Economics 24/06/2009: SMEs feeling the heat

Yesterday's business conditions survey from ISME paints a picture of dire operating conditions for Irish SMEs.

Q2 2009 survey results "confirm that smaller companies are still in the throes of economic despair with employment levels, investment and sales remaining extremely negative. Despite this harsh environment business optimism has improved for the second quarter running, albeit from historically low levels." The survey was based on 600 companies responses shows both that there is no 'green shoots' improvement and that expectations for 12 months ahead are not offering much hope of an upturn "with companies further readjusting downwards their employment and investment levels."

Business confidence "has improved since the previous quarter with a net 56% of companies less optimistic in comparison to a net 71% in the previous quarter. The most negative sector is Construction with a net 73% less optimistic, followed by Retail at 71%, Distribution (70%), Manufacturing (51%) and Services at 48%." In contrast, "74% of companies, up from 69% in the previous quarter, viewed the current business environment as being either ‘poor’ or ‘very poor’." Only 23% expect business conditions to improve over the next 12 months, up from 16% in Q1 2009. 66% of companies said viability of their businesses was under threat over the next 12 months, if present conditions remain.

Employment conditions continue to deteriorate dramatically:
"Nearly two thirds (62%), (56% in the previous quarter), of companies employing less than this time last year and only 6% employing more. These figures are the worst ever recorded and confirm that there has been no slowing down in job losses in the sector, with evidence suggesting that this trend is to continue over the next number of months. The Construction sector was worst affected with 83% of companies letting people go in comparison to 72% of Distributors, 61% of Retailers and Manufacturers, and 43% of Service firms."

Furthermore, "employment prospects remain bleak with 43% of companies anticipating letting people go over the next 12 months, with only 7% planning to increase employment numbers. Distribution companies are the most pessimistic with a net 52% expecting to let people go, in comparison to 40% in the Construction sector, 35% Retailers, 32% Manufacturers and 28% of service businesses."

Clearly distribution services are feeling the squeeze of higher excise duties, VAT and other consumption damaging taxes and retail sector collapse. Construction sector, despite having bled jobs at the fastest rate of all segments of Irish economy in the past still remains one of the focal points of jobs destruction. Ditto retailers. The spread between these sectors and services is narrow enough signifying that we are indeed heading for the second wave of layoffs in the higher wage sectors.

"Sales continue to fall off a cliff with a net 77% of companies reporting lower sales in comparison to a net 72% in the previous survey. To put this in context there has been an eight fold increase in the number of companies reporting reduced sales in comparison to the same period last year. Only 23% of companies expect to increase sales over the next 12 months. Not surprisingly profit levels are badly affected with a massive 73% of companies anticipating a reduction in net profits, while 61% expect revenues to decline over the next 12 months, down from 69% in the previous quarter."

A massive 81% of companies said their sales/order books are down in comparison to last year. But only 33% of companies reported that their stock levels are down for the year, in comparison to 24% in the previous quarter, suggesting that overcapacity is still plaguing this economy and putting more pressure ahead on employment levels.

Credit crunch is also getting worse: "26% of companies have orders, production capacity and markets unserviced for want of working capital."

And new orders are being pressured by existent orders cancellations (implying even more pressure on employment in the short term) as "54% of companies have encountered cancellation of orders in the last quarter." Interestingly (the level of detail supplied in the survey is remarkable), cancellations were from,

• Locally Based Multinationals 16%.
• Export Destinations 7%
• Local Indigenous Firms 77%
  

This means only one thing - domestic economy is still in a free fall and exporters are the last line of defense we have left. It is Stalingrad time for Brians & Mary and they are still in denial that the winter has arrived.

SMEs continue to reduce "investment in their businesses with 32% having done so in comparison to 30% in the previous quarter. 19% indicated they increased investment, down from 25% in the previous 3 months. Only 16% of companies anticipate an increase in investment over the next 12 months."

This puts to an end any arguments the Government might have had about aiding the investment cycle through 'knowledge' economy programmes and tax changes they 'introduced' in December 2008. It ain't working, folks.

Although our Government economists are keen on talking about deflation, "firms continue to experience inflationary pressures, with increases of 5% plus being reported for transport, energy, raw materials, Insurance and waste. However, there is evidence of reductions in wage costs and rents." So in the nutshell - the Government and its cronies in the unionised, state-controlled and priced sectors are still ripping-off consumers and producers, while ordinary workers are taking a pay hit.

Finally, "47% of companies apportion blame to the Government for the current economic crisis, with a significant number of SMEs concerned at the lack of direction being provided."

I don't have much to add to this one.

NAMA Costs: in full detail

Here is a full run of several assumptions scenarios for NAMA costings as based on joint work by Brian Lucey and myself. Note the changes in various assumptions. And note what is required for a break even scenario. It is beyond any doubt in my mind that NAMA cannot be made to work so as not to yield a substantial loss to the taxpayers. Any claims to the contrary are, in my view, a patent lie or an egregious error of judgement.

Economics 23/06/2009: CB of Ireland

One question: where is the 2008 central bank financial stability report? Hat tip to BL who spotted the minor inconvenience: its half past 2009 and the latest FS report CBofI website is for 2007... They must be trying to work out the title for it.



And while on Financial news, AIB announced yesterday that its trick-o-treat debt swap Tier 1&2 for Tier 2 'raised' €1bn in new capital. In a statement the bank said it was exchanging tier 1 and tier 2 securities for the equivalent of circa €1.3bn of new lower tier 2 capital qualifying securities. The face value of the securities received in the exchange is approximately €2.4bn. "The securities will be exchanged for between 50pc and 67pc of their face value in line with the previously announced exchange prices," the bank said. Commenting on the exchange, Goodbody Stockbrokers said AIB will need €935m more to bring its equity tier 1 to 4% by 2011.

Ok, folks, and Citi did generate the profits they booked last quarter... sure. In reality, this is rather pathetic. 4% T1 ratio is hardly a gold standard to begin with, but AIB's creative accounting is turning even this into mockery. If T1 is a true hedge against default or a bank run, what on earth will the bank do with the newly minted T2 securities? Default and hope no one will notice?



Now on to the real economy: last week Irish Small & Medium Enterprises Association (ISME) reported that according to its regular Credit Watch survey, average payment period for SMEs in Ireland is now the longest on record at 73 days, 23% are paid within 30 days, 45% are paid in 90 days or more and 15% are paid in over 120 days (up from 10% in March survey).
ISME CEO Mark Fielding: "The recent announcement that Government had approved formal arrangements to reduce the payment period by Government Departments to their business suppliers from 30 days to 15 days is purely a sop from the Tanaiste and does little to assist. Despite an increase in SME credit management training and practice, half of small businesses (50%) are waiting longer for payment, with the average payment period being 73 days; among the highest in Europe... The situation is continuously deteriorating as the delays have increased from 60 days in Autumn 2007 to the current excessive 73 days, and bans are, in the main, refusing to extend credit limits to assist cash-flow."

Surely, this is not doing much good to our already extreme rates of business insolvencies, but the real matter here is with the banks. In recent weeks, I have heard a number of acquaintances who run their own businesses telling me the stories of horror when BofI and AIB forced rent and loan terms reviews onto functioning and paying businesses in apparent attempts to 'extort' income up front ahead of schedule. The same banks have rolled over, day after day, for their developer-borrowers. It looks to me like may be some of the credit flows have gone from the functional enterprises to zombie development projects. What's next? Mortgages holders squeeze?

Economics 22/06/2009: All Quiet In Offaly Bogs & Apple

Hat tip to PMD: I was wrong. Irish economy is now on track to full recovery: read the details here.

In a nutshell, "workers at... bogs in Offaly, Westmeath and Longford" are back to "...harvesting process for peat delivered to power stations in Edenderry, Shannonbridge and Lanesborough."

The company - flagship of Ireland's knowledge economy is one of the largest peat producers in the world, with annual production second only to North Korea's 'Socialism = Electrification of Party Palaces' State-owned peat-fired rocket building enterprise. Bord na Mona's latest Annual Report (2007/2008) is available in English, Irish and Corporate-Social-Responsibilish on its website, showing

• Turnover of €371mln in 2007/2008 up 24.1% on 2006/2007 year;
• Profit after tax of €16.8mln - down 32.5% on 2006/2007
  
• Payroll costs €101mln (gross of employers’ pension costs) against €95mln in 2006/2007
• Average employment numbers 2,035 in 2007/2008 against 1,751 in 2006/2007.

So 'workers at bogs' were earning a tidy sum of €49,471 per annum on average in 2007/2008 - down from a whooping €54,037 per annum average for 2006/2007, making Bord na Mona one hell of a place to work for high wages and marking the company as one of the prime high-value added employers in Offaly.

A picture is worth a 1,000 words:So we have: more workers, less peat produced... lower profits...

Now, the company's latest Annual Report is loftily titled A New Contract with Nature. Of course, the State (aka taxpayers) is its shareholder and owner. Keeping in focus on contracts with nature (old and new ones), and keeping its unionised workers off the strikes lines, of course, does not distract Bord na Mona from delivering value to us, the taxpayers:
Hmmm... As I said above - all's good in Offaly bogs.


In the mean time, MarketWatch reports that Apple Inc. has sold "more than 1 million iPhone 3GS models through Sunday, just three days after the phone's launch". 6 million customers have downloaded the new iPhone 3.0 software in the first five days.

Spot the difference between RTE and the WSJ?

The next DofF Sales Brochure on Ireland Inc should, thus, contain a Yankees-only slide titled: "You have the iPhone, we have Bord na Mona's. Jealous?"

Economics 22/06/2009: Cutting public waste

Weekend papers had some rumors concerning the An Bord Snip Nua's forthcoming report with figures in the range of €4bn being quoted as the overall level of 'savage cuts' to be recommended. I have no specific information as to the exact figure that the body will recommend at this time, but I have expressed serious concerns previously that the An Board's cuts will be short of what is needed to restore balance to public spending.

Current official DfoF estimates put the need for 2010-2011 'cuts' in expenditure at €3bn in current expenditure and €1.75bn in capital expenditure. This, alongside with €2.5bn and €2.1bn in new tax revenue, is expected (by DofF) to deliver the Supplementary (April) Budget 2009 deficit targets. Clearly, these targets alone fully subsume the An Bord Snip's rumored levels of cuts. But wait, DofF's Fremowrk Programme published in April 2009 shows (Table 7) additional cost 'adjustments' of €4bn in 2012 and €3bn in 2013. Thus, the total for 2010-2013 in cost adjustments envisioned by DofF is €11.75bn.

In other words, should An Bord Snip deliver on €4bn in cuts, it will be €7.75bn behind the DofF targets for current spending cuts. If the DofF were to be serious in delivering on its own deficit targets, this means that additional tax measures between 2009 and 2013 will have to add up to the above number, or roughly, €1,800 per person in Ireland. Mad?

Now, let us do the magic for our An Bord Snip folks and look at the levels (not sources of cuts needed). Per Revised Estimates for Public Services 2009, we have:
Following these cuts for 2010, I will freeze spending at 2010 level for 2011 and 2012, generating the following 2010-2013 balance sheet:
Yes, cuts proposed above are savage indeed, but the benefit is that we will be running 7% deficit in 2010, 4% deficit in 2011 and 3% deficit in 2012, while generating €4.1bn, €3.6bn and €3.4bn in stimulus money at the same time. Translated into per-capita terms, we will have €2,636 per every man, woman and child in this country for tax cut between 2010 and 2012.

I guess, An Bord Snip can't be expected to worry about such minor numbers...


And while on the topic of Sunday papers: the report in the Sindo stated that the cornerstone of Brian Lenihan / Alan Ahearne's economic growth forecasts for 2011-2012 is their expectation that 150,000 people will leave Ireland in search of work elsewhere. If the Government and its adviser do indeed have such a 'policy' response in mind, I can chracterise it as:

1. Morally depraved and a sign of their abandoning any democratic and ethical responsibility. If Ireland is a mature democracy, Brian Cowen, as a Prime Minister of this country should immediately ask for both Lenihan's and Ahearne's explanation of the Sindo claim and, if it is confirmed, both should be forced to resign their posts.
2. Economically illiterate. Selection bias will ensure that the 150,000 who will leave will be above average in skills and superior in aptitude. With their departure, Ireland will lose a large number of young, more productive workers who also hold the greatest promise for this economy in the future. Equally damaging will be the fact that once the better skilled and younger workers leave this country, their success abroad will ensure that they will not be easily enticed to return to the Cowen-Lenihan-Coughlan & Ahearne Paradise in the future.

One part of the report in the Sindo - the part that cites senior DofF officials stating that Lenihan's strategy for dealing with this crisis is to tax his way out of fiscal insolvency - is true. I can confirm that my own 'birdie' from the Upper Merrion Street has chirped last Friday that senior Department officials 'are very concerned' that Brian Lenihan and Co are 'only interested in grabbing more tax revenue... with no regard for the effects their new taxes will have in the future' post-crisis. In particular, several tax areas currently under pressure have been mentioned as being the targets of such 'revenue grab': income tax, carbon tax, property tax, and employee PAYE.

Economics 22/06/2009: Unemployment & Social Welfare

For those of you who missed my Sunday Times article, here is an unedited version, along with more detailed explanation of my calculations on effective earnings for welfare recipients as compared against those for people engaged in lower-skills work across Irish sectors.


In 1987, after years of gradual decay, Ireland’s economy was scarred by 17% unemployment, of which 10.5% was long-term – of duration over 1 year. What got Ireland out of this quagmire was a combination of drastic currency adjustments, contractionary fiscal policies and a doze of realism when it came to real wages and welfare benefits.

In contrast, so far in the current crisis, 18 months into exponentially rising dole queues, our Government has reduced itself to repeating a handful of old and obsolete clichés.

The first one is to evoke an assumption that our demographic dividend – the term used to describe our younger than EU average labour force – is going to carry us out of the current mess to new heights of growth in years ahead. The second one is to claim that because the onset of unemployment was a sudden one, it is, therefore, temporary in nature. ‘All’s going to be fine, folks, once America starts growing’, says our Government. Will it?

Take the ‘demographic dividend’ argument. It is true that we have a strong younger labour force. However, it is dangerous to assume that these workers are always going to remain in Ireland. In demographics, like in everything else, there is no such thing as a free lunch.

In particular, young worker’s propensity to stay in this country is a function of several variables all of which are under threat from our current policies. Young and highly skilled workers require an environment in which their careers are less constrained by the incumbents. Given that Irish regulations favour the length of tenure over actual and potential productivity as criteria for promotion, layoffs and hiring, this is an area of serious concern. While October 2008 – April 2009 rate of increase in unemployment amongst all Irish workers was 64.5%, for 25-34 year-olds it was 77.5%. To keep young workers in this country, we need to give up some of the tenure-based job security that our trade unions enshrined in labour laws.

Likewise, given a choice between living in countries with much lower income inequalities and in those where pay is linked to individual and sectoral productivity differentials – vast majority of our younger and more able workers prefer to build their careers in the New York, London or Sydney, not in Stockholm or Helsinki.

A corollary of this is that high minimum wage and social welfare rates, and rigid labour markets regulations act as a relative disincentive for highly skilled young workers to remain in Ireland. Higher minimum wage and social welfare benefits depress the premium to skills and aptitude that is collected by the young workers more than for older workers. Younger workers in Ireland already face lower tenure-linked wages, bringing their real consumption and wealth closer to those employed in low-skilled jobs and those who are not engaged in the labour force at all.

Table illustrates by taking an example of single parent in average and lower skills employment in Irish economy and comparing her against a person on social welfare. The current social welfare payments and benefits exceed lower grade workers’ earnings in all broad sectors of our economy, with the gap ranging between €1,423 per annum for production workers in industry overall to €2,006 per annum for lower grade workers in manufacturing.

See below for charts and explanations

There is an added external threat to our younger labour force. As an open economy, with wage premia for younger workers rise in increasingly geriatric Germany, Italy, Belgium and other advanced economies, Ireland will face a simple choice – let our demographic dividend slip to other locations or create a more rewarding and meritocratic home market.

On the net, it is hard to make a case that our demographic advantage over older EU15 economies will automatically yield significant economic or social dividend in the near future.


The second major issue with our labour market policies relates to the recent increases in unemployment. Irish commentators and policy makers often take a simplistic view that the current bout of unemployment was unpredictable, concentrated in the construction sector and is a temporary feature of our economic landscape. Once growth returns, the thinking goes, some 250,000-300,000 of the 402,100 currently in receipt of unemployment assistance will go back to work. Happy times are just around the corner, as our Taoiseach as been suggesting as of late.

This is not what the actual data tell us. While the early rise in unemployment was indeed attributable to the construction sector, since October 2008 a rising share of layoffs were coming from white-collar traded and domestic sectors: finance, legal, marketing, advertising and so on. And it is primarily the younger workers who are getting laid off first.

Just as with the ‘demographic dividend’ discussed above, the unemployment figures are influenced by our labour markets policies. According to the latest comparative data, Irish minim wages are the highest in the OECD when measured as a percentage of an average gross wage. Ditto when measured as a percentage of the average after-tax wage. Short of Luxembourg, we have the highest percentage of employees who earn minimum wage.

High minimum wages are generally an impediment to low skills and youth employment. Crucially, high minimum wages are a barrier to jobs creation in professions that require significant on-the-job training and long periods of skills acquisition. Their adverse impact on employment is further exacerbated by the combination of high labour taxes and low capital taxes. The latter effect is simply due to the less understood fact that lower skilled labour is an easier substitute for machinery than skilled workers. Given tax incentives for acquisition of physical capital and simultaneously staggeringly high costs of employing low skilled workers, any employer has strong incentives to reduce lower-skills workforce over time.

This, in turn, means that around 60% of the total new Live Register signatories since November 2007 (the month when the unemployment crisis really started to unfold) are candidates for becoming perpetually unemployed. In a year to April 2009, the number of those on the Live Register for 1 year or more has risen from 49,555 to 70,828 – an increase that can be broken down into a 13.3% rise in April-October 2008 and 26.2% rise in the subsequent 6 months to April 2009. Long-term unemployment is now accelerating, suggesting that by April 2010, long-term unemployment and withdrawals from labour force will affect some 250,000 Irish workers, brining our overall rate of long-term unemployment to over 11% or above that experienced in the dark hour of 1987.

At this point in time, we must face the reality of the labour markets. No amount of spending on FAS or any other up-skilling programmes will make a dent in the gruesome unemployment numbers. Only significant reforms of our labour markets and a reduction in the total cost of employment of younger and less skilled workers will create an environment in which new positions leading to significant on-the-job training can be added to this economy. Chief among these should be lowering our minimum wages, cutting excessively high welfare supports and using the savings generated to reduce employment-distorting taxes on businesses and workers.

Calculations for the Social Welfare Wage Gap:
First, let us start with assumptions on benefits.
Converting the above into the rates of earning, hourly equivalent):

Comparing the above welfare hourly earnings against the latest CSO data on hourly earnings ex-bonuses etc:
Note that above we have welfare hourly equivalent rate of €18.18 per hour exceeding all hourly earnings in lower skilled production workers and manual labour categories for all sub-sectors, except our semi-states dominated Electricity sector. In other words, on per-hourly basis, if you are a lower-skilled worker in the sectors marked with red in the above table, you are better off on welfare than on the job. And this before we adjust for taxes, which we do here:
Just as above, once we factor in the work efforts across different sectors, and net out taxes, we have social welfare recipients coming out better off than lower-skilled employees in all but one broadly defined sectors. Three sectors (marked in blue) are also under threat of being only marginally better off for an average worker (not a low-skilled one, but an average one!).

Lastly, consider recognizing the fact that welfare recipients have virtually unlimited 'vacation' time, while people with jobs have to sweat for their severely restricted R&R allowances. Table below takes this into account by adding the value of 1 month vacation time to the social welfare recipient's benefits...
Bright red now marks new categories of employees who fall below the effective after-tax earnings and benefits of our average welfare recipient.

Lastly, it is worth noting that a person on minimum wage is currently twice worse off working than sitting on a permanent dole.

Economics 19/06/2009: IMF on NAMA and Construction Data

Per Reuters report (here), IMF is about to publish long over-due Consultation Paper on Ireland.

IMF, allegedly, will recommend Ireland "retain the option of including additional types of loans, such as residential mortgages, in its "bad bank" scheme for housing bad debts".

This if proven correct will open NAMA to an additional downside of some €30-40bn in stressed residential property loans, which cannot be foreclosed or enforced for political reason. A costliest form of rescuing the ordinary homeowners, as compared with directly repairing their balancesheets via cash/assets injection. It will completely politicize NAMA. Hence, I will be revising my NAMA cost estimates upward in days to come.

The Indo reports that the IMF had calculated that Ireland's "structural deficit", which excludes the impact of economic fluctuations on revenues and spending, could be as much as 10 percent of Gross Domestic Product (GDP), or 18 billion euros ($25 billion). Brilliant. If proven right, IMF will be bang-on with my estimates from December 2008 and full 1.8 percentage points ahead of DofF numbers.

"It (the IMF) will endorse the widespread view that most of the correction must now come on the spending side, rather than through more tax rises," the Irish Independent wrote. Now, recall that Brian Lenihan and his adviser, Alan Ahearne, told us that no serious analyst was sugegsting, at the time of the Mini-Budget of April 2009 that the Government should focus more heavily on spending cuts, and thus, per Lenihan, huge tax increases in April budget were justified. Of course, many analysts, ncluding myself, replied that this was a lie back at the time. Now, IMF is falling behind our view.

Now, two things worth mentioning before the report is out.

First, a birdie told me that the IMF was 'convinced' by the Government to delay publication of its report until after the local elections.

Second, another birdie told me that the report was less watered down than usual, because the usual 'consultative' process where by the Governments get to vet some of the IMF's recommendations and analysis in rounds of bargaining broke early in April/May.

I am looking forward to this report...

CSO data on Production in Construction and Building sector:
When a picture is worth a 1,000 words...
No signs of 'bottoming out' or 'Green Shoots' above Q1-Q2 2009 are dire and getting worse for the private building sectors. But what about the so-much touted 'Fiscal Stimulus' on our Brian-Brian-Mary 'Public Investment' side?
None! all is dead on Civil Engineering growth side, courtesy of a lie that is our public investment stimulus.
And things are getting much worse with time across the entire Residential and Non-Residential Building sectors.
But do spot an odd one out...

Economics 16/05/2009: NAMA delayed

Retail sales... Per CSO today: "The volume of retail sales (i.e. excluding price effects) decreased by 17.0% in April 2009 compared to April 2008. There was a monthly increase of 2.3%. The large year on year retail sales decrease in April 2009 is primarily due to the large decrease in the motor trades sector. In April 2009 motor trades decreased 50.1% on the same period last year. If Motor Trades are excluded the volume of retail sales decreased by 7.1% in April 2009 compared to April 2008 and the monthly change was +0.5%. The value of retail sales decreased by 20.5% in April 2009 compared to April 2008 and increased by 2.0% in the month. However, if Motor Trades are excluded, the annual decrease was 11.2% and the monthly change was-1.2%Published by the Central Statistics Office, Ireland."

Of course, if you are a retailer in Ireland, it is the value that you care about. The rise in core (ex-Motor) sales in April (+0.5%) was the first m-o-m increase since September 2008. But in terms of value, m-o-m rates were:Is this a 'dead cat bounce' or a real sign of stabilization? My gut feeling that May-June figures might come in with a moderately positive rebound (weather and recession-fatigue effects will drive people into shops), but the real test will be September-October. Notice, however core value rates staying below the waterline - signaling continued jobs pressure in the sector into the summer months.

Also telling - a look at the actual indices of activity:
Core value index still heading South and a mixed picture in other measures... Again - wait and see...


NAMA delay - predictable stuff of governance... So Brian Cowen (June 17th, Dail comments) thinks that the vote on NAMA might happen as late as in September and other decision-makers (e.g DofF) are indicating that even that might be an optimistic deadline. And, of course, going by the Government record on decision-making - the latter are right:

• Unemployment increases onset - November 2007. Problem acknowledged - July 2008. Policy solutions proposed - still waiting;
• Fiscal deficit onset - Fall 2007. Problem acknowledged - July 2008. First steps taken to raise taxes - October 2008. First (real) steps taken to reduce public spending costs - February 2009;
• Currency crisis onset - on exports side - January 2007. First acknowledged - Summer 2008. First steps taken to address - still waiting;
  
• Competitiveness (using HCI) crisis onset - around 2002. First acknowledged - around 2004. First (real) steps taken to rectify - still waiting;
• Cost of public services crisis onset - around 2002. First acknowledged - still waiting;
• It took the Government less than 3 months to draft and implement sweeping tax cull of our incomes (July-October 2008), but it took the same Government the same 3 months (since April 23rd) to reduce redundant Ministerial/TD pensions by a miserly 25%. It will now take at least 3 years before we can see a real change in the way our politicians pay themselves.
  

In this environment, why do the markets still listen to our political leaders? They promised NAMA to be in place for July vote. After all, in the case of NAMA delays there are real risks to the equity markets:

• banks, absent NAMA clarity, are constrained in raising own capital;
• banks might be facing much higher rates of interest in raising funding in the latter months;
• political risk of the Government bailing out (partially or wholly) of NAMA has now risen as well;
• political risks are now amplified by the fact that NAMA costs are going to play-out coincident with 2010 Budget;
• development projects and investments are now placed under a new round of uncertainty;
• banks valuations are now being impacted by the post-August detailing of the NAMA exposures; and so on.
  

These and other are real costs to the stock market prices and thus to the real risk-adjusted returns to investors.

And on related issue: Davy's note today contains an interesting discussion of Minister Lenihan's statement in the Dail on banks capital. Quoting from the note: "Regarding the suggestion that there was a danger in raising capital ratios, the UK raised them to give confidence to markets in respect of the banks. We did not follow suit, keeping with the minimum capital ratios. I do not propose to change that because I agree ... that if one raises capital ratios too high we will inhibit lending. We must have a minimum and that must be adhered to'.

Davy's analysis: "This would seem to confirm our suspicion that the Irish government is not planning on setting the capital bar particularly high for the Irish banks post-NAMA. Instead it
plans to let the preference shares help offset a slightly lower level of equity tier 1 (maybe 5%+) versus UK peers. In Ireland, the minimum capital requirement is a core tier 1 of 4% whereas in the UK the new FSA requirement is 4% but after a severe stress test. The market will of course make up its own mind on this but it is inevitable that ALBK and BKIR are going to need to do rights issues at some point if they are (a) going to pay back the government preference shares, and (b) want to lend again rather than be focused on reserve building."

My analysis, in addition to agreeing with Davy's: Minister Lenihan is consciously trying to alter the issue of post-NAMA capital adequacy of the banks by not imposing strict test-linked capital bounds. The whole exercise has nothing to do with actually freeing banks funds for increased lending in the economy, as, per Davy analysis, the banks will still face constraints in paying (a). Instead, it is about reducing, artificially, the demand for government recapitalization funding post-NAMA and making it palatable for the banks to accept slightly higher discount rates for assets transferred to NAMA. Investors will have to face a choice in this case:
Option 1: banks accepting the deal and running with lower capital reserves, exposing themselves to the downstream risk of emergency recapitalization should financial conditions deteriorate further in Fall 2008-Winter 2009;
Option 2: banks raising adequate by international standards capital outside state recapitalization scheme, undermining future profitability, but compensating for the above risk.

Good luck to anyone pricing the difference in two Options...


Minimum Wages... ETUI Policy Brief Issue 2/2009 titled "European Economic and Employment Policy Minimum wages in Europe: new debates against the background of economic crisis" provides an inetresting set of comparative charts and tables on minimum wages in Europe. Here they are:
In the above, don't let Luxembourg's numbers deceive you - Lux is a country where national accounting produces vast distortions in per capita incomes and earnings that make it irrelevant for comparisons with other EU states.
In the above, PPS adjustments in Lux and Belgium are distorted by large shares of external transfers into the economy, while the UK PPS-adjusted wage is adversely impacted by the strength of Sterling in 2007. Another issue not reflected above is the tax impact on minimum wage earners.It is worth mentioning here that while the levels of minimum wages are a problem for Ireland, the rate of growth in minimum wages over 2000-2008 is relatively modest, especially once we control for purchasing power.

Economics 16/06/2009: Oil & Gas and NTMA's auction

For a longer post with my thoughts on oil and gas prices, scroll down.


NTMA's gamble... per NTMA release today:

On Tuesday 16 June, NTMA offered two bonds in the auction,

• the 3.9% Treasury Bond 2012 and
  
• the 4.6% Treasury Bond 2016.

Actual results are below:
"Total bids were received for €2.397 billion and it was decided to issue a total of €1 billion [as planned]. An amount of €500 million of the 4.6% Treasury Bond 2016 was issued where the total bids received were 2.5 times the amount allocated, while €500 million of the 3.9% Treasury Bond 2012 was also issued where the total bids received were 2.2 times the amount allocated. The 2016 bond was sold at an average yield of 4.755% while the 2012 bond was sold at an average yield of 3.056%."

If you look at the table above, NTMA always preferred issuing €300mln in shorter maturity bonds and €700mln in longer maturity bonds - a 30:70 split. This time around, it appears it had to borrow heavier in shorter maturity range, hence 50:50 split. And this is for 2016 bond as opposed to 2019 bond earlier. Ouch...

Price spreads min-max were also relatively heavy on shorter maturity. Compare the following two screen shots:
June 16th auction: spreads of 19bps on 2016 bond (2.375 pa ) and 16bps on 2012 bond (5.33 pa)
May 119th auction: spreads of 37bps on 2019 bond (3.7 pa) and 5bps on 2014 bond (1 pa).

Again, NTMA are doing excellent work here, but it is a tough job...



Natural Gas - upward?

Natural-gas prices have been lagging oil prices over the recent months despite the fact that gas drilling and production are on decline worldwide. This has been noted by some Irish analysts, most notably – Davy, whose June 15 quick daily note must be credited for spotting the trend first in the Irish market.

Per Davy note (Caren Crowley): “The ratio of the US oil price to gas price is reaching record highs. A reversion to more normal levels requires the oil price to pull back or the gas price to rally. With the oil price looking unstoppable, it is all up to the gas price, but it is an uphill battle.” There is not much of a real in-depth analysis in the Davy note, so here are some of my thoughts on the issue.

First some short-term facts:

US gas prices have fallen 34% in 6 months to June 2009 and 72% off 2008 peak. In part, this is driven by demand declines. But, as Davy note states, supply capacity has been catching up on downward trajectory: “the number of rigs exploring for, and producing, gas has fallen 56% since September 2008 when it peaked at 1,606, and is at its lowest level since 2002.” This is yet to translate into actual supply cuts as “US gas inventories are abnormally high and are 22% above their five-year average.”

In early April, US natural gas inventories stood at 1,650bn cubic feet in the week ended and steady, equivalent to 300 bn cf above 5 year average and 400bn above year before. Chart 1 below (courtesy of Energy Information Administration) shows that this abnormal situation has gone worse since then with gas inventories breaching the 5-year min-max range for the first time since May 2007.
Now, 25%-30% of US gas production comes from relatively young wells (drilled in the last 12 months). A significant cull of drilling rigs operating today will, therefore, translate into higher demand for imports in winter 2009-2010. The number of running (producing) rigs was down to 1,039 in the week of April 1, 2009, according to Baker Hughes (BHI) - down 49% from the 2,031 level seen in mid-September 2008 -- the highest since 1980.

Chart 2 shows the same over the longer period, with clear signs of seasonality and a rising trend in inventories over time.
One noticeable feature here is that volatility below the trend has been declining throughout the April 2003-April 2006. Afterward, the maximal depletions of gas reserves have steadily increased through April 2008, before once again starting to decline in late 2008 through April 2009. The rate of the later decline has been so far consistent with the rate of decline in 2003-2006 period. This is exactly identical to the 4 years falling, 3 years rising and 1 year falling cycle in 1996-2002.

Another feature is the lack of similar cyclicality at the maximum surplus inventories level, in other words – in peaks above the trend (dashed line). In fact, the trend here is identical (in slope) to the average trend line. Furthermore, when it comes to surplus inventories deviations, current historically high levels (for November 2008) are actually below the maximal inventories trend.

The two facts together suggest that high inventories are not being driven by excessively high supply of gas (which would be consistent with abnormally low minimal inventories in around April trough and abnormally high maximal inventories in and around late Autumn).

Yet another interesting feature of the data is captured in Chart 3, which clearly shows that in recent months, weekly growth rate in inventories has not fallen substantially for positive growth rates, while the rate of natural gas inventories depletion (the negative range) has declined.


Given that this already accounts for seasonality and the weather effects have not been dramatically out of line, what’s going on? The answer is: twin effects of demand changes and equity markets trends are driving prices of oil, while only demand changes have been instrumental in determining the price of natural gas to date. And this is about to change...

On the demand side, power gen accounts for 58% of all US gas demand and this has been falling – 6-8% down so far in 2009. It is also important to note that gas-based electricity generation in the US is concentrated in the Western Pacific states and Northern Atlantic Board states – all of which have seen serious economic pressures on demand side.

But these fundamentals do not really explain the historic trend in gas prices. Futures prices for natural gas have now hit their lowest levels since 2002. Recent pricing below $4 per million British-thermal-unit on the NYMEX, down from $9 mbtu in Q1 2008.

Again, supply-demand analysis does not explain this. Fundamentals analysis focuses on abnormally cold weather in early 2008, which pushed spot prices up and resulted in higher levels of exploration activity. Production capacity increased, but demand collapsed. Fine theory, except, recall prices are down more than 50%, although US Energy Department expects natural-gas consumption to decline by only 1.3% in 2009.

And US gas prices are linked to global gas prices – which are facing significant pressure on the Russian supply side. How? In two ways:

Short-term pressure is rising due to delays in pumping annual storage reserves in Ukraine – a technical issue that can derail gas supplies to Europe. Basically, the principle here is a simple one. To run gas pipe between Russia and Western Europe (the pipe transiting Ukraine), Soviets built a pressure maintenance system that requires intermediate storage facilities (positioned on Ukraine’s territory out of the Soviets’ consideration for ‘balanced regional development’ and owned by Ukraine) to be filled to capacity. This ensures that if Ukraine’s own gas purchases start depleting the pipe flow, the flow can be topped up with reserves of gas. Ukraine is broke and has no cash to pay for this gas – which it will own once it is pumped into storage. Russians are telling Ukrainians that they can’t give them a $2bn loan for gas and are offering to split the loan between Russia and the EU. EU is refusing. So we have stalemate. Now things are getting even more complicated because Ukraine also owes Russians further $3bn worth of cash for gas supplied to the Ukrainian consumers. In short – if gas is not pumped into storage tanks within the next 2 months, there will be serious risk of disruption of gas supplies to Europe in fall/winter 2009-2010. This in turn will lead to price increases for gas globally.

Long-term pressure is also rising due to Russian gas production now shifting to the Eastern Siberian plains. Completion of the new pipeline to service China and Japan is a sign of this. The problem here is that unlike Western Siberian plains, Eastern Siberian plains have smaller gas fields, fewer developed fields and geology that is much more challenging (shale, smaller reservoirs, more complex folds and more broken folds) that the near-perfect sands of Western Siberia. Again, this signals an upside to gas prices in the longer term (I will write about this in few days in more details).

So in the nutshell, future supply constraints are daunting. And these should be working in both short term and long term in the future... Again, supply is not the main driver for the abnormal situation of falling gas prices and rising inventories.


So what is? One word answer is ‘oil and gas price correlations with equity markets’. In my view, it is a speculative buying of oil as a hedge against inflation and the ‘blue chip’ low risk commodity that is driving a wedge between oil prices and gas prices and simultaneously driving closer oil prices and equity prices.

A series of charts below illustrate this point.



Chart above shows relatively coincident long-run trends in DJIA and Oil prices that are not replicated in gas prices. This is confirmed in the scatter plot below. Here, strong correlations in oil and gas prices against DJIA occur over significantly different slope relations. If 100 points increase in DJIA index leads to a $1.4 increase in the price of oil, the same change in DJIA index is associated with a $0.16 rise in the price of gas. While at parity this appears to be a movement in favour of oil, given current conditions in the market (the extremely high negative correlation between price of oil and price of gas and extremely low price of natural gas) any changes in the stock markets valuations should, based on fundamentals, drive prices of gas closer to the price of oil. Expressed in current price percentage terms, table 1 below the chart shows these historically-justified price responses.

Chart below illustrates what I mean by extreme correlations
Notice that current correlation is:
(a) within the range of -0.75-1;
(b) the change in correlation between peak of June 2008 (+99.3) to today (-88.1) is the highest on record for downward adjustment.
Chart above shows the replay of the oil and gas prices correlation in line with the broad equity markets. Here, while correlation between DJIA and oil prices stands at +0.78 and remains in the positive territory since September 2008, the correlation between DJIA and gas prices is at -0.57 and has moved into negative territory in May 2009.

This is interesting, because the structure of gas prices to date contrasts the findings of the recent research on links between oil and gas prices. Jose A. Villar (Energy Information Administration) and Frederick L. Joutz (Department of Economics, The George Washington University) paper The Relationship Between Crude Oil and Natural Gas Prices, prepared for Energy Information Administration, Office of Oil and Gas in October 2006, shows that there exist “a cointegrating relationship relating [natural gas] prices [and] the WTI and trend capturing the relative demand and supply effects over the 1989-through-2005 period. The dynamics of the relationship suggest a 1-month temporary shock to the WTI of 20 percent has a 5-percent contemporaneous impact on natural gas prices, but is dissipated to 2 percent in 2 months. A permanent shock of 20 percent in the WTI leads to a 16 percent increase in the [gas] price 1 year out all else equal.”

So the lags structure implies that a temporary shock to oil price should be followed by a delayed shock to gas prices 12 months after and that the magnitude of changes in gas prices is roughly 80% of the magnitude of shock to oil price.

Clearly, as table above and charts illustrate, this relationship is currently being reversed, suggesting two emerging short- and medium-term trends:

1. fundamentals (firming demand/falling supply) trends indicating significant room for gas prices increases in the range closely linked, but shallower (at 70-80%) than those in oil prices. This implies trend price for gas of ca $8-8.25 per thousand cubic feet of gas;
2. short-run dynamics trends, indicating a ca 6% upside to gas price relative to oil price in the next 3-6 months, implying a price range of $6.8-6.9 per thousand cubic feet.

Short of a W-shaped global recession risk, there is little downside pressure on gas prices in the medium term in my view.

Economics 15/06/2009: policies for growth

For those of you who missed my Sunday Times article, here it is in an unedited version (scroll below).

Here is a link to my Friday's quote in WSJ editorial.


Our Government keeps droning on about Ireland not having a toxic derivatives problem in the banks… Hmmm… unless you count the banks themselves as derivative instruments. Take a look at our loan-to-deposit ratios (LDRs):

AIB: 153% at end-June 2008; 140% in March 2009;
BOI: 174% in September 2007, 157% March 2008, September 2008: at 160.3%,
ILP: 245% in November 2008, 277.4% in September 2008.
Anglo: 124.2% in September 2008
Nationwide: 154% in April 2009 down from 170% in 2007

Now, according to a UBS survey of bank balance sheets of September 2008, Ireland's average loan-to-deposit ratio was 163.1%.

US average: 51% LDR for pre-1960, rising to 85% between 1960 and 1980; breaching 100% in 1997, then 113% in 2007 at its peak, down to 97% May 2009.

Yes, we don’t need securitized packages of MBS tranches to get ourselves thoroughly poisoned…


On to my Sunday Times article:

Over the last two weeks, just as Brian Cowen was exulting over the prospects for Ireland’s return to economic growth thanks to his visionary policies, Russian Government, also facing a major economic crisis, unveiled a new set of economic programmes aimed at getting the state back on track. The package included a tough realistic Budget for 2009-2010, some tax breaks, a commitment to fiscal conservativism, an ambitious set of policies directed at reducing public sector waste, corruption and improving management practices, measures aimed at stimulating private sector investment and demand, and significant new initiatives in R&D and business and technology innovation.

To-date, Irish government sole responses to the crisis have been to raise taxes on businesses, consumers and income earners, and to cut capital investment. All to preserve excessively high level of current public expenditure. Moscow’s response was to cut wasteful spending, lower some business and personal tax rates and rationalise new investment programmes to focus on future growth priorities.

Hence, an ordinary working person in Ireland is now facing an effective tax rate of over 22% - up from 19% a year ago. Her counterpart in Russia is facing a flat rate income tax of 13%, the same as in 2008. An average Irish self-employed person is looking at surrendering over 32% of her income in income tax, up from 29% a year ago. Russian self-employed workers enjoy a new 6% income tax, down from 13%. In terms of incentives, it is clear that Irish Government’s priority is to skin the small entrepreneurs, while the Russians are taking an approach of encouraging individual risk-taking in business.

While Ireland is facing a double-digit fiscal deficit, our current expenditure continues to rise unchecked since July 2008 Government promise to get it under control. The Government is yet to produce a single forecast that actually projects a decrease in current expenditure at any time between now and 2013. This unambiguously signals that Irish leadership envisions fiscal policies adjustments to be fully financed out of increasing tax burden on the ordinary households and businesses.

In contrast, Moscow is cutting spending outside priority areas and temporarily shifting funding from longer-term investment projects. In effect, the Russians retain ring-fenced commitments to invest significant funds in new technologies and SMEs – areas earmarked for future growth, but the Government is borrowing short-term some of the already allocated funds to finance more immediate crisis-related spending.

For example, a year ago, Russian state allocated some €2.3bn for investment in nanotechnologies to cover its programmes over the period of 2009-2015. Last week, the Government wrote Rusnano – semi-state investment company in charge of the funding – an IOU for almost €500mln of these funds, temporarily withdrawing cash without sacrificing any of its investment programmes.

This reveals a more sustainable funding model for state investment in Russia that is based on pre-funding and ring-fencing long-term investment, than the one we have in Ireland, where current revenue is used to finance public investment irrespective of the length of investment horizon.

Other measures enacted by the Russian government in combating this crisis, such as export credits supports, aid to SMEs and state financing of some enterprises (either via equity stake purchases or preferential loans) would fit well in our own policy arsenal, were we more prudent with our expenditures in the years of economic boom. In just 7 years between 2002 and 2008, Russian fiscal authorities built a war chest of funds to sustain necessary public spending and investment. Even after almost a year of financing growing primary imbalances, Russian reserves currently stand at approximately 21% of 2008 GDP. Ireland’s NPRF never exceeded 12% of Ireland’s 2008 GDP – hardly an impressive record of state ‘savings’ over 17 years of robust growth.

History aside, Russian experience shows that forward policy planning and fiscally conservative approach to current spending are the necessary ingredients in dealing with a crisis. Which brings us to the scope for long-range reforms that present a feasible alternative to the present Government plans.

First and foremost, long-term changes are required in our taxation. This much is admitted even by our policy cheerleaders in the Department of Finance and the ESRI. However, to date, there is no indication that the taxation commission is guided in its decisions by the future growth considerations, rather than by the immediate objective of raising new tax revenue.

If Ireland were to seriously pursue high value-added growth development model, our taxation policy has to be altered dramatically. The burden of financing the Exchequer spending, currently disproportionately falling on the shoulders of the above-average income earners (majority of whom represent the same knowledge economy we are trying to expand) must be shifted away from personal income to less mobile physical capital. This will incentivise investments in education, labour productivity-enhancing R&D, training and other forms of human capital, and reduce the wage-costs pressures on companies that operate in the knowledge-intensive sectors. One of the means for delivering such a change would be to levy a significant tax on land offset by reductions in the upper marginal income tax rate.

Another aspect of the tax reform that can stimulate creation of sustainable long-term economic activity in Ireland is an idea of dramatically reducing self-employment and proprietary income tax in line with the Russian experience. Self-employed individuals assume all the risk of running their own business without gaining any of the tax benefits that accrue to corporations. Lowering personal income tax on self-employment to a flat rate of, say, one half of the effective rate of tax applying to an employee earning €60,000 pa (currently standing at 32%) will go a long way in encouraging shift from unemployment into small entrepreneurship.

A different issue is now resting in the hands of yet another Government commission. Current public sector pay, financing systems, and managerial and work practices are simply out of line with the rest of our economy. Across all sectors of Ireland Inc, public sectors sport the lowest value added per unit of labour inputs. Ditto for comparing Irish public sectors productivity against other small open economies within the OECD. Yet, the cost of financing these services is accelerating even during the current downturn, just as the sector overall output is falling. This is hardly news: since the mid 1990s, the range of services and products supplied by the state has been narrowing, yet the staff levels, especially at the top of the pay scale, remuneration costs and non-pay benefits grew.

Reforms must address this exceptionally poor performance, as well as restore pay and benefits to reflect low levels of productivity and value-added delivered by the public sectors.

However, even more important for the long-term growth is to enact systematic principle of separating service provider from the payee. In effect, Irish public sectors are quasi-regulated near-monopolies in their respective industries. Modern services in a small economy cannot function efficiently if the State employees responsible for these services provision are also responsible for pricing and rationing access to the services, regulating services supply and restricting external competition. Irish public sectors price inflation shows conclusively the overall lack of efficiency in our public services provision (see chart).
The Government should elect to provide payment for public access to services, without any prejudice in the choice of service provider. Thus, for example, in health, once standards for quality and safety are adhered to, any approved and properly regulated provider should be allowed to supply medical services to patients. The Exchequer should ensure that those without sufficient income are given state funds to access necessary services. But the Government should exit the business of actually supplying medical services.

Such reforms promise delivering on several key objectives. Experience in other countries, where services provision and access were effectively separated in the 1990s shows that existent service providers do engage in cost-reducing competition, thereby drawing down the cost to the Exchequer. Second, the range and quality of services supplied are improved. Third, granted critical access to the market, new enterprises and thus new employment grow, with some supporting export of such traditionally domestic-only services abroad. Fourth, services consumers do welcome greater choice of service providers and better quality of services. Separation of service provider and payee is a basic concept of organizing modern public services that is yet to dawn on our allegedly highly enlightened politicians and civil servants.

After some 11 months since the current Government has first acknowledged the existence of the economic and financial crises, it is both surprising and disheartening to observe continued lack of policy responses from our leadership. Yet now is not the time to sit on our hands and wait for the US and global economy upturn to rescue Ireland Inc. Instead, it is time we start putting in place few policies that can underpin the recovery in the short run, but can provide support for future long-term growth as well. Tax reforms and public sector revamp certainly top the priorities list.

Economics 14/06/2009: Housekeeping & DofF

Per housekeeping: there is a new post on my Long Run Economics blog with a full copy of DofF's latest ludicrously used-car-salesman-like presentation on Irish economy. Check it out here.


As a companion to the presentation, DofF also released a 3-page document: Ireland: Key messages Department of Finance May 2009. Below are my comments on some of the DofF views on Irish economy.

“Domestic pressures in the Irish economy, in particular the ongoing contraction
in the construction sector and its effect on the wider economy, are compounding the deterioration in international economic conditions.”

Conveniently, DofF fails to list any other challenges, suggesting that all would be fine in Ireland Inc were it not for building sites slowdown. No banking crisis to worry about when it comes to real growth, no fiscal crisis (made largely of DofF’s disastrous past policy choices).

“Ireland has a track record of adjusting and showing its flexibility; asset prices, wage levels and price levels are all adjusting rapidly to the new circumstances improving Ireland’s competitiveness.”

Ireland has a historical record of staying in recessions for decades, not ‘adjusting’ or ‘showing its flexibility’ but getting stuck in vicious past fiscal spending quagmires. This is exactly where we find ourselves today – perpetuation of unsustainable public spending spree that we entered in 2001.

Furthermore, per DofF assertion on wages, asset prices and prices:
• Declines in wages have been concentrated in the productive economy whilst unproductive public sector-dominated activities continue to post wage increases;
• Ditto for price falls (see below);
• Asset price declines – it amazes me that DofF can call the destruction of wealth we have experienced as an ‘improvement in Ireland’s competitiveness’, but the most bizarre twist of DofF’s logic comes when one considers the fact that these assets also include property prices. If property price falls are restoring our competitiveness, the same price declines are also responsible for the collapse of the property markets, including building activity, which per DofF earlier point is the cause of our problems. So per DofF – asset price falls are both good and bad for Ireland Inc…

The latest CPI data released last Thursday clearly shows continued trend of public sector-controlled inflation. In percentage terms, state-set prices for alcohol and tobacco rose 0.4% month on month in May 2009, while health continues to post 3.5% inflation when measured in annual terms. As do communications services – up 0.8% year on year. Recreation and culture – a category also largely influenced by state pricing policies posted a 0.2% rise in prices in May. While utilities and local charges have fallen 6.5% in monthly terms, this category of services remains in a positive inflationary territory in annual terms, up 4% year on year. One category of services highlights the differences between private sector and public sector controlled inflationary pressures: housing, water, electricity, gas and other fuels. Here, 12-months change to the end of May 2009 in mortgage interest costs was -42.4% (posting a -4.2% additional loss in may itself). This was exactly the same as the rate of price decline for largely private sector-distributed liquid fuels. In contrast, Electricity and Natural gas – two largely state-monopolized sectors posted price increases of 4.7% and 6.5% year on year respectively despite the last month’s price reductions of 10.4% and 11.3%. Similarly in health: state-priced hospital services costs are up 9.1% year on year in May, more privately supplied outpatient services up 1.9%. Consumers rip-off by public sector is well alive in our age of deflation and DofF has absolutely nothing to say on this.

“Ireland has made significant strides in the development of modern 21st Century infrastructure while positioning itself for its next stage of development as a knowledge economy. While there are obvious difficulties, it is important to state that keyfactors which facilitated Ireland economic success in recent years still remain. These include:
• stable political system; part of the EU and the eurozone; access to the Internal Market,
• young, highly educated, English speaking, flexible, mobile workforce,
• export orientated, open economy,
• relatively low corporation tax rate,
• pro-enterprise focus.”
Cringing yet? Me too…

“The Government has been clear in its strategy to address the difficulties in the public finances and has already taken a number of very significant steps in this regard:
• In July 2008, expenditure adjustments were introduced to save €440 million in 2008 and up to €1billion in 2009 [of course, they can’t tell us the exact number for 2009 savings arising from July 2008 measures, because there were no measures of any sort introduced in July 2008 – just promises. As per €440mln savings for 2008 – well these ended up with an overrun, not savings];
• Last October in Budget 2009, expenditure for 2009 was strictly contained and significant tax measures were brought forward to secure close to €2 billion in additional revenue in 2009 [not really - €2bn is the figure that does not include second order effects of proposed measures, so the real value of these tax measures was less than €1bn];
• In early January, the Government set a five year framework to 2013, with ambitious targets, to restore order to the public finances over the five years; In February, in line with the framework, a series of measures were announced to secure further savings of up to €2 billion on a full year basis primarily through the introduction of a pension levy for public servants [again, this is the case of powdering over the scars – the pensions levy will not generate claimed returns due to secondary tax effects and clawbacks, implying that the net effect on the revenue is expected at around €1.4bn, before we subtract a massive cost of the early retirement scheme];
• On 7 April, the Government introduced a supplementary Budget for 2009 which sets out further taxation and spending measures for this year amounting to some €3.3billion in 2009 and over €5billion in a full year. Government also signalled that there will be additional spending adjustments of €2.25 billion in 2010 and €2.5billion in 2011 with taxation increases of €1.75 billion in 2010 and €1.5 billion in 2011 [in case you’ve missed the point – yes, they will tax us all into economic oblivion to save their pals in public sector unions. Per claimed 'savings' and 'revenue enhancements' - I already did this analysis before (here)];
• Ireland will need to borrow some €25 billion in 2009 which it is well on the road to achieving but Ireland has a relatively low debt level to begin with. [ok, to date, we have borrowed €1.532bn in short-term paper maturing after 2009 and €4.9bn in longer term paper (see here). This is less than 26% of the total borrowing requirement for 2009! ‘Well on the road’, then? And that is before NAMA borrowings are factored in.];

“A greater integration of the Central Bank responsibilities with the regulatory and supervisory functions of the Financial Regulator is being considered.
• The objective is to deliver robust standards of banking and financial regulation and corporate governance;
• This will help restore the reputation of Ireland’s regulatory regime and rebuild confidence;
• It will ensure that best EU and international practice is applied to Ireland’s regulatory system and it is appropriately aligned with new developments in international supervisory architecture.”

Actually – already close links between the DofF, CB and FR are the main source of the problem with lax regulatory enforcement and lack of risk pricing capabilities at the Regulator level. Further integration is the worst form of response to the existent structure challenges. A truly independent regulatory office for financial services separate from the consumer agency would offer much stronger potential for enhancing enforcement and preventive powers.

Economics 12/06/2009: NTMA gamble

My apologies for staying off the blog posts for some time now - travel and compressed number of commitments this week have kept me with no time for blogging. Hopefully, this brief interlude is now over.

Per NTMA release:
"Irish Government Bond Auction on Tuesday 16 June 2009
The Irish National Treasury Management Agency (NTMA) announces that it will hold an auction of Irish Government bonds on Tuesday next 16 June, closing at 10.00 a.m.
Two bonds will be offered in the auction –
3.9% Treasury Bond 2012
4.6% Treasury Bond 2016
The overall total amount of the two bonds to be auctioned will be in the range of €750 million to €1 billion."

This is clearly a gamble on the 2016 bond and another tranche of medium term borrowing for 2012 issues.

Two problems continue to plague NTMA in my view:

Problem 1: issuance of bonds maturing prior to the magic 2013 deadline is threatening to derail the fiscal adjustments promised to the EU Commission, as these bonds will have to be rolled over into new issues and, potentially, at a higher yield. This also relates to the problem faced by the buyers of these bonds, as prices are likely to be depressed further should interest rates environment change.

Problem 2: signaling via maturity suggests that we are in trouble. If the state cannot issue credible 10+ year bonds, what does this say about the markets perception of the quality of our finances?

The bet NTMA are entering with the 7-year bond is that healthy results in the latest US Treasuries auction for 30-year paper yesterday will translate into a general bond markets demand improving.

Here are the combined results for the entire H1 2009 to date in issuance of bonds... not that NTMA would bother to put these in an Excel file for all to use...

First long-term:
Telling us that longer term bonds cover is at risk of being thin again (2.7 in March, down to 1.1 in April and up to 1.8 in May). Effective yields are rising: March issue at 4.5 coupon yields 5.81%, then down to April issue at 4.5 coupon yielding 5.08%, and up to May issue at 4.40 coupon and 5.19% yield. Next one will have 4.60 coupon and at what effective yield?

Plus notice how, with exception of one bond placement, all issues have gone past 2013. This means that offering another 2012 maturity bond next week is a sign of growing concerns for NTMA.

Short-term: a sea of borrowings here:
Covers are getting healthier, spreads on yields are shrinking and maximum allocated yields are starting to notch up again. What does it mean? Short-term money is relatively abundant and so covers should not be a problem for any non-junk paper, but the markets pricing spreads are getting tighter, more compressed to the higher yield range.
One more comment - both OECD and IMF have warned the governments not to succumb to a temptation to issue short term paper as refinancing it will bear a risk of higher yields. Guess what - based on the evidence above - is our Exchequer doing? H1 2009 issues to date:

• paper maturing in or before 2013: €12,157mln
• paper maturing after 2013: €2,978mln

Nothing more to say...