17/06/2011: Irish Exchequer Expenditure - May

A late catching up on the recent Exchequer figures for May. In the earlier post (here) I covered receipts side of the figures. Now, time to update the expenditure side as well. I was reluctant to write much about expenditure and revenue sides of the fiscal crisis in previous months, since early months show very little in terms of comparatives. By the end of May, however, almost 1.2 a year has gone by and some trends can be established, albeit of course with caution.

Total net spending by the Government for January-May 2011 was €18.364bn up on €17.867bn for the same period in 2010. Overall, spending fell 3.67% on the same period for 2008 (€699.5mln saved) but is up 2.78% on 2010 (dis-savings of €497.3mln).

This is not encouraging.
As chart above shows, the expenditure is now running between 2010 and 2008 levels. Sounds ok? Not really. Ireland will have to cut another ca 6% (based on rather rosy plans set out by the Troika back in November) in years to come. So far, we only managed to cut 3.67% relative to 2008 after three ‘savage cuts’ budgets.

The reason is that our 'cuts' were not really that deep, per se, but that they were transfers of expenditure from the capital side and some departmental current spending to Social Protection and Education & Skills. Here are two charts:


Here are some relative slippages (bear in mind that departments responsibilities and names have changed since 2008):
Social Protection spending rose 47.33% over the same period.

These were offset by above average (simple average of -20.69% decline across all departments) declines in spending levels in:

• Tourism, Culture and Sport – down 49.58%;
• Community, Equality & Gaeltacht – down 48.77%;
• Enterprise, Trade & Innovation – down 45.58%
• Environment, Community & Local Government – down 52.24%
• Foreign Affairs – down 28.93%
• Transport, Tourism and Sport – down 56.56%
  

Below average declines took place in:

• Agriculture, Fisheries and Food department spending declined 7.49% in January-May 2011 compared to the same period of 2008;
• Comms, Energy and Nat Resources – down 13.34%;
• Defence – down 15.69%;
• Education & Skills – down just 2.52%;
• Finance – down 17.925;
• Health & Children – down 1.75;
  

• Justice & Equality – down 15.525;
• Taoiseach’s – down 1.75%

Large fraction of these reductions is explained by the capital cuts (a subject for my future post) and by the timing of expenditure (we do not know if payments lags are rising in the public sector or not, and we do not know if capital spending is being delayed to generate positive news momentum).

But it is worth noting that some of the departments show deterioration in performance on the expenditure side relative to 2009-2010 (as opposed to 2008) base. Again, some of these are due to re-arranging of the departmental responsibilities, but in the end, what matters is that to-date, through the first 5 months of the year, Irish Exchequer expenditure cuts and tax increases have yielded just €699.5mln in savings on the 2008 levels.

Furthermore, we should note that promissory notes paid out to the banks in March are not factored into the overall voted expenditure, so the comparatives on the spending side are clearly showing that fiscal consolidation is not working so far. Which brings us to the following ‘rumour’ I heard from a senior governing coalition member. Allegedly, all indications are, Budget 2012 will be, to quote my source, “so bad, it’ll push thousands currently at the margin of leaving the country into booking their tickets out of Ireland this side of June 2012”. And this was in relation to the tax burden measures.

So lastly, lets take a look at year-on-year savings generated by all the austerity measures. The chart below shows that:

1. Savings generated earlier in the year in 2010 were driven primarily by the delays in payments and other temporary measures. Having started at a robust saving of 12.95% in January 2010, the Ex chequer allowed slippage of cuts to net a miserably low rate of overall expenditure reductions of just 1.55% for the year.
2. Both, in 2009 and 2010, by May, Exchequer spending was either contracting of rising at a much slower pace year on year.
3. The pattern for expenditure this time around – in 2011 – is strikingly different from that in either 2010 or 2009.
   

17/06/2011: Who's Confidence is it, folks?

Here are few charts to illustrate the fact that some 3 years into the 'Restoring Confidence' strategy of the successive Irish Governments... and things are not exactly working out.

First straight up, the markets 'voting' on Irish banks:
Looks like investors are not really in tune with Irish Government plans for 'repairing' our banking system despite unprecedented guarantees from the Sovereign which have:

• Explicitly underwritten virtually all deposits and most of the bonds held or issued by the IRL6;
• Implicitly underwritten virtually any extent of losses in the IRL6;
• Explicitly purchased some of the worst 'assets' held by the IRL6; and
• Explicitly underwritten all of the IRL6 funding through ECB and CBofI lending facilities

And what about the entire system of domestic financial institutions? Well, the story is pretty much the same:Recall, thus that at the present (and the picture remains stable in this context since around late 2008):

• Financial investors have no confidence in IRL6 (as these charts illustrate)
  
• Fellow peer banks around the world have no confidence in IRL6 (as clearly indicated by the fact that other banks are not willing to lend to IRL6)
• Bond markets have no confidence in IRL6 (since none of IRL6 can issue any debt paper)
• The ECB has no confidence in IRL6 as it desperately tries to shed their borrowings off its balance sheet (including by shifting it onto CBofI balancesheet)
• Private sector have no confidence in IRL6 as they have taken out some €24 billion worth of funds from IRL6 (per April 2011 data from CBofI) or 23% relative to peak
  

So the only ones still showing confidence in IRL6 is... Irish Government itself, with the Sovereing - itself severely strapped for cash - putting some €18.566 billion worth of taxpayers money into Irish banks deposits since April 2010. That's a whooping ca 8-fold increase in Confidence, then.

15/06/2011: Few points of the future of FS

This is the presentation I gave at the Roundtable (thanks to all 150+ academic & industry practitioners who came and engaged) on the Future of Financial Services at the Infinity 2011 Conference on International Finance. Slides and few points:
Since I was chairing the event, I had to limit severely my presentation and the core of the event was based on 3 presentations by industry experts and the discussion with the audience - less Q&A, more open discussion.
Consistent with my view, the global financial crisis continues to threaten macroeconomic stability of the global financial and economic systems.

• The core component of the crisis - the crisis across global financial markets has abated due to the efforts of the Central Banks and Governments around the world. But it has not gone away. The system overall remains fragile on the side of liquidity (with quantitative easing rounds now being scaled back and no liquidity traps remaining, holding liquidity already supplied in the system locked away from the process of real lending).
• The crisis continues largely unabated in the sub-geographies of advanced economies and in particular within the banking sector in Europe, Japan and to a much lesser extent - the US. In the US, where balancesheet repairs on the capital side took stronger forms, the crisis in now manifested on the demand side for lending as well as in continued stagnation in the core household asset markets (property in particular).
• The main focus of the crisis has shifted onto debt - with deleveraging of balance sheets being secondary to the need to continue deleveraging households - something that continues to evade the focus of the policymakers.
• A number of large economies are now also experiencing a full-blown or forthcoming sovereign debt crises.

Overall, the duration, the breadth and the depth of the current crisis are so profound that in my view they signal a structural nature of the crisis, leading to a permanent (or long run) shift in:

• Regulatory environments (tightening of regulatory and supervisory systems, higher demand for capital, higher demand for quality capital, etc) all of which, unfortunately, so far, represent no qualitative departure from the already failed model of regulation that led to the current crisis in the first place. In other words, there's 'more of the same' type of a response on the regulatory side that is emerging so far, which does not hold any real promise of change, but suggest dramatic increases in the cost of capital provision, especially via debt instruments.
• The process of re-banking advanced economies - yet to start - will be taking Europe, North America and other advanced economies to a New Normal which will require cardinal rebalancing of the markets for financial services provision. This, in my opinion, will see consolidation of global banking institutions and a decline in their combined market shares, and the emergence of highly competitive and innovative specialization-driven service providers. The latter will be drawing increasingly greater shares of the markets for FS globally and will be largely free from the legacy of the crisis. In this context, the legacy of the crisis that will remain with the sector is the legacy of massive destruction of wealth inflicted onto the clients by the minimal compliance (prudential or suitability tests-based standards) ethos of the pre-crisis investment and wealth management services providers. In their place, the new providers will be adopting (driven by market demand, not regulatory systems) a fiduciary principle-based services ethos, which will put client needs as the main driver of revenues for the sector. Up-selling complexity and risk is out as a business strategy for margins support. Client relationship-building and product-backed client support will emerge as the core replacement strategy.
  
• In terms of re-equilibrating demand and supply of credit, the problem of shrinking pool of savings (due to fiscal austerity-driven tax increases, and demographic aging in the West contrasted with consumption expansion in the New Advanced Economies - NAE) will have to alleviated through new instruments. Debt will remain constrained as long-term process of deleveraging unfolds, equity will be the king, but hybrid instruments (on corporate finance side, less so onr etail side) and some new instruments for investment will have to emerge.
  
• Lastly, the New Normal will be characterized by a drastic scaling back of real off-balancesheet public liabilities (pensions, health and social welfare nets). The age of reduced local (within advanced economies) savings, falling debt levels and tighter global supply of savings (consumption effects in the emerging and NAE economies) will result in reduced ability to finance sustained deficits. This will precipitate emergence of new financing mechanisms (more closely aligned pay and benefits) for public investment, further reducing private investment supply.

The New Normal is already emerging via the divergence of financial services environments across two geographies: the Advance Economies (the "North") and the NAE economies (the "South").
In addition to regulatory pressures of 'Do More of the Same' approach in the advanced economies, and on top of a persistent gap in growth between the advanced economies and NAEs regions, there are emerging gaps in Investment volumes heavily skewed in favor of NAEs, a margin gap and a capital gap (both in terms of quantity and quality of capital, with many NAE banking systems explicitly or implicitly underwritten by solvent and liquid SWFs).

This geographic bifurcation of the FS models will fully emerge, in my view, around 2015-2020 and by 2020-2025 we are likely to see the drive toward convergence of FS across two geographies:
This convergence will be driven, in addition to the above factors, by the rising pressure of competition with 'North' service providers pushing into NAEs to capture higher margins and new markets, and with 'South' service providers pushing aggressively into the advanced economies markets to capture know-how, exercise competitive advantage of relatively cheaper capital available in the 'South' and retaliate against 'North's' competitive drive into their own markets. The end result will be globally lower Returns to Equity (ROE) squeezed on both sides by higher capital requirements and compliance and risk management costs (E-up) and lower margins (R-down) due to lower availability of savings, regulatory costs increases outside capital costs alone and a long-term shift of demand away from high risk high margin products (the shift toward fiduciary standards). Overall risk (sigma) will abate, as global economy settles on a lower structural growth level, further reducing risk premia-driven margin and ability to upsell risk.

In this process of transition to the New Normal, it is, IMO, of interest to have expanded academic and practitioner debate and research relating to the following questions:

11/06/2011: Irish Competitiveness: latest data

Q4 2010 data for Euro area-wide competitiveness indicators is now out and it's worth updating my old charts and crunching through some numbers.

Remember - Irish and some European policymakers are quick to point to improving competitiveness as a core strength of Irish economy. I am slightly in a more skeptical camp on this. Improving competitiveness is good, but it matters where these improvements come from and whether our competitiveness is improving not in absolute terms, but relative to the rest of Euro zone. Let's take a look at what data tells us:

• Euro area Harmonized Competitiveness Indicator (unit labour cost-based) deteriorated in Q4 2010 to 97.9 from 96.3 in Q3 2010 (higher values reflect lower competitiveness). This means that qoq HCI for Euro area (the average benchmark to compare ourselves against) has deteriorated 1.66%, while yoy it is still showing improvement of 9.69%. For the 6mo from July through December 2010 Euro area competitiveness improved 9.55% on same period in 2009.
• Irish HCI has moved from 110.8 in Q3 2010 to 113.8 in Q4 2010 - a deterioration in competitiveness of 2.71% - much deeper drop than for the Euro area average. However, year on year we are still outpacing Euro area gains in competitiveness, with our competitiveness improving 10.60% on Q4 2009, against Euro area improvement of 9.69%. For the 6 mo through December 2010, Irish competitiveness improved 10.62% yoy again outpacing improvements in the Euro area at 9.55%.
• So the speed at which our competitiveness indicators are improving is about 16-17% faster compared to Euro area for the Q3-4 2010, but in Q4 our competitiveness has deteriorated about 10% faster than that of the Euro area.

Charts to illustrate:

This means that we have to think not only in terms of the rates of change, but in terms of actual levels of competitiveness. And here we are not exactly a shining example of a competitive economy:

• In Q3 2010, Ireland was the third least competitive economy in the Euro area, scoring 110.8 HCI reading against 111.7 for Luxembourg and 171.3 for Slovakia. In Q4 2010 we slipped down to the second least competitive economy ranking with 113.8 for Ireland, against 113 for Luxembourg. Not exactly where we would like to be, nor the direction we would like to be heading in. Especially since wages are not growing and unemployment is not improving, while overall employment is declining - in Ireland, while the opposite is true for many of our competitors. Which suggests that the value added of our output is declining to drive our HCIs readings up.
• More significantly, since Slovakia and Lux are not exactly our immediate comparators, as chart below shows, our performance remains extremely poor compared to other core Euro area economies.

So let's use the FF slogan from the past: "Lots done, more to do" to describe our situation. At the peak of our 'non-competitiveness', Irish HCI's exceeded Euro area reading by 25.9 points (Q1 2008). In Q4 2010, we exceeded Euro area benchmark by 15.9. Less than half of the gap in competitiveness has been erased by Ireland Inc. To get ourselves down to the level of our direct competitors (other Small Open Economies, SOE) we would need (assuming they stay put at Q4 2010 levels and excluding Slovakia and Ireland) to shave off roughly speaking another 8 points from our HCIs. In other words, you can think of this in the following terms - for all the pain we've experienced, we've traveled so far just under 56% of the road to becoming as competitive as the average other similar SOE. "Lots done, folks. Yet much left to do, still."

10/06/2011: Capital Assets Acquisition in Industry - Q4 2010 data

Another data update for Ireland - Capital Investment in Industry, based on the CSO data for Capital Acquisitions.

Updating to Q4 2010:

• Total volume of new capital acquisitions in the industry in Ireland reached €911mln in Q4 2011, up32.5% yoy.
• New investment in capital acquisitions in Ireland for 2010 reached €2.333bn, down 25.4% on 2009 and less than half the level recorded in 2008 (€5.033bn). This was the lowest amount of capital acquisitions over the years 2006-2010.
• Combined investments into capital acquisition in Pharmaceutical, Computer and Machinery sectors reached €261mln in Q4 2010 up 43.4% yoy. Total annual level of new investment in capital acquisition in these sub-sectors stood at €592mln in 2010, down 42.7% on €1.034bn n 2009 and down on annual levels in 2008 (€1.695bn), 2007 (€1.603bn) and 2006 €1.054bn)

Chart to illustrate:

10/06/2011: Industrial turnover and production - April 2011

Industrial Production and Turnover data was released today for April, indicating the overall activity in the manufacturing sector and the broadly defined sources of this activity.

In line with this, I went back and linked - re-based - 2006 and 2007 CSO data to current base to show some comparatives to pre-crisis dynamics.

Here are the highlights:

• Manufacturing activity was up 4.09% on annual basis, compared to April 2010. Monthly increase was 2.24%. However, Manufacturing activity was down 1.44% on 3 months ago and 4.16% on April 2007 (pre-crisis). The seasonally adjusted volume of industrial production for Manufacturing Industries for the 3mo period to April 2011 was 1.8% lower than in the preceding 3mo period
• All industries activity was up 1.32% mom and 2.67% yoy, but down 2.095% on 3 months ago and down 5.33% on April 2007.
• Modern Sectors posted a volume increase of 2.52% yoy and 1.41% increase mom. The activity in Modern Sectors is up 4.79% on April 2007, but is down 2.4% on 3mo ago.
• Traditional Sectors activity was up 1.39% yoy and 1.15% mom, but down 0.57% on 3mo ago and a whooping 18.05% on April 2007.
• It is interesting to note that Modern Sectors are positively correlated with Manufacturing output to the tune of 0.772 for the full sample (January 2006-present), but this correlation grew to 0.863 for the sub-sample covering the crisis (since January 2008) and continues to grow today - up to 0.926 for the sub-sample since January 2010.
  
• In terms of Modern Sectors influence on All Industries volumes, the same relationship holds, with full sample correlation of 0.713 rising to 0.812 for the crisis period and to 0.887 for the period since January 2010.
• The predominant role of Modern Sectors in driving Irish Industrial production is contrasted by a very modest role played by Traditional Sectors, where correlation with All Industries has declined from 0.416 in the full sample since January 2006, to 0.290 in the sub-sample covering the crisis since January 2008, to 0.142 for the sub-sample since January 2010.
  

Chart to illustrate:
Of course, the driving factors discussed above imply that:

• The collapse of construction and real estate investment exposed the extreme degree of indigenous industries dependence on these areas of economic activity;
• MNCs-dominated modern sectors, free of constraints of domestic demand, have been experiencing strong recovery. Manufacturing has regained pre-crisis peak of 109 (attained in 2007) back last year (reaching index reading of 110.1 for the year), which also pushed All Industries index a notch above pre-crisis peak. Modern Sectors have shot to new historic highs in 2010, reaching 124.7 index reading, compared to pre-crisis peak of 111.2 attained in 2007. It is worth noting that Modern Sectors have recovered from the recession back in 2009, having posted volume of production index reading of 112.7 - above the pre-crisis peak.
• These trends continued in April 2011, as CSO notes, since "the most significant changes [in Volume of Production Indices] were in the following sectors: Basic Pharmaceutical products and Preparations (+11.3%) and Beverages (9.9%)... The “Modern” Sector, comprising a number of high-technology and chemical sectors, showed an annual increase in production for April 2011 of 2.6% and a increase of 1.4% was recorded in the “Traditional” Sector.

Next, consider turnover indices:

• Turnover in Manufacturing sector in April registered index activity at 95.9, which is 3.01% above March activity and 3.45% above April 2010 activity. However, turnover is 4.29% below that recorded 3 mo ago and 14.40% below April 2007. The turnover in April was also lower than the turnover in any of the months from May 2010 through February 2011
  
• Turnover in Transportable Goods Industries posted index reading of 95.4, which was up 2.69% mom and 3.02% above April 2010 reading. The index was down 4.6% on 3 mo prior to April 2011 and 15.22% below April 2007 reading.
• This suggest that output sales conditions have improved mom (monthly changes in turnover exceed change in volumes), but are still down yoy.

Chart to illustrate:
Lastly, the above chart also shows new orders activity which has risen from 90.7 in March to 95.9 in April for all sectors. However, new orders activity remains slowest for any month since the end of April 2010 through February 2011. New orders index is therefore up 5.73% mom (good news) and 3.79% yoy (also good news), but it is still down 4.39% from 3 mo ago and is down 15.52% on April 2007.

09/06/2011: CPI data for May

Consumer Price Inflation data for May is out today. Recall that a month ago, higher mortgage costs and oil prices pushed inflation to a 30-month high, with prices in April up 0.4% mom and 3.2% yoy. This was the second highest rate of annual inflation since 2008. This time around, the catalyst for inflationary pressures was supposed to be mortgages costs, as ECB hike of 25bps in April was expected to feed through to retail rates. CSO is very careful about this aspect of inflation, having issued in the latest release an explanatory note (see below). Market expectation, consistent with my view expressed in December-January issue of Business & Finance magazine, is for inflation to average around 2.8-3.1% in 2011.

Now, on to today's data:

• May CPI rose 0.1% mom - below the markets expectations and below 0.6% mom rise in May 2010. Yoy inflation was at 2.7% in May 2011, again below expectations in the market.
• HICP - omitting, among others, cost of mortgages, car and home insurance, car taxes etc (see CSO note on this in the main release) - posted 0% change mom against 0.3% increase mom in May 2010. Annual HICP rose 1.2% relative to May 2010.

Charts to illustrate - first CPI, then two indices of prices:
In annual terms, largest increases were posted in

• Housing, Water, Electricity, Gas & Other Fuels - up 8.5% after posting 11.8% rise in April and 12.5% in March. Within the category, Rents posted a 1.0% decline yoy and 0.1% increase mom, while mortgages interest costs posted a 0.6% mom rise and 20.1% increase yoy. Electricity, gas & other fuels sub-category posted a 1.0% decline mom and 6.6% rise yoy with Liquid fuels falling 3.8% mom and rising 17.9% yoy.
• Miscellaneous Goods & Services posted a 8.4% increase yoy primarily driven by Insurance (+15.9% yoy) of which Health Insurance (+21.6% yoy, but -0.6% mom) was the biggest culprit. Motor car insurance was up 7.6% yoy and 0.7% mom.
• Communications were up 4.1% yoy - driven solely by 4.3% rise yoy in Telephone & communication services.
• Health was up 4.0% yoy - hospital services up 11.4% yoy (no change mom) followed by Pharmaceutical products (+2.5% yoy and 0% change mom)
  

Deflation was recorded in

• Furnishings, Household Equipment & Routine Household Maintenance (-1.9% yoy and -0.1% mom) with strong deflationary momentum in Furniture & furnishings (-5.7%), and Major household appliances (-4.0%)
  
• Education - down -1.3%- driven by 1,8% yoy decline in Other education and training and -1.4% drop in Third level education. On the opposite side of the spectrum, Primary education costs rose 1.3% yoy and Second level education costs were up 0.8% yoy.
  

Charts to illustrate these trends:

As usual - an imperfect measure of state v private sector controlled prices - first straight forward state-controlled or dominated or influenced sectors:

Next - an index of prices in two broadly defined sectors:
One point worth making - the above chart clearly shows that inflation has moderated in state-controlled sectors. It remains to be seen if this welcome change mom will translate into a longer term trend.

Finally, a point, as promised above, on the issue of mortgages costs. CSO provides a handy explanation of their terminology on page 10 of the main release, from which I quote here:

"... current approach to measuring mortgage interest in the CPI reflects the situation in the base reference period December 2006 when the standard variable rate was dominant. Subsequently, tracker mortgages have become more popular. This did not give rise to any difficulties while the standard variable and tracker mortgage interest rates moved broadly in line with one another, which would be the normal expectation. However, the decoupling that has taken place since August 2009 has resulted in dramatically different trends emerging. For example, between September 2009 and September 2010 the standard variable rate increased from 2.93% to 3.66% whereas the tracker rate did not change. The Mortgage Interest component of the CPI, which is largely determined by the trend in the standard variable rate, increased by 25.1% as a result and contributed +1.25% to the overall change in the All Items index. It is crudely estimated that the latter impact would have been reduced by between 0.2% and 0.5% had the Mortgage Interest component been calculated on a current weighting basis."

So what CSO are saying is that current mortgages costs metric overstates the overall impact of mortgages costs increases on CPI because more mortgages, since 2006, were issued in the form of tracker mortgages. That's fine, but there is also a sticky problem of the weights assigned to all spending categories, which are all based on December 2006. If since December 2006 the following changes took place:

1. Overall costs of mortgages rose relative to other costs,
2. Home ownership proportion in population rose (which could have been due to emigration out of the country selecting predominantly non-homeowners, for example),
3. There have been significant exits from tracker mortgages and fixed-rate mortgages since 2006 (perhaps due to either selection bias in defaults or due to bias in favor of fixed rate mortgages in maturing mortgages, for example)
   

Then the weights used for this sub-category of spending might be below their current levels, off-setting the above effects of tracker mortgages.

07/06/2011: Residential property prices

An impressively decent dataset from CSO on residential property prices has been released for the second monthly installment, so here are the charts and some high level analysis.

• Overall Residential Property Price Index (RPPI) for April was 78.2 or 0.8 points below March levels. Hence, mom the index has fallen 1.013% and is now 1 point below its 3mo MA. Year on year the index has fallen 12.233% and relative to peak of 130.5 reached in September 2007 it is now down 40.077%.
• Overall RPPI has recorded its 8th month of consecutive declines having risen statistically and economically insignificant 0.11%mom in August 2010. Year on year, April marked 38th consecutive month of declines.
  
• April index for houses fell 0.9 points to 81.3, down 1.095% mom, or 1 point below 3mo MA. Year on year index has fallen 12.013%. The peak for this sub-index was reached in September 2007 at 132.0.
• April index for apartments fell to 60.4, down 0.6 points - a mom decline of 0.984% and a yoy decline of 15.288%. April reading was 1.233 points below 3mo MA. This sub-index peaked at 123.9 in February 2007.
• Dublin properties sub-index has fallen 0.5 points in April to 70.5, a decline of 0.704%mom or 12.963% yoy. The sub-index now stands 0.77 points below 3mo MA and 47.584% below the peak of 134.5 in February 2007

Charts to illustrate:
To summarize - the deflation of house prices continues, although the monthly rate of decline has now fallen below both 6mo and 12mo average. This, however, might be due to seasonality, since April marks a relatively moderate month in terms of price movements in every year since 2008. house prices have now fallen 38.41% since their peak, while apartments prices have declined 51.25% from their peak.

It is worth noting - not as a criticism of the CSO, since it cannot do anything about the data - that the index is computed based on mortgages drawdowns, hence excluding any share of transactions that might take place on the 'gray market' (tax evading payments, swaps etc), as well as cash-only purchases and mortgages issued by lenders other than the 8 largest lending institutions from which the data is available.

Another issue, again - little that CSO can do for this - relates to hedonic adjustments undertaken in index computation. Hedonic characteristics used by CSO exclude a number of relevant parameters, such as number of bathrooms and the site size, as well as existence of garage and/or off-street parking. This, alongside with the tendency - due to planning permissions restrictions - to under-report actual floor area and number of bedrooms - means that the hedonic model might be relatively weak.

Finally, CSO employes a Laspeyers-type indexation method, which is "calculated by updating the previous month’s weights by the estimated monthly changes in their average prices". However, like all types of indices, Laspeyers indices suffer from some specific drawbacks. In particular, these indices are weaker in periods of adjustment in the markets. Here's a quick non-technical discussion:

Laspeyers index is designed to answer the question: "How much is the sales price today for the house that is of the same quality as in the base year (2005)?" Quality is compared using the hedonic model mentioned above, based on specific size of the house (floor area), its amenities (number of bedrooms, house type) and location (note - we do not know the granularity of such 'location' adjustment, which can be critical. For example, I live in Dublin 4, but not the "fashionable" part of it. This means that if location code used is D4 for my house, it will receive signficantly higher locational weight relative to true value of my location than a house in a "fashionable" D4 locale.

One key objection to Laspeyers index is that it is computed while assuming that the base year (2005) house remains unchanged over time. Hence, quality is assumed to be constant for referencing, implying the index over-states inflation and under-states deflation.

In addition, index does not capture the effects of substitution in housing. In other words, Laspeyers index does not reflect conversions of house features to substitute away from more expensive options, etc, or purchases shifting in favour of smaller properties.

Index also assumes that geographical distribution of house sales does not change over time - a feature that introduces significant biases into the index when locational markets are not uniform (when there are significant differences within the markets).

Finally, the index overstates price appreciation at the peak of the bubble, since at that point, less desirable properties were disproportionately represented in the market as buyers chased any home available for sale. This is known on the basis of the US data where at the top of the markets 'gentrification' of lower quality locations in many states has led to Laspeyers indices understating price inflation.

For thes reasons, Laspeyers indices are known as 'constant quality' indices.

Chain-linked indexation, employed by CSO, helps addressing some of these issues, but it does not eliminate them. Of course, that too has its drawbacks, namely the more substantial data requirement, plus the lack of index additivity (you can see this indirectly in the first chart above by the gravitational pull of the houses index on overall index.

07/06/2011: Irish Trade in Goods & Services

Having completed a new dataset on Irish trade - for both Goods and Services - here's the latest data we have.

Please, note, CSO does not report monthly stats for trade in services, which form a significant share of our exports and influence our trade balance and current account. Instead, CSO's monthly series make a claim about 'trade' without explicitly identifying that this 'trade' only covers goods. That identification, instead is buried in the 'fine print' methodology pages.

Ok, to the numbers. Given the vast size of Irish economy, the latest data on overall trade we have comes from QNA and covers Q4 2010. By the end of Q4 2010:

• Exports from Ireland stood at €40.073bn, down 1.35% qoq and up 11.67% yoy. Annual increase in Q4 2010 was €4.187bn, making Q4 2010 the highest level of exports in Q4 of any year since 1997.
• Lowest level of exports during the current cycle (since 2007) was reached in Q3 2009, implying that growth in exports returned in Q4 2009. Highest level of exports were reached in Q 3 2010.
  
• Imports stood at €34.546bn, up 8% qoq and 12.99% yoy
• Trade balance as of the end of Q4 2010 was a positive €5.527bn, down 35.98% qoq and up 4.05% yoy (+€215mln).
• Ireland's quarterly trade balance bottomed out in Q1 2008 and grew since then, peaking at €8.633bn in Q3 2010.

Charts below illustrate:

06/06/2011: Putting IMF's comment against data

According to the report by RTE: "The acting Managing Director of the International Monetary Fund has said Ireland's economic recovery programme 'appears to be on track'... However it still requires what he described as 'forthright action by the Irish authorities to re-establish the basis for sustained growth.' Mr Lipsky said there were positive signs in the Irish economy, such as a return to export growth. However Mr Lipsky described Ireland's economic recovery as 'a difficult challenge'." [emphasis is mine]

One cannot expect RTE news to critically challenge Mr Lipsky on his pronouncements, but... can someone ask Mr Lipsky what did he mean by the 'positive signs in the Irish economy, such as a return to export growth'?

Here are two charts showing that export growth did not return to Ireland any time recently, but in fact was here for some months before IMF showed up in Dublin and certainly well before this year.
So let's give Mr Lipsjy a quick briefing:

• Irish exports reached their recession bottom at the annual value of €82.238 in 2009. Hence the growth in Irish exports returned in 2010 when annual exports value rose to €89.427bn.
• In terms of annual trade balance, local minimum occurred in 2007 when Irish trade balance stood at €25.740bn. Since then, every year throughout the crisis our trade balance grew, reaching €43.785bn in 2010.
• In monthly time series, our exports reached the bottom of the cycle in December 2009.
• Relative to 2003-present trend, March 2010 was the month when Irish exports have fully recovered from the recession. That is full 8 months before IMF waltzed into Dublin and full 14 months before Mr Lipsky discovered our return to export growth.
• In terms of Trade Surplus, Irish external trade has 'returned to growth' back in January 2009, when our monthly exports exceeded long-term trend.
• Lastly, if we are to take Mr Lipsky's phrase on its face value, the return to growth in our exports dates back to January 2010 (17 months before Mr Lipsky's statement recognizing the phenomenon) and our trade balance (monthly series) returned to growth in January 2008.
  

06/06/11: Travel to Ireland

A quick post on the recently released data for travel to and from Ireland. Now, several caveats to cover before we plunge into the numbers:

1. The present Government has prioritized (not unlike the previous one) tourism as core area for stimulus and recovery. I am not going to pass my judgment on this plan - let's wait and see what comes of it.
2. The data relates to Q1 2011, so it predates the present Government.
3. Some Q1 2011 data covers pretty dismal - weather-wise - weeks in January, but to offset that, it compares against even more poor - again, weather-wise - Q4 2010.

So, here are the headline figures, as issued by CSO (analysis is mine):

• Irish trips overseas have fallen to 1,270,100 in Q1 2011, down 3.96% qoq and 11.75%yoy. Comparing to the Q1 peak in 2007, trips overseas are now 19.37% down. This means that in Q1 2011 some 305,100 fewer Irish residents took trips outside Ireland than in Q1 2010.
  
• Trips to Ireland from abroad have fallen to 1,177,600 in Q1 2011 from 1,414,300 in Q4 2010 - a decline of 16.74% qoq. In year-on-year terms, Q1 2011 was up 8.55% on Q1 2010 - which, of course, is good news. Relative to Q1 2007, trips from abroad are down 20.34%. This means that in Q1 2011 some 300,700 fewer foreigners visited Ireland than in Q1 2007.
• Net travel to Ireland in Q1 2011 was -92,500, which means that 92,500 fewer people visited Ireland than the number of Irish people who traveled outside Ireland. This metric is sort of a tourism trade balance. Despite posting another deficit, Q1 2011 saw a significant improvement in terms of net travel to Ireland relative to Q1 2010 (-354,400), Q1 2009 (-137,600), Q1 2008 (-220,300) and Q1 2007 (-96,900), although in Q1 2006 there was a positive net travel into Ireland of 43,300. Unfortunately, most of the improvement in the net travel to Ireland in Q1 2011 came from the precipitous decline in the number of Irish people traveling abroad.

It is worth noting that in both charts above there is a marked downward trend over time in terms of Ireland's ability to attract foreign visitors as well as to retain domestic travelers. This is especially surprising for a number of reasons:

1. The decline in the net travel, for example, is persistent since before the crisis and is, therefore, likely to be structural, rather than recessionary.
2. Despite lower cost of traveling in Ireland, induced by the crisis, the numbers of visitors from abroad is not rising. This too suggests that something structural is going on, as overall international travel is recovering from the global recession.

Looking at core geographical areas from which visitors to Ireland traditionally come:

• Trips from Great Britain have declined to 564,300 in Q1 2011 (47.9% of all visitors) from 657,600 in Q4 2010 (a decline of 16.4% qoq). However, compared with Q1 2010, visitors from Great Britain were up 7.16%. Compared against Q1 2007, the number of visitors from GB to Ireland is down 26.86% or 207,200. It is worth noting that overall Ireland's tourism industry reliance on visitors from GB is up in Q1 2011 (see chart below).
• Number of visitors from the rest of Europe was 399,000 in Q1 2011, down 16.4% on Q4 2010, but up 8.87% on Q1 2010. The number is down 19.62% on Q1 2007 or 97,400.
• Number of visitors from North America in Q1 2011 stood at 153,600 (down 23.73% qoq and up 11.87% yoy). The resilience of this market for Irish tourism is highlighted by the fact that Q1 2011 numbers were only 1.66% down on Q1 2007 (only 2,600 visitors less).
  

It will be interesting to see in months to come if the recent royal and presidential visits to Ireland have any impact on tourists' preferences for traveling to Ireland. It will, of course, be very difficult to detect, in part due to data inconsistencies and in part due to other factors that influence travelers' choices of locations.

Lastly, I must say I am glad the Government had removed the senile €10 travel tax. We might not see an immediate positive impact of this move on Irish tourism, but in the long run, we need to focus on removing every possible impediment for people to opt out of choosing Ireland as their preferred destination.

04/06/2011: The 'Confidence' trick?

Updated below: In the update below I address one particular point raised by some readers of this blog relating to PMIs and my analysis of these.


As promised in the earlier post, for the fans of the 'If only we were confident in Ireland' school of economic thinking... The school of thought, also known as the 'Green Jerseys', maintains that if confidence is high, then growth and employment will follow, so to get Ireland out of the crisis, positive thinking is needed.

Let's take a look at the data.

Keep in mind that we only have data for the period of May 2000-present and only for Services sector. Of course, Services is the largest sector in the Irish economy and it is more labour intensive, so the conclusions drawn from these observations should be expected to remain broadly valid for Manufacturing as well.

If the 'Confidence' thesis holds, we should expect some strong relationship between Confidence reading in PMIs and employment sub-index of the very same PMIs as well as PMIs main index which captures activity. This relationship might be subject to lags, of course, as Confidence sub-index is self-assessment of the future some 12-mo in advance, while Employment sub-index reflects current staffing levels, and the core PMI reflects current activity. Now, keep in mind that the 12-mo in advance expectations is for a continuum, not spot, in other words, growing confidence means expectations for improving business over the 12 months horizon.

First, consider whether there is a coincident relationship between Confidence and PMIs and Employment sub-indices:
Yes, there is a strong positive relationship between expansion signaling readings of confidence today the future and current levels of economic activity as measured by employment and PMIs. In other words, things tend to be optimistic (pessimistic) when PMIs are booming (shrinking) and employment is rising (falling).

Sounds like the 'Confidence' theory working? Not really - what's happening here is that when things are great, we expect them to stay great, on average. Alternatively, when things are bad, we expect them to stay bad for some time ahead. Which, of course is consistent with the fact that data we have covers 2000-present - two periods of pretty much persistent boom and then bust.

So let's take a look at change from month to month.

• Does change in confidence imply change in current PMIs and employment? (If the 'Confidence' theory is right - it should, as future expected changes in activity should have a positive growth effect on current activity)
• Does change in confidence today imply a change in future PMIs and employment? (If the theory is correct, then it should, with some lag kick in in terms of positive real outcomes)

Sorry, but it appears that a change to higher Confidence in the future in any given month relative to previous month has virtually no relation to either present or future Employment changes or future PMIs. It has a tiny positive connection to present PMIs, however, but barely enough to be called 'significant' from statistical point of view. In other words, we might get all giddy chirpy about the great future we have, and yet it will be unlikely (highly unlikely) - according to the PMIs data - to translate into significant gains in either services activities or employment, neither today, nor in the near future (I tested longer lags up to 12mo and the results do not change by much).

This of course does not mean that positive sentiment is not a good thing for the economy. If positive sentiment is backed by something more tangible - reforms, improved exports, growth in consumer or investor confidence - some real productive fundamentals, then of course it will matter. But that is not the 'Confidence' theory. The 'Confidence' theory says 'negativity hurts economy'. No, folks - it doesn't. You can't talk yourself into a recession. And the 'Confidence' theory claims that if we get 'positive' about the future, things will improve (presumably improve significantly, otherwise, what's the point). This is not what the data is showing.

So what's going on, then? We know that Confidence is associated with performance, but we also now know that at least in Ireland, over the period looked at, changes in confidence are not associated with changes in performance either today or in the future.

Of course, Ireland is a small open economy. Which means it is volatile and is subject to constantly shifting external 'winds' of change. May it be the case that 'Confidence' theory doesn't work in Ireland because our real economy is subject to external forces and shocks? Ok, let's test this proposition. Let's control for contemporaneous backlog of orders, leaving only that component of Confidence that is not influenced by these backlogs. In other words, let's consider that part of our self-assessed optimism (pessimism) that is unrelated to the actual observed increases in new orders (decline in these orders). Furthermore, let's slightly smooth the series tor educe volatility by using a 2mo moving average on all variables.
An interesting result above. The link between confidence and contemporaneous PMI and Employment is now virtually gone (compare the results with Chart 1 above), which exactly supports my conclusions made following Chart 1. What matters to the turning of the economy, folks, is the real economic activity - rising backlogs, new orders, new export orders. What doesn't matter much at all, it appears, is 'Confidence'. So, please, go on, feel great - it might improve your smile, your utility, your view on life - all of which are great results. But don't hold much hope that it will improve the economy and reduce unemployment.

In the end, to achieve these two objectives, we need new businesses to be created, new markets to be accessed, new products and services to be developed and marketed, and so on, and new reforms implemented. Unfortunately, the 'Confidence' theory can lead us into complacency of avoiding making hard choice to have such reforms, to support our entrepreneurs, our companies and workers.

Ignoring the rain might make getting wet tolerable or even fun, but it won't make you any less soaked.

Update: Some websites contain references to these series of posts on PMIs. In particular, there is an occasional refrain to my view that (1) I would prefer seeing strong (above 60) readings in some sub-indices, and (2) my insistence that an 'improvement' in the sub-index reading from a number below 50 to another, higher number below 50 is not an improvement. Let me explain my views on these 2 points.

1. Readings above 60 are rare, that is true. But PMIs refer to comparative/relative performance metrics. Now, real recovery is not, I repeat - not - associated with growth returning to a long-term trend, but growth overshooting long-term trend as economy goes from negative growth (contraction) to expansion. Thus, for example in the Services series, near-recession of 2001 is returned to growth by PMIs reaching for 60.8 by April 2002. In Manufacturing series contraction in October 2001 to 46.1 is returned to growth with June 2002 reading of 54.5 (so -3.1 from 50 to +4.5 - a ratio of 1.45), contraction of July 2003 (45.8) is returned to growth with a peak of 55.2 in June 2004 (-4.2 to +5.2 - a ratio of 1.24). Now, bottom of the latest contraction was at 32.6 which should be consistent - if we take the above two episodes averages (ratio of 1.35) - with a rise to above 67. We've gone up to 62 in March 2010, but we have not seen this translate into overall economic growth. Hence, my preference would be to see more episodes of 60+ readings in PMIs. Either way, all of the episodes we have on the record so far are episodes relating to either 'near recessions' or temporary declines in the series not associated with a recession at all. Except for the current crisis, that is. O course, this 60 is not a 'hard' target. Read carefully what I said (here): "Either way, of course, I'd rather see PMIs at above 60 reading, than heading for a downward territory". This is a statement of 'truism' - as in: I'd rather see things improve than get worse. Sadly, some anonymous commentators on some of the forums out there are not getting even this simple concept...
2. When the series read below 50, the series show contraction. Thus, for example, a reading of 44 in one month followed by a reading of 46 in the next month does not mean that economy has improved from month to month. It means that the economy has deteriorated at a slower rate. If you are familiar with compounded effects of recessions (expansions), you would know that having a loss of 10% in month 1 followed by a 5% decline in the other month implies a cumulative decline of 14.5%. An improvement would be if following a 10% drop in on month, economy grows by, say, even 1% in the next month, thereby reducing the original decline to a cumulative decline of 9.1%. Let me quote Brad DeLong on this: "Getting worse more slowly is not the same as getting better".