Economics 13/12/2009: Nothing exceptional

Last couple of weeks, there have been some pretty severe news flowing from the Irish economy and Irish banks. Is the current bear market in Irish banks shares a temporary adjustment / profit taking or is it a long overdue fundamentals-driven correction?

Here are few charts and my view of the story.
The general trend, per chart above, has been down since 2007 peaks, but also - convergence of the two banks to the same trading range. By 2009 beginning, the investors were no longer willing to significantly distinguish between BofI and AIB shares, preferring to treat them as a single sick puppy, rather than two different banks with different management styles, business models and investment exposures.
And guess what - they still do. The entire 2009 trading was still based on the story of Irish Banks, rather than individual stories of AIB and BofI. Now, over a short period of time, say during general market panic, this can be explained by a temporary loss of fundamentals clarity, implying that investors might see both banks as being the same. We are no longer in this period, as global markets willingness to take risks has improved significantly in H2 2009. But the same markets that are now willing to differentiate Goldman Sachs from Bank of America are still unwilling to differentiate AIB from BofI.

Another interesting feature of the data is that Nama effect (a positive push for shares of AIB and BofI) has now been fully exhausted. And this is pretty impressive - we approve €54bn in funds, nearly bankrupting the entire economy, and in return we get the markets sending banks' share price back to where they were in May 2009, prior to the Nama approval.

So in terms of absolute prices, neither Nama, nor the latest Budget, seem to be working. But what about the risks in actual trading positions on the banks?
Well, if anything intraday volatility in AIB is down, not up, in the last 12 months. And that shows once again that the markets are not buying into AIB story. There is now less heterogeneity in investors' assessment of AIB value proposition than before:The same is true for BofI:The same story for a broader IFIN index

And there is nothing out of the ordinary in terms of volumes either:
Still relatively heavy, but not as heavy as in late 2008 - early 2009.

But now look as spreads (high-low) and monthly volatility: calmer, much calmer seas than over 2008. Again, no panic - just calm and measured trading here.
One can't really say here that investors are treating Irish banks shares in some idiosyncratic way, with an abnormally high sensitivity to risk. There is actually much less sensitivity to risk in the markets today than in 2008 and even 2007. So the current bear trend in Irish banks shares is driven by the markets assessment of fundamentals. In other words, markets are doing the job - spotting the 'dog' and pricing it down...
Any doubt? The above chart confirms that there is no abnormally heightened sensitivity to risk when it comes to AIB and BofI shares. The only outline events of 2009 in these shares relate to the bear rally that has just ended. The downtrend, therefore, is the norm.

Economics 09/12/2009: Budget 2010 - first shot at numbers

I will be blogging on the Budget 2010 over the next few days, but here is the main point:

The Budget did not deliver a significant adjustment to our structural deficit.

1. Claimed adjustments to the deficit totaling €3,090 million on current expenditure side and €961 million on capital side. These are gross figures which imply that we can expect net adjustments of ca €2,600 and €800 million each to the total deficit reduction of no more than €3,400.
2. Per table below, the Exchequer deficit will likely stand at €21,400 million in 2010 and not anywhere near the projected deficit of €17,760 million.
3. Stabilization of deficit is not happening on a significant downside, but in a marginal fashion, which is simply not good enough.

The main conclusion here is that the Budget has not gone far enough in reducing the structural deficit. There is another €10-12 billion worth of cuts looming for 2011-2012. It would be dangerous to assume that this can be corrected for through re-jigging tax system in 2011 as Minister Lenihan appears to imply.

At this junction, I simply cannot see how the Budget delivered anything more than a breathing period for Ireland before we resume our slide toward Greece. 12.4% deficit before we factor in demand for capital from Irish banks is just not enough. Full stop.

The Minister is now talking about €3 billion cut in 2011, then €5 billion cut in 2012-2013. This implies that from next year's standing position we are looking at a deficit of well over €9-13 billion in 2014. Assuming economy grows at a robust 2.5% every year from 2011 through 2014, this would imply a deficit of 4.9-7% of GDP - way long of the SGP-required 3%. If economy grows at even briskier pace of 3% per annum over the same period, the resultant deficit will be around 4.8-6.9%. Again, not much of a fit for our promises to the EU...

Economics 08/12/2009: Irish businesses ICT use

Per CSO release yesterday: “in 2009, 95% of all enterprises had a computer connected to the internet while 66% had a website or homepage. Access to the internet using broadband remained high in 2009 with 84% of all enterprises having a broadband connection. High-speed DSL broadband was used by 45% of enterprises compared with 41% in 2008. The use of mobile broadband reached a level of 27% in 2009 compared with 24% in 2008. As a consequence there has been a decline in the use of lower-speed DSL broadband and other fixed connections (e.g. cable, leased line etc).”

Sounds good? Well, actually… More detailed data shows the following worrisome trends:

• Use of computers has actually fallen from 98% of enterprises surveyed in 2008 to 97% in 2009. It has remained static at 98% in Manufacturing sector, fallen from 99% to 96% in Construction sector (possibly a function of inactive enterprises, or in the opposite direction – a surprising result if the survivourship bias applies to the sample). In Services sector there was a decline from 98% to 97% between 2008 and 2009. These results are rather strange. On one hand, if the sample included inactive firms, then one can expect the declines due to companies folding operations in Construction and lower value-added Services sectors. But if only actively trading firms were included, then this suggests that survivourship bias was actually selecting against the ICT-using firms for some unexplainable reason.

• Interestingly, the proportion of firms with a written ICT strategy has increase overall from 20% in 2008 to 21% in 2009, and in no sub-sector was there a decline in proportion. Construction sector firms led here with an increase from 8% in 2008 to 11% in 2009, which suggests that CSO sample incorporates survivourship bias. And this is really bizarre – on one hand, sample selection clearly favoured surviving firms that have ICT policies, but on the other hand the same sample favoured survivor firms with lower penetration of ICT… Hmmm…

• Proportion of firms using internet fell from 96% to 95% between 2008 and 2009. The declines were showing in all three broader sectors, with Construction firms registering the largest drop from 99% to 96%. This is again inconsistent with survivourship bias apparently present in the data. But even more strange were the results for the percentages of firms having their own websites. In Manufacturing, the number of firms with their own websites rose strongly from 72% a year ago to 77% in 2009. In Construction sector, surviving firms actually dramatically increased their websites presence from 48% to 58% despite having shown a decline in internet use in general. There was a decline in proportion of companies with their websites in Services sector – from 65% to 64%.

• Overall use of e-services (interfacing either with the public sector or private sector clients) has declined across the board except for Manufacturing sector.

• E-commerce is growing strongly with percentages of purchases and sales via e-commerce pathways as a share of total purchase costs and turnover, respectively, rose strongly between 2008 and 2009. But as in 2008, most of e-Commerce appears to be driven by purchases, not sales. And in volumes, e-Commerce has declined in line with overall economic activities. There is only tentative evidence that e-Commerce has taken up some of the traditional purchasing and sales activities share during this recession.

• Another interesting and surprising feature of the data shows that enterprises with access to broadband have reduced their e-Commerce-based purchases from 60% to 54%, and also reduced their e-Commerce-based sales from 28% to 23%. Enterprises with no connection to broadband have lowered their purchases via e-Commerce vehicles from 29% to 24% and their sales from 14% to 9%. This seem to show that access to broadband does not result in more resilience to the recessionary contraction in enterprise activities. But, enterprises with broadband connection have retained their propensity to employ workers who e-work at 37%, while enterprises with no broadband connection have increased this share from 9% to 10%. Rising workforce mobility and flexibility for those with no broadband connection while static workforce mobility / flexibility for those with broadband connection? Clearly this can’t be happening…

Economics 06/12/2009: Replacement rates for Irish social welfare payments

Department of Finance has published (unnoticed by most) its estimates of the replacement rates for Irish Social Welfare system. Per DofF, any replacement rate in excess of 70% is problematic, as it creates significant disincentive for the recipients to seek reentry into the labour force. Well, yes. I agree.

However, what DofF fails to recognize in its estimates is the fact that welfare recipients avail themselves of free healthcare (medical cards) and subsidized drugs scheme, plus, having no jobs to attend to, they do not have to spend a penny on childcare.

I have updated the DofF own estimates to reflect these costs wherever they apply and this is reflected in the table below which also reproduces DofF own estimates.

Effective wage in my estimates refers to the earnings that must be attained in the workplace in order to supply the same level of real income as provided by social welfare. My estimate is based on DofF replacement rate estimates, plus additional benefits as outlined in the footnote.
Telling picture. For a country with average income of ca €25,000 per capita, we are talking about virtually all groups of welfare recipients, case-studied by DofF, getting more on welfare than in average employment.

Red-bold cases are clear welfare traps with replacement income in excess of 70% relative to reference group.

Economics 05/12.2009: Budget 2010 Estimates

The Department of Finance has published estimates of income and expenditure for next year on Friday. These form the DofF outlook for 2010 before incorporating any Budget 2010 changes.

The format in which the estimates are published is such that one cannot operate standard Adobe pdf features and requires by-hand copying of data in order to transpose the table into the Excel or any other database. One can only speculate why this is done by DofF, but any economist out there can probably wish that someone obliges the DofF to start publishing things in modern documentary formats and provide separate excel files suitable for analysis.

So here is the data with my own parallel estimates. As with DofF, my estimates do not include any promised or signaled ‘savings’ and ‘tax increases’ that might be announced in the Budget 2010.

The main table:
The above shows that DofF projects a rise in current spending next year of over €5bn, (higher social welfare and debt service costs). My projection is for a rise of under €6bn (because of even higher social welfare costs, plus an increase debt-raising fees, but no difference on DofF’s estimate of debt financing cost). Details are, of course, to follow below.

So what do these estimates (My v DofF) suggest:

• On Current Receipts side, tax revenue differences are explained below, as are non-tax revenue differences, all in these allow for some €2.4bn discrepancy between my estimates and DofF estimates;
• On Current Expenditure side, my view is that net voted expenditure is underestimated by DofF, primarily in terms of social welfare increases and some crime-related increases (I believe we will see growing number of criminal convictions for acts against property), plus the Government is underestimating the scale of costs which will be involved in dealing with households defaulting on mortgages and going to courts against the banks. I also think the Government has no idea just how expensive litigation relating to Nama will be;
• So deficit on Current Account is much wider – by €2.6bn;
• On Capital account (see below) the main difference is driven by my view that Anglo will require €2bn in 2010 and that other banks will also swallow the same amount via NPRF ‘investment’ or something of the sorts. This is atop the similar spending via Nama issuance of new own bonds;
• So deficit on Capital Account is now €5.7bn wider in my case than in the case of DofF estimates.
• Net effect, Exchequer balance is, in my view, heading for a deficit of €30.4bn in 2010, up on €25.3bn in 2009 and up on DofF estimate of €21.9bn for 2010. Do tell me if you think things will improve so significantly on 2009 once January 2010 arrives as to justify DofF’s optimism.
  

Receipts side:
The differences between my and DofF estimates come from my view that:

• shopping to Northern Ireland will not decelerate, assuming no change in our VAT relative to UK and no changes in the FX rate
• no redundancy payments windfall and lower self-employment taxes will mean lower income tax
• MNCs transfer pricing will slow down due to investment by MNCs outside Ireland picking up
• lower deposits with CB will arise due to lower loans levels, depressing CB income
• lower dividends activity due to semi-states slowdown and arrears build up;
• lower pay out under Guarantee scheme due to creation of the Third Force, decline in banks returns on loans and Anglo fall-off.
  

All in, total Tax and non-Tax revenue will be lower by €1,039mln and €571mln respectivel

Next, let’s look at the detailed expenditure lines as stipulated above.
My main concerns (driving the differences to DofF estimates) are:

• Social welfare costs will be much higher due to transition to welfare from long-term unemployment;
• DETE will be more involved in artificially creating ‘training’ jobs for unemployed;
• Health will also see increases in costs due to welfare cost rising;
• All organizations dealing with crime will experience an increase in costs due to rising number of crimes against property;
• Internal public sector employment conflicts will be driving costs of arbitration and conflicts resolutions;
• Rising numbers of households insolvencies will be pushing up courts and related costs;
• Costs of Nama and Banks supervision/oversight will also rise, etc.
  

Net impact, I expect costs to rise by €1.1bn more than DofF does.

Details of non-voted current expenditure below:
No major differences here between mine and DofF estimates. Unlike in the case of non-voted capital expenditure:

Of course, this table incorporates my view that Anglo and other banks will swallow some €4bn in 2010 in new capital. This already assumes that most of the funding for other banks will come via Nama issuing new Nama-own bonds that the Government will attempt to keep off its own balancesheet. Of course, this is a bogus accountancy trick, but let us entertain it as the Government insists we should.

This pretty much finishes my analysis of the Exchequer estimates. If the Government does not attempt to dramatically reduce its own spending in the next Budget, we might see our annual deficit rising to over 16% of GDP. Even if DofF is correct and the deficit will be 13.5%, this does not change the bleak reality that some 9% of this figure is a purely structural deficit. In other words, no matter what, we will have to shave off ca €15.4bn worth of spending in the next 2-3 years. No other way about it.

Economics 01/12/2009: A real breakthrough of Mr Cowen

So per latest reports, the nation is saved. Facing a systemic deficit of €14bn per annum, the leaders of the Social Partnership have been contemplating a dramatic reduction in the cost of Government business. The dramatic news from the Government buildings, suggested a pay cut for public sector workers of 5% gross, or less than 3% net, delivering something to the tune of €836mln in gross savings (as claimed by the unions). Which, of course, will be clawed back to less than €600mln through automatic stabilizers (taxes on earnings paid through taxes and so on - per reported estimates by the DofF). For a moment, it all looked like our Taoiseach Brian Cowen reigned over the business-as-usual at the Partnership Table.

Credit for derailing this 'savings' deal goes to the public outcry, the media, a handful of backbenchers, the Department of Finance and also to Brian Lenihan - all of whom have managed to restore our policy back to senses. The numbers bandied around by the unions' heads were simply not adding up.

For a moment - it all looked like:
As one fellow economist described the 'New Deal' to me: “a Dora the Explorer bandaid on a shark bite”. Optimist he is – more like a prehistoric shark bite, judging by its gaping size.

Now recall, Brian Lenihan has promised three things to the nation and the EU:

1. cut €4bn in deficit this year and the same next;
2. no new taxes (except for carbon tax and, may be, higher taxes on the so-called 'rich');
3. cut €1.3bn in public sector spending
   

As long as the talks with the Partners are dragging on, this is becoming an impossible trinity of policy objectives. Will Joseph Brodsky's ending for his Elegy serve as a perfect descriptor of the Government's real legacy in the history of Ireland?

... And it says on the plinth
'commander in chief'. But it reads 'in grief', or 'in brief'
or 'in going under'.

Oh, and one last thingy - if you think that €600mln in 'savings' ever had a chance of materialising, think of public sector workers taking a 14-day holiday who will have an option to do agency work to replace their own jobs... earning a nice tidy premium...