Economics 16/05/2010: IMF on fiscal stability III

Continuing with IMF data on Fiscal Stability (see earlier posts here and here), tables below detail Irish public spending breakdown between payment to Public Sector employees, Social Welfare, Capital and Current expenditure heads.

Table 3a. Expenditure Structure: Advanced Economies, 2008 (as a share of GDP)
Table above shows primary fiscal expenditure breakdown by broad heads across 32 developed nations. Ireland GNP adjustments were added by me. The figures are for 2008 and reflect:

• The fact that Ireland had the second highest primary government expenditure as a share of economy of all countries. A burden of Government that is, frankly, unprecedented for a mature, competitive economy, especially when one considers the fact that we, Irish taxpayers, receive virtually nothing exceptional in return for our cash.
• We managed to have the fifth highest proportion of public spending that is being swallowed by pay to our grossly over-compensated public sector workers. Denmark, Iceland, Malta and Sweden were ahead of us in these terms. I can't vouch for Malta, but in all three other states, taxpayers get a lot more services for their money.
  
• Crucially, none of our competitors - smaller open economies that actually do create jobs - had the size or the structure of public spending close to that of Ireland.
• Our generosity of the social benefits is significantly above average in absolute terms. When one realizes that the other countries we are being compared against all have older populations and higher unemployment (remember - these are 2008 figures), we can safely claim that Irish social benefits system is amongst the top two most generously funded in the entire developed world.
  

Now, consider how these expenditures are allocated relative to the total primary Government budget:
Table 3a. Expenditure Structure: Advanced Economies, 2008 (as a share of the total primary expenditure)
Table above shows that:

• Ireland had the second largest proportion of its primary expenditure allocated to the capital budget in 2008. Lest we forget, parts of the Irish Government's capital budget, under the NDP accrue to personnel spending as well - including NDP-specified expenditures on 'human capital', and other soft things.
• The above clearly distorts spending priorities reflected in employees compensation and social benefits shares of total primary spending.
• Despite this, our public sector employees have still manged to capture a greater share of the total primary spending that average.
• It is also worth noting that some countries with greater share of public expenditure accruing to the employees' compensation include countries with functions defense forces, such as Israel and members of NATO.

Stay tuned for more revelations from the IMF database...

Economics 15/05/2010: IMF on fiscal stability II

Continuing with IMF Fiscal Outlook update released yesterday (see the first post here) - I have compiled IMF data on Ireland's fiscal position, and added some GDP/GNP gap and Nama analytics. As usual, the table below should be self-explanatory:
So quick conclusions:

• For all the talk about Government doing the right things, our deficit is record busting for 29 leading advanced economies in 2010 and 2011 in terms of share of GDP. It is expected by the IMF to decline only marginally to 28th and 27th ranks in 2014-2015.
• Despite repeated assurances to the markets and the EU, Ireland is not expected to reach 3% deficit limit by 2015, with IMF expecting our deficit to be -5.3% of GDP in the end of 2015.
• When converted to a more realistic measure of our income - GNP - our deficit is jaw-dropping 16% in 2010. It is forecast to be at -6.9% in 2015.
• Iceland, Portugal and Greece are expected to significantly outperform Ireland in terms of deficit in 2010-2015.
• For all the talk about 'small Government', Irish Government spending as a percentage of our economy (GDP) has increased dramatically between 2000 and 2009, rising by over 50%.
  
• In 2009 our Government's share of the economy measured by GDP was in excess of the average for the advanced economies.
  
• In terms of GNP, our Government's share of economy was over 34% higher than the average for the advanced economies.
• In 2010, Irish Government's share in the economy is expanding, despite the chorus of voices from the Left that we are not having a public sector expansion. It is forecast to rise to 46.6% of the entire economy relative to GDP and 61% in terms of GNP. Average for advanced economies is expected to be 43.2% (a decline on 2009).
• Last year, we ranked as the economy with second largest share of GNP accruing to the State. In 2010 we will be the first economy.
• Irish Government's graft on Irish economy was heavier than that of Sweden in 2009 and will remain such through 2015.
• Despite having none of the superior public services supplied by the Swiss Government, Irish economy is paying its Government a toll (in terms of economic income captured by the State) that was 6.4% greater than in Switzerland in 2005, rising to 41% in 2008, to over 61% in 2009. This is the true measure of the rip-off-Ireland carried out by the Public Sector here.
• The same rip-off is expected to grow over 2010-2015, rising to 66% in 2010 before declining to 53.5% in 2015.
• Low government debt has been paraded by the State officials and politicians as a crowning achievement of this economy. Back in 2000-2007 that might have been warranted, despite the fact that, when measured relative to GNP, our debt was not really that much lower than that of some of our peers.
• The debt situation has changed dramatically since then. This year, despite all the talk about the Government's corrective actions on deficit, our debt is going to put us as 24th-ranked country in the advanced countries. In 2011 we will slip down to 25th.
  
• By 2015, factoring Nama our debt to GDP ratio will stand at 122% - ranking us 3rd worst performing advanced economy in the world by debt/GDP metric. Ex-Nama, we will hit 122% of debt/GNP.
  

These numbers put into perspective my arguments that the Government is not doing its job of controlling public spending. Three 'tough' Budgets behind us, we are still rolling down the slippery slope of fiscal insolvency.

The latest talks about finding €3 billion in fresh cuts is yet another plaster on a gaping shark bite of our fiscal policy wreck. We need to find €15 billion in cuts, NOW, folks, and we need to abandon Nama, before we can call in the press and tell them that Ireland is on the mend.

There will be more analysis based on IMF data coming in days to come. So stay tuned.

Economics 14/05/2010: IMF on fiscal stability I

So the IMF analysis of changes in global fiscal positions is out today and makes an interesting reading. Here are some high level observations, pertaining to Ireland.

In relation to the EU and Irish Government consistent attacks on so called ‘bond speculators’, IMF states: “Net CDS positions amount to only about 5 percent of outstanding government debt in Portugal (the country with the highest share), 4 percent in Ireland, and 2 percent in Greece and Spain. In other countries, including Italy, the ratio is even lower, and it is extremely small for Japan, the United Kingdom, and the United States.”

In other words, CDS markets are shallow and cannot be expected to have a significant effect on sovereign bond spreads or yields.

However, per IMF: “The analysis uses 5-year CDS and 10-year bonds, as they are the most liquid maturities. Granger causality tests over the period January 2008–April 2010 show that the CDS spreads anticipated bond spreads (measured by the Relative Asset Swap spreads), while the reverse is not true.” In other words, as I’ve stated on many occasions before – CDS markets are a good predictor of sovereign yields.

Another interesting analysis from the IMF. I am adding to it adjustment for Ireland to GNP figures, per usual argument that GDP is largely irrelevant for our country real income metrics. I also added rankings columns for two main parameters of fiscal sustainability.
One should be concerned with the figures provided above. While international comparisons call for GDP as a benchmark for national income, in Irish case, this metric is best captured by GNP. And of course, GDP/GNP gap is growing rather dramatically...

I will be posting more on IMF analysis over the next couple of days, so stay tuned.

Economics 12/05/2010: Irish Nationwide - an expensive delay

I have gone through the Irish Nationwide balance sheet, as summarized in the table below (all values are in millions of euro):
All scenarios are explained above and all assumptions are in there as well.

So the conclusions are:

• If we continue injecting cash into INBS, the total cost of winding down the bank will be the loss of all cash already put into it, plus the expected post-Nama injection of ca €1,148 million. The grand total bill for shutting INBS via Minister Lenihan's preferred option will be €7,234 million;
• Shutting down INBS back in 2009 would have cost between €2,030 million and €3,078 million, were the Government to listen to people like Peter Mathews, Brian Lucey, Karl Whelan and myself. The bond holders (senior ones) would have been paid 50 cents on the euro.
• Shutting it down now, without going Nama route will cost €1,575-2,659 million, plus the money we already dumped into it to date, i.e €2,700 million. Which is still cheaper than what Minister Lenihan's plan would deliver.
  

Either way, the DofF and Minister Lenihan really must come clean on the issue of bondholders at this stage. How much more can this economy carry on throwing good money after bad?

Economics 13/05/2010: AIB's IMS blues

AIB released its Q1 2010 IMS statement:

• It will issue 198m shares to the Government in lieu of a €280m preference coupon it will not be paying (remember the stockbrokers and the Government argued that this coupon payment will be a handsome return on our ‘investment’ in AIB?).
• AIB, subsequently will be in for an 18.6% Government stake in the bank.
• Some analysts are saying that the lack of dividend is due to AIB being precluded from paying cash dividends on debt instruments while its business case was under review at the EU.
• I would say that this represents a convenient excuse. In reality, AIB simply cannot afford a €280 million pay out, given its funding conditions and given its capital requirements.
  

There is more farcical stuff in the IMS. AIB claims that while trading conditions remain challenging in Ireland, its UK (ex Northern Ireland), Polish and Capital Markets operations are booming. Ooops, the very family silver that AIB is going to sell to cover its bad loans in the Republic is still the only set of assets that have any positive value in AIB.

IMS confirmed that AIB will need €7.4bn in new capital, and that this based on Nama discount expected to average 45%. As AIB is shifting €23bn of the bad and the outright ugly loans to Nama, this discount might change. So no speculation here…

Aside from speculation, if AIB is hoping to get some dosh for its 22% stake in the US M&T, worth estimated $2.3bn. If this target is achieved (a big if, given that large placements like these would probably attract some discount) the sale can deliver new capital of €900mln. The target for capital raising then moves to €6.5bn. Selling Polish holdings will provide maximum of €2.4-2.6bn, assuming euro holds against zloty and assuming a discount of no more of 10% on block sales, inclusive of commissions. Of course, this means that AIB will have to write down its book value on the asset side, so that the net gain is likely to be around €1.2-1.4bn to capital side.

Which leaves us with a hole of €5.1-5.4bn to plug. The UK side of business is a sick puppy, unlikely to yield any net gain on risk-weighted assets side, but let’s be generous and give it €500mln of value. On the other hand, AIB investors are raking the dosh in… well, not really. I would expect the bank to be able to sell something to the tune of €1.2bn worth of equity at the most (its current market cap is €1.22bn as of yesterday close price). Suppose this is the net (although discounts might imply much shallower rate of capital raising). Will the Exchequer be required to pump in another €3.4-3.7bn into AIB?

But wait, this is hardly a final number. Remember, so far AIB has been assuming (in its impairments provisions) that the 2009 performance will continue into 2010. It sounds conservative, until you actually pause and think. There are serious lags on some assets deterioration and on recognition of impairments. These lags are driven by two major factors:

1. On households and corporate loans side, impairments take time to build up. For example, an average unemployed person with job tenure of 6 years would have gotten around 36-42 weeks of redundancy (factoring in tax relief) when they lost their jobs back in the H1 2009. They might have had savings. At an average rate of saving of 5% of annual income over 6 years, that would add up to 30% annual income or another 16 weeks worth of income cushion. Again, net of tax the cushion rises to ca 19 weeks. This means that any serious distress on their mortgages will show up around 55-61 weeks after the layoffs. Guess that pushes the dateline for major stress on mortgages only starting to manifest itself to around May-July 2010.
2. Much of the non-Nama book of commercial and development lending that will remain with AIB has been rolled up, redrawn across covenants and so on. How long will it take for these to come up for another appraisal? I’d say on average 12-24 months. So look back at 2008-2009 loans that were non-performing then and were rolled over for 12-24 months. These will start flashing red once again sometime around 2010-2011.
   

Neither (1) nor (2) is provided for (as far as risk capital goes) under the current €7.4bn new capital requirement. By the time the demand on these hits, AIB will have no assets left to sell. Then what?

How I know that AIB is once again has its head stuck in the sand on future impairments? Well, this morning’s IMS tells me as much. For its non-NAMA loans, AIB is expecting bad debt charges to be matching 2009 rates. IMS says that bank’s €27bn residential loans book is continuing to perform “better” than the sector averages (as if there is any meaningful average here to be had). And significantly it says that residential bad debt charges are currently not significantly different from 2009. The non-NAMA exposure to property in Ireland will be €12bn of which €9 is investment and €3bn land and development. These are still material at this stage, as any further writedowns on this part of the book are going to hit capital base again.

On the macro side of its balancesheet, AIB is still going to be a sick bank with loan to deposit ratio declining from a severely unhealthy 146% to a still unhealthy 124% post-Nama. And this is really rosy, folks. And the cost base and margins are unlikely to improve. Take for example deposits costs – AIB’s IMS highlighted the reality of high cost of attracting new deposits. Wait till Government starts hovering dosh from the punters through the new Post Office bonds. Supply of deposits will drop. And then, wait for the ECB to cut its discount window operations again, should things improve in the euro area funding markets. AIB, alongside BofI, is heavily dependent on being able to roll the collateralized borrowings from ECB. AIB’s term funding as a percentage of wholesale funding is massively up from 30% in December 2009 to 41% by end Q1 2010, reflecting a €6bn of issuance.

So can anyone explain just how on earth can AIB escape a de facto nationalization?

Economics 12/05/2010: How not to do austerity...

How not to do austerity? Well, Ireland is a good example.

For all the tough talk about reforms and changes to spending habits of the public sector, the new employment in civil service document released two weeks ago, drawn up by the Department of Finance envisions that staffing levels will fall from 37,376 estimated for the end of 2010 to 36,594 at the end of 2012. That’s a whooping (or in terms of SIPTU/ICTU savage) drop of 782 workers, or less than 2.1%. The resultant savings, assuming jobs cut will be at the media level of pay for the civil service, will total a massive €39.41 million per annum. Translated into our public sector’s spending habits, that’s about 16 hours and 20 minutes of our deficit financing for the first 4 months of this year. Not counting the banks costs.

The Government has told the nation before that the new public service pay and reform deal negotiated with unions at Croke Park last month will "substantially" reduce the number of State employees over the coming years. Hmm... guess 2.1% is philosophically ‘substantial’, even if not economically substantive.

But wait, these are gross savings, pathetic as they might be. To get to the net figure, we must factor in early retirement incentives doled out to civil servants by Brian Cowen in Supplementary Budget 2009 and golden handshakes for voluntarily leaving staff.

So take a rule of thumb - the cost of laying off civil service workers ranges around 15-20% of their total annual salary per year of service – once the value of pensions and redundancy payments are factored in. This is very, very much conservative, given the one-off payments and other perks accruing to retiring public sector workers and given that their tax liabilities collapse upon the retirement, especially over the first year. Take 15% on the lower end and assume that average tenure of the workers leaving the service is around 15 years (lower-end assumption as those taking early retirement would more likely to be more senior than that).

What do you have? The cost – and not all of this obviously will hit the taxpayers at one single shot, but most will – will be around €133,400 per worker reduced. And that’s at the lower end.

Savings of €50,294 per annum, at a cost of €133,400 means that given our Government’s innate inability to manage its own workforce, the first time we, the taxpayers, will see positive net savings on the deal (assuming opportunity cost of funds at 5% and automatic stabilizers on the salary payments to public sector workers at 30% - income tax, levies, etc - none of which are going to apply under voluntary retirement) September 2015!

I am not kidding you – September 2015! By which time, of course, the Unions would have forced the Government to get a new Benchmarking going…

Folks, we are now truly turning the corner!