27/02/2011: Ireland v Iceland: Economy, part 1

This is the first post of two dealing with comparatives between Irish and Icelandic economies during the ongoing crises. The post was motivated by a number of recent articles in Irish press presenting Irish situation in terms of the allegedly stronger crisis performance than Iceland, as well as Paul Krugman's response to these (here). This post will deal with real economy comparatives, while the second post will deal with fiscal performance relatives.

Both economies experienced deep crises in 2008-2010: Icelandic economy contracted to 90.41% of 2007 levels by the end of 2010, while Irish economy declined to 92.13%. Per IMF Q4 2010 forecasts, Icelandic economy is likely to reach 103.12% of its 2007 level GDP by 2015 while Irish economy is expected to reach 106.10%. However, latest revisions to 2011 forecasts (but not yet to 2011-2015 period) suggest that this advantage of the Irish economy over Icelandic economy is unlikely to hold.

In terms of real GDP per capita Icelandic economy contracted to 88.64% of 2007 levels by the end of 2010, while Irish economy declined to 91.08%. Per IMF Q4 2010 forecasts, Icelandic economy is likely to reach 98.05% of its 2007 level GDP by 2015 while Irish economy is expected to reach 106.10%. Again, latest revisions to 2011 forecasts (but not yet to 2011-2015 period) suggest that this advantage of the Irish economy over Icelandic economy is unlikely to hold in the next IMF database updates.

In terms of GDP based on purchasing-power-parity (PPP) per capita, Current international dollars, Irish economy has contracted by 10.25% in 2010 relative to 2007, while Icelandic economy declined by 7.75% - much less. Why? This result is especially worrisome, given that over the same period Irish economy experienced deep deflation (see below), while Icelandic currency was devalued substantially. Thus, Irish purchasing power should have risen, while Icelandic purchasing power should have fallen. And yet, real purchasing power of Icelandic income earners held up better than that of Irish counterparts.
In projections through 2015, the IMF expect that per capita, PPP-adjusted GDP in Iceland will reach 10% above 2007 levels, while in Ireland it will reach 7.58% above 2007 level. This, once again, means that the IMF expect Icelandic income earners to fare better than their Irish counterparts.

The same is reflected in the gap between GDP per capita in Ireland and Iceland. This gap stood at 3,487.63 in favour of Ireland in 2007. By 2009 it fell to 832.61 and by 2010 rose to 2,135.11 still below 2007 levels. According to IMF projections, the gap is expected to be 2,788.53 by the end of 2015. Notice that the average gap between 2008 and 2015 will remain below its historical average levels for 2000-2007. This confirms that much of the underperformance in terms of absolute real GDP per capita discussed above is due to (1) historical trends and (2) price differentials between the two countries.

What about economic performance in the two countries relative to the global economy? Chart below shows the shares of each economy in total global GDP. In 2007, Iceland accounted for 0.019% of the world GDP, while Ireland accounted for 0.268%. By 2010 these shares were 0.016% and 0.237 respectively. The decline in Iceland was 15.79% and in Ireland 16.55%. So Iceland outperformed Ireland here.

By 2015 IMF expects Icelandic economy’s weight in the global economy to be 0.015% - a decline of 21.05% on 2007. For Ireland the same forecasts imply 0.215% weight in the global economy and a decline on 2007 of 24.30%. Again, Iceland is expected to outperform Ireland into 2015 in these relative (to global economy performance) terms.

Comparatives with Iceland aside, however, Irish economy is expected to reach, by 2015, virtually identical level of global economy share as it enjoyed between 1996 and 1997, in effect erasing the entire period of some 20 years worth of economic growth.

As I mentioned before, Ireland clearly showing real deflation trend during the crisis, which is not the case for Iceland (in part, Icelandic inflation reflects devaluation of its currency).
It is worth noting that moderation in Icelandic economy inflation has been dramatic and highly orderly since 2008-2009 peak. This shows that the economy is expected to be adjusting through its post-default and post-devaluation period in an orderly fashion. In contrast, Irish deflation during the crisis has been pronounced and persistent.

Now on to unemployment. It is clear that Irish unemployment is running at the rates more than 50% above those in Iceland. By the end of 2015, IMF forecasts Irish unemployment to be 9.5% and Icelandic unemployment to be 3.12% or more than 3 times lower than that in Ireland.
Again, note the dynamics of expected adjustments to peak unemployment in the two countries. IMF clearly forecasts unemployment to decline in Iceland at a much faster rate than in Ireland. Given that icelandic unemployment declines are more likely to arise from jobs creation, rather than emigration, while Irish unemployment declines are robustly influenced by rampant outward migration of displaced workers, these dynamics also reflect the deeply-troubled nature of the Irish economic crisis, when compared with that of Iceland.

Which, in turn, shows that more likely than not, stronger Irish performance in GDP growth terms above is really driven by the MNCs and their transfer pricing, rather than real economic activity at the domestic economy. Lest I be accused of voicing anti-MNC sentiments - we do live in a society where saying factual things can get us labeled anything totally unrelated to the factual evidence presented - MNCs activities are great. All I am suggesting is that counting on them to carry us out of our real economy collapse (unemployment, shrinking employment, declining real disposable incomes etc) might be a bit naive.

Although IMF provides no forecasts for employment numbers after 2011, we can use population statistics and employment numbers through 2011 to compare two countries in terms of employment rates as percent of total population. In 2007 51.76% of Icelanders were in employment – a percentage that declined to 45.20 in 2010 and is expected to fall to 45.09% in 2011. In Ireland, 2007 employment rate was 48.93%, and this has fallen to 41.18% in 2010 and is expected to be 41.33% in 2011.
Again, in terms of employment rates Ireland is far behind Iceland – a sign that although out workers might be more productive (with a large share of this productivity accounted for by the transfer pricing by the MNCs), we tend to have smaller share of people working.

Do notice that the Icelandic economy performance in terms of employment takes place against the backdrop of having younger population than Iceland. Over the period of time covered, Iceland showed relatively stable rate of employment, while Ireland posted dramatic increases in employment rates during its growth period. This means that our current performance in terms of employment rates cuts against our demographic trends, while that of Iceland is in line with their demographic structures. In other words, one could have expected a decline in Icelandic employment rates even absent the crisis, while we should have expected continued increase in Irish employment rates absent the crisis.

In terms of external trade, both countries have improved their chronic current account deficits throughout the crisis. However, the great exporting nation of Ireland have seen much more shallower improvements than those found in Iceland. Krugman makes exactly this point in his article (linked above), but he considers net exports instead of the current account.
Chart above shows that between 2007 and 2010, Icelandic current account deficits fell from 16.29% of GDP to 0.91%. The Icelandic current account deficits are expected to continue declining through 2015, reaching forecast 0.38% of GDP by 2015. In Ireland, 2007-2010 decline was from 5.24% to 2.73%, while by 2015 the current account deficit is expected to fall to 1.24%.

The reason I prefer using the current account is because of several reasons:

1. As I have argued in a different post (here), current account can be used as a metric of our ability to repay debt out of trade surpluses, once we account for transfers abroad to pay dividends and profits on earnings by the foreign investors into Ireland, including the MNCs, take in our own investors earnings from abroad etc
2. Current account does not mask the extent of transfer pricing on our net exports
3. Current account also links to Government debt costs and thus lends itself naturally to the second post to follow
   

As we show in the next post, much of the reason for better external economic balance performance of Iceland is due to lower transfers from Government to the foreign bondholders, s Icelandic debt is expected to perform much better through the entire crisis. This means Icelandic current account is going to be relatively stronger than Irish one, as Ireland is expected to lose increasingly larger share of its economy to payments to foreign debt holders in years to come.

Next post will cover Government/fiscal policy performance of the two countries.

19/02/2011: Paying down our debt out of Exports

Let's do a quick exercise. Suppose we take our current account - defined as the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid and remitted profits). Suppose every year we use the current account balance solely for the purpose of repaying our Government debt. How long will it take us to do so.

Let us start with some notes on methodology.

Our current account is in deficit - since 2000, there was only one year - 2003 - when we had a surplus in the current account (charts below), which really means our external trade was not enough to generate a surplus to the economy. So let us assume that the we can reverse this 180 degrees and that the deficits posted in 2009-2010, plus those projected by the IMF to occur in 2011-2015 are all diverted to pay our Government debt.
Notice - this is impossibly optimistic, as our Government does not own current account, but suppose, for the sake of this exercise that it can fully capture net profits transfers abroad and cut the foreign aid to zero, plus divert all interest payments on own debt and private external debts to repayment of the principal on own debt.

Secondly, assume that only Government debt is taken into the account (in other words, we assume away Nama debt, some of the quasi-sovereign financing of the banks resolutions, and all and any potential future banks and spending demands in excess of the EU/IMF assumptions, as well as all future bonds redemptions - the latter assumed to have a zero net effect at roll-over, so no added costs, no higher interest rates, etc).

In other words, here is what we are paying down in this exercise:

Now, suppose we take current account balances for 2009-2015 (projected by IMF) as the starting point. The reason for this choice of years is that they omit fall-off in our exports in 2008 and also the bubble years of 2004-2007 when our current account imbalances were absurdly large due to excessive outward investment and consumption of imports.

Next, assume:

• We deal with present value of the debts
  
• We apply an average 3% annual growth rate to repayments we make (current account transfers grow 3% on average per annum)
  
• Currency effects are removed (so we use flat USD1.33/Euro FX rate throughout)

So here is the result:
And the conclusion is: if Ireland diverts ALL of its net current account (2009-2015 IMF projections taken at 3% average growth rate forward) to pay down Gov debt, it will take us until 2064 to reach 2007 level of official (ex-Nama+banks) Government debt.

Note: incidentally - the charts tell couple of interesting side-points based on our historical debt path:

The Government told us that we are not in the 1980s - as we had much higher levels of debt then. Ok, the figure above shows that as of 2010 - we ARE back in the 1980s: 2011 debt will equal as a share of GDP that attained in 1989. According to IMF database, our debt has peaked at 109.241% of GDP back in 1987. It is projected to be 104.7% in 2013. Not that much off the peak.

But, of course, in the 1980s there was no quasi-Governmental debt - the debt of Nama, some of the banks recapitalization measures and the debts that still might arise post-2013 from the Government banks Guarantees and resolution schemes. If we add Nama's 31bn worth of debt issued, this alone will push our 2011 debt levels to 121.8% of GDP and factoring in coupon rate on these, but 2015 our Official Gov Debt + Nama will stand (using IMF projections again) at 124.8% of GDP - well in excess of the peak 1980s levels of indebtedness.

Secondly, despite what any of us might think about the Celtic Tiger years, the Government never paid down the old debt, it simply was deflated by rising GDP. Which suggests that even during the Celtic Tiger boom years - our exporting economy was NOT capable of paying down actual debt levels.

16/02/2011: Banks issuing loans to themselves

Note from the banks front:

ECB’s printing machine keeps working over time. Greek and Irish banks have issued at least €70 billion of bonds to themselves to create the collateral required to get cash from the ECB before last week. Then, Greeks announced they will issue €30 billion more unsecured bonds to themselves for the purpose of pawning these at the ECB. The European Central Bank's balance sheet now funds the equivalent of 18% of Greek banking sector assets, 15% of Irish and 7% of Portuguese. CBofI holds another 7%.

Some amazing 'innovation' on financial front this is.

16/02/2011: Heading for another round of crisis pressures?

Two nice charts, lest we forget where the crisis is at:

Greek 10y sovereign bonds:
And Irish 10y sovereign bonds
Both courtesy of Goldcore, both are daily yields over 1 year.

13/02/2011: What a Jeopardy champ can do in the world of finance

Here is my article along with Shanker Ramamurthy that was published last Thursday in the American Banker, discussing IBM's Watson super computer system's potential applications in the financial services industry - helping to advance industry thinking on how in the era of "big data" only advanced non-linear analytics can make sense of structured and unstructured data flows to transform it into valuable insights.

VIEWPOINT: New Computer, New Modeling Possibilities
By Shanker Ramamurthy and Constantin Gurdgiev
February 10 , 2011 - p8

Next Monday a new IBM computer system called Watson will battle two quiz-show champions in a game of Jeopardy! There is more at stake here than winning a game. The potential applications of this technology to transform the operations of industries such as health care, government and finance are enormous.

In the financial services industry, integrated risk management is an everyday struggle. Financial practitioners and supervisory and regulatory authorities must make split-second decisions using information coming from all sides: the Internet to corporate and call center channels.

The challenge is to efficiently process diverse data streams and pick out relevant data insights to apply to strategic business and regulatory decisions.

In the banking industry today, data "fuzziness" abounds. Uncertainty exists about the quality of data, assumptions and models that are being used to make judgments. This, of course, clouds the true picture of risk and biases our decision-making, often in econometrically undetectable ways.
Most banks today run risk models on a discrete and disaggregated basis while relying on often subjective assumptions. High-performance computing advances, represented by Watson's capabilities, can rectify this - by providing visibility into concentrations of risks and risk-related activities, as they happen. Simultaneously, it deploys nonlinear analytics in selecting both the statistically and operationally important scenarios.

The beauty of a nonlinear computer that "learns" is that it can analyze a complex set of implied possible scenarios and give answers to the broadest set of questions. This potentially can lead to the emergence of analytical systems that not only report on probabilistically likely events but also identify latent "Black Swan" events and even sense deeper levels of uncertainty.

For example, a legislative decision altering a specific set of financial strategies can have no impact on traditional linear models because the outcomes can be weighted by an extremely low assigned or assumed probability. But in a nonlinear world, such an outcome can still be testable as part of the selection list for reporting. More importantly, it can be made recognizable by the analytic system and, therefore, objectively reportable.

A system like Watson has the potential to get answers to incredibly difficult questions about strategic decisions, risks and market changes that can otherwise be elusive.

For example, it has the ability to create an interactive risk-pricing system using a menu of models that evolve as the system learns, detecting structural breaks in data before analysts can spot them and build them into existing programs.

Of even more significance, Watson will be able to deliver scenario analysis based not just on either event probability or expected loss/gain but also on more complex company objectives.

This can involve analyzing corporate strategy inputs, including non-quantifiable questions, alongside fully quantifiable inputs. Imagine asking a computer "How do I increase my loan book profit margin by 10%?" or "What actions can I take to strengthen my capital reserves, with minimum impact to my asset base?"

At a much deeper level, the nonlinear learning capabilities that Watson pioneers can lead to the creation of systems that are able not only to handle traditional risks and their interactions but also to evolve into systems capable of transforming deep uncertainty into explicit models. Though still some years away, this could mean an artificial intelligence able to sense Donald Rumsfeld's famous "unknown unknowns," converting them into specific models suitable for risk analysis and getting meaningful, actionable responses.

The real-time, decision-making capability that is so sought after in the financial industry will be a crucial, competitive differentiator.

As risk intensifies within interconnected global markets, the complexity and exploding volumes of data will only rise.

Shanker Ramamurthy is the general manager of banking and financial markets at IBM Corp. Dr Constantin Gurdgiev is the head of macroeconomics in the Center for Economic Analysis at the IBM Institute for Business Value.

13/02/2011: IMF's statement on Iceland

I twitted about the latest conclusions from the IMF on the state of Icelandic economy post-banks collapse. Here are the exact details of the IMF statement and the statement itself. Emphasis and comments in brackets are mine:

"Financial sector restructuring is moving forward [in contrast, one may add to Ireland's]. Savings banks and non-bank financial institutions are being recapitalized [in Ireland's case, recapitalizations of the banks have been predominantly wiped-out by the continued writedowns, so net increases in actual capital have been negligible], and the supervisory framework is being strengthened by amendments that will be enacted in the coming months [no serious far-reaching amendments have been introduced in Ireland since the beginning of the crisis and the marginal ones that were are yet to be enacted].

"Moreover, recent agreements to restructure the debts of households and small enterprises will help put households, corporations and banks on a more secure financial footing, which is essential for a sustainable recovery [this stands in contrast with what has been happening in Ireland. In addition this directly and indisputably puts the blame for the policy errors in the Irish case onto our Government and EU shoulders, for it is clear that within the EU/IMF deal framework, the IMF was basing its policy proposals on their experience in Iceland].

“Policy discussions focused on the strategy to liberalize capital controls, fiscal and monetary policies, and financial sector reforms [none of these issues are even on our agenda].

Here is the actual press release from the IMF