22/12/2011: Retail Sector Activity Index: November 2011

I covered detailed retail sales for November data in the previous post (link here). Now is the time to update the Retail Sector Activity Index.


It is worth noting that my Retail Sector Activity Index for October has predicted November moderate uplift in sales - a nice surprise for the index just created:
"A large jump in consumer confidence in October (to 63.7 from September reading of 53.3) is the core driver of improvement in the overall Index od Retail Sector Activity, which now stands at 102.2 - above the expansion level of 100. This means that we can expect a small uplift in retail sector activity in months ahead, but this uplift can manifest itself through improved volumes of sales (value static, so margins declining) or improved value of sales (inflation) or both (more demand-driven uplift)."


As shown in my detailed analysis (linked above), the retail sales did indeed improve in November, and the improvement took place across all three possible drivers (depending on specific areas of sales):
" Only notable increases yoy are in Non-specialized stores ex-Department Stores (where inflationary pressures drove value up 1.4% while volume was up only 0.5%), Fuel (where inflation was so rampant that value of sales rose 10.3% while volume of sales fell 3.7%) and Electrical goods (where season sales started early and cuts were running deep with value +0.5% and volume up 7.5% yoy). Everything else was either down or flat."

So now to that data update:

• Retail sales (core) volume index rose to 100.6 in November from 98.8 in October. 
• Retail sales (core) value index rose from 94.6 in October to 95.6 in November
• Consumer confidence, however, declined from 63.7 in October to 60.1 in November.

The above implies that RSAI have dropped slightly from 108.64 in October to 107.96 in November. Dynamics however remain encouraging for continued firming up of sales:

• RSAI November reading is 3% ahead of 3mo ago, and 5.33% above the reading a year ago.
• 6mo MA now stands at 105.94, ahead of previous 6mo MA of 104.91, signaling what can be a moderate uplift.
• For comparison, 2006-2007 average is 125.41.

Charts to illustrate:

Medium-term, however, the indices remain below historical trends, with more firm confidence still failing to drive up retail volumes and values:

In other words, structural weakness in the sector remains unchanged. It will take couple of months of solid gains in retail sales (annual gains of 1.5-2% minimum per month) to deliver signs of real structural improvement.

22/12/2011: Europe's policy errors

By now, you have figured it out - I am a big fan of my old UofC professor, John Cochrane. And in this latest article (here) he delivers even more real common sense.

Defaults:

"Conventional wisdom says that sovereign defaults mean the end of the euro: If Greece defaults it has to leave the single currency; German taxpayers have to bail out southern governments to save the union.
This is nonsense. U.S. states and local governments have defaulted on dollar debts, just as companies default."

Cochrane is correct. Orange County, CA - size ca 1/2 Ireland - has defaulted before and so... no end to the State of California or to the Feds and, crucially, no bailout. New York went bust in 1975, Cleveland in 1978. Fitch did a study in 1999, updated in 2003, that shows 2,339 cases of municipal bonds defaults in the US for 1980-2002 totaling USD32.8 billion. And guess what: no bailouts and yet the dollar still exists. Fitch estimated cumulative default rate for 1980-1986 issuance of 1.5%m cumulative default rate for 1987-1994 issuance of 0.63%, average recovery rates were around 63-64%, consistent with standardized CPD pricing practice of 40% haircut. This is not to say that defaults are costless or easy, but there is no ex-ante intrinsic reason for the common currency to implode were a country like Greece - expected by all to default - to restructure its sovereign debts.

Bailouts:
"Bailouts are the real threat to the euro. The ECB has been buying Greek, Italian, Portuguese and Spanish debt. It has been lending money to banks that, in turn, buy the debt. There is strong pressure for the ECB to buy or guarantee more. When the debt finally defaults, either the rest of Europe will have to raise trillions of euros in fresh taxes to replenish the central bank, or the euro will inflate away."

Correct again: latest LTRO allocation of €489bn this week, with €235bn of this being lent in excess of the banks covering shorter-term ECB debt is the case in point. ECB's hope is that the banks - already sick from overloading with low quality sovereign debts on their balance sheets - will use €235bn to buy more sovereign debt. This, of course, will help ECB to cut back its own purchases of Government bonds and to, thus, pretend that 'the market' for sovereign debt in Europe is somehow being repaired. The madness of this 'solution' is that it creates even greater link between ECB, banks and sovereign debt - the very cause of the crisis contagion. You can see an excellent, albeit a bit politically-correct piece on this in the Economist (here).

And to correct for the 'politically correct' bit - here's my view of LTRO: In a nutshell, the ECB will lend the banks unlimited money at 1% so they can buy PIIGS+Belgian+French debt making 2-6% margin as pure profit and benefiting from capital gains in the process. As bonds prices firm up on the back of these purchases, banks collateral deposited with ECB will also improve in value, allowing them to borrow even more. This positive correlation between banks borrowings from ECB and their profits gains will continue until in 3 years from now the entire pyramid collapses - the banks will have to repay ECB funds, prompting massive sales of bonds. And in the mean time, there will be no lending in the real economy, as banks funding will be tied into financing Government spending and banks will continue to deleverage out of real assets. This makes LTRO an equivalent of an RX to a drug addict for unlimited supply of free opiate.

As Cochrane puts it:
"Sovereign default would damage the financial system, however, for the simple reason that Europe has allowed its banks to load up on debt, kept on the books at face value, and treated as riskless and buffered by no capital. Indebted governments have been pressuring banks to buy more debt, not less.

As banks have been increasing capital, they have loaded up even more on “risk-free” sovereign debt, which they can use as collateral for ECB loans. The big ECB “liquidity operation” that took place yesterday will give banks hundreds of billions of euros to increase their sovereign bets. Bank depositors and creditors have figured this out, and are running for the exits.

...By stuffing the banks with sovereign debt, European politicians and regulators are making the inevitable default much more financially dangerous. So much for the faith that regulation will keep banks safe."



Fiscal Union:
"More fiscal union hurts the euro. Think of Poland or Slovakia. ...A common currency without a fiscal union could have universal appeal. A currency union with a bailout-based fiscal union will remain a small affair."

"Europeans leaders think their job is to stop “contagion,” to “calm markets.” They blame “speculation” for their troubles. They keep looking for the Big Announcement that will soothe markets into rolling over another few hundred billion euros of debt. Alas, the problem is reality, not psychology, and governments are poor psychologists. You just can’t fill a trillion-euro hole with psychology."

Conclusion:

"The euro’s fatal flaw then wasn’t to unite areas with differing levels and types of development under one currency. ...Nor was it to deprive governments of the ephemeral pleasures of devaluation. Nor was it to envision a currency union without fiscal union.

Banking misregulation was the euro’s fatal flaw [emphasis is mine]. Sovereign debt, which can always avoid explicit default when countries print money, doesn’t remain risk-free in a currency union. Yet banking regulators and ECB rules continue to pretend otherwise.

So, by artful application of bad ideas, Europe has taken a plain-vanilla sovereign restructuring and turned it into a banking crisis, a currency crisis, a fiscal crisis, and now a political crisis."

And then,
"When the era of wishful thinking ends, Europe will face a stark choice.

1. It can have a monetary union without sovereign defaults. That option means fiscal union, accepting real German control of Greek and Italian (and maybe French) budgets. Nobody wants that, with good reason.
2. Or Europe can have a monetary union without fiscal union. That would work well, but it needs to be based on two central ideas: Sovereigns must be able to default just like companies, and banks, including the central bank, must treat sovereign debt just like company debt.
3. The final option is a breakup, probably after a crisis and inflation. The euro, like the meter, is a great idea. Throwing it away would be a real and needless tragedy."

I agree.

22/12/2011: Retail Sales for November

Ok, folks, RTE is shouting "Biggest Retail Sales Rise Since March" (see link here) but you do know to turn to this blog to see the real numbers. So here are the updated charts and historical trends and some analysis.

It is worth noting that my Retail Sector Activity Index for October has predicted this uplift:
"A large jump in consumer confidence in October (to 63.7 from September reading of 53.3) is the core driver of improvement in the  overall Index od Retail Sector Activity, which now stands at 102.2 - above the expansion level of 100. This means that we can expect a small uplift in retail sector activity in months ahead, but this uplift can manifest itself through improved volumes of sales (value static, so margins declining) or improved value of sales (inflation) or both (more demand-driven uplift)."
Please note that below analysis exactly confirms the above predictions.

However, this does not mean that I share with the RTE headline excitement about the actual sales indices performance in November 2011. Here's why:

First of all - general retail sales (including motors), seasonally adjusted:

• Value of retail sales rose from 87.2 in October to 88.2 in November, an increase of 1.1% mom, a drop of 0.68% yoy. History in making? Well, not really - in 2 months of October and November, retail sales rose 1.50%, in 2 months of May-June retail sales value grew 1.25% (statistically indifferent from 1.5% gain in last two months), and in 2 months between February and March they rose 1.26%, which is again identical - statistically-speaking - to the rise in last 2 months. So history is not being made here.
• Significantly, annual rate of declines has slowed down in November to -0.7%, which is the best reading since June when there was zero change in retail sales year on year, but then, again, in January value of sales was up 4.3% yoy and then in February it was down just -0.2% yoy. Now, again, no historical headlines here.
• Let's take a look at the trends. At 88.2 current reading is ahead of 3mo MA of 87.4 and 6mo MA of 87.7, but it is below 201 average of 88.86. In other words, current sales are worse than monthly average for 2010. And current sales are slightly ahead of 2011 monthly average to-date of 87.82%. Not that the RTE would bother mentioning that.
• Relative to the peak, value of retail sales is still down 24.10% in November.
• In Volume terms, there was a 1.6% monthly rise from 91.9 in October to 93.3 in November. This is statistically insignificant difference too. In 2 months through November, index of the volume of retail sales rose 1.97%, in May-June it was up 2.07% and we do know that it was not exactly boom time on the high street back then.
• Volume index is now down 0.8% yoy and 19.8% down on peak. 3moMA is at 92.23 and 6mo MA at 92.47. However, 2010 monthly average is at 93.6, which is ahead of November monthly reading. So, as with value index, the 'record sales' in November are lower than the average monthly sales volumes in 2010. 

Charts to illustrate:

Frankly, I am not seeing anything that jumps out on an extraordinary scale. Some uplift, most likely supported by the decline in foreign travel for shopping and by better weather conditions this year than in 2010, but hardly spectacular. Only notable increases yoy are in Non-specialized stores ex-Department Stores (where inflationary pressures drove value up 1.4% while volume was up only 0.5%), Fuel (where inflation was so rampant that value of sales rose 10.3% while volume of sales fell 3.7%) and Electrical goods (where season sales started early and cuts were running deep with value +0.5% and volume up 7.5% yoy). everything else was either down or flat. You tell me if this is something that we can cheer about?

Let's take another look at the pure index numbers: 

• Value index at 88.2 was the highest reading since June when it stood at 88.8. In last 12 months through November, index was in excess of 88.2 or equal to it on 5 occasions other than November 2011, which makes this month's reading oh, sort-of average.
• Volume index at 93.3 in November 2011 is the highest since 93.8 in June 2011 and is the 4th highest in the last 12 months - also not exactly a trend-breaking performance.

So adjusting for motors sales, core retail sales indices were:

• Value of core retail sales rose 1% mom from 94.6 to 95.6 in November. November 2011 reading is 0.1% ahead of November 2010 reading and the current index stands at the 5th highest reading level over the last 12 months.
• Relative to peak value of core retail sales is down 19.39%. 2010 monthly average reading is 97.57% - ahead of November 2011 reading. More ironically, year-to-date 2011 average monthly reading is 95.62 which is identical to the November 2011 reading.
• By all possible comparisons, November 2011 reading for the Value of core retail sales (ex-motors) is average.
• Volume reading reached 100.6 - the first over-100 reading since April 2011. Index is now up 1.8% mom and down -0.8% yoy. This is the set of numbers that excited the RTE the most.
• Yet, 2010 monthly average reading for this index was 102.7 - above the November 2011 reading. However, importantly, 2011 year-to-date average monthly reading is 99.7 - statistically insignificantly different from November 2011, but still below November reading in actual terms.
• Still, November 2011 is worse than the average month of 2010. Not exactly a strong performance.

Charts to illustrate:

Ok, let's summarize the above: supposedly we had an exciting retail sales month in November. Yet, by all measures CSO reports, November performance this year was worse than average monthly performance in 2010, and by 3 out of 4 measures reported by CSO, November was worse than the average month in 11 months from January 2011 through November 2011.

Oh, and as an aside, here are the comparatives in retail sales volumes across Ireland, EU17 and EU27 (data reported with a monthly lag here, so latest we have is for October sales):

22/12/2011: Long term growth and the crisis

Let me highlight the following angle on considering latest Irish economic forecasts. The downgrade by IMF, OECD and EU Comm, plus ESRI to 2012 growth of 0.9-1.0% - as much as I personally think these forecasts to be optimistic as they are - cuts across the strikingly more optimistic Department of Finance forecasts for 1.3% growth (in the Budget) or 1.6% growth (in the documents released one day ahead of the Budget). This is pretty clear.

But the real issue here is that in the long term, IMF projects Irish growth of 2.3%, 2.7% and 3.0% in 2013-2015, with the output gap of 3.6%, 2.2% and 1.1%. The implied loss to the Irish economy due to the crisis, from 2010 through 2015 is a cumulative €37.5bn. In other words, our economy's long-term growth potential for growth, held back by the structural recession and debt overhang, plus fiscal mess, is - between 2010-2015 - €37 billion higher than the expected realized income. Or 20.9% of the expected 2015 GDP.

While differences year on year are significant in terms of fiscal targets, the fact that in 6 years between 2010 and 2015 Ireland's economy will be forced (by our inept Government policies on debt and banks, plus our inept EU 'partners' policies on 'bailout' and banks) to waste almost 21% of our expected annual income shows the following:

• Current policies are incapable to drive Ireland back to its potential long term growth rates, and
• Ireland is clearly distinct from other peripheral countries which, while having a similar crisis, do not have the same potential for future growth as Ireland.

21/12/2011: Sunday Times December 18, 2011 article

This is an unedited version of my Sunday Times article for December 18, 2011.

Last week’s EU Summit was billed as offering long-term solutions to the fiscal stability in the euro area and setting out the tools for dealing with the immediate threats. Just a week after the summit, however, the euro zone finds itself in the midst of an ever-deepening crisis once again.

This, of course, is a logical conclusion to the meeting that not only failed to present any new measures, but went on to undermine credibility of the previously deployed solutions, such as the EFSF, the ESM, Private Sector Involvement in bondholders haircuts in Greece, the expanded IMF engagement in lending to the euro zone member states, and the ECB deployment of aggressive quantitative easing programmes.

Let’s take a look at the hard numbers that emerged from the summit.

Post-July 2011 plan was to enhance EFSF lending capacity to €1.5-2 trillion either by raising new funding or by running €500 billion EFSF concurrently with €1 trillion ESM. Post-December summit we have: no increase in EFSF, no concurrent schemes and a vague promise of a €1 trillion target for ESM. This means that the effective lending capacity of the long-term funds in euro zone will be less than one half of what was expected.

That, of course, assumes that EFSF and ESM will carry on borrowing under AAA rating status and that funding markets will be receptive to new issuance of debt. The former is now jeopardized, courtesy of the summit failure, leading to France downgrade. The latter has been under severe questions for weeks now, since the EFSF failed to raise €3 billion in the last auction earlier this month. In fact, things are now so desperate, that this week EFSF was forced to issue 91 days bills. A fund that is lending under 7.5-10 year mandate now runs short term funding schemes that imply a massive maturity mismatch risk.

In order to by-pass ECB’s statutory restriction on financing the member states, for months prior to the December summit, EU leaders were voicing the idea of lending funds to the IMF so that the IMF can re-lend these same funds, leveraged ca 4-5 times back to the euro member states. This too now appears completely out of reach. Following the summit, the US, Canada and Japan stated unequivocally that they will not support targeted funding by the IMF. In addition, Russia, Brazil, China and India have in the past said no to matching euro area loans, meaning that the scheme cannot come into existence as a general fund allocation. Of course, in all the excitement surrounding the Summit, everyone forgot to ask a simple question – where will the EU governments find the said €200 billion if they can’t raise the money to fund the EFSF?

Private sector participation in Greece – the cornerstone of the July and October 2011 summits – was also put to gather dust this week. Firstly, the European Banking Authority clearly stated that efforts to-date to agree such ‘voluntary’ participation have come short of the required target of 90% of foreign bond holders. Secondly, in the 5^th review of Greece’s progress under the lending programmes, the IMF team in Athens concluded that: “There are yet significant risks ahead for the [Greek] authorities’ program, including …the possible failure to agree with creditors on a PSI deal, leading to a non-voluntary outcome.” And furthermore, despite having engaged in planning PSI operations since June 2011, after six months of haggling and planning by the EU, “… the specific details of the operation remain to be finalized …” The sums involved are hardly insignificant. October 26 summit – up to 1/4 of the entire EFSF once banks recapitalization measures are included. Absent full implementation of PSI, Greece will be insolvent vis-à-vis IMF, triggering a mother of all defaults.

Last, but not least, the hopes of the ECB riding into the battle with direct quantitative easing were cindered by Frankfurt. Following the summit, ECB decision makers were quick to state that direct assistance to the member states and expanded bonds purchases were not consistent with the ECB statutes and strategy. Of course, no open market operations – no matter how large – could have been sufficient to deal with the crisis. To-date, ECB balancesheet of loans to sovereigns (via direct purchases of Government bonds) and euro area banks has swollen dangerously close to €1 trillion. And, yet, this had virtually no real long-term effect on the crisis dynamics.

Adding insult to the already grave injuries, the Summit precipitated two new crises in Europe – a political one and an economic one. The former is manifested in the legal problems surrounding formulation, passing and enforcement of the new Fiscal Pact. But these are legal and political problems so let us focus on the economic ones.

Even for the deficit hawk like myself, the Fiscal Pact is equivalent to an economic suicide. The Pact formula of 3%-0.5%-60% is a combination of the already failed Stability and Growth Pact targets enriched with the lethally obscure and totally unattainable 0.5% structural deficit limit.

Between 1990 and 2008 – in other words, before the crisis hit – Ireland was able to satisfy the 0.5% structural deficit target only once in very 10 years, same as Belgium, Germany and the Netherlands. Austria, France, Greece, Italy, Portugal and Spain never once satisfied this criterion. Two best performers in the euro area – Malta and Finland have met the target in 6 out of the 19 pre-crisis years. In terms of 0.5% structural deficit rule, all member states, except Germany will require further austerity measures.

For Ireland, a longer-term expected slowdown in growth over the next 10 years compared to previous two decades will mean that it will be even harder to stick to the target for the structural deficit, as we see reduction in the potential growth rates going forward.

Ireland fared much better as far as the 3% standard deficit goes, satisfying the criteria in all but 1 year. The same does not hold for other euro area states. France has failed to meet the target in more than 5 out of 10 years, as did Spain; Italy in more than 7 in each 10 years; Portugal and Germany more than 4; Greece – never once. And looking forward, under rather rosy IMF September 2011 projections for 2012-2013, Belgium, Cyprus, France, Greece, Ireland, Slovenia and Spain will require even more austerity than already planned to comply with 3% deficit rule.

For Ireland, complying with the 3% rule will require the deepest additional adjustments in the euro area, while complying with the 0.5% structural deficit rule will need second largest adjustment. In fact, this week, Sen. Sean Barrett, a TCD economist proposed a bill that aims to bring about a more open and transparent approach to the public finances and stresses the overall significance of the structural deficits rules for Ireland.

Messrs Kenny and Noonan have signed off on the deal that will be the costliest to Ireland of all other states, disastrous to our economy in its current condition and, given the legal issues surrounding its enforceability for countries not in debt to the Troika, also pretty much useless for the EU at large.

The second point of weakness in the Irish Government position with respect to the new Pact relates to the implicit Government support for the Financial Services Transactions Tax (FSTT). Empirical evidence firmly shows that Tobin-styled taxes in financial services, when effective in reducing the speed and volume of transactions, have to be prohibitively high, impacting more adversely secondary financial services centres, like Dublin IFSC and benefiting offshore locations and jurisdictions that fall outside the new tax net. In summary, Tobin tax can lead to less transparency, more tax evasion and lower economic growth across the EU. James Tobin himself argued against the blanket introduction of his ideas in later years.

By agreeing to the new Pact without as much as voicing a threat of the veto over the FSTT, the Irish Government has signed a long term death warrant to Dublin's competitiveness in front-office international financial services - the highest value added segment of the sector and one of the best performing areas of Irish economy in recent years, including during this crisis.

On the net, as the direct result of the Summit failures, the probability of the Euro zone exits for Greece, Portugal, Ireland and Belgium has risen. At the same time, the sustainability of public finances in Italy, Spain and France is now in doubt as Fiscal Pact is likely to result in a reduction in the potential growth rates for Span and France and no increase in future growth for Italy. Likewise, the probability of Irish fiscal adjustment path must be questioned, especially since the Pact will depress our longer term growth rates, that are already, barring the Pact introduction, less than spectacular.

It is thus, that the Government deficit of leadership has finally contributed to a bitter failure at the EU policy level. Contagion has spread from all matters economics and financial to the heart of politics in Europe.

Box-out:

Breaking up the doom-and-gloom newsflow that dominates our everyday reality, last month’s high level Irish delegation trade visit to Russia, headed by Tanaiste Eamon Gillmore, yielded some encouraging progress on the longer-term bilateral trade and investment policies development front. Since 1976, Irish and Russian authorities have been in somewhat infrequent and irregular dialogues on these issues under the umbrella of the Joint Economic Council. Last month, for the first time ever both sides agreed to set up sector-specific working groups with regular reporting and strict annual targets for deliverables. Given that Irish exports to Russia are set to grow 40% plus this year, having 52% in 2010, while Irish trade surplus with Russia is about to expand by 150% in the last 2 years, this is a truly welcomed development. In 2010, Irish trade surplus with Russia was €465 million ahead of that with China, €352 million ahead of trade balance with India and €119 million greater than the trade surplus with Brazil.

21/12/2011: Irish Planning Permission Q3 2011

In Q3 2011, there were 2,512 planning permissions granted for dwelling units, compared with 4,641 units for the same period in 2010, a yoy decrease of 45.9 %.

However, overall, Q3 2011 number of new dwellings approved stood at 1,271, up 0.55% qoq and down 22% yoy. Relative to peak in Q2 2004, the number of new dwelling units approved declined 83.2% in Q3 2011.

Per CSO: 

• Planning Permissions were granted for 1,887 houses in the third quarter of 2011 and 2,817 in the third quarter of 2010, a decrease of 33.0%. 
• Planning permissions were granted for 625 apartment units, compared with 1,824 units for the same period in 2010, a decrease of 65.7%.
• Total floor area planned was 969 thousand square metres in the third quarter of 2011. Of this, 48.0% was for new dwellings, 29.7% for other new constructions and 22.3% for extensions. The total floor area planned decreased by 31.4% in comparison with the same quarter in 2010.
• Planning Permissions for new buildings for Agriculture rose to 194 this quarter. This compares to 132 permissions in the same quarter of 2010.

More detailed analysis of CSO data shows that total number of new permissions rose 4.76% qoq in Q3 2011 from 4,244 in Q2 2011 to 4,446. However, Q3 2011 total number of permissions was down 16% yoy and down 74.4% on the peak attained in Q3 2007.

Charts below illustrate:

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

Fourth review of Ireland's programme under the Troika package is out and makes for some interesting reading. As usual, between-the-lines reading skills required. This is the first post on the report, focusing on housing markets and mortgages arrears.


The review is overall positive, complimentary and almost glowing. This warrants a number of caveats:

• The review is based on QNA data through H1 2011, so Q3 2011 fall-off in GDP and GNP are not factored in
• The review is based on the general data sources through mid-October, so November Exchequer results do not appear to have been factored in either

Aside from the strengths highlighted in the media, here are the critical points of the report. Mortgages arrears first, with subsequent posts dealing with other core issues covered.

"However, housing market and household debt indicators continue to deteriorate (Figure 2). With the fall in house prices accelerating in October to 15.1 percent on an annual basis, prices are down 45.4 percent from their peak in 2007. The rate of mortgage arrears by value continued to rise, reaching 10.8 percent in September 2011 (8.1 percent in terms of the number of mortgages), up from 6.6 percent in September 2010. With the share of longer-term arrears (greater than 180 days) continuing to rise, the authorities have deepened their analysis of the mortgage arrears problem (Box 1)."

Of interest here is the analysis the IMF refers to. Here is the summary (quoted from the IMF report, my comments in italics):

1. Aggregate mortgage arrears continue to rise sharply and in September 2011 reached 8.1 percent by the number of loans to owner-occupiers. 
2. To better understand the nature of mortgage distress, the CBI has utilized loan-by-loan data from end-2010 that were collected as part of the review of banks’ capital needs published at end-March 2011. [I am puzzled with this statement. CBI clearly stated at the time of PCARs that they did not analyse individual loans data for mortgages, but considered samples of mortgages. At a later date - in September 2011, CBI gave a presentation of a study based on the specific loans data, but this was also based on a sample of data, a large sample, but still a sample, not the entire population of the mortgages on the books of 4 banks.]
3. Of those households in arrears over 90 days, almost 40 percent have been in this position for a year or more. The average amount of arrears on these loans is €27,000, compared with an average outstanding balance of just over €200,000. [Please, keep in mind, per IMF, this is data through the end of 2010, so it is, by now - one year old!]
4. On top of arrears of 90 days or more, there are a significant number of borrowers who have restructured loans or delinquent payments of less than 90 days, bringing the total affected to about 20 percent of borrowers at end-2010. [These figures - 20% of borrowers either in arrears or restructured, or as I call these 'at risk' - is much greater than reported by the CBI in their quarterly report, showing for Q3 2011 that only 12.96% of all mortgages outstanding were either in arrears, restructured or repossessed]
5. Arrears tend to be highest in relation to buy-tolet properties and first-time buyers, as these purchasers took on large debts owing to high house prices during 2005–08. 
6. Negative equity is extensive. It is estimated that 36 percent of owner-occupier households with mortgages in these institutions are in negative equity (at September 2011 house prices). [This, of course, is now higher again, as October and November price declines totalled 3.71%] 
7. For owner-occupier loans taken between 2005 and 2008 (half of outstanding loans), 48 percent of properties are in negative equity, while 52 percent of buy-to-let loans are in negative equity. [The two numbers are remarkably close to each other.]
8. Negative equity does not imply arrears. Despite widespread negative equity amongst borrowers, the vast majority of negative equity borrowers, over 90 percent, were not in arrears at end-2010. 
9. About half of owner-occupier borrowers in arrears at end-2010 had positive equity, with around 38 percent having at least 20 percent equity in their homes. The average negative equity of owner-occupiers without arrears is €68,000, modestly smaller than the average of €84,000 for owner-occupiers in arrears. [Which, of course, means that these arrears can be dealt with at no loss to the banks via a combination of restructuring, equity stakes assumption by the banks and/or foreclosures. In the end, this also means that significantly less resources will be needed to help those who are in negative equity and at risk of arrears - i.e. those who are subject to punitive provisions of our personal bankruptcy code]
10. Buy-to-let properties. Of the total loan book analyzed, 22 percent (€20 billion out of €87 billion), relates to buy-to-let property debt. The average outstanding balance for the 52 percent of buy-to-let properties in negative equity is about €320,000 and the average negative equity is just over €100,000.
11. Within the four institutions covered by the Financial Measures Program, 33 percent of buy-to-let borrowers also have an owner-occupier mortgage with the same lender.  

Some very interesting observations from the IMF summary of the CBI evidence on drivers of arrears: 

• Studies, including from other countries, point to unemployment, debt service, and loan-to-value ratios as key determinants for arrears, although geography and loan vintage are also important, as are rental and payment rates for buy-to-let properties. 
• Data availability can be an issue, however, especially for current income. 
• An alternative approach developed a transition matrix for predicting mortgage arrears based on loan vintage, borrower type, interest rate type, and region.

There's no summary of the transition matrix provided.

Here are three more interesting charts relating to the Irish property market:

20/12/2011: The end of Neo-Keynesianism

I have recently written about the lack of debt reductions under the 'austerity' packages in Europe (see link here). Now, Washington Post weighs in with an excellent note on the demise of the Neo-Keynesian doctrine of unlimited borrowing-based deficit financing - link here. It is, therefore, perhaps befitting to note that today's Le Monde quotes Professor Jean-Marc Daniel of ESCP saying that "without doubt we are living in the last hours of a European Social model". The article, cited in the eurointelligence.com briefing note, but not linked, also cites absurd abuses of the Social Contract in Greece and other PIIGS.

This, of course, is a logical conclusion to the economically illogical proposition that states with severe debt overhang (in excess of 80% of GDP or GNP for public debts) can borrow their way out of the debt crisis.

But the problem goes deeper than that. Europe 2020 - the only growth policy platform for the EU27 - relies extensively on the Social Model as the core driver for growth, both in terms of justifying subsidies and transfers that are represented as 'socially productive' even if they are economically dubious in nature, and in terms of justifying more significant role for public investment in driving future growth capacity.

Neo-Keynesian doctrine of continued and accelerating deficit financing in the face of public debt overhang is now pretty much dead. Next step - the idea of 'Social Economy' that is based on achieving equality of outcome by transfers of income and wealth, both intra- and inter-temporal. States do run out of borrowing capacity, folks. And it doesn't matter a bit whether this happens when you need to run a deficit or not.

20/12/2011: Residential property prices for November

Today's data focus for Ireland is on residential property price index for November.

Prior to today's release, in the 12 months through October 2011, residential property prices were down 15.1% year on year - steeper decline than in July-September 2011 (12.5%, 13.9% and 14.3% respectively). In 12 months through October 2010 the rate of prices decline was 11.1%, shallower than in the 12 months through last October. So price drops were accelerating before November data release. In fact, mom prices dropped 2.2% in October, against 1.5% mom decline in September.

The latest data, therefore, was expected to come in with some moderation in the rate of decline. And in that, there was no surprise - mom change for November is at -1.54%, ahead of September, but behind October reading. 


November index of all residential properties prices is now at 70.1, down from october 71.2. 3mo MA is down to 71.37 from October reading of 72.63. We have to go back to November 2007 to see the first time that the overall index did not decline (it stayed flat in that month) and back to September 2007 to see the last monthly increase in the index. 12 mo MA of monthly changes is now at -1.41% mom and year-to-date monthly average change is -1.49%.


Nama is continuing taking a hit on its valuations. Referencing back to November 30, 2009 Nama valuations cut-off date, November 2011 prices are down 25.35%, which, adjusting for LTEV uplift applied by Nama implies that Nama valuations on its residential properties portfolio are 32.13% under water. Correcting the above for 'burden sharing' cushion applied by Nama legislation, Nama is nursing a loss of 28.9% on its residential properties-related holdings.

As chart above shows, overall residential property prices are now 46.28% down on the peak and year on year the prices are down 15.64%.

Houses prices index has fallen from 74.3 in october to 72.9 in November - down 1.88% mom, In October, monthly rate of decline was -2.24%, but November decline is second sharpest in the last 5 months. Year on year, house prices are down 15.72%, while in october the same rate of decline was 14.89%. Relative to peak, house prices nationwide are 44.78%.

Apartments fared better this time around, with index reading improving from 52.2 in October to 53.6 in November, a monthly rise of 2.68%. The index is also more volatile than that for all residential prices and house prices. Last time we saw a rise in house prices mom was in August 2010, and last time we saw monthly increase in apartments prices was in December and January 2010.

Apartments prices are now -16.89% down yoy and this marks an improvement on -19.82% decline yoy through October. Relative to peak, apartments prices are down 56.74%.

In my view, the divergence between apartments prices and house prices, if sustained over time, will be signaling the overall collapse of the purchasing power by the first time buyers, as well as demand push toward lower cost commuting locations as cost of transport continues to climb up courtesy of the Government policies. It can also signal the reflection of improving rental yields for some, especially city centre-located - properties. It is worth noting that Dublin apartments drove the monthly change for nationwide figures reported above, with Dublin apartments price index increasing from 50.8 in October to 53.2 in November a strong gain of 4.7% mom and driving year on year decline to -16.1% in November against -21.2% in October.


Prices in Dublin (all properties) posted index reading of 62.2 in November, down 1.43% mom on October reading of 63.1. This was the shallowest monthly decline since July 2011 when the index posted no change mom. Yoy index is now down 17.62% in November from 17.52% in October. Relative to peak the index is down 53.75%.

Updating annual forecasts, I expect overall RPPI to post a reading of ca 71.27-71.30 or a decline of 41.7% relative to peak. For houses, I expect index to run at 74.5-75.1 for 2011, marking a decline of 39.7% relative to peak annual index, while for apartment the same forecasts are for 56.5-56.7 index reading and a decline relative to peak of 49.7%. Dublin prices are expected to end the year on an index reading of 63.5-64.0 - a decline of 47.9% on peak. Mid-points are illustrated below:

So, overall, no surprise - another month of declines, another month on the road toward the average price around 60% off the peak. One to watch here is the sub-index for apartments prices, especially in Dublin.


It's worth noting here that per NTMA (source: Nama, December 2011), commercial property yields have been rising strongly in recent months. See chart below. This can also correlate positively with the rental yields for Dublin apartments, especially for centrally located properties.

19/12/2011: Relax, Keynesianistas!

My article for Canada's Globe & Mail in the Global Exchange section: here.