23/3/2013: Sunday Times 10/03/2013

This is an unedited version of my Sunday Times article from March 10.


Some two years ago in these very pages, I have described the prospects for the Irish economy as following a flatline trend with occasional volatility. In other words, back in the beginning of 2010, the economy’s prospects for the near-term future were consistent with an L-shaped recovery: stabilization followed by near-zero growth.

Taking the first three quarters of 2012, in headline terms, the above prediction has translated into 2009 to 2012 GDP growth of just 0.22% per annum, GNP decline of  0.16% per annum and domestic demand drop of 4.81% per annum. Again, let’s take a look at the above numbers from a different angle. Compared to the pre-crisis levels, the latest GDP data shows that over 2011-2012, Irish economy was able to close just 22% of the gap between GDP peak and the Great Recession trough, implying that it will take Ireland through the end of 2014 before we get our GDP back to the half-point of the Great Recession. At the same time, Domestic demand continued to hit crisis period lows in 2012 and all international projections show that 2013 will be another post-2007 low for these data series.

With these rather depressing statistics in mind, one is warranted to take with a grain of salt ever-more frequent and boisterous pronouncements from the Government that Irish economy has ‘turned the corner’. Ditto for the ever-more saccharine messages from the EU policymakers to the ‘best pupil’ in their austerity policies ‘class’.

And the most recent data – through Q4 2012 and January-February 2013 – is offering no signs of any statistically significant improvements in the economy compared to the rather abysmal 2012.

Mortgages arrears were once again up in the last quarter of 2012. While the rate of increases was markedly slower than in previous quarters, number of accounts currently in arrears 21.4% year on year. As of the end of 2012, some 186,785 private residencies-related mortgages are either in arrears, in temporary restructuring or in the process of repossessions – almost 25% of all accounts outstanding  if we were to use as the base total accounts numbers comparable across the 2009-2012 horizon.  All in, some 650,000-700,000 Irish residents are currently under water when it comes to paying on their original mortgages. Some turnaround in the economy to witness.

Data for January-February 2013 on new cars registrations shows that not only the motor trade is continuing to suffer from on-going collapse in sales, but that there is no indication of any substantial improvement in either the Irish households or the Irish SMEs outlook for the future. New private cars registrations are down 20% year-on-year over the first two months of 2013, while new goods vehicles registrations are down 21.4%. This shows clearly that Irish consumers are not engaged in purchasing large-ticket items and, supported by the declines in durable goods consumption evident in the retail sales data, signals that consumers have little real credence in the ‘green shoots’ theory espoused by our Government officials and business leaders. Lack of demand uplift in goods vehicles, on the other hand, shows that when it comes to capital investment, Irish businesses are also refusing to buy the hype of economic turnaround. In any cyclical recovery, capital expenditure, especially on rapidly depreciating items such as vehicles used in transporting goods for wholesale and retail trade, logistics and transportation services, is one of the leading indicators of improving economic conditions. Data for the first two months of this year shows no such uplift.

Core retail sales, once stripping out motor sales, are showing a slightly more upbeat activity. While all retail business activity has declined on average over 3 months through January 2013 compared to year ago, some encouraging signs of uplift were present in the Department Stores sales, and sales of electrical goods when it comes to volume and value of sales. Nonetheless, two factors continue to characterize Irish domestic consumption: extremely low activity from which any increases might take place, and exceptionally anemic trend in any rises we do record.

On the investment front, gross domestic capital investment remained basically unchanged in the first 3 quarters of 2012 compared to 2011,ann there are currently no signs that this situation has changed since the end of Q3 2012. We are now into the fourth consecutive year of gross investment failing to cover amortisation and depreciation of the capital stock accumulated over the years of the Celtic Tiger. Recalling that our growth success over 1992-1998 was predicated on a rapid catching up in capital stock and quality relative to our, at the time more prosperous European partners, this means that the ongoing crisis is effectively erasing any capital gains achieved post 1999.

In short, domestic side of the economy shows no green shoots of any harvestable variety. And the potential headwinds we are likely to face in the near-term future are still severe.

In property markets and when it comes to mortgages arrears, we face a long list of risks that are yet to play out.  Impacts of property taxes introduced in the Budget 2013, the upcoming lifting of the banking guarantees,  and the saga of the Personal Insolvency regime reforms all represent distinct threats to the fragile stabilisations achieved in these areas of the economy.

On business investment front risks are also mounting, rather than abating. Continued lack of bank credit and strong indications that in the near term Irish banks are likely to follow their other Euro area counterparts in dramatically hiking the retail interest rates for both existent and new loans.

When it comes to consumers’ appetite for spending, latest consumer confidence data shows significant deterioration in confidence in February, compared to January 2013 and to 2012 average. If anything, when it comes to consumers’ reported outlook for 2013, things are getting worse relative to 2012, rather than better.

Which leaves us with the Government’s old favorite signal of the recovery: Irish exports.  The hype about Irish external trade prowess is such, that even a usually somber IMF has recently waded in with a lengthy paper outlining how Ireland is likely to turn back to Celtic Tiger era prosperity on foot of booming exports.  In summary, the IMF missive, titled Boosting Competitiveness to Grow Out of Debt – Can Ireland Find a Way Back to Its Future concluded that “Ireland is poised to return to its path of strong growth and low imbalances” on foot of “enhanced competitiveness”.

The idea that ‘exports-led recovery’ is Ireland’s only salvation from the systemic and structural crises we face is not new. Previous Government put as much credence into this proposition as the current one. Alas, this idea – as I have pointed out repeatedly – is simply not reflected in the reality of the Irish economy for a number of reasons.

It is true that Irish exports growth has improved significantly during 2009-2012 period, rising from negative 3.75% in 2009 to a positive 6.25% in 2010 and 5% in 2011. In the first three quarters of 2012, exports of goods and services were up 6.8% on the same period of 2011.

Alas, the composition of our exports has shifted dramatically toward more services exports, as opposed to goods exports. In addition to reducing the overall level of real economic activity and employment associated with every euro worth of exports, this shift also has meant a number of changes that further divorce our external trade activity from economy. Firstly, most of employment creation in the exports-oriented services sectors, such as International Finance and ICT services, is oriented toward specialist, highly educated foreign employees, instead of domestic unemployed or underemployed individuals. Secondly, services exports are associated with greater cost (or imports) intensities as they require higher payments for patents and intellectual property, which are neither taxed in Ireland, nor are developed here. This means that while exports of services generate high revenues, much of these revenues is not captured within our economy. Thirdly, exports of services, as opposed to exports of goods, are more concentrated in a handful of giant MNCs. This fact, known as the ‘Google effect’ drives up the cost of hiring skilled workers for Irish SMEs, reduces margins at Irish enterprises, lowers investment into Irish SMEs, and actually undermines our competitiveness, rather than improving it.

In short, booming exports along the current trend can actually cost this economy its ability to sustain indigenous entrepreneurship and investment in the long run. Instead of supporting growth and recovery, the green shoots of some of our exporting activities can turn out to be super-strong weeds of the economy suffering from a classical Dutch disease where resources flow to an increasingly inefficient use in specialist sectors, exposing the society and the economy at large to future adverse shocks.

Lastly, as with other indicators, the latest data, covering only goods exports, shows that our external trade is suffering from a significant slowdown in global demand and the pharmaceutical sector patent cliff. Once again, I warned about both of these factors more than a year ago.

At the same time, on the more positive note, the ongoing US and global economic recovery should provide some support for goods exports from Ireland, especially in the areas relating to capital investment goods and equipment in months ahead.

In short, the miracle of the ‘exports-led recovery’ is simply nowhere to be seen at this point in time, despite the fact that exporting activity continues to expand and despite the fact that this activity represents the only bright spot on our economic horizon.

After five years of the greatest economic crisis in the modern history of this nation, it is time to ask our political leaders a question: at what point in time does one’s rhetoric of economic turnarounds becomes an unbearable burden to one’s political and social reputation? For the previous Government it took just under 3 years to face the music of its own making. For this Government, the clock is ticking on.

Box-out:

Having achieved a relatively underwhelming progress on restructuring the Promissory Notes of the IBRC, the Government has turned its attention in recent weeks on attempting to restructure our debts to the European sides of the Troika. However, the issue of the Promissory Notes is still an open topic. Last week at a conference in Brussels I had a chance to speak to some senior decision makers from the European Parliament and the EU Commission who unanimously voiced their concern over the potential for the ECB to alter the terms and conditions of the Irish Promissory Notes restructuring deal. ECB has two material powers to do so. Firstly, it can simply alter by a majority decision the technical aspects of the deal. Secondly, the ECB has the ultimate power to determine the overall schedule of the sales of the long-term bonds issued to replace the Promissory Notes to the private investors. This latter power is very significant. Under the current arrangement, the Central Bank of Ireland has committed to an annual schedule of minimum disposals of bonds. Based on this schedule, the cumulative long-term benefit of the deal to Ireland can be estimated in the range of Euro 4.5-6.3 billion over the 40 years horizon. Accelerating the rate of disposals by a third on average over the deal horizon can see the net gains to the Exchequer declining by more than a quarter. Hardly a confidence-inspiring outcome for the Government that put so much hype behind the deal.

22/3/2013: National Accounts 2012: Ireland - Part 3

The first post of the series covering 2012 National Accounts looked at the headline numbers for real GDP growth. 

The second post covered sectoral weights in GNP and our GDP/GNP gap.

Overall, there are two main themes in rebalancing of the economy that showed up in data so far: 

1) Increasing share of MNCs activity in GDP (and temporarily GNP), which means that the official figures for the National Accounts now even more overestimate the real economic activity in the country; and

2) Long-term falling out of Agriculture, Forestry & Fishing and Construction sectors from the economy, with Public Administration & Defence clearly showing signs of contraction, albeit at the rate that is, so far, trailing contraction in overall economy over the period 2003-2012.

In this post, let's take a look at the opportunity cost of the crisis.

Recall that relative to peak, Irish GDP is down 5.97% as of the end of 2012 and GNP is down 8.08% despite 'two years of consecutive growth' the Government is so keen on emphasising. 

Also recall that 1980-2011 average growth rates in constant prices terms were 3.58% per annum, whilst IMF forecasts consistent structural or potential growth rate is currently around 2%. Using 2% figure we can, therefore, estimate the opportunity cost of the current crisis as losses to GDP and GNP arising from the growth foregone during the crisis. Chart below illustrates:

The grand total in opportunity cost due to the crisis (note, this is not an exercise in 'blaming the Government' or providing any estimate of real or actual losses, but rather an estimate of the opportunity cost of the crisis) is:

-- EUR104.5bn of cumulated foregone GDP for 2008-2012 or per-capita EUR22,823;

-- EUR58.8bn of cumulated foregone GNP for 2008-2012 or EUR12,828 per capita

With taxes net of subsidies at 9.647% of the GDP in 2012, the above implies roughly EUR10.1bn in foregone net tax receipts or ca EUR2bn in annual receipts. Using 2008-2012 average weight of net taxes in GDP implies EUR2.4bn in foregone annual net tax receipts.

What does this mean? Aside from the massive opportunity cost of the crisis, we have a rather revealing figure on foregone tax receipts. The figure clearly suggests that even were economic activity running at the 2% growth rate since 2007 without the crisis, re-alignment of economic activity away from domestic sectors toward MNCs-dominated activities and toward MNCs-dominated services activities in particular would still result in unsustainable deficits and would still required some sort of a fiscal adjustment, thanks to our taxation system that is extremely unbalanced when it comes to supporting MNCs-focused activities.

22/3/2013: Cypriot Plan B - any better than Plan A?

So the reports are that Cyprus has a Plan B. And the outlines of the Plan - filtering through yesterday - are quite delusional.

The Plan consists of 3 main bits:

1. Split Laiki bank (see below) into a good and a bad bank. The 'bad' bank will take on deposits of over 100K and deposits under 100K (guaranteed by the State) will be shifted into 'good' bank. Other banks will be recapitalised but there are no specific as to how, when or to what levels of capital. This stage of the Plan aims to reduce the recapitalisation costs by about €2.3bn. The problems with this stage are massive, however. First: smaller depositors are more likely to run on the bank as they are less likely to have termed deposits and as their withdrawals (even under capital controls to be imposed - see below) will be less restricted than for larger depositors. In other words, the Plan B is likely to reduce stability of deposits and funding in the resulting 'good' bank. Second: while Cypriot banking system losses are currently crystallised, reducing uncertainty for any recapitalization, there is no guarantee that depositors flight will not undermine their balance sheets beyond capital injections repair. Thirdly: the new 'good' bank will have a balance sheet (again, see table below) saddled with massive exposure to ELA & ECB funding at ca 40% of the total liabilities. If associated assets move along with larger depositors, it is likely that ECB funding ratio to Assets is going to be close to 50%. How on earth can this be called a 'good' bank beats me.

2. Step two in the delirious process of Plan B repairs of the Cypriot banking system will be the creation of a sovereign wealth fund backed by state, church, central bank and pension funds 'assets'. Even 'future gas revenues' are thrown into the pot. Put simply, the fund will be a direct raid on state pension funds, state properties and enterprises and gold reserves. It will also contain a direct link to the collective psychosis induced by the crisis - the pipe dream of Cypriot 'Saudi Arabia of the Mediterranean' Republic. Honestly, folks, this crisis has taught us one thing: the quantity of hope-for oil & gas reserves in the country is directly proportional to the degree of economic / financial / fiscal insolvency of the nation. So, having set up a bogus and bizarre fund (with hodgepodge of assets and a rich dose of 'dreamin in the night' claims to assets) the state will issue 6-year bonds against these 'assets' to raise some €2.5bn. Now, what idiot is going to voluntarily buy into this fund is quite unclear at this stage, but presumably, with bond yields set at crippling levels, the fund will find some ready buyers.

3. Step 3: the remaining shortfall of €1bn is to be covered through a small deposit levy on deposits above 100K.


Laiki bank latest balance sheet summary is provided (via Global Macro Monitor) here:

It is a whooper… with Assets at EUR30.375bn the bank is over 178% of Cypriot GDP. Deposits are at 105% of GDP.

The question is whether this plan, even if acceptable to the EU and ECB, will prevent or even restrict the deposits flight once the Cypriot banking system opens up. The EU Commission is working with Cypriot Government on developing capital controls to stem outflow of funds. But there are serious questions as to whether such capital controls can be imposed in the country that is part of the common market.

Another pesky problem is whether the bonds issued by the fund in Step 2 above will count toward Government debt. Presumably, EU can allow any sort of fudge to be created (e.g. Nama SPV in Ireland) to avoid such recognition. If not, then whole Plan B is a random flop of a dead whale beached on Cypriot shores…

Third pesky issue is what happens if the Fund goes bust. With pension funds committed to it, will the Cypriot state simply default on all of its pensions obligations? deport its pensioners to Northern Cyprus? whack the remaining (I doubt there will be any) Russian 'oligarchs' once again? or invade Switzerland? The Cypriot Government attempted to dress up the Plan B as the means to avoiding hitting small savers and ordinary people with the bank levy. It so far seems like risky leveraging of ordinary retirees and future retirees to plug the very same hole that would have been created in their budgets by the deposits levy.


Meanwhile, here's the question for those reading this blog in Ireland: According to the ESCB Statures Article 14.3, the Governing Council of ECB can make a determination to shut off liquidity assistance to the national banking system only on foot of a 2/3rd majority vote. The ECB Council did announce such a move for Cyprus comes Monday. This implies that at least one peripheral state National Central Bank governor casted the vote against Cyprus. Would that have been our Patrick Honohan, one wonders, given the frequent propensity of Irish officials to kick other peripheral states in order to gain small favours from the EU/ECB?

22/3/2013: National Accounts 2012: Ireland - Part 2

The first post of the series covering 2012 National Accounts looked at the headline numbers for real GDP growth (link here).

This post covers sectoral weights in GNP and our GDP/GNP gap.

In terms of the latter, GDP/GNP gap in 2012 stood at 22.02% in favour of GDP, down from the record 25.0% in 2011, but still the third highest in 2003-2012 period. The trend remains up and latest decline in the gap clearly appears to be mean-reverting adjustment similar to the pattern established since 2005-2006.

The above suggests that over time we can expect upward movement in the gap, leading to the contraction in GNP (either in growth terms or even in levels). For example, adjusting 2012 GNP for 3-year average gap implies lower GNP by some 0.3% or EUR378mln, adjusting the same for 3-year average annual growth rates in the gap implies GNP lower by EUR3.0bn or 2%.

While the above exercises are highly stylised and should not be taken as rigorous assessments, they show clearly that volatility in our GNP induced by the MNCs transfers of profits abroad is significant and renders some of the y/y comparatives highly suspect.

Now on to sectoral contributions to the economy:

• Agriculture, Forestry & Fishing share of GNP declined from 2.4% in 2011 to 2.1% in 2012, thus falling back to where it was at the peak of the property and construction boom in 2006. This is the joint-lowest sector weight in GNP in 2003-2012 series with 2006 being another year of lowest contribution. Put simply, we have a Department out there in the Civil Service that is overseeing something that amounts to only 2.1% of the economy and not once in 2003-2012 period amounted anything more than 2.9%. In fact, 2003-2012 average contribution for the sector is just 2.53% with subsidies from EU accounting for much of that. You don't have to be a genius to see that the 'Food Island' ideal is just a pipe dream when it comes to our own production levels. We might have a larger food sector, but it is not dependent critically on our agricultural sector.
• Industry accounted for 28.4% of GNP, down from 29.3% in 2011. 2003-2012 average contribution is 30.24% which shows overall the secular decline in the sector importance. Most of this decline was driven by the collapse of Building & Construction sector which went from 9.9% share in 2004 to 1.4% share in 2012 - massive 8 years of consecutive declines. Ex-Construction, Irish industry (well, mostly MNCs) have grown in their share of GNP contribution from 24.6% in 2003 to 27% in 2012.
• Distribution, Transport & Comms sector share remained relatively static at 27.5% of GDP in 2012 compared to 27.6% in 2011 when it heir the record levels for 2003-2012 period.
• In line with the declines in overall activity, Public Administration and Defence sector posted a decrease in its share of GNP from 5.9% in 2011 to 5.5% in 2012. Still: back in 2003-2006 the sector was running at 3.9% to 4.1% and 2003-2012 average is still 5.2% - below the current running levels. 
• Other Services sector importance in GNP contribution fell back from 46.7% in 2011 to 45.2% in 2012 and the sector is now slightly behind the 46% average for 2003-2012.
• Taxes Net of Subsidies slipped further from 12.4% in 2011 to 11.8% in 2012. The 2003-2012 peak was in 2007 at 16.1%.

Thus, overall, there are two main themes in rebalancing of the economy: 

1. Increasing share of MNCs activity in GDP (and temporarily GNP), which means that the official figures for the National Accounts now even more overestimate the real economic activity in the country; and
2. Long-term falling out of Agriculture, Forestry & Fishing and Construction sectors from the economy, with Public Administration & Defence clearly showing signs of contraction, albeit at the rate that is, so far, trailing contraction in overall economy over the period 2003-2012.

21/3/2013: National Accounts 2012: Ireland - Part 1

This is the first post on the QNA data for National Accounts for 2012 released today.

In this post, let's take a look at the National Accounts in Constant Market Prices Terms for GDP disaggregation by Sector of Origin.

Top-line results:

• Agriculture, forestry and fishing sector (the 'Food Island' thingy) posted a big decline y/y in 2012 in overall activity, down from EUR3,049bn to EUR2,744bn between 2011 and 2012. The sector is now down 30.6% on peak (2005) activity and 20.4% below the 2003-2012 average level of annual activity. Sector activity is down 27.1% on 2003. In brief, this is the sector is in the fifth consecutive year of contractions. 
• Industry activity rose marginally in 2012 to EUR37.269bn from EUR 37.168bn in 2011 (up 0.27% y/y). The pace of annual increases slipped from 1.88% in 2010 to 1.76% in 2011 and to 0.27% in 2012. The sector activity is down 20.53% on peak (2004) and down 9.43% on 2003-2012 average, with sector activity now running at 17.03% below 2003 levels.
• As the sub sector of Industry, Building & Construction activity continued to decline in 2012, marking 8th consecutive year of decline since the peak in 2004. The sub-sector activity dropped to EUR1.857bn in 2012 down 7.38% on 2011 level with 2012 being the first year since 2008 when activity y/y declines were in single digits percentage terms. Needless to say, the sub-sector activity is now running 86.4% below peak levels, 72.3% below 2003-2012 average and 85.1% below 2003 levels.
• Distribution, Transport and Communications sector activity rose 3.09% y/y in 2012 to mark another year of record activity at EUR36.125bn. The rate of growth y/y was robust, but behind 3.88% recorded in 2011 and 4.7% in 2010. The sector activity is now running at 25.8% ahead of 2003-2012 average and 66.71% up on 2003 level. Good performance.
• Public Administration & Defence sector didn't do a hell of a lot over the year, posting EUR7.236bn contribution to GDP in 2012, down 4.17% y/y. This was a deeper contraction than 3.58% decline in 2011, but shallower than 5.6% drop in 2010 and 4.5% in 2009. The sector activity overall is now down 16.7% on peak (2008) and is 2.93% ahead of the 2003-2012 average, while overall activity level is up massive 34.4% on 2003 level. All in, the sector is the only other sector (in addition to Distribution, Transport & Communications) that sees its activity running ahead of 2003 levels.
• Other services (including rents) sector activity rose from EUR59.252bn in 2011 to EUR59.372bn in 2012 in constant prices terms, up 0.2%, marking the first year of growth since the peak in 2006. The sector overall performance is now 5.03% below 2003-2012 average and is 0.7% behind 2003 levels.

All in, as mentioned above, only two sectors of economy are currently (end of 2012) up on 2003 levels of activity once we control for inflation: Distribution, Transport & Communications and Public Administration & Defence.

Taxes net of Subsidies fell marginally from EUR15.769bn in 2011 to EUR15.456bn in 2012, down 1.98% y/y. The rate of decline has now accelerated once again from 1.13% in 2011, but is behind 2.65% drop in 2010. Compared to peak (2006), Taxes Net of Subsidies are down 32.9% and down 17.6% on 2003-2012 average. This category contribution to GDP is now down 15% on 2003 levels once we adjust for inflation.

Overall GDP at constant market prices rose to EUR160.214bn from EUR158.725bn in 2011 up 0.94% y/y, posting slower rate of growth than 1.43% in 2011. The GDP, adjusted for inflation now stands at 5.97% below the peak at 2007 and 1.11% below 2003-2012 average. Compared to 2003 GDP is up 4.74%.

Net Factor Income from the Rest of the World recorded another outflow from Ireland of EUR28.908bn in 2012, down on outflow of EUR31.742 bn in 2011, marking the second highest rate of annual outflows during 2003-2012 period.

Lower outflows and higher GDP helped push GNP up to EUR131.306bn in 2012 from EUR126.983bn in 2011, a rise of 3.4% y/y, reversing 2.47% decline in 2011 and up on 0.94% increase in 2010. Relative to peak (2007) GNP is now down 9.61% and GNP is down 3.41% on 2003-2012 average. Compared to 2003 the GNP stands at -0.45%.

So overall, 2012 did post growth of 0.94% on GDP side in real terms and a more robust gain of 3.4% on GNP side. However, both expanded on foot of external sectors and factors, namely marginal growth in Industry (+0.27% y/y marking big slowdown on 2011 growth), Distribution, Transport & Communications (+3.09% y/y in 2012 marking another slowdown on 2011 growth rates) and Other Services (+0.2% y/y - an improvement on contraction of -0.93% in 2011). GNP growth was also underpinned by reduced outflow of funds from multinationals abroad, which is a temporary factor, likely to be reversed once MNCs begin new investment outside Ireland.

In the next post I will cover sectoral weights and GDP/GNP gap.

18/3/2013: Irish Corporate Tax Haven in the News, Again...

As you know, I have been gradually building up a record of articles in international and Irish media detailing the tax haven nature of our (Irish) tax laws and practices when it comes to corporation tax.

Here is the link to a new article by the WSJ on the topic:
http://online.wsj.com/article/SB10001424127887324034804578348131432634740.html

And here is a link to the most recent compilation of information & articles on the topic from my blog:
http://trueeconomics.blogspot.ie/2013/02/1822013-oecd-on-corpo-tax-havens-for-g20.html

15/3/2013: IMF Assessment of the Euro Area Banking Sector Risks - part 4

This is the fourth post on today's release by the IMF of the 2013 Financial System Stability Assessment Report for European Union report, and probably last.

The first post - summarising top-line conclusion from the Technical Note on Progress with Bank Restructuring and Resolution in Europe is available here: http://trueeconomics.blogspot.ie/2013/03/1532013-imf-assessment-of-euro-area.html

The second post dealt with the Technical Note coverage of the Non-Performing Loans issues: http://trueeconomics.blogspot.ie/2013/03/1532013-imf-assessment-of-euro-area_15.html

The third part focused on the real economy side of the banking sector risks within the euro area: http://trueeconomics.blogspot.ie/2013/03/1532013-imf-assessment-of-euro-area_5878.html

And related Country Risk Survey study for Q1 2013 covering euro area banking sector risks is available here: http://trueeconomics.blogspot.ie/2013/03/1532013-irish-banks-still-second.html .


This note is focusing on the actual report itself: European Union: Financial Sector Stability Assessment.


Top-level assessment:

Per IMF: "Much has been achieved to address the recent financial crisis in Europe, but vulnerabilities remain and intensified efforts are needed across a wide front:

• "Bank balance sheet repair. Progress toward strong capital buffers needs to be secured and disclosures enhanced. To reinforce the process, selective asset quality reviews should be conducted by national authorities, coordinated at the EU level." [In Irish context, the real review should be carried out, imo, across the quality of capital claimed to be present on banks balance sheets. Rating agencies have highlighted the Ponzi-like risk scheme whereby contingent capital measures are provided by the Sovereign supports whereby neither the Sovereign, nor the banking system can actually sustain a call on capital of any appreciable volume. Asset quality reviews are also needed, as Irish banks are carrying large exposures to unsustainable and already defaulting mortgages.]
• "Fast and sustained progress toward an effective Single Supervisory Mechanism (SSM) and the banking union (BU). This is needed to anchor financial stability in the euro area (EA) and for ongoing crisis management. The European Stability Mechanism (ESM) is to take up its role to directly recapitalize banks as soon as the SSM becomes effective." [It is pretty much clear now that ESM is not going to be deployed unless significant pressure rises on Italy and/or Spain. In this context, calling for 'effective' ESM is like calling for a 'real' Santa Claus. Meanwhile, neither the SSM nor BU can be expected to become functional any time soon. The institutions behind both are yet to be defined, let alone fully legislated. And from legislation line, it's a long distance still to functionality.]

"Restoring financial stability in the EU has been a major challenge. The initial policy response to the crisis was handicapped by the absence of robust national, EU-wide and EA-wide crisis management frameworks. In a low-growth environment,
several EU countries are still struggling to regain competitiveness, fiscal sustainability, and sound private sector balance sheets. Their financial systems are facing funding pressures as a result of excessive leverage, risky business models, and an adverse feedback loop with sovereigns and the real economy."
[This is significant across a number of points. Firstly, in contrast to the European leadership claimed wisdom, the IMF clearly links banking crisis not just to sovereign crisis, but to the real economy, and these links follow not just balance sheet line, but the line of private sector debts. Secondly, the IMF clearly believes that private sector debt overhang is a core structural problem and has contagion implications across the entire system. EU leaders, even in countries heavily impacted by debt overhang, like Ireland, are solely obsessed with banks balance sheets (less) and sovereign finances (more).]

"Much has been done to address these challenges… Nevertheless, financial stability has not been assured. Recent Financial Sector Assessment Program (FSAP) assessments of individual EU member states have noted remaining vulnerabilities to:

• stresses and dislocations in wholesale funding markets; 
• a loss of market confidence in sovereign debt; 
• further downward movements in asset prices; and 
• downward shocks to growth." 

"These vulnerabilities are exacerbated by

• the high degree of concentration in the banking sector; 
• regulatory and policy uncertainty; and 
• the major gaps in the policy framework that still need to be filled."

"The SSM—while critically important––represents only one of a number of crucial steps that need to be taken to fill key gaps in the EU’s financial oversight framework.

• "As crisis tensions abate, it is important that the implicit unlimited sovereign guarantees in place for the last several years be effectively removed through affirmation and implementation of the principle that institutions with solvency problems must be resolved." [Note: in Ireland's case once again there is a departure from this principle - we are, simply put, not resolving insolvent institutions presence in the market. Instead, we are continuing to deleverage and consolidate the insolvent banking sector at the expense of its future viability and current borrowers and non-financial companies requiring credit. Resolving insolvency - especially after 4.5 years of supports - requires shutting down insolvent banks. That would de facto mean survival of the Bank of Ireland and significantly slimmed down AIB. And that's all. None else. We are far, far away from the Government even considering such an action, which means that the zombified banking sector will continue extract excessive rents out of stressed borrowers and businesses in this country for years to come all to dress up the banking sector 'stabilisation' whilst achieving no structural resolution of the crisis.]
• "The Single Resolution Mechanism (SRM) should become operational at around the same time as the SSM becomes effective. Resolution should aim to minimize costs to taxpayers, as well as to deposit insurance and resolution funds, without disrupting financial stability." [The sheer nonsense of this statement is exposed by the core EU authorities insistence that ESM will not apply retrospectively. In other words, the ESM will be a promise of a miracle cure to the dying patient contingent of the patient surviving for a number of years required to devise the cure. And the same applies to the last two points below.]
• "This should be accompanied by agreement on a time-bound roadmap to set up a single resolution authority, and common deposit guarantee scheme (DGS), with common backstops." 
• "Guidelines for the ESM to directly recapitalize banks need to be clarified as soon as possible, so that it becomes operational as soon as the SSM is effective."

So here you go, folks, per IMF, there's an ambulance to help the injured, but currently it exists only on the paper and even as such it is still pretty much unworkable. Good luck with setting up that triage, mates.

15/3/2013: IMF Assessment of the Euro Area Banking Sector Risks - part 3

This is the third post on today's release by the IMF of the 2013 Financial System Stability Assessment Report for European Union report.


The first post - summarising top-line conclusion from the Technical Note on Progress with Bank Restructuring and Resolution in Europe is available here: http://trueeconomics.blogspot.ie/2013/03/1532013-imf-assessment-of-euro-area.html

The second post dealt with the Technical Note coverage of the Non-Performing Loans issues: http://trueeconomics.blogspot.ie/2013/03/1532013-imf-assessment-of-euro-area_15.html

And related Euromoney Country Risk Survey study for Q1 2013 covering euro area banking sector risks is available here: http://trueeconomics.blogspot.ie/2013/03/1532013-irish-banks-still-second.html .

This note is focusing on the Technical Note on Financial Integration and Fragmentation in the European Union.


Let's start with a fascinating chart showing the sources of financing for the real economy in the EU compared to the US:

The scary bit here is the overall significant imbalances built in the system of financing in the EA17, compared to Denmark, and to the US:

• Thin bond markets across ALL euro area states
• Inexistent private credit markets
• Imbalanced over-reliance on bank credit
• In the case of Ireland, Netherlands, Spain, Cyprus, Portugal, Austria, Italy, Germany, Malta, Finland and Greece - mature markets were characterised with exceptionally thin or thin equity markets

And as chart below shows, euro area is also suffering from extreme over-concentration of the banking credit markets in the hands of the 'globally systemically important banks' (G-SIBs):

Per IMF: "The main EU banking systems are dominated by a set of globally systemically important banks (G-SIBs). These European G-SIBs have grown in size and importance and are highly interconnected with the rest of the global financial system (see Annex 1). Their assets more than tripled since 2000, amounting to US $27 trillion in 2010. As key players in global derivatives and cross-border interbank markets, they are also among the most interconnected GSIBs. European G-SIBs tend to be larger and more leveraged than their peers. In particular, they are very large relative to home country GDP, and in many EU countries, their size may dwarf the capacity of the home government to raise revenues."

Per footnote, this over-concentration is driven by the legacy models of banking in the euro area: "In part this is because European banks tend to follow the universal banking model, which combines a range of retail, corporate, and investment banking activities under one roof. There are some accounting differences that would make the balance sheets of the IFRS-reporting banks appear more “inflated” than the balance sheets of banks reporting under the U.S. GAAP (e.g., netting of derivative and other trading items is only rarely possible under IFRS, but netting is applied whenever counterparty netting agreements are in place under U.S. GAAP)."

Not surprisingly, banking sector stress directly links to the real economy and even more so to the sovereign positions:

And, within the real economy, the crisis is hitting the hardest the SMEs: "The deleveraging process raises concerns about a credit crunch that would particularly affect SMEs. SMEs in peripheral Europe are particularly hard hit by the deleveraging process, as deposit outflows and capital shortages at banks limit the availability and raise the cost of bank loans. Data from the European Commission and European Central Bank Survey on the Access to Finance of SMEs show that the availability of external finance from banks has decreased since 2009 while the demand for external finance has increased.

"However, there is much cross-country variation, with the availability of external finance having deteriorated markedly since 2009 in Greece and Ireland and having remained fairly stable in countries like Finland and Germany. Regression analysis suggests that the deterioration in the supply of credit to SMEs is partly driven by the financial dis-integration process, as measured by the decline in cross-border BIS claims."

Which, of course, is not surprising - Big Banks Dominance = Closer Links to the Governments and Big Business via the Social Partnership / Corporatist models for governance.

So, great stuff, Messr Kenny & Noonan - Irish banks (duopoly-modeled super-concentration with above average links to sovereigns and some of the most aggressive delveraging plans on the books within the EA17) offer as much hope of restarting lending to SMEs as that of sustaining viable rice growing industry in Sahara.


The next post will continue with my analysis of the IMF report and technical notes. Stay tuned for more later tonight.

15/3/2013: IMF Assessment of the Euro Area Banking Sector Risks - part 2

This is the second post on today's release by the IMF of the 2013 Financial System Stability Assessment Report for European Union report.

The first post - summarising top-line conclusion from the Technical Note on Progress with Bank Restructuring and Resolution in Europe is available here:


And related Euromoney Country Risk Survey study for Q1 2013 covering euro area banking sector risks is available here: http://trueeconomics.blogspot.ie/2013/03/1532013-irish-banks-still-second.html .

Some beef on the Non-Performing Loans (NPLs):

"NPLs in EU banks continue to rise, outpacing loan growth (Figure 4). Since 2007, loans to the economy have decreased by 3 percent while NPLs increased by almost 150 percent, i.e., €308 billion in absolute terms. And, this trend shows no sign of reversal, reflecting the continued macro deterioration in parts of the EU and the absence of restructuring."

"When NPLs remain on balance sheets, they absorb management capacity, and continued losses can weaken banks’ profitability. They can also foster forbearance, thereby deterring new investors by impairing transparency. In several countries, independent asset quality reviews and stress tests have facilitated a diagnosis of the quality of banks’ assets, supporting prospects for private recapitalization."

Per IMF note: NPLs have jumped from 2.6 percent in December 2007 to 8.4 percent of total loans in June 2012

Euro area periphery is worst-hit, for obvious reasons: "NPLs across EU banks differ largely, with those in the “peripheral” countries (Greece, Ireland, Italy, Portugal and Spain) witnessing the largest increases. For instance, from December 2007 to June 2012, the NPL ratio for Italy increased by 2.5 times, while in Spain, the increase was seven times (Figure 5). Ireland stands out with average NPLs of around 30 percent, followed by Hungary and Greece. However, definitions in this area remain non-harmonized and impair comparability across the EU".

Now, note that 'turned-the-corner' Ireland is in the league of its own when it comes to NPLs ratio to total loans. Taken to the average ratio of total loans to GDP, Irish NPLs must be absolutely stratospheric.


And now, onto IMF view of the NPL resolution processes in the euro area (again, italics are mine and all quotes are directly from the IMF note):

"Borrower restructuring needs to be facilitated, with legal hurdles lifted. The legal framework should facilitate the restructuring of NPLs and maximize asset recovery. In several EU countries, including Italy, Greece and Portugal, the IMF is involved in bankruptcy/insolvency law reform, including by introducing fast track restructuring tools and out-of-court restructuring process. For instance, repossession of the collateral backing a retail mortgage may take several years in Italy versus few months in Scandinavia and United Kingdom. The asset recovery process is also very prolonged in many EEE countries."

[Do note absence of IMF input in the case of Ireland and that is a general gist of the Note - it simply passes no assessment of the Irish personal insolvency regime 'reforms', which is strange given the prominence of these reforms and the fact that these are the first comprehensive reforms in the euro area periphery. Personally, I read this lack of analysis as the IMF reluctance to endorse the Irish Government approach to the NPLs resolution when it relates to mortgages.]

"An efficient framework for handling NPLs is key to rehabilitate viable borrowers and provide the exit of non-viable borrowers."

[Note the IMF emphasis on rehabilitating viable borrowers AND providing the exit for non-viable borrowers. These twin objectives strike contrast with the Irish Government approach to resolving the personal insolvencies and mortgages crises. Instead of rehabilitating viable borrowers, the Irish Government is pursuing an approach of giving the banks full power to avoid any writedowns of the loans, even when such writedowns can define the difference between rehabilitation and insolvency. When it comes to providing exit for non-viable borrowers, the Irish Government has adopted the approach of reforming the personal insolvency regime from 12 years bankruptcy duration to 3 years, but then extended the process of availing of the bankruptcy from few months to up to 3 years. The pre-bankruptcy period of up to 3 years under the new regime is a period during which the banks have full power to extract all resources out of the households with little protection for the household, in contrast with the previous bankruptcy regime. Thus, in terms of life-cycle financial health, Irish households going through the new reformed personal insolvency process are unlikely to gain any meaningful relief compared to the previous regime.]

"Active management of NPLs is needed. In principle, NPLs can either be:

1. retained and managed by banks themselves at appropriately written-down values, while the banks receive financial assistance from the government for recapitalization; or
2. relocated or sold to one or more decentralized “bad banks,” loan recovery companies, or Asset Management Companies (AMCs) that specialize in the management of impaired assets; 
3. sold to a centralized AMC set up for public policy purposes (possibly when the size of NPLs reaches systemic proportions)."

IMF also notes that: "The European Banking Coordination “Vienna” Initiative (2012) in a working group focused on NPL issues in Central, Eastern and Southeastern Europe. Recommendations, among others, focused on establishing a conducive legal framework for NPL resolution, removing tax impediments and regulatory obstacles, as well as enabling out-of-court settlements."


Stay tuned for the third and subsequent posts covering other technical notes released by the IMF.

15/3/2013: IMF Assessment of the Euro Area Banking Sector Risks - part 1

Today's releases of the horror flicks starring Irish financial sector are up and running, folks.

As noted in the previous note - premiering Q1 2013 article on euro area banking sector analysis from Euromoney Country Risk surveys (link: http://trueeconomics.blogspot.ie/2013/03/1532013-irish-banks-still-second.html) - the IMF has released today 2013 Financial System Stability Assessment Report for European Union report.


This is the first blog post on the report and associated technical papers, and it covers the Technical Note on Progress with Bank Restructuring and Resolution in Europe.


From the top-line conclusions by the IMF (all quotes marked, italics within quotes are mine):

1. "The European Union (EU) banking system restructuring is under way, but is far from complete. Some bank restructuring has started, and the level Tier 1 capital ratios of EU banks have been substantially increased."
2. "But system-wide, capital ratios have been met partly by deleveraging or recalibrations of the risk weights on activities."
3. "Consolidation in the banking sector has been slow, with banks rarely closed."
4. "Nonperforming loans are building up in banks’ balance sheets, and addiction to central bank liquidity remains high especially for banks in peripheral countries."
5. "Despite the EBA recapitalization exercise having led to €200 billion of new capital or reduction of capital needs by European banks, fresh capital is difficult to attract in an environment where prospects for profitability are uncertain."
6. "Several hurdles impair restructuring and resolution in Europe, and urgent progress needs to be made:

• "First, EU bank resolution tools need to be strengthened, aligning them with the Financial Stability Board Key Attributes for Effective Resolution. Fast adoption of the EU resolution directive is welcome, but enhancements are warranted. Swift transposition should follow." [We are still ages away from having any effective resolution tools and any sort of functional regulatory consolidation, let alone functional and effective supervisory consolidation.]
• "Second, restructuring of nonperforming loans (NPLs) should be facilitated [more on this below]. The legal framework should not slow down restructuring and maximize asset recovery. In several EU countries, such as Italy, Greece and in Eastern Europe, bankruptcy reforms lag behind in that, for instance, current practice does not allow the seizure of collateral in a reasonable timeframe. Banks should also manage more actively their NPLs, possibly allowing a market for distress assets to emerge in Europe." [Note the absence of Ireland in the list of laggards above. It is generally strange that the IMF is avoiding passing any judgement on the only case of actual reforms that has impacted only one of the peripheral countries.] 
• "Third, further evolution of the General Directorate for Competition’s (DG COMP) practices will be needed in systemic cases to ensure consistency with a country’s macro-financial framework and support viability of weak banks, recovery of market access, and credit provision. Increased transparency would give added credibility and accountability." [Again, we are ages away from delivering on these.]
• "Fourth, disclosure should be significantly enhanced and harmonized by the EBA, to restore market confidence. In particular, interpretable metrics regarding the quality of banks’ assets, in terms of NPLs, collateral, probability of defaults (PD) and loan recovery rates (LGD) are key for assessing the strength of banks and restoring confidence in the banking system." [see comment above]

Summary: what needs to be done is, largely, nowhere to be seen, yet...

Update:


And when it comes to much of hope of the forthcoming regulatory changes altering the status quo of the dysfunctional regulatory system, don't hold your breath, folks.

The Big Hope is on the forthcoming EU resolution directive aiming to create coordinated system of responses to any future structural financial crises. Here's IMF view on that one:

• First, polite stuff: "A critical new EU resolution directive is in preparation. As a national approach to resolution may well not be appropriate in the EU given the importance of cross-border banking, and the failure of existing cross-country coordination mechanisms, the European Commission (EC) has taken steps to harmonize and strengthen domestic resolution regimes. This should help avoid regulatory arbitrage and make orderly resolution effective and efficient for cross-border banks. In June 2012, the Commission issued a draft directive for harmonized crisis management and resolution framework in all EU countries. The Irish Presidency will make the adoption of the resolution framework a top priority and plans to adopt it during the first part of 2013. The new national resolution regimes endow EU countries with strong early intervention powers and resolution tools. The transposition of the directive into national laws should be accelerated relative to the current deadlines (01/2015, and 01/2018 for bail-ins)."

I wrote about this Directive recently (http://trueeconomics.blogspot.ie/2013/02/2422013-eus-banking-union-plan-can.html) and was not too enthusiastic. Alas, here's IMF's less pleasing assessment, although dressed up in polite language of 'suggestions':

• "Box 1. Proposed Resolution Directive––Risks and Areas for Enhancements

1. Resolution of banks is undermined by the absence of a more effective EU-wide framework to fund resolution. Binding mediation powers for the EBA and mutual borrowing arrangements between national funds face inherent constraints (in particular, the EBA cannot impinge on the fiscal responsibilities of EU member states).
2. Passage of the directive will substantially enhance the range of tools available to resolution agencies in the EU. But the scope of the directive should be widened to include systemic insurance companies and financial market infrastructures. The European Commission launched a consultation at the end of 2012 on this issue. All banks should be subject to the regime, without the possibility of ordinary corporate insolvency proceedings.
3. The breadth and timing of the triggers for resolution should be enhanced by providing the authority with sufficient flexibility to determine the non-viability of the financial institution (including breaches of liquidity requirements and other serious regulatory failings, not just capital/asset shortfalls). There should be provision for mandatory intervention in the event a specified solvency trigger is crossed.
4. The directive affords less flexibility for using certain resolution powers than the key attributes. For instance, it does not permit exercising the mandatory recapitalization power and the asset separation tool on a standalone basis. Also, bail-in safeguards should not prevent departure from pari passu treatment where necessary on grounds of financial stability or to maximize value for creditors as a whole.
5. Depositor preference should be established for insured depositors2, with the right of subrogation for the DGS."

Thus, to sum up the best-hope response of the EU - it is useless, largely toothless and predominantly weak. And to add to this - it will only be fully functions in 2018! You might as well think we live in a Natural History museum, where urgency of response is differentiated by months, rather than minutes.




Next post will cover the issue of Non-Performing Loans.

15/3/2013: Irish banks - still the second sickest of the sick euro area banking sector

In anticipation of the today's release (16:00 GMT) by the IMF of the 2013 Financial System Stability Assessment Report for European Union, Euromoney Country Risk analysts have published an interesting article Country Risk: Five years on, banks still inflict chronic pain on eurozone. Here are some of the very insightful charts - including an update on the previously covered banks stability scores (see here for January 2013 post and here for Q3 2012 data).

Let's start with the aforementioned chart on banks stability scores:

Pretty poor showing here for Ireland. Unlike the rest of the economy, we clearly have not 'decoupled' from the peripherals in terms of banking sector health and that is given:

1. Unprecedented and incomparable by the rest of the EZ standards levels of support for banks in Ireland;
2. Lack of any progress on mortgages crisis; and
3. Longer duration of the banking crisis in Ireland than in any other peripheral state.

We had the second weakest banking sector in the EZ throughout 2011-2012 and we still do. So much for the theory that Irish banks are 'lending into the economy' or 'have been repaired' and so much real support for the body of economic knowledge that says the deeper the debt overhang crisis, the longer and the deeper the required deleveraging crisis...

Now, something that shows that despite the consensus in Ireland and in the bonds markets, we are not quite due an upgrade as risks are still favouring continuation of the banking crisis (note, my view is that we are due an upgrade, but a single notch one, to reflect economic decoupling from the peripherals):

And the sovereign-banks links? Well, they are still there and still nasty for Ireland:

And here are few sobering words from the ECR:

"While some observers might still be convinced the worst of the banking crisis is over, the [Euromoney’s Country Risk] survey provides compelling evidence that bank stability risks are as concerning, if not worse now, for many European countries than at the beginning of last year, according to its contributing experts. More than five years on from the catastrophic events of 2007/08, the resolution of the region’s banking sector problems is still firmly at the top of policymakers’ to-do list, but with plans seemingly stalling, the implications of failing to act could prove critical."

Just in case you are in the 'green jersey' 'we've-turned-the-corner' camp, here's ECR quote putting Irish gains in the above scores into perspective:

"Across the eurozone, bank stability risks were unchanged last year in four countries – Austria, Belgium, Cyprus and Slovakia; with Cyprus the lowest of the group – and improved in four more: Malta, Italy, Ireland and Portugal. However, for the latter three, the rebounds were small and their scores remained at low levels of 5.5, 4.3 and 3.3 out of 10 respectively, illustrating heightened levels of risk."

So how bad are things in the euro periphery and in Ireland? Well:  "And the banks are just as problematic across the periphery. Taken as a whole, the seven riskiest eurozone countries (Greece, Portugal, Spain, Ireland, Italy, Cyprus and Slovenia) had an average bank stability score below that of most other regions, worse even than Mena or Latin America – see chart (below)." Keep in mind, that is for the average and Ireland is way worse than the average.

So next time you see Irish 'banks' adds claiming they are 'open for business' and 'doing our bit to help the economy' etc, just check these charts once again. They are, by all international comparatives, graveyard zombies, still holding this island at ransom.

14/03/2013: Irish Construction & Building Sector Activity 2012

Latest index for Irish Building and Construction Production volumes and value is out today, confirming what I wrote about on the foot of new planning permissions data (here), namely that Construction and Building sector continued to shrink in 2012 and there is little hope beyond some public spending projects uptick for the already devastated sector.

Top headline numbers for full year 2012 (these are imputed from Q1-Q4 2012 data):

• Value index for all production activity in Building and Construction sector declined from 25.9 in 2011 to 24.7 in 2012 (using base of 2005=100). This means all activity in value terms has hit another historical low for the series and is running at less than 1/2 of the level of activity in 2000 when the index was reading 53.5.
• 2012 was the sixth consecutive year of declines in the sector activity by value and volume. 
• Peak sector activity was registered in 2006 with index reading of 109.7, which implies a decline from peak through 2012 of 77.5% in value terms.
• Value sub-index for Building excluding Civil Engineering has dropped from 20.9 to 18.2 between 2011 and 2012 (decline of 12.8% y/y) and is down 83.2% on peak attained in 2006.
• Residential Building value sub-index is down to 8.6 in 2012 from 10.2 in 2011, marking a decline of 92% on peak (2006).
• Non-residential building sub-index for value is down to 55.2 from 61.7 in 2011 and is 53.9% below peak levels attained in 2008.
• Civil engineering value sub-index was up in 2012 to 66.0 from 58.6 in 2011 (+12.6% y/y) but is down 49.3% on peak attained back in 2007. 

Similar story is traceable across the volume of production indices.

Charts to illustrate (note, charts are referencing a different base - instead of 2005=100 these have been rebased to 2000=100 for more clear compounded effect illustration):