Economics 5/12/10: Debt, debt, debt... for Irish taxpayers

I decided not provide any analysis of the figures below. These figures speak for themselves. To explain their purpose: I have computed the expected burden on current and future taxpayers from the total ex-banks debt carried by Ireland Inc as:

• Households debts (mortgages, car loans, personal loans, credit cards, etc);
• Government debt (inclusive of quasi-Governmental debt undertaken under the EU/ECB/IMF loans and Nama).
  
• I also incorporate total corporate sector debts, including non-financial corporations debt and debts entered into by non-banking financial corporations. However, the corporate debt DOES NOT form the part of taxpayers liabilities, although at least some of it will have to be repaid out of our (taxpayers) pockets one way or another.

All figures input into calculations were taken from CSO and Central Bank of Ireland databases. All core assumptions are outlined in the second table.

Finally, note - the total figures of debt per taxpayer are for Household Debts and Government (including Nama & ECB/EU/IMF loans) debt. Do not, please, confuse them with the official Government debt alone.

So here are two tables. Interpret them as you wish:


PS: some people accused me of double-counting:

• banks debts and mortgages/households debts. I am not - banks debts are excluded from the above considerations;
• Government bonds outstanding and rolled over. I am not - the only net increase between 2010 and 2014 in Government debt due to roller overs of existent (pre-2011) bonds is due to an increase in the interest rate taken on rolled over bonds at 1% (again, conservative, as per ECB/EU/IMF deal we will be paying 1.13% over the current average rate of interest on already issued bonds).
  

Economics 5/12/10: Reserves requirement ratio

In response to the following tweet:

"A question. You wrote here http://j.mp/eL9QWg that the decision of the Chinese government to raise reserve requirement ratio for the commercial Chinese banks in order to cut down on their lending as "monetary tightening".

According to this article by Phillippe Legrain

http://j.mp/hnSF9w

The Republic of Ireland could have taken similar measures during the past decade to cool down the property bubble but didn't.

I thought after European monetary union, a monetary option wasn't open any more to the Republic of Ireland.

Yet what you described as "monetary tightening" in China was possible in the Republic of Ireland according to Phillippe Legrain."

My view on the topic: Legrain is correct.

As a member of the Euro zone, Ireland retained full control over one of the tools of monetary policy, known as 'reserve requirement ratio' - or capital requirement ratio. Irish regulators (CBFSAI) has a full right to increase requirement on the banks operating in Ireland to hold the proportion of their deposits and/or proportion of their loans in reserves as capital to cover any expected losses.

Such an increase in the ratio would have reduced amount of credit available in the system and would have offset the dramatic increase in lending spurred on by the introduction of higher risk products such as 100% mortgages.

At a dinner event in 2006 I told, at the time, Governor of the Central Bank of Ireland that this is exactly what he needed to do to cool down the market for mortgages lending in the Republic. His reply was along the lines that this was politically impossible to do.

That this lever of policy is still available to Ireland is best illustrated by the two recent decisions by the new Financial Regulator to hike capital requirement ratios for Irish banks to 8% Tier 1 and most recently to 12%. Unfortunately, this decision came too late.

Were Irish banks required by the CBFSAI to hold, say 12% of their risk-weighted assets in form of capital, the taxpayers would have seen their total exposure to the banking crisis significantly reduced. Instead of ca €16.2 billion in capital available to cover writedowns against the total lending of €360 billion across our banking institutions, our banking system would have had ca €34-35 billion in capital cushion against lending of €280-290 billion. (Note: these are back of the envelope calculations, but they still show the impact of raising reserve requirement ratios).


PS: for those of you who missed an excellent PIMCO note on Irish situation and EU's 'solution', here's a link. (Hat tip to Georg)

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

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

Economics 5/12/10: Probability of default

This is an unedited version of my December column with Business & Finance magazine. Note, the copy was filed before the EU/IMF deal was announced for Ireland, so some assumptions have deteriorated since then.


At this point, it is pretty much certain that the events of the last month will have a lasting and profound effect on Ireland’s economy and society at large. So much is clear. What remains uncertain – in these news-saturated times – is the exact nature of the short-term outcome of three processes at play: the Budget 2011, the IMF/EU ‘bailout’ and the end state of Irish financial markets.

Over the last 24 months this column has predicted, with surprising even to myself, accuracy the following events:

• The complete and total failure of the Irish Government attempts to repair our collapsed banking sector – with even Nama cheerleaders of the past now coming around to recognise that the entire policy has delivered nothing but a powerfull new bureaucracy that put banks and property markets onto a permanent life-support;
• The true extent of the expected losses in the banks, totalling around €67-70 billion ex-mortgages defaults, in contrast to successive rosy estimates by the public officials, the banks, our stockbrokers and the Government;
• The inevitability of the banks nationalization and the risk of the Government vastly overpaying for the eventual ownership of the banking system (my estimates suggest that the taxpayers will end up paying some €40 billion more for the banks than necessary, due to the waste built into the system of previous recapitalizations and Nama);
• The continuation of the economic recession, with a clear and concise prediction of the double dip collapse in GDP and continued contraction in GNP;
• The inevitability of the IMF/EU taking over the reigns of power at the Department of Finance; and
• The losses of tens of thousands of Irish and foreign younger and better-educated workers to emigration and unemployment.
  

Calling it right in these circumstances doesn’t give myself any sense of accomplishment or pride. To put simply, as a taxpayer and a parson calling Ireland home, I would rather have been wrong in my predictions. Unfortunately I, along with a number of other independent analysts, including Peter Mathews, Brian Lucey, and Cormac Lucey, and a number of others, was right.

Even more unfortunate is the fact that the latest events suggest that some of our past predictions are now being overtaken by reality. So let us start with what the future is likely to hold.

First, consider the budgetary arithmetics. The failed spectacle of last week’s release of the multi-annual budgetary framework for 2011-2014 horizon was a clear exercise in Government’s evasion of reality.

Take the headline figures, first.

The Government aims to cut €6 billion from its deficit in 2011. Yet, the very same Government will now require to borrow some €120-130 billion over the next 4 years to finance its day-to-day operations, the redemptions of maturing bonds, write-downs of bad loans, banks recapitalziations and shoring up countless mortgages that are either in a default or heading there. At the rates that ECB and IMF charge Greeks for their emergency funding, this figure can be in excess of €6.1-6.8 billion. At the rates that should apply under the EFSF formula, the interest bill for our new borrowings would add up to roughly €8.6 billion.

In other words, up 58% of the planned 2014 budgetary savings will go up in smoke once the ECB / IMF loans are drawn down.

Add the numbers up. Even if we were successful in driving the deficit to 3% in 2014 as the Government plan – not that there’s a chance in hell that this can be achieved in reality, especially with the new IMF/ECB inetrest charges bills coming, something that the Govenrment has completely failed to even account for in its budgetary framework – Ireland will face continuously increasing debt levels through 2016-2017 due to the cost of new borrowing.

By my estimates, the overall debt levels of the Irish Government will rise to €210-220 billion by the end of 2014, requiring between €12.1 billion and €15.4 billion in annual interest charge against the state. Almost half of 2010 tax receipts will be eaten up by interest charges alone. Put differently, if the Irish Government were to be compared to a household with average income and a mortgage with cost of financing at around 50% of the revenues it bring in, we would be looking at a mean wage earner living in a property with a mortgage that exceeds 11 times its annual pre-tax income. Only a person with absolutely zero understanding of basic finance can think that this type of a scenario can lead to anything other than bankruptcy.

And this is assuming that in the medium term, our collapsed banking sector will be miraculously restored to rude health and the sovereign bond markets will greet Ireland back as a full-fledged issuer of government debt. Both assumptions would stretch the imagination even of the most optimistic forecaster.

Next, take a look at the sub-components of the Budgetary framework.

This Government clearly believes that Ireland’s recession is over. In fact, it believes that we are now on the cusp of a roaring economic growth. Otherwise, how can the Department of Finance hope to raise some €5 billion in new taxes through 2014 and €1.9 billion in 2011 alone? Such a level of tax increases would mean that every working man and woman of this country will be expected to contribute €8,300 annually on top what they already pay the Exchequer.

The Government thinks that Ireland’s economy can grow at 2.75% per annum on average through 2014. My own view is that we cannot hope to deliver such rates of growth. My mid-range forecast for average growth in the Irish economy in 2011-2014 is closer to 0.75-1% per annum, with a significant likelihood of further economic contraction in 2011.

Assuming the average rate of growth in the economy of 1% per annum through 2014 – at the top of the range of my estimates – the new taxes will add up to 25% of the projected average earnings in 2014. Again, this is on top of taxes already being collected.

Someone is clearly smoking something funky out in the rarefied atmosphere of the Government buildings.

The Budgetary framework appears to avoid factoring into the deficit calculations the full costs that the Exchequer is likely to face in years ahead. For example, it is difficult to understand how the announced provisions can cover both the need for day-to-day operations of the Government and the forthcoming additional borrowing costs related to the bailout funding, as mentioned above.

The framework also fails to provision for the expected future impact of mortgages defaults. Should, as widely expected now, the Irish households face a rising cost of mortgages finance due to banks shifting more and more burden of capital and operating costs adjustments onto the shoulders of ordinary mortgage holders, we can expect the number of mortgages in official default to reach over 100,000 over the next 2 years. Again, Govenrment’s rummaging through our pockets through higher taxes will accelerate this process. Pushing ca 60,000 new mortgages into default can cost, roughly speaking, €700 million to the annual social welfare and interest relief bills of the Government.

In other words, say whatever you may, but the so-called ‘draconian cuts’ envisioned by the Government are not enough to plug the hole in public finances without a significant reduction in levels and cost of public sector employment and a much more dramatic revision of the social welfare and health spending. We might not like these measures to be put on the agenda, but the reality bites – without shaving off some ¼ of the public sector wages, pensions and employment costs, and without reducing our social welfare and health spending by at least 1/5th each, Ireland is unlikely to begin repaying its vast debt accumulated since 2007 anytime before 2020.

In addition, let us not forget that the entire Government budgetary framework rests on a number of crucial, but economically and politically unjustifiable assumptions. First, there are the assumptions of extremely benign interest and exchange rates environments – the ones that crucially underpin the real cost of borrowing by the state, but also the implicit rate of growth in our exports, the cost of our imports of inputs into exports production and consumption, the rates of mortgages defaults and other economic variables.

Perhaps the only really progressive measure introduced in the programme is the Site Value Tax – a tax levied on the value of land for residential and zoned land, but exempting for the political reasons agricultural land. The idea of the site value tax, advocated by me in these very pages, before is that it should replace transactions taxes on property without penalizing households who invest in improving their homes and properties. The tax can be effectively used to recover the benefits of public investment in schools, infrastructure and other public amenities that currently accrue to the private land owners. Although the Government hopes to raise €530 million from this measure, little detail is provided in the plan as to the specifics of the SVT application.

Government puts much faith into its plans for reinvigorating the economy. These too were outlined in today’s document. The Government that brought us into insolvency through its handling of the crisis over the last 2 and a half years is aiming to “remove potential structural impediments to competitiveness and employment creation” (something that they failed to achieve since 2001) and “encourage exports and a recovery of domestic demand” (with domestic demand clearly identified in the very same document as the sacrificial lamb on the altar of fiscal adjustment).

A net positive, if unfortunately timed to coincide with deep recession, the reduction in minimum wage is hardly the core to the sustained jobs creation in this economy. By Government own admission, even with this measure, Ireland will retain one of the highest minimum wage rates in the EU.

More important are Government plans to strengthen its labour market “activation policies” for the unemployed and “promote rigorous competition in the professions”. Both would be welcomed were we to have any confidence that they can delivered on. The very same Government that promises now liberalization of professional services has presided over a decade-long preservation of non-competitive marketplace in professions. And as far as employment activation policies go, it is patently clear that barring a deep root and branch reshaping of Fas, there is no chance any efficiency can be gained from the existent activation systems.

Which brings us to the point where the evidence of the last few weeks converges to a point which warrants the following prediction. Regardless of the IMF/EU ‘bailout’ loans, Ireland is now firmly on the course toward a restructuring of its debts at some point in the near future. The only choice we have, as a nation, is the path of this restructuring. The options we face are dark. Irish Government can either recognize the gravity of our situation and force an orderly debt for equity swap within the Irish banking sector, simultaneously imposing significant writeoff on the household debts of at least 15-20%. Or we can muddle through more borrowing, more debt, toward a disorderly, market-driven default on the very same banks debt and potentially (depending on the extent of our future borrowings) sovereign debt.

The choices we have, therefore, are unpleasant, painful and unprecedented by the standards of an advanced economy. But their real causes – the failures of the last 2.5 years of crisis management policies – make them virtually unavoidable.

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

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

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

Economics 4/12/10: Exchequer expenditure side

Let's take a look at the dynamics of the Exchequer expenditure, building on the data released for November earlier this week.

First the total expenditure:
On total spending side, November 2010 posted improvement of €1.795 billion year on year or 4.22%, and €2.867 billion on November 2008, or 6.57%. Much of this came out of the capital investment cuts, but even putting this aside it is clear that adjustments on the spending side of Exchequer balance sheet have been too slow to reach the levels required (ca 20-25%).

Next, by separate departments.
A cut of 28.53% on 2009 levels in November.
Chart above shows bizarre reality of our budgetary allocations. Arts, Sport and Tourism gobbled up some 2.2 times more resources than Communications, Energy and Natural Resources in November 2010. This was 2.67 times in 2008, and 2.26x in 2009. No one is to say that Arts, Sport and Tourism are not important, but does anyone feel we've got some priorities screwed up pretty solidly here?
Community, Rural and Gaeltacht Affairs - with a budget 1.97 times (November 2010) greater than that of the Communications, Energy and Natural Resources has also been one of the core laggards in delivering savings. Presumably because it finances such vital economic activities as delivery of Irish language translations of the speeches of our Dear Leaders. Again, anyone seriously thinking that our priorities should be in spending double the amount we spend on communications, energy and natural resources on rural supports schemes and Gaeltacht subsidies?
Education - despite what we might have heard - is one of the least affected spending departments, compared to others. Year on year November 2010 delivered cuts of 4.3%, while 2 year cuts amounted to 3.2%. This does look like at least some priorities might be right. In contrast, ETE saw cuts of 26.9% over 2009-2010 span (November to November) and 26.2% of these came in 2008-2010.

Just in case if you think we were already spending enough on preserving various arts, linguistic and other cultural values, here comes Environment, Heritage and Local Government (of course, I am being slightly sarcastic, as it also provides funding for Local Government):
Environment, Heritage and Local Government delivered the largest cuts of all departments year on year - at 36.3% through November. It also delivered the largest cut on 2008 - 44.1%. In contrast, boffins at Finance are still lagging the average cuts with 2009-2010 reductions of just 4.3% and cumulative 2008-2010 cut of 17.7%.
Foreign Affairs are down 26.7% on 2008 levels and most of this came in in 2009, so 2009-2010 November to November figures are -4.8%. Health - a giant of all departments with a budget of 26.2% of total spending in November 2010 and 27.1% for the full year 2009 and 27.9% in 2008. Notice that as with Education, the priority of inflicting least cuts in Health is also held steady. Overall Health is down 15.3% on 2008 and 11.2% on 2009.
Social Welfare accounted for 22.3% of total departmental spending in the full year 2009 and 19.1% in 2008. These figures rose to 28.65% in 11 months through November 2010. In fact, the department is the only one where the expenditure has risen steadily in 2009 and 2010, for quite apparent reasons. Total rise was 40% over the last 2 years and 21.8% of that came in 12 months since November 2009.

Like Finance, Taoiseach's Group is enjoying shallower cuts than other departments:
So far, Taoiseach's Group lost 17.8% of its 2008 level spending, while Transport lost 30.1%. In part, this reflects differences in the size of capital budgets for two departments, but in part it also represents the skewed priorities of this Government when it comes to cutting current spending, especially within core civil service numbers.

Table below summarizes these results of annual comparisons:

Next, lets plot levels and percentages of reductions in total expenditures, year on year:
Notice the decline in 2009-2010 savings in relative terms over the course of the year. This can be explained in part by the often mentioned, but never confirmed, delays in payments by the Government to suppliers and a lag in capital expenditure.

Chart below summarizes the 2008-2010 changes in spending by quarter (with 4th quarter reflected as to-date figures through November):

Now, for the last bit - the deficit:
Notice that the above is not including banks measures in 2010, but does include bank measures in 2009, which of course, obscures the true extent of our savings. But that is a matter for another post.

Economics 2/12/10: Exchequer returns - Burden of taxation

Let's take a quick look at the tax burden incidence as per latest Exchequer results.
Proportionally, the burden of taxes paid continues to rise (year on year) for Income Tax, VAT (although VAT burden increases have eased a little bit) and Excise Tax. The burden has been falling for CGT and CAT, Stamps and Customs. It is flat for Corporation Tax.
This goes back to the arguments I made recently - no matter whether it is the Exchequer who assumes new debt, or the banks (under the Guarantee and protection extended to them by the Exchequer), the taxpayers are the ones who will be on the hook to repay it all.

Economics 2/12/10: Exchequer returns - tax receipts

The mixed bag - aka Irish economy - story of the Live Register from yesterday is continuing into today. The Exchequer results for November are being heralded by many 'official' analysts as a sign of significant improvement in the economy.

Are they? Really? Let's update my charts on the matter.

Top level view: tax receipts through end of November totaled €29.489 billion in 2010. This is some €470 million of 1.6% ahead of the DofF projections. Happy times? In 2008 they were €38.86 billion and in the "terrible year" of 2009 they were €30.75 billion. So the good news is that we are still in the worst year of the crisis when it comes to total tax receipts.

I guess I am just not buying the story of 'close to target' being a net positive signal for the economy. It might be a net positive for the DofF - who's forecasts are now accurate (after 3 years worth of trying). But for the rest of this economy, things are worse today - as tax revenues go - than they were a year ago.
Now, November is the month when tax receipts accelerate dramatically. Good news, this year was no worse in the rate of increase than last, even a little better. Bad news, acceleration from October to November has been slower in this year than in 2008. Glass is half full on dynamics.

For 11 months of 2010, all tax heads, except for income tax are on target or ahead of target. Again - good news for DofF forecasters, but not great news for the economy.
You can see how both income tax and VAT are performing poorer in 2010 than in 2009 and 2008. I'll summarize all these differences in a table below. But for now - all other tax heads in charts:
Corporate tax is performing 'spectacularly' better than target +19.1% - sizzling. But year on year it is still 2.2% lower in 2010 than in 2009 and a whooping 26.3% below the levels of 2008. Errr... you see, targets don't really matter, reality does. Ditto for Excise tax: down 0.2% on 2009 and 19.9% on 2008.

Next, then:
Stamps perform better in 2010 than in 2009 so far. This is the one tax head of two that has shown an improvement year on year - plus 7.55% on 2009 and yet still -43.8% on 2008.
CGT... oh, what the hell - you can see, the story is the same as for all other tax heads save for stamps and customs.

Here's a summary table: performance to target (the DofF Delight special):
Charted over the year above.

Now, relative to previous years (the Real McCoy):

Year-on-year rates of change in charts now:

As noted before: with exception for two, by now pretty minor tax heads, accounting for just 2.9% of total tax revenue (Stamps) and 0.7% (Customs) of total tax revenue, everything else is performing worse this year than in 2009. I guess the only good news is that they eprforming not as badly as they could have were the things to completely collapse. Some solace then.

Economics 2/12/10: What PMIs tell us about the job market

An interesting additional point of view on jobs market. Today's Manufacturing PMIs suggest no improvement in November jobs outlook in Manufacturing sectors:
So far, there are absolutely no signs of jobs creation here with employment PMIs indicators:

• Services - October reading (latest so far) at 46.2 - well below expansion 50+) and declining on September reading of 49.8; and
• Manufacturing - November reading at 49.3, signaling worsening performance from already contractionary 49.8 in October.
  

Economics 1/12/10: Live Register

Live Register data was out today, throwing some positive news into the generally adverse newsflow. The headline figure is that November LR has declined 4,200 in seasonally adjusted terms month on month.

This follows declines of 5,400 in September and 6,200 in October. In 11 months through November we are still clocking and increase of 9,900. Expressed in weekly terms, chart below illustrates the dynamics.


Now, net average and monthly changes:
Seasonally-adjusted implied unemployment rate dipped slightly again, for the third month in the row:
Unemployment, as estimated by the LR, now stands at 13.5%, having slipped from the high of 13.8% back in August. It is impossible to tell, based on LR, whether the moderation is driven by contracting labour force (with LR dropouts) or emigration (ditto) or outflow of LR recipients to education, or all three. However, some reduction in new jobs destruction can be expected over a period of time of 3-5 months, given the level of jobs destruction prior to mid 2010. Whether this is sustainable trend or a 'dead cat bounce' effect is a matter of time.

One possible glimpse at what is going on relates to the males LR numbers, which has fallen by a larger proportion than female in November. Males unemployment was much faster to rise and started to do so earlier in the cycle, which means that males are now more likely to come off LR and also to emigrate. However, the emigration story might be overplayed here. There was a monthly decrease of 4,698 (-1.3%) in Irish nationals on LR and an increase of 147 (+0.2%) in non-Irish nationals. So, with non-nationals more likely to emigrate (return migration or movement to another third country for employment), these numbers suggest that emigration is most likely not a significant contributor to the LR changes.

On the other hand, based on occupational groups, the encouraging signs are clearly evident:

• The largest percentage decrease was in the Professional group (-6.0%), followed by the Clerical and secretarial group (-3.9%) - potentially, a sign that professional services are starting to stabilize

In contrast,

• In the year to November 2010 the largest percentage increase was in the Other occupations group (+11.2%), while the next largest increases were in the Personal and protective service (+8.8%) and Sales (+7.1%) groups.
  
• The largest percentage decrease was in the Managers and administrators group (-3.7%).
  

So overall, the numbers would be cautiously optimistic, at least as far as potentially signaling a bottoming out of the jobs destruction cycle.

One point of pressure that remains is the duration of unemployment:

• There was a monthly unadjusted decrease of 7,270 (-2.6%) in short term (less than one year) claimants on the Live Register in November, while the number of long term claimants increased by 2,719 (1.8%). This clearly shows that transition into long-term unemployment continues.

Likewise of concern is the quality of employment (although, of course, having at least a part-time job is much better than none at all):

• In the year to November 2010 the number of casual and part-time workers increased by 6,578 (+8.9%).

Economics 26/11/10: Contagion is spreading to Spain & Italy

Another day, another spike of contagion from Ireland's Sovereign bonds to other Eurozone countries:
Yesterday's closing bell marked another day in which markets have completely disagreed with the EU officials and Irish Government view of the reality of our and PIIGS' ability to weather out the current crisis.

Economics 23/11/10: How much will Government need to borrow in 2011

So we topped the European chart again today:
And a quick one for the start of the day tomorrow:

Let's do some arithmetic again:
Leni's Proposition 2: Through 2011 IRL Gov will need

• €18bn in deficit financing +
  
• €30-40bn in deposits shoring +
  
• €15bn in banks capital (note - some this can be spread over couple of years)+
  
• Banks losses cover of, say, another €10bn =
  
• Grand Total of 73-83bn.
  

Check: is that right, Leni? No answer so far... oh, well... we did the sums, as he asked.