This is an unedited version of my column in the Village Magazine for February 2015
January IMF review
of the economic situation in Ireland rained a heavy dose of icy water over the already
overheating Government spin machine, and much of the IMF concerns centre around
exactly the same themes that were highlighted in these very pages last month.
Top of the IMF
worries list is growth.
Budget 2015
assumed GDP expansion of 3.9 percent in 2015, with 3.4 percent average growth from
2016 through 2018. The IMF forecasts growth of 3.3 percent in 2015, 2.8 percent
in 2016 and “about 2.5 percent thereafter”. In simple terms, over 2015-2018,
cumulative growth forecast discrepancy between IMF and the Government is now
just shy of 3.3 percent. Put differently, based on IMF forecasts, Irish
Government may be significantly overestimating economic prospects of the
country.
Source: IMF and Department of Finance
The drivers behind
IMF’s skeptical view of our prospects are exactly in line with those discussed
in this column before. Exports growth is likely to be much shallower than the
Government anticipates, while the domestic demand is still subject to massive
debt overhang carried by households and companies.
As an aside, the
IMF assessment of the Budget 2015 measures is far from confirming the
mainstream Irish media and Irish Left’s view. The IMF had this to say about the
measures: “Income tax cuts that increase the already strong
progressivity of the system are the main items. While not significant to the
revenue intake, reductions in property taxes by 14 local authorities, including
Dublin, are a setback for collections from this recent broadening of the tax
base.” Doing away with the tax breaks is fine, if it is done in the environment
of falling distortionary taxes. Still, coupled with elimination of the property
capital gains relief, the entire Budget 2015 was hardly a transfer from the
poor to the rich, but rather a net tax increase on the upper earners,
especially the self-employed professionals, relative to lower waged.
But back to the
impact of growth risks on our Government’s balance sheet. Consider the IMF
estimates for public debt dynamics.
Firstly, note that
public debt fell from 123 percent of GDP in 2013 to 111 percent of GDP at the
end of 2014. Impressive as this change might be, it is driven by one-off
changes and not by any significant debt drawdowns. Consolidation of the IBRC
into General Government accounts and its subsequent liquidation first pushed
Irish Government debt up by 6.2 percent of GDP (EUR12.6 billion) in 2013 and then
cancelled most of the same in 2014. All in, IBRC liquidation shaved off 6
percentage points off our 2014 debt to GDP ratio. In between, change in the EU
accounting rules raised our 2013 GDP by 6.5 percent. Stronger economic
conditions and smooth exit from the Troika Programme have meant that the Irish
Government was free to spend some of the borrowed cash reserves on buying out
IBRC-linked bonds held in the Central Bank. This drawdown of previously
borrowed cash contributed to some 4 percentage points drop in Irish debt to GDP
ratio. For all the Government’s bravado, last year’s economic recovery
contributed only 1.75 percentage points to the debt decline or roughly one
sixth of the overall improvement.
Still, barring
adverse shocks, we remain, for now, on course to drive debt to GDP ratio below
100 percent of GDP before the end of 2019.
As IMF notes, however,
a temporary drop of 2 percentage points in 2015-2016 forecast nominal GDP
growth rates would push our debt to GDP ratio to 117 percent in 2016. And on
the balance side, a one percent rise in primary spending by the Government can
push public deficit to 3.6 percent of GDP in 2015 and 3.0 percent in 2016
instead of Government projected 2.7 percent and 1.8 percent, respectively.
The IMF is
concerned that the Irish Government is suffering from the ‘adjustment fatigue’,
especially once the upcoming political pressures of the general election start
looming on the horizon. The danger is that “…medium-term
fiscal consolidation is at risk from spending pressures, requiring the adoption
of a clear strategy to enable the restraint envisaged to be realized. … As the
public investment budget is already low, current expenditures will have to bear
the brunt of spending restraint, while ensuring the capacity to meet demands
for health and education services from rising child and elderly populations.
Nominal public sector wages and social benefits must be held flat for as long
as feasible and the authorities will need to continue to seek savings across
the budget.”
Somewhat predictably, the Irish authorities offered no
strategy for fiscal management beyond 2015 and no expenditure policy solutions
that can address such risks. Instead of sticking to promised costs moderation,
the authorities told the IMF that increased current spending, including on
higher public sector wages, can be offset by “discretionary revenue measures”.
In other words, should the Government want to fund pre-election giveaways to
its preferred social partners (aka public sector wage earners) it can simply
hike taxes on less favoured groups. A slip of the veil revealing the ugly
nature of our politics-captured economic strategy.
Politics is now firmly displacing economics in both, the way
we set our forecasts, as well as interpret the existent data.
Take, for example our reported nearly 5 percent growth over
2014. Various recent ministerial statements extoled the virtues of the
Government that made Ireland “the envy of Germany” as the best performing
economy in Europe. Largely ignored in the official rhetoric was that much of
this growth came from the “contract manufacturing outside Ireland that is
dominated by a few companies”. The problem is that none of it has any real
connection to Ireland and, as IMF notes, much of it “could quickly turn”.
Private domestic demand,
excluding
aircraft leasing and investment in tech services-linked intangibles
rose
by closer to 3 percent. Again, according to the IMF this figure may be a more
realistic estimate of the real recovery. In other words, somewhere between 30
and 40 percent of the recorded growth in 2014 was down to just one an
accounting trick. And multinationals had plenty other accounting tricks up
their sleeves that no one is bothering to count.
Even the 3 percent domestic growth estimate stands inconsistent
with the data on household finances. Stripping out gains in household net worth
attributable to the property markets, households’ financial positions hardly
improved in 2014. Mortgages in arrears accounted for 23.7 percent of all house
loans outstanding, when measured by the balance of loans, down from 25.6
percent a year ago. Based on the Central Bank data, at the end of Q3 2014, some
244,816 mortgages accounts (amounting to EUR46.1 billion) were either in
arrears, in repossession, or at risk of arrears – a number that is roughly
4,500 higher than a year ago. Based on the Department of Finance data, 85
percent of all accounts in arrears ‘permanently restructured’ at the end of
November 2014 involved arrears solutions that result in higher debt over the
life time of mortgage than prior to restructuring.
Based on the Central Bank data, Q3 2014 household deposits
in the Irish banking system stood at EUR85.9 billion, slightly down on EUR86.0
billion a year ago.
In part, the above
figures translate into the improvement in banking sector performance at the
expense of households. In the first half of 2014, Irish banks recorded their
first positive return on assets since the beginning of the crisis, and the net
interest margin (the difference between the bank lending rate and the cost of
funding) rose to a crisis-period high of 1.5 percent. But credit growth
remained negative, contracting at a rate higher than in 2011. Put this in
simple terms, the banks continued to bleed their clients dry at a faster rate
than the recovery was making them stronger, and there was preciously little
observable improvement in households’ financial positions compared to 2013.
Certainly not enough to claim the picture to be consistent with rapid economic
growth.
The IMF isn’t
undiplomatic enough to say that, but the Fund is clearly concerned more than
the Irish authorities at this state of imbalances. As they should be: the
Central Bank internal stress-testing for new mortgages being issued by the
banks today is for the interest rates rising to over 6-6.5 percent over the
life time of the loan.
Of course, the
Central Bank is a myopic institution when it comes to telling us what effects
such rates would have on existent corporate and household loans. But give it a
thought. Currently, average existent mortgage on the market is priced at
interest rates below 2 percent per annum. And with that, 17.3 percent of all
mortgages accounts are officially in arrears, and 34.3 percent of all balances
relating to mortgages loans are either in arrears, in repossessions or
restructured.
Should the
interest rates double, let alone triple, what mortgages default rates on
currently performing mortgages can we expect? What amount of economic growth do
we need to shore up our household finances sufficiently enough to escape the
interest rate squeeze that even the Central Bank admits might arrive in the
foreseeable future? Can the current trends in the recovery – the ones that are
leaving households out in the cold, while superficially inflating official GDP
figures – deliver any sense of sustainability of our economic performance
across the financial, fiscal and economic areas in this country should even
mild shocks take place?
One can only
wonder as to the answers to these questions, as well as to the silence of our
authorities on these topics.
