in other words - it will be restructured (effectively a soft default). "Mr Kenny said the new deal means Ireland's overall debt burden, including the bank debt, can be re-engineered in a way which will give Ireland equal treatment to Spain and any other countries which avail of the new system."

• "where funding is made available through the EFSF it will later be transferred to the ESM" so it is now the Government position that we will have a second bailout. 

So the Irish Government is de facto 'defaulting' and welcomes this. And it is going into the second bailout despite repeated claims that it will be funding itself via markets post 2013. And it welcomes this too. Reverse gear has not been used as much for some time on Merrion St.


I have consistently called both events as inevitable for Ireland. Hence, in my view, the 'deal' is a net positive. However, we cannot tell how positive it is yet.

One area of concern will be the treatment of the banks debt under ESM - with respect to seniority and any attached Government guarantees. In particular, in my view, if ESM were to assume directly unsecured banks debt, even with an attached explicit sovereign guarantee, such debt will have to adversely impact ESM cost of funding.

The biggest issue with the above statement is that it will NOT reduce overall economic debt carried by the EU states, including Ireland. The potential reduction in the cost of financing this debt is good news. The fact that this economy (not banks or some rich uncle in America) - aka us - are still on the hook for debts of insolvent banks remains.

Ditto for Euro area as a whole. You might call it 'Government Debt related to the banks', you might call it 'quasi-Government Debt related to the banks' or 'Non-Government Debt guaranteed by the Government to the super-senior lender related to the banks' or indeed a 'Pink Teddy Bear that stinks up the room' - the debt is... err... still there and there will be more of it post this 'deal'.

Update 1: some interesting thoughts - it appears from the EU statement that any euro area member state in compliance with fiscal constraints can apply for ESM funding of the banking sector measures. Now, if - as the Irish Government are claiming - such funding can be applicable to restructuring past sovereign exposures to banking sector, then:

• As Belgium is already starting to signal, it can be applied  to €4 billion spent on Dexia Banque Belgique plus €54 in guarantees extended to the bank (link covering more current exposures potential), plus €6 billion in Franco-Belgian assistance the bank received back in 2008 (link).
• Germany's €150 billion 'rescues' of Hypo and other banks via FMS (link here)
• Austria - same Hypo (link here) but peanuts so far
• Dutch Government pumped some €32 billion into its banks (link)
• and so on...

Now, give it a thought - ESM is supposed to run at €500 billion absorbing existent EFSF up to €700 billion. So even if Spain just caps EFSF and it transfers to ESM, we have - before Italy comes waltzing in - ESM full capacity potential left after the banks bailouts are retrospected into it - of what? Some €200 billion max?.. or absent EFSF - at the announced running volume - nil.


This sort of suggests there is serious problem with an idea of allowing retrospective roll-backs of banks-related debt and measures to ESM...




Update 2: It appears that Enda Kenny's alleged contribution to the summit ('winning the deal for Ireland') is not a part of the record of the summit, at least as far as I can see (one example - here).


Update 3: H/T to Brian Lucey: this is just in - Germany apparently/allegedly wants ESM bank aid to be tied to acceptance of the Financial Transactions Tax. I suppose compliance with a harmonized corporate tax will be the condition too. In the end, the 'Enda deal' might just become a seismic event... So the logic of FTT link is therefore, in Irish context will be:
Step 1: EA leaders use Irish taxpayers to rescue own speculators and banks from Anglo/INBS etc default on bonds.
Step 2: EA leaders use FTT to demolish jobs in Dublin IFSC, so they can finance their 'growth package'?
The sort of the 'deal' we've been waiting for from our 'European partners'?

Update 4:  Citing Spiegel source, Global Macro Monitor blog states [emphasis is mine]: "What happens to the countries that have already received money from the temporary rescue fund, the EFSF? Officials in Brussels said that the new decision did not change anything about the programs for Greece, Portugal and Ireland. All the agreed goals will continue to apply and be monitored by the troika. But those countries might also start clamoring for the terms of their deals to be relaxed. The summit’s decision gives the Greek government in particular more ammunition for renegotiating the terms of its bailout, a step that new Greek Prime Minister Antonis Samaras has already said he wants to take."

22/4/2012: Sunday Times 15/4/2012 - What if Ireland Defaults?

With some delay, this is my article for Sunday Times April 15, 2012 - an unedited version, as usual.

Since 2008, judging by a number of parameters and metrics, Ireland has been firmly in the grip of a historically unprecedented financial, fiscal, banking and economic crises. This is the consensus that emerges from book, titled What if Ireland Defaults? published by Orpen Press last week and edited by myself, Professor Brian Lucey and Dr. Charles Larkin (here is the link to Amazon page for the book and for ebook version). The book brings together views on sovereign and other forms of default by twenty two academic, media, political and social policy thinkers is designed to re-start the debate about the future trajectory of the Irish economy saddled with unprecedented levels of public and private debt. Coincidentally, What if Ireland Defaults? Was published in the same week as the IMF Global Financial Stability Report that focuses on the issues of household debt overhang. The IMF report too stresses the dangers of the excess debt levels across the economy and provides strong argument in favor of a systemic restructuring of private debt in countries like Ireland.

The roots of the Irish debt problem are historical in their nature, not only in the magnitude of the debt overhang involved, but also in terms of the correlated economic, fiscal and financial crises that define our current economic environment.

First, the Irish crisis has resulted in a deep and protracted contraction in the economy that is unparalleled in the modern history of advanced economies. In current market prices terms, and not taking into the account inflation, our national output is down 24.2% on pre-crisis peak, having fallen to 2003 levels. Investment in the economy is down 59.6%. These rates of decline are so far in excess of what has been experienced in Greece and are ten-fold deeper than those experienced in an average cyclical recession.

The duration of the Irish crisis is also outside the historical records. Since Q1 2008, Irish economy recorded fourteen quarters of nominal contraction in GNP and thirteen quarters of contraction in GDP. In effect, the economic crisis has already erased 8 years of growth. At an average nominal rate of growth of 4% per annum, it will take Ireland fifteen years to regain domestic output levels comparable to 2007. And this is without accounting for inflation.

Second, Ireland is now a worldwide record holder when it comes to the cost of dealing with the banking sector crisis. Combined weight of banking sector capital injections, and Nama is now close to 80% of our GNP. Irish Exchequer exposure to the Central Bank of Ireland ELA and the ECB borrowings by the state-owned banks lifts this number well beyond 200% of the national output. No advanced economy has ever experienced such a massive collapse of the domestic banking sector.

Another unique feature of Irish crises is their inter-connected nature. Economic recession – driven originally by the external demand contraction and debt overhang in the domestic economy was further compounded by the asset bust which itself is of a historic proportions. To-date, Irish property markets are down 49.3% on pre-crisis levels and the decline continues unabated. Large numbers of 30-50 year old families – the most economically-productive cohorts of our population – are now deeply in negative equity and are increasingly unable to sustain debt servicing. Officially, over 14% of our entire mortgages are currently either in a default, officially non-performing or short-term restructured.

The property bubble collapse, twinned with the debt crisis, didn’t just undermine the banking sector and cut into household wealth. The two have also left Irish economy without a growth driver that fuelled it since 2001-2002 when the property and lending bubble replaced the dot.com bubble implosion. Put differently, we are witnessing a structural economic recession. Since 1998-1999, Irish economy has lived through one bubble into another. Currently, excessive indebtedness and lack of a functional financial system are leaving Ireland without even a chance of finding a new growth catalyst.

In these conditions, the most significant problem we face today is the debt crisis. Our combined real economic debt – the debts of households, non-financial corporations and the Government – relative to our GNP is the highest in the advanced world. And, unlike our closest competitor for this dubious distinction, Japan, we have no means for controlling the interest rates at which our economy will have to finance Government and private sector debts.

It is the totality of the real economic debts, not just the debt of the Irish Government, that concern those economists who are still capable of facing the economic reality of our collapse. This point is referenced in the What if Ireland Defaults? by a number of authors, and as of this week, their views are being supported by the IMF, the Bank for International Settlements and a growing number of academic economists internationally.

Frustratingly, at home, our views are seen as contrarian, alarmist, and even populist. As the crisis has proven, year after year, the official Ireland Inc is simply unequipped to deal with reality.

Majority of Irish economic analysts incessantly drone about the threats arising from the Exchequer debts. Some, occasionally, add to this the banking debts. Fewer, yet, might reference the households. None, save for a handful of usually marginalized by the establishment economists, bother to treat the entire debt pile carried by our economy as a singular threat.

The silence about Ireland’s total debt, and the ongoing denial of the long-term disastrous economic and social costs of the total debt overhang are the frustrating features of our current state of the nation. It is this frustration, alongside the realization that Ireland can be blindly stumbling toward a renewed debt crisis, that informed myself and two of my co-editors to re-launch the debate about the potential inevitability and consequences of debt restructuring.

To re-start this debate, What if Ireland Defaults presents a range of views on the current Irish situation, from the basis of sovereign, banking debt and household debt restructuring.

The very idea of what constitutes a default is a complex one. In the book we interchangeably use the term ‘default’ as denoting a restructuring of the debt to reduce the overall level of debt. This can be accomplished by reducing the debt level itself, restructuring interest payments, extending the maturity of debt, or any combination of the above. In addition, a default can take place in an relatively orderly and coordinated fashion, as for example in Greece, or as a disorderly, unilateral action, as in the case of Russia in 1998. Lastly, default can be pre-announced, as in the case of Iceland, or unannounced – as in the case of Argentina. All of these differences are reflected in the chapters of the book dealing with historical experiences relating to sovereign defaults.

In the case of Ireland, there is a broad consensus within the book that a sovereign default is neither desirable nor inevitable. In other words, no author sees the situation where Irish Government debt will have to be restructured unilaterally, without prior cooperation with the EU authorities via the ESM or a similar collective structure. However, substantive disagreements do arise among the authors as to whether Ireland will require a structured default on banking and household debts. In this context, some of the contributions to the book pre-date and preclude the research on the necessity of household debt restructuring published by the IMF this week.

The overriding sense from What if Ireland defaults? is of an economy on a knife edge. Given favourable economic circumstances, especially in regard to our exports, a positive change in EU’s political attitudes with regard to the legacy bank debt, and the return of domestic economic growth, the debt levels which Ireland now faces can become sustainable, in that a default on either private or public debts is not probable. However, we cannot consider these developments as guaranteed, and in their absence, restructuring of debts may become inevitable.

In short, both the IMF report this week and the wide range of contributors to What if Ireland Defaults? are in a broad agreement: Ireland should be putting forward systemic policy measures to restructure household (and by a corollary, banking) sector debts. Absent such measures, a combination of the long-term continued growth recession and debt overhang, further compounded by the risks to interest rates and debt financing costs in the medium term future will force us to face the possibility of a sovereign debt default. Avoiding the latter outcome is more than worth the effort of creating a systemic resolution to the household debt crisis.

CHART: 

Sources: Haver Analytics, National Central Banks, McKinsey Global Institute, NTMA and DÁIL QUESTION  NO 122, 14th September 2011, ref No: 23793/11

Box-out:

A recently-published Cleantech Global Innovation Index 2012 shows the potential for the development of the green-focused economies in Ireland. The study ranked 38 countries across 15 indicators that relate “to the creation and commercialisation of cleantech start-ups, …measuring each [country] relative potential to produce entrepreneurial start-up companies and commercialise technology innovations over the next 10 years.” Overall, as expected, North America and Northern Europe “emerge as the primary contributors to the development of innovative cleantech companies, though the Asia Pacific region is following closely behind.”

Ireland is ranked ninth in the world in the cleantech league tables and scored strongly on general innovation drivers (underpinned by the presence of innovation-intensive sectors dominated by MNCs and some domestic exporters) and commercialised cleantech innovation (also largely linked to MNCs and a handful of Irish indigenous companies). We fall below average on cleantech-specific innovation drivers, such as policies supporting innovation in energy and green-IT and IT-for-Green. Ireland has only average scores for supportive government policies and access to private finance, which is disappointing.

What the global rankings, and the Irish experience clearly show is that globally there is an extremely weak positive relationship between cleantech-specific innovation and commercialized cleantech innovation. In Ireland this relationship is stronger than average. This is most likely due to the more advanced MNCs and exporting base in the Irish economy in general, whereby domestic innovation activities, including those booked by the MNCs into Ireland for tax purposes, is aligned with commercialization via exports.

31/10/2011: Bailout-3: The Gremlins Rising premiers

What a day this Monday was, folks. What a day. Just 4 days ago I predicted that the latest 'Bailout-3: The Gremlins Rising' package by the EU won't last past January-February 2012. And the markets once again cabooshed my perfectly laid out arguments squashing my prediction.

As of today we had:

• Italian bonds auctioned last week at 6.06% yield for 10 year paper, the most since 1999. The yield was up from 5.86% at the auction a month ago which marked the previous record high. For Italy, given its growth potential and debt overhang, yields North of 5.25-5.3% would be a long-term disaster. Yields close to 6.1% are a disaster! But things were worse than that last Friday: the Italian Treasury failed to fullfil its borrowing target of €8.5bn to be sold. Instead, the IT sold only €7.9bn worth of new paper. Boom - one big PIIGSy gets it in the 'off-limits' region!
• Also on Friday, Fitch issued a note saying that 'voluntary' haircuts of 50% on Greek debt will constitute... eh... a default / credit event (see report here). Which kinda puts a boot into the softer side of the 'Bailout-3' deal. Boom - Greece gets it in the gut!
• Today, Belgians went to the bond markets and got rude awakening: Belgium placed €2.155bn worth of bonds along 3 maturities: 2014, 2017 and 2021. The country wanted to raise €1.7-2.7bn (with upper side being more desirable), so there was a shortfall on allocation. 10 year bond yields for September 2021 maturity are at 4.372% against 3.751% for those issued in September 2011. Belgium is yet to raise full €39bn planned for 2011 as it has so far covered €37.517bn in issuances to-date. it will be a tough slog for the country with revised deficit of 5.3% of GDP in 2012 (assuming no new austerity measures) and debt/GDP ratio of 94.3% expected in 2012. Boom - a non-PIGSy gets a kick too.
• Also today, Germany marched to the markets with €1.933 billion in new 12-month bubills at a weighted average yield of 0.346% and the highest accepted yield of 0.354%. On September 26th, Germany sold same paper at an average yield of 0.2418%. Today, Germans failed to allocate €67mln of bills despite an increase of 40% in yields in just 5 weeks. Big Boom - the largest Euro area economy gets smacked!
• And for the last one - per reports (HT to @zerohedge : see post here): Europe, hoped to issue €5 billion in 15 year EFSF bonds. Lacking orders, it cut issuance volume by 40% to €3bn and the maturity by 33% to 10 years. As @zerohedge put it: "But so we have this straight, Europe plans to fund a total of €1 trillion in EFSF passthrough securities.... yet it can't raise €5 billion?" Massive Boom, folks - mushroom cloud-like.

So here we have it, a nice start for the first week post-'Bailout-3: The Gremlins Rising'...

26/09/2011: Greek crisis and exit strategy

At last - an excellent summary of the Greek crisis possible outcomes and exit strategies, courtesy of BBC (link here).

The bottom line is that no matter what Greece and Troika do or fail to do, the crisis will either move onto a full-blow economic implosion of Greece or global meltdown. This puts Greek dilemma, from euro area's perspective, squarely into the category of the choices faced by a patient with gangrened leg: to cut or to die. In other words, unless someone can find a node to hang a decent outcome on in the above - and I can't find one - the optimal policy mix from the point of view of both Greece and the euro area would be:

• Swap tranche release in October for commitment from Greece to exit the euro area under oversight from the IMF (staged exit with monetary support provided by the IMF and ECB). Future tranches should be tied to Greek Government progress on the bullet points below.
  
• Greece should default on sovereign and banks debts (60-70% writedown on sovereign and 50% writedown on banks), in part financed out of the current bailout package, in part netted through ECB (with ECB providing support for non-Greek banks and financial institutions writing down Greek assets on their balance sheets).
  
• Post-default, Greece should remain within the EU but outside the euro to avail of the benefits of free trade, labour and capital mobility.
  
• EU assistance to support growth via infrastructure investment should be extended to Greece in 2012-2017, in part to provide stronger foundations for growth and in part to provide an incentive to see through structural reforms in public sector and overall economy.

In effect, Greece will be incentivised via emergency supports and future investment assistance to exit the euro area voluntarily. There are no guarantees that post such exit Greek new currency and indeed its economy can gain a footing in the markets. However, retaining Greece within the euro zone does not appear to be a feasible option at this stage.


Note: The argument that Greece should default and exit euro is hardly a novel one. Nouriel Roubini recently made a very strong case for this here. Roubini also, in my view correctly, recognizes that transition from euro to domestic currency will require some financial supports from the EU.