Economics 8/8/10: Some Tullamore fun

Per report by RTE today (here), our Minister for Agriculture Brendan Smith said that Ireland's agri-food sector "is making a colossal contribution to economic recovery". The Minister was speaking at the Tullamore Show in Co Offaly.

I am impressed. Of course, agri-food sector is a relatively undefined (by CSO core national accounts statistics - it doesn't even exist) sector, so Minister's claims cannot be fully tested. You see, they belong to that great category of assertions that are non-falsifiable.

But we can take a look at Minister's direct sector of charge - Agriculture. Here are few charts based on latest data from the Quarterly National Accounts and National Income and Expenditure Annual Results for 2009.

Let us start with the Agriculture, Forestry & Fishing sector contribution to GDP:
Not exactly spectacular contributions to the national income - AFF sector delivered just 2.38% of national GDP in Q1 2010 - and that was above average performance. All in, the sector output was worth just €995mln. Not a pittance, but when one considers the massive levels of CAP-delivered financial subsidies the sector receives, I wonder what is so 'colossal' in this?

When measured in terms of constant factor costs, AFF sector has hardly performed any better. Its share of our GDP stands at a miserly 2.37% in Q1 2010, which is down on 2.39% achieved in Q1 2009. Back in Q1 2005 the same share was at a height of a 'colossal' 2.77%.

Annual value of the sector output, in constant market prices, never once exceeded €4,000mln since 2005 and has actually declined over the years from the peak of €3,953mln in 2005 to €3,555mln in 2009.

But may be Minister Smith's sector is 'colossal' in terms of its contribution to growth in our economy?
Again, data suggests that, sadly, this is not true either. In 2004-2009 the overall net value added in AFF sector has fallen by 4%. Other sectors experience growth in net value added of 2.5% over the same period. AFF has managed to collect massive load of subsidies over these years. Subsidies to all other sectors have been negligible and actually declined precipitously.

May be the AFF sector provided a relatively stronger shoulder for our floundering economy in 2008-2009? Not really -

• Between 2007 and 2008, Net Value Added in the AFF sector shrunk by 10.4% while NVA in all of the economy declined by 3.9%;
• Between 2008 and 2009, NVA in AFF sector has fallen by 24.4% against a drop of 8.6% in the economy-wide NVA;
• So far in the crisis - between 2008 and 2009, Net Value Added in Agriculture, Forestry & Fishing sector has declined by 32.3% while economy-wide NVA declined by less than 12.2%.

But wait, if AFF sector is not so 'colossal' in terms of growth in income or its contribution to income, may be it is a giant in terms of capital formation (aka wealth storage)?
Look at the national accounts data. The AFF sector is barely registering on the radar as a capital investment sector. True, it does appear to be more stable in the wake of the massive wave of capital values destruction since 2007 that impacted other sectors (e.g. construction, development, finance etc). But...
As you can see from above, sector share of overall capital pie remains miserably low, with exception of the two years when our land markets went nuts - 2007 and 2008 (incorporating lags).

Overall, per latest CSO data (so grossly outdated, we only have figures for 2009 so far):

• Net value added at basic prices in the entire sector was €1,197.5mln in 2007, €840.2mln in 2008 and a dramatic €204.2mln in 2009. In other words, once subsidies and consumption of capital are taken out, Irish Agriculture, Forestry and Fishing managed to post of collapse in the Net Value added of -76% between 2008 and 2009.
  

Sorry, Minister, I don't seem to find much of evidence of anything colossal going on in our AFF sector at all, apart, that is, from the subsidies it receives from the EU (€1,850mln in 2009 net of taxes paid by the sector or well in excess of the sector operating surplus of €1,612mln) and the precipitous rate of collapse in

• Goods output (down 18.1% yoy in 2009) and
  
• Operating surplus (down 30% yoy in 2009).

Of course, as I have mentioned above, the CSO nomenclature does not allow us to test the proposition of 'colossal' potential for our agri-food sector. But as far as Minister Smith's direct charge goes, we are now decades away from the days when Agriculture, Forestry & Fishing last time provided a significant, let alone 'colossal', contribution to economy or economic growth or increases in the country stock of wealth.

Which is really sad, given our natural conditions for excellent agricultural production.

Economics 6/8/10: Anglo's plans & systemic risks

Updated

Here are some interesting questions (note - just questions for now, on the foot of comments made by Prof Brian Lucey earlier today) regarding the 'Good' v 'Bad' Anglo plans.

Take it from the top: we started with a bank with €71bn on the books valued at valuations of the peak markets. This is now allegedly going to:

• €25bn of the face value of loans pre-writedowns - to the 'Bad' bank, implying that these loans are so poor in quality, even Nama, with an average 50%+ (LTEV-inclusive) haircut is not touching it. This implies that even in the long run, these loans are not going to generate more than, say, 30% recovery rate (a generous 30% that is, but let's take it as such. Note: that is across the entire loan book of the 'Bad' bank);
• €10bn of the face value of loans pre-writedowns - to the 'Good' bank, implying that these loans are better than Nama average, so the LTEV on these loans is above 50%. Assume that the LTEV on them is 60% (which makes them better than Ulster Bank's Irish book, per today's results for Ulster - again a generous allowance, but let's entertain it);
• the remainder is going to Nama.

Now, another little factoid: Central Bank of Ireland has lent Anglo €11.5bn under a MLRA repo agreement secured against the non-Nama loans.

Per Anglo last published results: "Sale and repurchase agreements with central banks include €12.2bn (30 September 2008: €7.6bn) borrowed under open market operations from central banks and €11.5bn (30 September 2008: €nil) borrowed under a Master Loan Repurchase Agreement (’MLRA’) with the Central Bank and Financial Services Authority of Ireland."

Let's do some simple math.

Value (recall - I am factoring referencing to Long Term Economic Value, not the current mark-to-market value, which is even lower):

• €10bn in 'Good' Anglo can be (optimistically) expected to yield €6bn valuation using LTEV;
• €25bn in 'Bad' Anglo can be (again, optimistically) expected to yield €7.5bn valuation using LTEV.
• Allow for 1.5% margin of costs on both sides, to €525mln pa, or over 5 years - i.e. much shorter than Nama horizon - €2.6bn (note: current bank cost structure, which one can expect to be preserved as both banks go about conducting impaired assets recovery - a higher cost activity)
  
• Total non-Nama book value is, inclusive of LTEV net of expected management costs, therefore could be already around €10.9bn.

Against this value of €10.9-13.5bn, CB of Ireland holds €11.5bn worth of loans to the Anglo.

Now to the question: Does this mean that CB might be facing a potentially significant loss on the repos?

This possibility raises two issues:

1. If the repos are spread across 'Good' and 'Bad' bank, then the 'Good' bank is hardly a feasible undertaking, as repos alone already exceed the value of the 'Good' bank even absent impairment charges, while 'Bad' bank has clearly no ability to repay any fraction of these;
2. If the repos are inherited by the 'Bad' bank, then, either CB has to declare a loss (and I am not sure how it can do this), or the taxpayer is on the hook for the repos by having to pay them down through the 'Bad' Anglo.
   

Now, alternatively, let's ask the following question: to recover CBs repos from non-Nama assets, we need to have a combined 'Good' & 'Bad' banks recovery rate of 33% (not covering the costs of operating both banks, funding, bond holders etc). And this, once again, refers to the valuations done on the face value of the loans before any recent impairments - before the bubble burst. To recover all other CBs' funds, plus our own - we need a recovery rate of ca 68% (again ex all costs etc). That's really highly unlikely, folks.


Quite a dilemma, then, especially since ECB (see here) didn't approved the repos in the first place... and since Anglo also owes the other Eurozone Central Banks some €12.2bn more.

What could Mr Trichet say about Anglo's priorities in repaying the loans? Would he be (a) so kind as allow CB of Ireland to recoup its repos, which ECB thought were dodgy enough to refuse to take them itself? or (b) insist that other CBs be repaid first before our own repos are covered? If (a) - I'd say Mrs Merkel would have a few kind words to say to Mr Trichet, given her electorate's feelings about having to bailout Greece. If (b) - the above potential negative valuation of the repos will have to be multiples larger...

Just asking some questions for now... Wonder if there are any answers out there...

Economics 5/8/10: Russia and wheat prices

Following the worst drought in 130 years, the unprecedented heat wave and subsequent wild fires, Russia stopped exports of wheat, corn, rye, barley and flower from August 15 through December 31, 2010. Russia is the third largest exporter of wheat in the world. It expects 2010 harvest to come at 65-75mln tonnes, a 25% shortfall on 2009. Prior to the latest disasters, which started in April this year and is expected to continue at least through August, Russia expected to post second record breaking export years in wheat in 2010.

Despite the shortfall, Russian Government does not expect significant shortages of wheat for domestic markets. Government holds estimated 9.5 million tonnes of wheat in reserves and has ordered fixed price deliveries of wheat to regions impacted by the fires and drought.

The implications of the Russian exports ban are multiple:

1. There is a direct impact on wheat prices, with short term futures rallying today 8%, while longer term deliveries contracts being on an exponential uplift curve (see chart below for December deliveries contracts);
2. There is indirect impact on other commodities and food products, such as milk, etc, as wheat and its by-products are used across almost entire production and breeding chain.

Wheat prices on the CBOT were up 42% in July, the biggest monthly gain since at least 1959. Monday prices were up 5%, and are now the highest for 22 months.

Economics 5/8/10: Service PMIs

Time to update my earlier post on PMIs - this time with new data on services PMIs. The original post is here. Once again, the data is from NCB Stockbrokers PMI release and you can read their very good objective analysis on their site.
New business activity in the chat above is the one to worry about going forward. Giving a snapshot of more recent periods:
Here, both, the flattening out of the expansion rate in total business activity and the decline in the growth of new business activity are pretty clearly evident. Nonetheless, both series are above 50, signaling continued expansion.
Underlying macro parameters are a mixed bag. Business expectations are still improving and are pretty robust, though the rate of improvement is slipping. More dramatic is the slippage in the rate of new export business orders expansion. In the mean time, contraction continues across services employment and profitability, though the rate of contraction is slowing and is almost reaching zero.

Unlike in the case of manufacturing PMIs, services-related prices are trending in the right direction:deflation is setting in once again in input prices and deflation is ongoing, but at a slowing rate, in terms of output prices.

Putting services and manufacturing sectors side by side, first consider the employment picture:
Both employment pools are contracting. Manufacturing employment has crossed into negative growth territory, while employment in services sectors is falling at a slower rate than before.

Lastly, putting side by side actual PMIs:
Expansion in manufacturing has been under pressure in Ireland over the last three months. Meanwhile, services sector has been on expansionary path since the beginning of the year.

Of course, PMIs are not a perfect signal for near term future of the overall economic activity. Nonetheless, the series have been signaling weak expansion for almost 7 months now. This is the good news. The bad news is that there is low degree of confidence in the gains made so far, especially in manufacturing. In all likelihood September-November will be the key months when it comes to either stabilizing economy in a growth mode, or triggering a double dip. In my view, the risk of the latter before the end of Q1 20111 is around 40-45% and rising.

Economics 5/8/10: Live Register - up & up, again

Live register is out today with some poor news: the seasonally adjusted LR rose from 444,000 in June to 452,500 in July (+8,500 mom).This year to July 2010 LR rose by the cumulative total of 34,403 (+8%).

The latest increase in LR is marked by women signees leading males signees by 4,600 to 3,900. This suggests that (a) services sectors are more likely to show accelerating contraction in employment, and (b) the trend for jobs destruction in higher value added activities is still running strong.

This is confirmed by LR new data on occupation breakdown of lost jobs. Per CSO: "All occupational groups showed monthly Live Register increases in July. The largest percentage increase was in the Professional group (+12.3%), while the smallest percentage increase was in the Craft and related group (+0.1%). In the six months to July 2010 all occupational groups showed Live Register increases with the largest percentage increase in Professional (+22.8%), while the next largest increases were in Clerical and secretarial (+15.6%) and Sales (+13.0%). The smallest percentage increase was in the Craft and related group (+0.1%)."

So for the headline impact of the news - take an average weekly earnings (Q4 2009) at €716.09 (€37,237pa), take the average professional grade weekly earnings at €793.35 (€41,254pa), apply tax rates consistent with these earnings at €3,963-5,610 net tax liability, plus €1,225-1,386 PRSI, plus €1,489-1,650 Health Levy and €745-825 Income levy. Net loss to the Exchequer of tax revenue alone is €7,422-9,471. Employer-side taxes lost are ca €1,250-1,400. Now, add to this the cost of unemployment benefits, loss of Vat on private health insurance, provision of public benefits, such as health etc - you have total cost to the Exchequer of €28,040-30,240 per each new signee.

So July figures are signaling a hit on the Exchequer balance of ca €257mln over the year - just like that, one month worth of newly unemployed.


The average net weekly increase in the seasonally adjusted LR was 1,700 in July or virtually identical to June figure of 1,725.
Monthly rate of change accelerated in July to 8,500 up from 4,900 in June and marking the fastest rate of monthly increase in a year to date, and the highest rate of increase since July 2009:
The standardised unemployment rate in July is now at 13.7% up from 13.4% in June. This compares with 12.9% in the first quarter of 2010, the latest seasonally adjusted unemployment rate from QNHS.
Some final comparatives:

• Weekly net increases average from January 2008 through July 2010 were 2,102 - above the July average weekly net rate of increase of 1,700. However, over the last 12 months, average net weekly increases were 386 - well below the figure for July;
• Monthly average rate of increase in LR was: January 2008-July 2010 = 9,100, 12 months to July 2010=2,783. July 2010 monthly increase was 8,500.
  

Economics 5/8/10: Good news - we might be 'one-off' broke?

Good morning, folks. As a day starter, please take a note: We are bust! Yesterday’s Exchequer returns are a worthy reading on the theme of the day and hence I am writing a third post on the subject. Let me recap where we are at:

Tax receipts are now under €17.2bn cumulative for the first seven months of the year. As far as our ‘ever optimistic’ official analysts go, things are going on swimmingly. But in reality, we are on track to meet my December 2009 forecast for a shortfall of €500-700mln on the year. And that despite the fact that Ireland has ‘turned the corner’ on growth – highlighting the fact that the read through from GDP to tax revenue is not a straight forward thing. Of course, most of the shortfall is due to our real economic activity – as measured by GNP – is still tanking.

So relative to profile, here’s the picture:Good news on expenditure – overall voted expenditure was 2.6% below anticipated for the period to July. But this ‘achievement’ was driven solely by the cuts to capital spending. Thus, net voted capital expenditure for the first seven months of the year now stands at €2.2bn – full €660mln (-23%) below target. Net voted current expenditure is so far on target, while national debt is costing us slightly less (-€213mln) than DofF anticipated.

So overall, we are on track to deliver the Exchequer deficit of ca €19bn in 2010, close to the target €18.78bn, as capital spending accelerates in H2 2010. But we won’t reach the overall target to GDP. Most likely, we are going to see a 12% deficit to GDP ratio.

And this does not include the full extent of funding for Anglo and INBS. Brian Lenihan has already committed the state to supply €22bn to Anglo alone, of which €14.2bn was already allocated, but only ca €4bn went on the Exchequer accounts. Of the still outstanding €7.8bn, the question is how much of this amount is going to be directly shouldered by official deficit figures. The second question is – will €22bn cover Anglo demand for capital post Nama Tranches II and III transfers – recall that Anglo is yet to move loans for Tranche II. The third question now relates to AIB – given its interim result announced yesterday, one has to wonder if the bank will need more capital. What is beyond question now is that the State will be standing buy with a cheque book ready, should AIB ask for cash.

All in, Ireland Inc’s sovereign accounts this year are likely to come out with a 20% plus deficit relative to GDP. That’s a massive number implying that over a quarter of domestic economy will be accounted for by the shortfall in public finances. Our debt can easily reach over 87% of GDP and close to 110% of GNP (and that’s just including the full Anglo amount of €22bn and excluding Nama and the rest of recapitalizations liabilities).

Scary thought. But don’t worry – the Government will come out to say that it was all due to one-off measures. One-off in 2008, 2009, 2010, and one can rationally expect 2011 and even possibly 2012. By which time Nama liabilities will begin to unwind… serializing the one-offs into the future.