05/12/2011: Irish Exchequer Receipts: November 2011

Time to catch up with that data on Exchequer receipts for November - the critical month that makes or breaks Government budgets.

Income tax receipts: these are down to €12,709mln in 11 months of 2011, or -€272mln to target (-2.1%) but an impressive 22.5% above same period 2010 levels.

Sounds like tax policies of the past bearing fruit? Not really. Income tax rose €2,336 on 2010 in absolute terms, but at least €1,850mln of this is due to Health Levy reclassification as USC and aggregation into income tax receipts. Yes, folks, for all income tax increases in years past, the Exchequer netted less than €500mln in new revenues this year, or to be slightly more precise - an uplift not of claimed 22.5% (DofF maths), but of closer to just below 4.7%. The picture below looks good, but in reality, Income tax revenues are running below 2008 and 2009 levels, still, once Health Levy is factored in.

More ominously, the under-€500mln lead this year is based on the annual rate of Health Levy pay-in for 2010 spread evenly over all months. Of course, it probably was also peaking at around November, as usual seasonality in returns applied to it as well as to other income-related measures. Which means that it is quite possible that the annual rate of income tax increases will be even lower, once we see December figures than 4.7% figure suggests.

Let's recall that these figures come on top of shrinking workforce and rising unemployment and you get the picture - people at work are not getting anywhere, with their taxes rising dramatically in recent years, but Government revenue is not recovering either.

When it comes to VAT (second largest source of state revenues), the numbers are abysmal. November 2011 revenue is at €9,550mln or €464mln off target and 3.3% below 2010 figure (-€464mln). VAT receipts are 7.9% below those for the same period of 2009. Chart below shows what happens

Corporation tax receipts - the reflection of our booming exporting economy came in at €3,510mln or €236mln behind target and 4.3% or -€158mln down on 2010. Compared to 2009 these are now off 6.43% or -€241mln. Fourth straight year of decline.

Excise tax, the third largest category, is upo a whooping €15mln on target to €4,130mln, year on year the uplift is €39mln or 0.9%. And there was an even greater uplift in Stamps - up €442mln o  target to €1,297mln and up 51.6% year on year. Except, of course, that uplift is accounted for by the hit-and-run pension levy. Net of the pension levy, Stamps are actually down 1.75% yoy.

So total tax receipts are:

• Down €520mln on target (-1.6%) but officially up 7.9% (+€2,325mln) yoy
• Up just €18mln year on year once we net out Pension & Health Levies.
• Down on target in 3 out of top 4 tax headings and 
• Down on target in 5 out of 8 headings

Meanwhile, rosy forecasts continue to flow from the DofF which projects that 2012 total tax revenue will rise 4.13% (see here)... pass that funny gas mask, doc.

05/12/2011: Government Book of Estimates 2012 - latest comic from DofF

So the book of estimates is out pre-Budget 2012 and there are some notable numbers in it. Let's run from the top:

• Table 1 projects Current Receipts of  E38,081mln in 2012 or E1,344mln of 'natural increases' in tax receipts, presumably from roaring economic growth
• Table 1 also projects capital receipts falling by E660mln due to lesser tax on tax (aka banks measures 'returns')
• Table 1 projects increase in total revenue of E683mln to E39,905 - where this will come from, one might wonder. Table 2 shows that all of these increases will come from tax revenues growth - remember, estimates do not include any new measures to be passed in Budget 2012. In particular, DofF assumes that tax revenues will rise 4.13% yoy in 2012. Why? How? On back of 1.3% growth - the rosiest forecast we've had so far? How much do they plan to extract from value-added o get these figures? Suppose economy expands by 2.2 billion in 2012 (ca 1.3%), tax revenue is supposed to grow by E1.41 billion, so 'extraction rate' is over 64%. That is the full extent of our assumed upper marginal tax rate pre-Budget 2012 measures, folks. Either we are worse than France (the highest full economic tax rate) or the DofF estimates are a bit shambolic.

On the austerity side, there are some notable features of the 'estimates':

DofF assumes interest payments on Government debt of E7.488bn in 2012, up on €4.904bn in 2011. That means that we will be spending

• 71% more on payment on our debt, including that to our 'European Partners' than we will be spending on capital investment, or
• 21% of all our tax receipts will be going to finance interest on government debt
• Given projected yield from Income tax of E15.09bn in 2012 (do forget for the moment that this is basically a form of numerical lunacy, not a hard number, as there is absolutely no reason why income tax next year will be at these levels), our Government debt interest bill will account for 49.6% of our entire projected income tax revenue.

Remember, this all is sustainable, per our Green Jersey 'experts' and we haven't even reached the peak of our debt, yet...

And, yes, there's Austerity... after three years of 'cuts' we have:

• Current spending is expected to rise from E48.148 bn in 2011 to E51.233 bn in 2012, so that
• General Government Deficit will reach E16.2 billion or E600 million ABOVE 2011 level.

At last we have our truth - in the numbers of even overly optimistic Government own projections - there is no austerity, folks. There is re-arrangement of spending chairs on Titanic's deck. Painful for many, to be true, whose services and subsidies are being cut, but certainly not visible in terms of actual fiscal balance.

So how rosy are Government figures on those projections side? Government 'estimates ' assume that in 2012 Irish GDP will stand at E162 billion, which is a whooping 4.88% above 2011 levels. Right, someone has been drinking that lithium-laced water that the nation should get per our Buba Doc proposals aired last week - GDP growth in 2012 will be 4.88% nominal per DofF.

Bonkers! QED.

3/12/2011: Latest Euro Crisis Proposal: A Debt Fund to Solve Nothing

The latest technocratic deram of European sovereign finance engineers is out. Here's the extracts from Reuters report with my comments (full report link here):

"Wolfgang Schaeuble outlined his plans under which states would effectively siphon off a chunk of their debt to a special national fund and pay it off over about 20 years while committing to reforms to keep debt levels on target."

What's that, you say? To "boost confidence" of the proverbial markets, the Euro states "should put into a special fund that part of its debt which exceed 60 percent of its GDP, and should pay that off with tax revenues. Over a period of 20 years, the debt should be reduced to 60 percent".

So let me run through this in some order:

1. The debt will remain the debt - within the fund and outside.
2. The 'balanced budget' rules once adopted (and in Germanic fashion anything adopted = implemented) will assure no new debt accumulated.
3. Part of the debt above 60% of GDP will be extended in maturity (somehow, there will be 'no credit event' there?)
4. The part of the debt above 60% of GDP will be repayable out of tax revenues (the rest, presumably will be repayable out of  Schaeuble's pension fund?)
5. There will be no common liability - as "an earlier proposal this month from a panel of independent economic advisers to the German government which was rejected as unrealistic by Merkel, envisaged a European Redemption Pact. That proposal, for a fund of up to 2.3 trillion euros, was anathema to Merkel because it suggested pooling excess debt into a fund with common liability." Which means risks of each individual state debt will remain the same within and outside the fund. Just how this will impact sovereign yields begs some explaining.
6. Repayment of debt accumulated in the fund will have, presumably, some priority over other debts. Otherwise, what's the difference if this debt is in the fund or not. If so, what seniority implications will there be for two types of debts - within the fund and outside the fund? If none, there will be no material difference between the two and thus no change on current status quo. If Fund debt were to be more senior (having a first call on repayment by tax revenues) then the remaining debt quality will deteriorate. Implications - the Fund will make things worse, not better, for the sovereigns.

Overall, the whole idea of a Fund can only work if the following are simultaneously true:

1. There is a pooled liability for the Fund-held debts to assure improved ratings (already ruled out).
2. The combined (Fund-held and non-Fund) debts of all countries participating in the fund are jointly and separately sustainable (repayable) and the reason for the Fund creation is solely a short-term liquidity crunch. Note: only in this case future tax revenue will be sufficient to repay debts. But of course we already know that the Euro area problem is that the debts are NOT sustainable in Italy, Portugal, Greece and Ireland, and most likely also unsustainable in Belgium.
3. More indebted countries receive, during the period of repayment, sufficient fiscal transfers to prevent their economies from imploding and thus preventing their unsustainable debts triggering common liability clauses. This might be the case, but how will it go down with the electorates and Governments in surplus countries, over 30 years, one can only wonder.
4. The commitments to new budgetary rules of, say 2% maximum deficit, are fully implemented in real budgetary processes across all member states over the entire 30 years horizon. 

And that's a lot of "if"s, even more "no"s and not a single one "Yes!"...

2/12/2011: Euro crisis: wrong medicine for a misdiagnosed patient

There's been much talk about the fiscal union and ECB money printing as the two exercises that can resolve the euro area crises. The problem is that all the well-wishers who find solace in these ideas are missing the very iceberg that is about to sink the  Eurotanic.
 (image courtesy of the ZeroHedge.com):

Let's start from the top. Euro area's problem is a simple one:

• There is too much debt - public and private - as detailed here, and
• There is too little growth - including potential growth - as detailed here.

Oh, and in case you think that discipline is a cure to debt, here's the austerity-impacted expected Government debt changes in 2010-2013, courtesy of the OECD:

In other words, it's not the lack of monetary easing or fiscal discipline, stupid. It's the lack of dynamism in European economy.

Let me explain this in the context of Euro area policies proposals.

• The EU, including member states Governments, believes that causality of the crisis follows as: Loss of market confidence leads to increased funding cost of debt, which in turn causes debt to become unsustainable, which in turn leads to the need for austerity and thus reduces growth rates in the Euro area economies.
• My view is that low growth historically combined with high expectations in terms of social benefits have resulted over the decades in a build up of debt, which was not sustainable even absent the economic recession. Economic recession caused the tipping point in debt sustainability beyond which markets lost confidence in European fundamentals both within the crisis environment, but also, crucially, beyond cyclical recession. My data on structural deficits (linked above) proves the last point.

So while Europe believes that its core malaise is lack of confidence from the markets, I believe that Europe's real disease is lack of growth and resulting high debt levels. Confidence is but a symptom of the disease. 

You can police fiscal neighborhood as much as you want (and some policing is desperately needed), but you can't turn European economy from growth slum to growth engine by doing so. You can also let ECB buy all of the debt of the Euro area members, but short of the ECB then burning the Government bonds on a massively inflationary pyre, you can't do away with the debt overhang. Neither the Euro-bonds (opposed by Germany) nor warehousing these debts on the ECB balance sheet (opposed by Germany & the ECB) will do the trick. Only long-term growth can. And in that department, Europe has no track record to stand on.

Take Italy as an example. Charts below illustrate the country plight today and into 2016. I use two projections scenarios - the mid-range one is from the IMF WEO for September 2011, the adverse one is incorporating OECD forecasts of November 2011, plus the cost of funding Italian debt increasing by 100bps on the current average (quite benign assumption, given that it has increased, per latest auctions by ca 300bps plus).

As chart below shows, Italy is facing a gargantuan-sized funding problem in 2012-2016. Note that the time horizon chosen for the assessment of fiscal sustainability is significant here. You can take two assumptions - the implicit assumption behind the Euro area policy approach that the entire problem of 'lack of markets confidence' in the peripheral states can be resolved fully by 2013, allowing the peripheral countries access to funding markets at costs close to those before the crisis some time around 2013-2014. Or you can make the assumption I am more comfortable with that such access to funding markets for PIIGS is structurally restricted by their debt levels and growth fundamentals. In which case, that date of regaining reasonable access to the funding is pushed well past 2015-2016.

Government deficits form a significant part of the above debt problem in Italy (see below), but what is more important is that even with rosy austerity=success model deployed by the IMF, the rate of decline in Italian public debt envisioned in 2013-2016 is abysmally small (again, see chart below). This rate of decline is driven not by the lack of austerity (deficits are relatively benign), but by the lack of economic growth that deflates debt/GDP and deficit/GDP ratios and contributed to nominal reductions in both debt and deficits.

But the proverbial rabbit hole goes deeper, in the case of Italy. IMF projections - made before September 2011 - were based on rather robust euro area-wide growth of the first quarter of 2011. Since then two things have happened: 

1. There is a massive slowdown in growth in Italy and across the euro area (see here), and
2. Cost of funding Italian debt has risen dramatically (see the second chart below).

These two factors, imperfectly reflected in the forecasts yield my estimation for Italian fiscal sustainability parameters under the 'adverse' scenario.

The above shows why, in the case of Italy, none of the solutions to the crisis presented to-date will work. Alas, pretty much the same applies to all other peripheral countries, including Ireland.

Which means that the latest round of euro area policies activism from Merkozy is simply equivalent to administering wrong medicine in greater doses to the misdiagnosed patient. What can possibly go wrong here?

1/12/2011: Manufacturing PMI for Ireland - November

Manufacturing PMI for November has signalled renewed downward pressure in sectoral activity.

Having posted a surprise, EU-wide trend-breaking increase from 47.3 in September to 50.1 in October (a reading above 50 is consistent with expansion, albeit a reading between 50 and roughly speaking 52.5 is statistically insignificantly different from 50), the core Manufacturing PMI fell again into the contraction territory in November, posting 48.5.

More ominously, 3 mo average through November is now 48.6 and 3mo average through August is at 49.2, so last six months on average have posted a contraction in Manufacturing activity. Thus, Manufacturing PMIs are now firmly flashing recession warning signs. A year ago, 3mo average through November 2010 stood at 50.2. 12 mo MA is remaining above 50 at 51.8 due to solid gains achieved in January-April 2011.

Output reading is now also below 50 with November Output measure coming in at 48.3, down from 52.7 in October. 3mo average through November is barel above 50 at 50.3 and 3mo average through August is at 50.5. November 2011 reading is the lowest since January 2010.

Like the main indicator, New Orders sub-index has posted average below 50 readings in 6 months through November. The sub-index is now at 49.7, down from 51.4 in October. New exports orders sub-index remained just below 50 for the third month in a row at 49.9 in November, compared against 49.8 in October. And backlogs of existent orders continued to contract at 44.2 in November - 9th month of straight declines.

Output prices accelerated factory gates deflation at 48.2 in November compared to 49.2 in October - for the fourth consecutive month. Meanwhile input prices index signalled continued strong inflation at 55.2 in November, unchanged from October. This trend is present in the data since January 2010 uninterrupted. Thus profit margins in manufacturing continued to decline at accelerating pace (more on this in a separate blog post once we have PMIs for services as well).

Stocks of purchases declined rapidly at 41.3 in November - deeper contraction than 44.5 registered in October. Meanwhile rate of decline in stocks of finished goods (46.1 against 45.4 in October) has slowed down, suggesting build up of inventories and putting potential pressure on one of components of GDP and GNP down the line.

Employment also posted third consecutive month of declines - November reading is 48.3 against 47.1 in October. 3mo average through November is 47.3 - well below already contractionary 3mo average through August at 49.5. In 2010, 3mo average through November stood at a less sharply contracting 47.9.

Overall, pretty brutal data for Manufacturing.

1/12/2011: Sunday Times, 27 November 2011

Here is the unedited version of my article in the Sunday Times, November 27, 2011.

Since the collapse of the bubble, Irish perceptions of the residential and commercial property markets have swung from an unquestioning adoration to a passionate rejection.

As the result of the bubble, the overall share of property in average household investment portfolio is likely to decline over time from its Celtic Tiger highs of over 80% to a more reasonable 50-60%, consistent with longer term averages in other advanced economies. But housing will remain a significant part of the household investment for a number of good reasons.

While providing shelter, housing wealth also serves as a long-term savings vehicle and an asset for additional borrowing for shorter-term investments. Security of housing wealth in normal times acts as an asset cushion for family-owned start up businesses and a convenient tool for regular savings. Over the lifetime, as demand for housing grows with family size, we increase our savings, normally just as our life cycle earnings increase. We subsequently can draw down these savings throughout the retirement when income from work drops.

In short, in a normal economy, housing and household investment are naturally linked. In this light, the grave nature of our economic malaise should be apparent to all. Ireland is experiencing a continued and extremely deep balance sheet recession, with twin collapses in property prices and investment that underlie structural demise of our economy.

The latest Residential Property Price Index, released this week, shows that things are only getting worse on the former front. Overall, residential property price index fell to 71.2 in October from 72.8 in September. The latest monthly decline of 2.2% is the sharpest since March 2009 and the third fastest in the history of the index. Relative to peak prices are now down 45.4%. Take a look at two components of household investment portfolios: owner-occupied and buy-to-let properties. For the majority of the middle class families, the former is represented by a family home. The latter, on average, is represented by apartments. Nationwide, per CSO, prices of these assets are respectively down 43.7% and 57.9% relative to the peak.

The impact of these price movements is significant and, contrary to the assertions of the Government and official analysts, real and painful. House price declines imply real capital losses to households and these losses have to be offset, over time, with decreased consumption and falling investment elsewhere. Absent normal loss provisioning available to professional financial sector investors and businesses, households suffer catastrophic collapses on the assets side of their balance sheet, while liabilities (value of mortgages) remain intact. Decades-long underinvestment and low consumption spending await Ireland.

Dynamically, things are not looking any brighter today than a year ago. House prices have fallen 14.9% year on year in October, the worst annual drop since February 2010. Apartments prices are down 19.8% over the last 12 months – the worst annualized performance since April 2010.  Given the price dynamics over the last three years, as well as the current underlying personal income, interest rates and rental yields fundamentals, Irish property prices remain at the levels above the short-term and medium-term equilibrium. This means we can expect another double-digit correction in 2012 followed by shallower declines in 2013.

Not surprisingly, the collapse of the property markets in Ireland is mirrored by an even deeper crash in overall investment activity in the economy. The latest National Accounts data shows that in 2010, gross fixed capital formation in Ireland declined to €19 billion in constant prices. This year, data to-date suggests that capital formation will drop even further, to ca €17 billion or almost 58% below the peak levels. In historical terms, these levels of investment activity are comparable only with 1996-1997 average. If we assume that the excess investments in the property sector were starting to manifest themselves around 2002, to get Irish economy back to pre-boom investment path would require gross fixed capital investment of some €26.9 billion per annum or more than 60% above current levels.

Between 2000 and 2009, Irish economy absorbed some €319 billion in new fixed capital investments. Assuming combined rate of amortization and depreciation of 8% per annum, just to keep that stock of capital in working shape requires €25.5 billion of new investment. This mans that in 3 years since 2009, the Irish economy has lost some €15.5 billion worth of fixed capital to normal wear-and-tear. In short, we are no longer even replacing the capital stock we have, let alone add new productive capacity to this economy.

Looking into sectoral distribution of investment, all sectors of economic activity outside building and construction have seen their capital investment fall by between 18.4% in the case of Fuel and Power Products to 70.4% in the case of Agriculture, Forestry and Fishing sector. So the aforementioned aggregate collapse of investment is replicated across the entire economy.

The dramatic destruction of capital investment in the private sector is not being helped by the fact that Government capital expenditure is also contracting. In 2010, Voted Capital Expenditure by the Irish Government declined to €5.9 billion. This year, based on 10 months through October data, it is on track to fall even further to €4 billion – below the target of €4.35 billion and more than 53% below the peak. In fact, the entire adjustment in public expenditure to-date can be attributed to the capital spending cuts, as current expenditure actually rose over the years of crisis. Since 2008, current expenditure by the state is up 1.9% or €775 million this year, based on the data through October. Thus in 2008, Irish Government spent 17.4% of its total voted expenditure on capital investment. This year the figure is likely to be under 8.8%.

Forthcoming Budget 2012 changes are likely to make matters worse for capital investment. In addition to taking even more cash out of the pockets of those still in employment – thereby reducing further the pool of potential savings – the Government is likely to bring in the first measures of property taxation. This will reinforce households’ expectations that by 2013-2014 Ireland will have a residential property tax that will place disproportional burden on urban dwellers – the very segment of population that tends to invest more intensively over time in property improvements, making the urban stock of housing more economically productive than rural. A tax measure that would be least distorting in terms of incentives to increase productivity of the housing stock – a site-value tax – now appears to be abandoned by the Government, despite previous commitments to introduce it.

Furthermore, we can expect in the next two years abolition of capital tax reliefs, increases in capital tax rates and high likelihood of some sort of wealth taxes – direct levies on capital and/or savings for ordinary households. In the case of the euro area break up, Ireland will also see draconian capital controls.

In short, we are now set to experience an 8-10 years period of direct and accelerating destruction of our capital base. It doesn’t matter which school of economic thought one belongs to, there can be no recovery without capital investment returning back to growth.

Box-out:

In the recent paper titled “The Eurozone Crisis: How Banks and Sovereigns Came to Be Joined at the Hip”, published last month, two IMF researchers identify Europe’s Lehman’s moment in the global financial crisis as the day when the Irish Government nationalized the Anglo Irish Bank. In contrast to the current and previous Governments’ assertions, the IMF study argues that the Anglo was not a systemically important bank worthy of a rescue. As the paper puts it: “The problems [of collapsing financial sector valuations] entered a new phase – becoming a full-blown crisis – with the nationalisation of Anglo Irish in January 2009. The relevance of Anglo is, at first, not obvious, since it was a small bank in a relatively small country. However, …it is possible that the large fiscal costs as a share of Ireland’s GDP associated with this rescue raised serious concerns about fiscal sustainability. Suddenly, the ability of the sovereigns to support the financial sector came into question.” In other words, far from helping to avert or alleviate the crisis, Anglo nationalization caused the crisis to spread. “In retrospect, the nature of the crisis prior to Anglo Irish was simple, being mostly driven by problems in the financial sector… The winding down of Anglo Irish, for example, would have been preferable to its nationalization…” In effect, the previous Government made Anglo systemically important by rescuing it. If there ever was a better example of the medicine that kills the patient.