Economic Incentives

Changes in Current Expenditure

2012-01-30T13:16:00.001Z

The Databank from the Department of Public Expenditure and Reform is a useful resource. Here is a quick look at overall gross voted current expenditure broken in three categories

Pay and Pensions
Social Welfare
Non-Pay

From 1994 to 2011 gross voted current expenditure rose from €14 billion (30.0% of GDP) to €54 billion (34.3% of GDP). Here is the proportion of gross current voted expenditure that went on the three categories.

Pay and pensions as a percentage of current expenditure peaked at 41% in 1998 and had fallen to 37% by 2008. Since then social welfare expenditure has consumed an increasing proportion of current expenditure. If we look at the nominal amounts of expenditure.

We can see that all three categories are lower but the largest falls have been in non-pay current expenditure which has been falling since 2008.

Investment in EU countries

2012-01-30T00:00:00.001Z

The following graphs contain details of investment of as a proportion of GDP for 20 EU members. These are the EU15 (members of the EU before the accession of Eastern European countries in 2004 and 2007), the members of the Eurozone not in the EU15 (Cyprus, Estonia, Latvia, Malta, Slovakia and Slovenia) and Poland. This gives 21 countries but as Malta has no data reported to Eurostat in the required categories the sample is 20 countries.

First, here is investment as a proportion of GDP in the chosen countries between 2002 and 2007. Ireland ranks fifth of the 20 countries shown and second in the EU15. The top six countries from the EU15 are Spain, Ireland, Portugal, Greece, Austria and Italy.

If we analyse the investment by sector of source, we get the following rankings for Ireland in the 2002-2007 period. Click the links to see graphs.

Government: 2nd (1st in EU15)
Household: 2nd (2nd in EU15)
Business: 18th (14th in EU15)

It is government and household investment that pushed Ireland up to fifth in the overall ranking (and second in the EU15). Business investment as a proportion of GDP was lower in only Greece and Cyprus. The top three countries for household investment between 2002 and 2007 were Greece, Ireland and Spain.

If we move t0 the period since 2007 when investment in Ireland peaked, the following picture emerges for the years 2008 to 2010. .

Ireland drops from fifth to 19th and is now flanked by Germany and the UK. This might be appropriate for a mature economy with low unemployment but that if not an description that is usefully associated with the Irish economy. The rankings by sector now are:

Government: 4th (1st in EU15)
Household: 9th (8th in EU15)
Business: 20th (15th in EU15)

Ireland’s relative position fell in all three sectors with a fall of seven positions for household investment and a drop to last for business investment. Even with the cuts in the public investment since 2008, Ireland still ranked highest in the EU15 for government investment in the three years to 2010.

The IMF provide forecasts of investment up to 2016. They don’t give a breakdown by sector but we can look at the total. Ireland is last.

The average for the 20 countries above Ireland (the IMF provides forecasts for Malta) is 20.0% of GDP. For Ireland, the forecast of investment as a percentage of GDP from 2011 to 2016 is 10.5%.

The recent IMF review for Ireland (Table 2, pdf page 31) shows that they expect public investment to fall to 2% of GDP by 2013 and stay there at least up to 2016, with investment from the household and business sectors bottoming at 6.8% of GDP in 2011 and rising slowly to 9.8% of GDP by 2016.

Retail Sales are only stabilising

2012-01-28T11:29:00.001Z

Yesterday’s release of December’s Retail Sales Index has led to some reasonably upbeat headlines.

RTE: Stronger spending finish to 2011 – CSO
Irish Independent: Festive shoppers hike sales by 3pm for retailers
Irish Times: Retailers get December boost as sales rise by 3%

Retail sales did rise towards the end of the year but the 3% figure for December is for the All-Business Index. This includes the Motor Trades which even in December has a significant impact on the index. The Motor Trades weighting for December is 8% (for January it is 35%).

Instead we will focus on ‘core’ retail sales which strips out the effect of the Motor Trades. Here is this index since the start of 2008.

The drops seen in 2008 and 2009 have eased but signs of a sustained recovery remain absent. Although there was an increase in retail sales towards the end of the year the ‘bump’ occurred in November, not December. December showed a small monthly increase in sales by volume (+0.2%) but there was a decrease in value index (-0.1%).

[Sales in December are going to be much greater than those in November but the Retail Sales Index is adjusted for such seasonal patterns and the monthly weightings given to each sector also reflect this seasonality.]

One positive-looking graph is the annual changes in the value (+1.1%) and volume (+0.7%)indices. These are both positive for the first time since March 2008. We must be wary though. The CSO can adjust the index for seasonal consumption patterns but they cannot adjust the series for seasonal weather patterns. Sales last December were disrupted by a cold snap that brought snow and ice.

It will only be over the coming months that we will know if the bump seen in November will be maintained. It is difficult to see how the annual rates will stay positive next month. There will have to be a monthly increase in sales value of 2% in January just to ensure that the Value Index does not have a negative annual change.

Here are the monthly changes showing that the recent bump occurred in November.

Fitch keeps Ireland at BBB+

2012-01-27T23:39:00.001Z

For the second time in a fortnight a ratings review has seen Irish government bonds hold their rating at BBB+. According to Fitch:

BBB ratings indicate that expectations of credit risk are currently low. The capacity for payment of financial commitments is considered adequate but adverse business or economic conditions are more likely to impair this capacity.

The Fitch statement on the ratings decision begins

The affirmation of Ireland's sovereign ratings primarily reflects two factors:

- Whilst Fitch has reduced the score assigned to capture financing flexibility in its assessment of the credit profile of those eurozone sovereigns that have large fiscal financing needs and significant financial/economic imbalances, in Ireland's case its 'BBB+'/'F2' rating had already incorporated this lack of financing flexibility as demonstrated by it losing market access in 2010 .

- Ireland's progress with fiscal and structural adjustment under the IMF-EU programme. Notwithstanding the intensification of the eurozone crisis over the last months, on-track fiscal performance and the improvement of macroeconomic and financial fundamentals led to the decline of interconnected fiscal sustainability and financial stability risks and all programme targets have been met.

Not a lot to generate much reaction here though I must have missed “the improvement of macroeconomic fundamentals”. Economic growth? Inflation? Unemployment? There has been some stability but hardly enough to warrant description as an improvement. The full statement is below the fold.

The strong political support behind the multi-year fiscal consolidation plan and the broader public acceptance of its necessity are key supports to the adjustment process. According to preliminary data, the 2011 deficit-to-GDP ratio was better than the 10.6% target set in the IMF-EU programme with current official estimates suggesting the deficit came in at just under 10%. Fitch believes the 2012 target of 8.5% is attainable, not least due to the lowering of the interest rate on the EU portion (a total of EUR 40.2bn by 2013) of the official loans.

Export-driven recovery characterised the first half of 2011. While domestic demand is still contracting, the flexibility of the Irish economy, in particular the cut in nominal wages and prices resulting in a sharp improvement of competitiveness, helped to take advantage of strong external demand in early 2011.

Overall, financial stability concerns have receded following the PCAR exercise in March 2011. Market confidence has increased in Irish financial institutions, as evidenced by deposit stabilisation in H211 following previous sharp declines, successful raising of private capital by the Bank of Ireland and wholesale funding transactions. Following the public recapitalisation of the sector by EUR63bn, the capital adequacy ratios of the three largest banks are among the highest in the eurozone, providing a sizeable buffer for the expected losses. However, downside risks remain - non-performing loans are still rising, property prices have yet to reach a bottom and low mortgage foreclosure rates suggest further adjustment lies ahead.

Nevertheless, significant external headwinds persist. The Negative Outlook reflects the exposure to the economic downturn of major European trading partners, a key concern given the export-oriented growth model of the Irish economy, and the adverse impact of heightened eurozone financial tension on Irish financing conditions. In particular, the timing and interest rate level of the sovereign's return to market financing remains uncertain, although the recent bond switch aiming at smoothing the maturities between 2014 and 2015 is an encouraging sign.

Contagion from further intensification of the eurozone crisis or a material slippage of the fiscal consolidation path, either due to looser fiscal policy stance or a significant deterioration of the growth trajectory, could lead to a negative rating action. On the contrary, the successful implementation of the IMF/EU programme, a return to sustainable economic growth, and the moderation of the eurozone crisis would stabilise the rating Outlook.

The legislative process of the adoption of the fiscal compact represents a new and country-specific risk for Ireland. The Irish authorities may be required to hold a referendum on the fiscal compact. In light of the initial Irish 'No' to the EU Treaty in the June 2008 referendum, Fitch finds the probability of another rejection non-negligible. The uncertainty that would be created by another such 'No' vote would put further pressure on the rating.

Yields continue to fall

2012-01-25T09:31:00.001Z

The eight-week downward run in Irish government bond yields continues. Here are the indicative yields as calculated by Bloomberg and their close yesterday.

Two-year Irish government bond yield: 5.64%
Five-year Irish government bond yield: 6.17%
Nine-year Irish government bond yield: 7.45%

The five-year yield as calculated by Bloomberg is approaching what could be considered sustainable. In fact both Italy and Spain have been forced to issue bonds at similar rates in the period around Christmas. Here is an image of the eight-week fall.

Before the current crisis the five-year yield on Irish government bonds was generally between 3.5% and 4.0%. Last July this yield was over 17% and getting back to anything like normality before the end of the EU/IMF programme seemed like a forlorn hope.

With the debt mountain we have now accumulated a return to such levels is unlikely. At best we could probably hope to see yields of 4.5% to 5.0%.

Here are the actual closing prices and yields of outstanding government bonds for trades recorded with the Irish Stock Exchange yesterday.

Is repaying bondholders still an issue?

2012-01-20T09:45:00.001Z

Yesterday’s Troika press conference has attracted more attention than usual because of an exchange between journalist and broadcaster, Vincent Browne and Klaus Masuch, head of EU Countries Division at the European Central Bank. The exchange can be seen here.

Although not named we can only assume that Browne was referring to Anglo Irish Bank. Anglo’s 2008 Annual Report provides details for the year ended 30th September 2008. This is also the date of the guarantee so it gives us a good indication of the liabilities that were guaranteed on the same night.

By the end of September 2008, the Anglo balance sheet had ballooned to a massive €100 billion. On the asset side Anglo had forwarded loans of around €72 billion. We now know that Anglo made losses of around 50% on this loan book. We have filled that €30 billion+ gap.

Then comes the issue of where Anglo got the money to make these loans. The Anglo balance sheets reports €100 billion of liabilities of which over €70 billion were just deposits (€52 billion from ‘customers’, €20 billion from banks). It also shows that there was about €17 billion of 'Debt Securities' (i.e. bonds) in issue at that time.

A note to the accounts gives a breakdown of this total at the 30th September 2008:

Medium term note programme: €10,622 million
Other debt securities in issue: €6,658 million

The category of 'other debt securities' includes commercial paper and certificates of deposit which are almost analogous to deposits. There were also some €4 billion of subordinated liabilities but those are not of concern here as most of those were not repaid. [Junior debt holders in the covered banks incurred €15.5 billion of losses across the covered banks.]

Anyway at the end of September 2008 Anglo had €10.6 billion of bonds outstanding. A breakdown showing the amounts of these that were secured and unsecured is not provided. These bonds (along with all other liabilities) were guaranteed on September 30 and over the past three and half years many of these have been repaid. After Monday's payment of €1.25 billion there will be around €3 billion of Anglo bonds left to be repaid.

The issue raised by Browne is the repayment of unsecured bondholders in Anglo after the expiry of the original two-year guarantee in September 2010. Unfortunately for 2010, Anglo changed its year end to 31st December so we cannot get the exact balance sheet position at the expiry of the original guarantee from the 2010 Annual Report.

By the 31st December 2010 the balance sheet of Anglo had shrunk to €72 billion and the total amount of debt securities outstanding had fallen to €6.9 billion. All the deposit-like 'other securities' had been redeemed so the €6.9 billion was all bonds. At this stage the bank was again mainly funded by deposits but these were now almost 80% central bank deposits.

Of the €6.9 billion of bonds we are told that "€3.0bn of medium term notes, all of which are Government guaranteed with maturities of up to five years, were issued during the year." That means there could only be a maximum of €3.9 billion of bonds which were outside the guarantee.

This was confirmed in March 2011 with this release from the Central Bank. This showed that on the 31st March 2011 there was €3,147 million of senior unsecured unguaranteed bonds in Anglo on the 18th of February 2011 from a total of €6,255 million of bonds (the other €3 billion being the guaranteed bonds).

It is the re-payment of these €3.1 billion of unsecured bonds that was the subject of yesterday's exchange. It is hard to know how much could be saved if these bonds weren't repaid but given the 60%-80% haircuts applied to subordinated debt it is likely that a haircut of 40% to 60% would be applied to senior debt. If we take the mid-point and assume that a 50% haircut could be applied then the State will lose around €1.5 billion by repaying these bonds.

Of course, we don’t have the money to repay these bondholders. We have borrowed it (or rather we will borrow it) through the Promissory Notes. Repaying the bonds will not cost us €1.5 billion. The price is €1.5 billion but the cost will be the annual interest payments made on the borrowing to pay the bonds. At an interest rate of 5% it would cost €75 million per year to service €1.5 billion of debt. The true savings of not repaying these bonds is this €75 million per year.

Here is the question and the answer and some subsequent comments from this transcript.

Vincent Browne: “Klaus Masuch, did your taxi driver tell you how the Irish people are bewildered that we are required to pay unguaranteed bondholders billions of euros for debts that the Irish people have no relation to or no bearing with, primarily to bail out or to ensure the solvency of European banks? And if the taxi driver had asked you that question,hat would have been your response? That’s my first question.”

Masuch: “I can understand that this is a difficult decision to be made by the government and there’s no doubt about it but there are different aspects of the problem to be, to be balanced against each other and I can understand that the government came to, came to the view that, all in all, the costs for the, for Irish people, for the, for the stability of the banking system, for the confidence in the banking system of taking a certain action in this respect which you are mentioning could likely have been much bigger than the benefits for the taxpayer which of course would have been there. So the financial sector would have been affected; the confidence of the financial sector would have been negatively affected, and I can understand that there were, that there was a difficult decision but that the decision was taken in this direction.”

Browne: “That, that… Well, that doesn’t address the issue. We are required to pay, in respect of a defunct bank – that has no bearing on the welfare of the Irish people at all – we are required to pay in respect of this defunct bank, billions on unguaranteed bonds in order to ensure the health of European banks. Now how would you explain that situation to the taxi driver that you talked about earlier?”

Masuch: “I think I have addressed the question.”

Browne: “No you haven’t addressed the question because you referred to the viability of the Irish financial institutions. This financial institution I’m talking about is defunct. It’s over. It’s finished. Now, why are the Irish people required, under threat from the ECB, why are the Irish people required to pay billions to unguaranteed bondholders under threat from the ECB?”

In his answer Mausch basically said that it was the government’s view (he never actually have his view) that the benefits of repaying these bonds were greater than the savings that could be made by not repaying them. We know that the saving could be around €1.5 billion.

It would have been useful if Mausch was pressed further on what he felt these benefits were. It is still not clear what benefits, if any, did accrue from undertaking to repay these bonds; it certainly wasn’t “stability of the (Irish) financial system”. There may have been benefits from repaying these bonds and this has been couched in references to veiled threats from the ECB. Would the ECB “pull the plug” if these €3 billion of bonds aren’t repaid? Unlikely, but in the greater scheme of things the €1.5 billion in question here is not the key issued.

The key issue is the €25 billion of Promissory Notes given to Anglo (along with €6 billion to Irish Nationwide) to cover the loan losses referred to above. Most of the money that these Notes allowed Anglo to get from the Central Bank went to repay depositors rather than bondholders.

This issue is how (or whether) we repay the €28.5 billion of these Notes that are still outstanding. This money is owed to the Central Bank of Ireland but when the Central Bank gets it, it will just “burn” it. There is no one waiting for this money to be repaid so the question is why do we have to repay it now. Prof Karl Whelan is once again excellent on this point in this article in Business and Finance.

This issue was raised at both the Noonan/Howling and Troika press conferences. You can listen to the responses in this extract. It seems we can expect some kind of ‘position paper’ to be released before the end of February. This issue is far more significant than some pre-ordained grandstanding about bond payments. The bondholders are gone. The debate must move on. Maybe the next haranguing of the ECB will press them on this.

Interest on the Promissory Notes

2012-01-19T23:48:00.001Z

A restructuring of the €31 billion of Promissory Notes given to Anglo Irish Bank and Irish Nationwide (now merged in the Irish Bank Resolution Corporation) has been getting a good deal of attention recently. Much of the focus has been on reducing the interest rate coupon on the Notes but as we have said a number of times it is not clear that this would actually save the State money.

Here is a table of the issued Promissory Notes from a previous post.

When we account for the “interest holiday” taken in 2011 and 2012 the equivalent annual coupon for Tranche 4 is 8.6%. This means that the average annual coupon rate across the €31 billion was about 5.8%.

The interest rate on each tranche was based on the yield Irish government bonds of the same maturity on the day the tranche was provided to Anglo/INBS. This increased from 4.17% to 8.60% as the tranches were issued beginning on the 31st March 2010, though the second and third tranches on the 31st of May and 28th of June 2010, and finishing with the final tranche on the 31st December 2010.

For the first six months of 2011, Anglo reported it had Interest Income of €644 million on the €25.3 billion of Promissory Notes that it had received. The amount of the Promissory Note outstanding was reduced to €23.8 billion when the first annual payment was made on the 31st of March.

The “bank” also paid €519 million of interest to the Central Bank of Ireland for use of Emergency Liquidity Assistance (ELA). The total amount of ELA the bank was drawing down stood at €45.0 billion on the 31st December 2010 and had reduced to €40.8 billion by June 30th 2011. With an haircut of around 20% applied to the use of the Promissory Note as collateral it is clear that the Promissory Notes were supporting about half of the ELA that Anglo was drawing down.

Therefore we could allot around €260 million of interest expense to the ELA backed by the Promissory Notes. In the first six months of 2011 Anglo made an interest profit of around €380 million on its Promissory Notes transactions. As Anglo is 100% state-owned this profit is not lost. Any reduction of the interest rate on the Promissory Notes will simply reduce this profit and no money will be saved.

What about the €519 million of interest Anglo paid to the Central Bank of which around €260 million is due to the Promisory Notes-backed ELA? We don’t have the 2011 Annual Report for the Central Bank of Ireland yet but we we can track the flow of the interest that was paid to the Central Bank over the past few years. This is given under the heading 'Other' in the Income Received total in the Central Bank Annual Reports

2008: n/a
2009: €240.5 million
2010: €510.2 million

Given the level of ELA that was issued during these years it is possible that the interest rate charged was around 2.5%. In 2010, Anglo paid €435 million in interest to the CBoI for ELA so it is clear that the bulk of the ELA was issued to Anglo.

The full extent of the ELA (up to €50 billion) only arose in late 2010 so it will be interesting to track the 'Other' Income Received when the Central Bank publishes the 2011 Annual Report later in the year.

It is hard to see if this interest is paid on to anyone else by the Central Bank, with anyone else of course being the ECB. Earlier this week John McManus in a very good piece on the Promissory Notes in the Irish Times said:

"The Central Bank is in turn getting the money it lends to Anglo from the ECB at a much lower and not disclosed rate which is reported to be 2 per cent or less. It keeps the difference. The real cost to the State is the rate at which the ECB provides cash and it is far from penal."

In a piece from last February on the ELA, Laura Noonan of the Irish Independent wrote:

“While money that comes directly from the ECB is issued for terms ranging from seven days to 90 days, the money given out through ELA is typically granted for seven days.”

I’m not so sure the Central Bank needs to get the money. This might be the case but it is also possible that the Central Bank of Ireland just created the money as only central banks can do.

This little note on the ELA mentions nothing about a payment to the ECB and, says:

The little known ELA facility allows national central banks (NCB) to provide funds to domestic financial institutions in financial difficulty over and above the liquidity provided by the ECB's regular refinancing operations. These operations are separate from the Eurosystem, but the ECB's Governing Council can with a ⅔ majority oppose the granting of further ELA, if, for instance, it considers the emergency assistance provided constitutes monetary financing.

The assistance provided is supposed to be temporary and to an illiquid but solvent financial institution. The lending is not subject to ECB collateral requirements. Thus a bank can present its NCB collateral which would not be acceptable by the ECB (but which would be acceptable by the NCB).

If you really want to get into ELA you can read this five-page note from Citigroup’s Willem Buiter. On the first page it states:

Any profits or losses made from the collateralised lending of NCBs under their ELA facilities are for the account of the NCB alone and are not shared/pooled with the rest of the Eurosystem.

There is lots of technical sounding stuff here but it really throws little light on the subject. To try and track these profits we can look at the Central Bank surplus that is payable to the Exchequer each year. Here it is for the past six years.

2005: €109.2 million
2006: €98.5 million
2007: €183.4 million
2008: €290.1 million
2009: €745.9 million
2010: €671.0 million

There could be other reasons for this but the Central Bank surplus has increased in the period in which the ELA has been provided. The interest received from the ELA doubled to €500 million in 2010 but the Central Bank surplus fell. Again it will be the 2011 Annual Report that will give a more telling indication of the impact of the ELA in the surplus that is transferred to the Exchequer.

We know for definite that the interest profit that Anglo makes on the Promissory Notes is not initially lost as Anglo is 100% state-owned. It remains to be seen what Anglo will do with these profits. It appears that the chunk of the interest that the Central Bank takes for providing the ELA also stays within the State.

Getting back to markets

2012-01-17T22:11:00.001Z

Just a few days after John Corrigan of the NTMA said this:

“Our plan would be to try and return to the Treasury Bill market, which is for debt instruments with less than three month maturity, to try and return to that market by mid-year which would represent the first signs of normalisation, and as regards the longer-term market towards the end of 2012 early 2013 but again it is subject to external conditions improving.”

It might be worth considering this:

Meanwhile, Greece saw its borrowing rates ease marginally in a bill auction on Tuesday.

The public debt agency said it raised €1.625 billion ($2.06 billion) in a sale of 13-week treasury bills, an interest rate of 4.64 per cent, compared with 4.68 per cent in the last such auction in December.

Demand for the bills was 2.90 times the amount on offer, roughly the same as last month.

Unable to issue long-term debt due to untenably high borrowing costs, it maintains a market presence through regular treasury bill auctions.

A country whose ten-year yield is nearly 35%, whose two-year yield is 164% and is forecast to default in exactly nine weeks was out in the markets today and raised over €1.5 billion of three-month funds at an interest rate of 5%, with demand of close to €5 billion.

While getting back to short-term markets is undoubtedly an important first step, it is a small step and is one that a country with a nine-year yield of 7.5% and a two-year yield of 5.7% should have little problem in achieving. Irish has an outstanding bond maturing in seven weeks that is yielding 2.12%.

Today saw a steepish decline in the nine-year yield on Irish government bonds as calculated by Bloomberg.

At 7.47% this is the lowest the reported yield has been since the 4th of November 2010.

S&P keeps Ireland at BBB+

2012-01-13T22:59:00.001Z

For the second time since August, S&P has reaffirmed its BBB+ rating for Irish government bonds. BBB+ is two grades above junk status and is defined as “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”. In August, though, the outlook was Stable, now it is Negative. That implies there is a one-in-three chance of a downgrade over the next two years.

Italy, Portugal and Spain all had two-notch downgrades. Italy has been moved to BBB+ and now stands alongside Ireland. Portugal, which previously had a BBB- lowest investment grade rating, now has a junk status grade of BB. Spain began at AA- and is now at A. As with Ireland the outlook on all of these is Negative. The last of the PIIGS, Greece, did not form part of the current review and remains at the low-junk CC grade and a disorderly default is a growing possibility.

A lot of the current S&P statement explaining the decision on Ireland deals with the general eurozone environment but there are some interesting country-specific elements. Two of these are:

1. All other things being equal, we view the government's fiscal consolidation plan as sufficient to achieve a general government deficit of around 3% of GDP in 2015.

2. We expect the general government net debt burden to fall to about 103% of GDP in 2015, having peaked at 109% in 2013. Our net debt estimates include the impact of the government's €64 billion (40% of GDP) in banking sector recapitalizations during 2008-2011 and €29 billion (18% of GDP) in debt issued by the National Asset Management Agency (NAMA) as of end-2011.

In August they were forecasting that their measure of net debt would peak at 110% of GDP in 2013. That has now being reduced to 109% of GDP (possibly as a result of the double-counting error in the Department of Finance.) The 103% net debt/GDP for 2015 is unchanged. On the general eurozone response to the crisis they state:

1. In our opinion, the political agreement [the fiscal compact of December 9th] does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.

2. [.] we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.

The full text of the S&P statement is below the fold.

LONDON (Standard & Poor's) Jan. 13, 2012--Standard & Poor's Ratings Services today affirmed the 'BBB+' long-term and 'A-2' short-term ratings on the Republic of Ireland. At the same time, we removed the long-term rating from CreditWatch with negative implications, where it was placed on Dec. 5, 2011. The outlook on the long-term ratings is negative.

Our transfer and convertibility (T&C) assessment for Ireland, as for all European Economic and Monetary Union (eurozone) members, is 'AAA', reflecting our view that the likelihood of the European Central Bank restricting nonsovereign access to foreign currency needed for debt service is extremely low. This reflects the full and open access to foreign currency that holders of euro currently enjoy and which we expect to remain the case in the foreseeable future.

The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.

We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called "periphery." As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.

However, we have not adjusted the political score of the Republic of Ireland down. This is a reflection of our view that the Irish government's response to the significant deterioration in its public finances and the recent crisis in the Irish financial sector has been proactive and substantive. This offsets our view that the effectiveness, stability, and predictability of European policymaking and political institutions (with which Ireland is closely integrated) have not been strengthened so as to match the severity of the broadening and deepening financial crisis in the eurozone.

Excluding government-funded banking sector recapitalization payments, the authorities have adjusted the budget by almost €21 billion (13% of estimated 2012 GDP) since 2008 and plan additional fiscal savings of some €12.4 billion (7.8% of GDP) for 2012-2015. All other things being equal, we view the government's fiscal consolidation plan as sufficient to achieve a general government deficit of around 3% of GDP in 2015. In our view, there is currently a strong political consensus behind the fiscal consolidation program and policy implementation so far has been extremely strong. In the face of a weaker-than-expected outlook for economic growth, additional measures (€0.2 billion, 0.1% of GDP) have been introduced to meet the government's targets.

We expect the general government net debt burden to fall to about 103% of GDP in 2015, having peaked at 109% in 2013. Our net debt estimates include the impact of the government's €64 billion (40% of GDP) in banking sector recapitalizations during 2008-2011 and €29 billion (18% of GDP) in debt issued by the National Asset Management Agency (NAMA) as of end-2011. NAMA's purpose is to acquire, hold, and dispose of land and property; it has acquired and is now working out eligible assets from participating financial institutions. Should NAMA asset disposals progress more rapidly than our current assumption (10% of GDP over 2013-2015), the government's net debt burden could improve at a faster pace.

In our view, Ireland has a flexible and very open economy. This is illustrated by the 25% depreciation in the trade-weighted exchange rate between May 2008 and October 2011 (latest data) and by goods and services exports estimated at about 113% of GDP in 2012. Partly as a result of these factors, as well as the noncyclical nature of a substantial part of Irish exports, net export growth has contributed positively to the muted Irish economic recovery in 2011. However, in our view this also leaves the Irish economy and, ultimately, the Irish government's fiscal consolidation program, susceptible to worsening external economic conditions. This is reflected in our downside hypothetical scenario, which contemplates real GDP per capita economic growth, general government deficits, and general government net debt averaging 0.9%, 6.6%, and 114% of GDP, respectively, over the 2012-2015 period, compared with our base-case scenario of 1.7%, 6.1%, and 107%.

We have lowered our assessment of Ireland's external score. On Dec. 5, 2011, we said that this score was unlikely to change as our concerns raised with regard to a sudden stop in interbank funding had already been realized in Ireland. However, the Irish government and Irish financial institutions have not had access to the capital markets for unsecured long-term funding since early 2010. Our assessment of the sovereign's external risks has been updated to reflect this.

Yields under 8 percent as yield curve looks ‘normal’

2012-01-11T18:50:00.001Z

The downward slide of Irish government bond yields continued today and the nine-year yield as calculated by Bloomberg finished at 7.91%. Apart from a two-week period at the start of October this is the only time that this has been below 8.0% in the past year. This time last year the yield was at 8.4%.

Here is the one-chart for the nine-year yield.

What is perhaps of even greater interest is the Daily Outstanding Bonds Report published by the NTMA.

We can see that no Irish government bond is yielding more than 8%. Michael Noonan has spent the day proclaiming that “Ireland is fully funded until 2013” (or two-thirteen in Noonan-speak). This is true. What happens in 2014?

The €11.9 billion bond due to mature on the 15th January 2014 is now yielding 6.85%. It now costs €94.84 to buy a unit of this bond. Last July this bond could was trading at less than €70 giving a yield of close to 20% (if you could find someone willing to sell). The perceived risk of this bond has dropped considerably in the past six months.

Finally, it is interesting to see the reasonably normal shape of the yield curve for Irish government bonds.

It would be more than reasonably normal if we could knock a few more percentage points off the yields but lets take it one step at a time. It’s a good deal better than this yield curve from just five months ago.

Willem Buiter on an Irish Default

2012-01-11T17:15:00.001Z

Citigroup’s Chief Economist Willem Buiter’s comments that Ireland will need a second bailout have been getting an inordinate amount of coverage. There have been plenty of observers who have made the same point from as early as the beginning of the EU/IMF programme in November 2010 and even Minister Leo Varadkar admitted as much last last May. “Bailout 2” is not news.

What is more interesting are Buiter’s comments on the prospects of an Irish default. This following are interlaced from two media reports of his Dublin press briefing.

“Ireland needs further assistance,” said Buiter, predicting that although Portugal and Greece will need to restructure their debts and will effectively default, Ireland can avoid going down the same route by having a plan ready in the event a second bailout is needed. (1)

“Ireland is not Portugal, nor is it Greece, but it is, because of the bank debts from September 2008, in very bad fiscal shape,” said Buiter. “I think the politicians and European partners will pursue the option of more generous funding terms before they get to sovereign-debt restructuring.” (2)

One of the primary concessions Ireland should look for is the cost of the Government promissory notes that have been put into Anglo Irish Bank, now known as Irish Bank Resolution Corp, said Buiter. “What Ireland needs to do is refinance expensive debt more cheaply,” said Buiter, saying that a deal on the notes would provide the Government with “material help”. Minister for Finance Michael Noonan was reported to be attempting to convince the European Central Bank to lower the cost of the notes last month, ultimately unsuccessfully. Buiter said that although these notes carry an interest rate of 6% or 7%, the ECB could shoulder some of the burden and that in time it may decide to do so. (1)

Buiter said a refinancing of 30 billion euros ($38.2 billion) of so-called promissory notes that Ireland used to recapitalize Anglo Irish Bank Corp., recently renamed Irish Bank Resolution Corp., at a rate of about 3 percent through the euro region’s bailout fund would “be a material help.” It “would also politically show a recognition of Ireland’s extraordinary efforts to get its fiscal house in order.” (2)

So Ireland can avoid a debt restructuring (default) if it has a “plan ready”. As agreed last July Ireland will have access to EU funds after the end of the current programme in 2013 when they said that “ We are determined to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes.” So part A is all sewn up.

Part B is a restructuring of the Promissory Notes. Unless we can get a reduction in the €31 billion capital amount I’m not sure there are substantial savings by reducing the interest rates on the Promissory Notes. The notes have an interest rate of up to 8% but we are not paying the interest to a third party. The Exchequer pays the interest to the IBRC who in turn pay it to the Central Bank. This was summed up by Lorcan Roche Kelly with this neat graphic.

This is somewhat paraphrased from the original post (apologies to Lorcan who was making a related but different point).

The interest on the current promissory note is set with reference to the 10 year Irish bond yield. This note could be set with reference to anything and it doesn’t really matter. We will either be paying the interest to a bank that we own, or to a central bank that we own. We pay them €1 bn, they make profit of €1 bn and pay that back to their shareholder – the state. The payment is circular, so the interest rate doesn’t matter, we are paying it to ourselves.

Most important is the term (the point in the future where we actually pay this back). Ireland does not need to worry about any debt roll-overs coming in the near future, so make it a 100 yr term. We will ‘promise’ to have this paid back by the 2111. Hopefully, inflation will have taken care of some of the burden by then. With this exceptionally long term ,we are not disadvantaging any of our creditors, because they will have been paid their money up front, via the nationalised banks. The drop on the ‘real’ value of the debt will not matter at all, because we owe the money to ourselves.

Buiter wants the interest rate reduced from an interest rate of 6% or 7% to about 3%. This actually doesn’t save us anything. What if the interest rate was more than doubled to 15%? Would that cost us money?

We would be paying 15% interest to the IBRC (which we own) who would continue to pay the Central Bank of Ireland (which we also own) interest for the €40 billion of Emergency Liquidity Assistance that the IBRC is using. The IBRC would have a surplus on this transaction and this money would be returned to the State as a dividend. The IBRC would make a profit which they can return to us or maybe use to buy golf club memberships for their staff.

The losses in the bank would be covered by the €31 billion of capital provided by the Promissory Notes. The interest has no bearing on that. The details of a restructuring plan for the IBRC have been released by TheStory.ie. This says that:

The total cost to the taxpayer for IBRC under the stress case is estimated at €35.8bn

The State has provided €30.9 billion of Promissory Notes and a €4.1 billion direct cash injection into the entities that make up the IBRC. This is €0.8 billion short of the total cost estimated under the “stress” case. That cost of the Anglo/INBS debacle is going to be around €35 billion and we have already provided that money. The issue is how we repay it.

To followed Buiter’s advice and to somehow convert or transfer the Promissory Notes over to the one of the EU bailout funds would actually be a mistake. Even if this was done at 3% we would be paying the 3% to an external entity and the interest would be lost. It is better to be paying 7% to ourselves rather than 3% to someone else.

Of course we are involved in the slow-scale transformation of the Promissory Note debt into lower interest debt through the €3.1 billion annual repayment at the end of March. There are now €28 billion of the original Promissory Notes outstanding following the first payment last year. To money to make the payment came from the Exchequer which is borrowing from the EU/IMF at an average rate of 3.55% to fund the deficit.

This coming March we will make an further €3.1 billion payment. This transforms the debt from €3.1 billion of Promissory Notes owed to the IBRC to €3.1 billion of loans owed to the EU/IMF. This does not increase our debt but instead of paying interest on this debt to the IBRC we will be paying interest to the EU or IMF. From 2013 this process will slow considerably as the interest due on the Promissory Notes start to be accrued from then. See here. Over time the Promissory Note debt will be refinanced to “cheaper” debt but is this actually a good thing?

As Lorcan correctly points out it is the term that matters. Why should we be repaying the Promissory Notes now? The interest rate doesn’t really matter and nobody really loses if we repay them 100 years from now. The only ‘cost’ is that there is around €30 billion of cash floating around that the Central Bank of Ireland (or the ECB more like) would like to see “put back in the vault”.

But why do we have to do this now we the State is in a hugely distressed financial position? Why not give the €30 billion back to the Central Bank 20, 50 or even 100 years from now as Lorcan suggests. Prof. Karl Whelan has been excellent on this point here and here, and explains it in much clearer terms.

Willem Buiter thinks that Ireland needs a two-point plan that will enable us to avoid a sovereign default. This is a reasonably positive diagnosis. “The patient is sick, but he will survive” could be one way of putting it.

We will get the official funding that he (and practically everyone else) thinks we need. We might get to “refinance expensive debt more cheaply” through a reduction in the interest rate on the Promissory Notes by transferring them to either the EFSF or EFSM. However, rather than being of benefit to us that could actually cost us money. What we need is to stop repaying them until we are in a far better position to do so.

3.55% Interest on the EU/IMF loans

2012-01-09T15:37:00.001Z

Here is an update of a table showing the interest rates on the loans we are getting as part of the EU/IMF programme (HT: Kevin). The data is for loans drawn down as of the 14th of November 2011. Click image to enlarge.

When we last looked at this back in August for loans drawn down by June the average interest rate was 5.58%. We can now see that this has been reduced to 3.55%. This is because of the reduction in the EU loans agreed at the EU summit on July 21st last.

The interest rate on loans from the European Financial Stability Mechanism (EFSM) has fallen from 6.99% to 2.97%, while the interest rate on loans from the European Financial Stability Fund (EFSF) has fallen from 5.90% to 3.06%.

The highest rate is the 4.83% that applied to the UK bilateral loan but that is due to be reduced. As a result of this the IMF loans will have the highest rates but they could also be reduced as there are some suggested changes to Ireland’s quota with the IMF.

A previous post suggested we need to source around €25 billion of funding to get through 2014, as the €67.5 billion of funds under the current EU/IMF programme will be exhausted by the end of 2013. From the above we can see that we need to be in a position to begin repaying the EU/IMF loans (by borrowing from someone else) from July 2015.

Replacing funding that comes at a cost of 3.55% will not be easy but for the moment it does keep a cap on our interest payments.

State Funding through 2013

2012-01-07T01:51:00.001Z

Over the next two years the Irish government needs about €46 billion of funding.

We still have to draw down around €33.5 billion of the loans agreed as part of the EU/IMF programme. The remaining €12.5 billion can come from a combination of our existing resources, State Savings Schemes and some market funds.

There was €13 billion in the Exchequer Account at the end of 2011. The NTMA have suggested that this could be reduced to around €5 billion over the next two years although the European Commission have indicated that they would prefer to see the cash buffer maintained at its current level.

It is forecast that €1.5 billion a year will be raised from the State Savings Schemes over the next two years. This is well above the 2000-2007 average but in line with performance over the last few years. At €1.36 billion the amount raised in 2011 was just below this.

If the €1.5 billion a year is achieved then the State needs around €10 billion to see it through to the end of 2013. We have €13 billion of cash on deposit (and there is also around €5 billion remaining in the National Pension Reserve Fund (NPRF)).

How much of this cash is used will depend on how much market funding can be raised. The plan for the NTMA to “dip its toe” back in the markets before the end of this year, but given the amount of cash on reserve this can be delayed until 2013.

All told the State is in a reasonably secure position for the next 24 months (where ‘reasonably secure’ simply means we won’t run out of money). After that there is the small matter of a €12 billion bond maturing in on the 15th January 2014.

We are due to begin repaying some of the EU and IMF loans in 2015 and there is also the need t0 find funding for the €10 billion Exchequer deficit due to arise in 2014 and the €7 billion deficit in 2015.

While the plan is to “dip” back into bond markets before the end of 2012 we have to ensure that we have the capacity to meet the €12 billion debt rollover in January 2014 and that year’s €10 billion Exchequer deficit. Even if the balance on the Exchequer Account is allowed to fall from €13 billion to €5 billion we will still need to raise around €25 billion of market funding by the end of 2014.

This will be a challenge but we will not face a crunch until the start of 2014 and there is a lot that can happen over the next two years.

National Savings Schemes

2012-01-07T00:31:00.001Z

Although have we been “shut out” of bond markets, the EU/IMF is not the only remaining source of funding for the State. The National Treasury Management Agency (NTMA) run a series of State Savings Schemes and they have seen a substantial inflow of funds in the last few years.

After seeing annual increases of no more than a couple of hundred million between 2001 and 2006 and even a reduction in 2007 the annual change in the amount held in various State Savings Schemes soared from 2008 on. In 2010 almost €3 billion was put into this schemes and this dropped to under €1.5 billion in 2011.

The total amount in the schemes is almost €12 billion.

We don’t have details for 2011 yet, but the NTMA’s 2010 Annual Report gives some insight into the breakdown of the total amounts and annual changes for the different schemes in 2010 when inflows peaked at about €3 billion.

There was also close to €2.5 billion is various Post Office Savings Bank Deposit Accounts (including savings stamps) which took in almost €500 million in 2010.

Although small in the greater scheme of things this source of funding makes a useful contribution. An added advantage is that is cheap, the average interest rate is likely to be less than 3%. The average rate of the EU/IMF funds we had drawn down by the middle of November 2011 was 3.55%. At the end of 2011 the €12 billion in the State Savings Schemes will make up around 7.5% of Ireland’s General Government Debt.

Back to eight percent

2012-01-06T20:52:00.001Z

The last time we looked at Irish government bond yields we wondered whether they were heading back to ten percent. In the space of just two days the the yield on the nine-year Irish government bond as calculated by Bloomberg surged from 8.2% to 9.6%. Since then the yields have shown a gradual decline back to 8.2%.

On the 6th of January 2011 the yield as given by Bloomberg closed at 8.80%. Today it finished at 8.13%. In relative terms these bonds are viewed as a lower risk now then they were 12 months ago.

We can’t infer a huge amount from these changes. The volume may not be very high and we cannot be sure who is doing the buying, if any. Also we will not be borrowing from these markets any time soon so there is no direct impact from these changes.

The relative performance of 9-year Irish (green) and 10-year Italian (orange) bond yields for the past month has been markedly different.

Expenditure in the Exchequer Statements

2012-01-05T11:13:00.001Z

We seem to spend an inordinate amount of time going through every possible representation of the tax revenue figures in the Exchequer Statements. The latest post is a good example of this. Why not devote even a fraction of this attention to the expenditure figures in the Exchequer Statements?

The answer of course is that the Exchequer Statements do not contain expenditure data that can be analysed in any meaningful fashion. The appendix with the Analysis of Net Voted Expenditures shows that net voted expenditure was €45,711 million in 2011; in 2010 it was €721 million higher at €46,432 million. What does this mean?

It is very hard to say. Net voted expenditure is gross expenditure adjusted for departmental receipts (known as appropriations-in-aid). If net expenditure changes it can be difficult to determine if this is as a result of expenditure changes or changes in departmental receipts.

This leads to statements like the following in the Information Note to this month’s Exchequer Statement:

The underspend on the Social Protection Vote was due to higher than expected PRSI receipts, which more than offset overspends on a number of schemes, including Jobseekers Allowance.

Huh. Spending is down because receipts are up. Underspending and overspending in the same sentence. All in all it is almost impossible to tell if spending is up or down. There are changes and adjustments in the tax revenue figures but in general they are easier to track, and more information is presented, than those in the expenditure figures.

Note 4 in the Exchequer Statement indicates that expenditure in health has increased to €12,897 million from €11,578 million in 2010. In the current era of austerity and expenditure cuts it seems unusual to suggest that expenditure in health increased by 11.4% in the last year. Of course, this is nonsense but that is what the Exchequer Statement shows.

The reason for the change is the abolition of the Health Levy. In 2010, the Health Levy was a departmental receipt for the Department of Health. The receipts of €2,018 million were subtracted from gross expenditure to get the net expenditure figure for health reported in the Exchequer Statements.

Although net voted expenditure for health has risen we cannot use this to say that we are spending more money on health. We don’t get monthly updates of actual (i.e. gross) expenditure in the Exchequer Statements but we can get the annual figures from the Databank provided by the Department of Public Expenditure and Reform.

Gross expenditure in health fell from €15,169 million in 2010 to €14,316 million in 2011. There was a 5.6% reduction in expenditure in health in 2011 but it is impossible to determine this from the monthly Exchequer Statements. It would be extremely useful if the gross expenditure figures were also provided in the monthly Exchequer Returns.

As it is the best we can do are annual tables like the following for the Health Group.

Reporting net expenditure figures as is done in the Exchequer Statement has no impact on the reported Exchequer balance but we do not see how the figure is reached. Even if monthly gross expenditure figures were provided for every department there would still be difficulties due to the abolition and creation of some departments and changes in the functions and responsibilities of others.

Anyway, the conclusion is that expenditure in health fell in 2011, particularly non-pay expenditure of the HSE (-8.5%) and the Office of the Minister for Children (-45.3%) even if the Exchequer Statement is reporting an increase in “net” expenditure. As a result of issues like this there is little value in spending much time exploring the expenditure figures in the Exchequer Statements.

End of Year Tax Receipts

2012-01-05T01:15:00.001Z

The Department of Finance have released the end of year Exchequer Statement for 2011. The relevant documents are:

Here we will have a look at the figures in the usual detail. First up cumulative tax revenue by month.

Cumulative tax revenue has been ahead of the 2010 outturn for every month of the year. The increase peaked in September at 8.7% (when the new pension levy was collected) and has eased since then to finish the year up €2.3 billion or 7.2%. This has been hailed as the first rise in tax revenue in three years.

By looking at the individual tax heads we can see that virtually all of this increase is due to Income Tax.

The CSO reports that employment fell 46,000 in the year to September and that average weekly earnings rose 1.4% over the same period. These do not seem like labour market indicators that support a 22.4% rise in Income Tax. Budget 2011 contained a series of measures that were forecast to bring in about an extra €1 billion of Income Tax in 2011. So where did the other €1.5 billion come from?

It came about as a result of the reclassification of the old Health Levy into the new Universal Social Charge. The Health Levy was a departmental receipt collected by the Department of Health and did not appear in the Exchequer Account. All money collected under the Universal Social Charge enters the Exchequer Account and is included under the Income Tax heading.

In 2010 the Health Levy raised €2,018 million. This money was collected again in 2011 but under the guise of the Universal Social Charge in Income Tax receipts rather than as a receipt for the Department of Health. There might have been an increase in tax revenue in the Exchequer Account but there was little or no increase in government revenue.

The other tax showing a strong increase on 2010 is Stamp Duty. As we said when the September Exchequer Statement was released:

This again is not the positive sign the bare numbers would suggest. Stamp Duty is only up because the €457 million collected as a result of the Pension Levy introduced in May’s “Jobs Initiative” is included here. If we compare like-for-like Stamp Duty revenue is performing just like every other tax – i.e. worse than last year.

VAT is down €360 million but about one-third of that is due to the reduction in the 13.5% to 9% for certain goods and services in the same Jobs Initiative.

On a monthly comparison every month was ahead of the 2010 equivalent bar one: the last one. Tax revenue for December 2011 was €51 million lower than in December 2010.

If we look at the individual tax heads we can see the causes of this.

The standout figure is obviously the 96% drop in Corporation Tax receipts. The Information Note offers an explanation for this:

[…] some €261 million in corporation tax receipts due for receipt in December were not received into the Exchequer account in time to be accounted for in 2011. The bulk of these receipts have since been received and will form part of the January 2012 tax revenue outturn.

It is not really clear what has happened but this will add a bit of new year ‘pep’ to the Exchequer Returns in 2012.

If we just look at the last quarter of 2011 the picture is a little more benign.

Apart from the continued weakness in VAT receipts and the glitch in Corporation Tax all tax heads in the final quarter of 2011 are ahead of their performance from 2010. The 40% rises in Capital Gains and Capital Acquisitions Taxes are noteworthy, but the contribution of these taxes to total tax revenue remains small (just 5.8%).

No analysis of Tax Revenue is complete without investigating whether receipts are “on target” which were published last February. They’re not.

Tax revenue in the final quarter of the year might be up on its 2010 performance but it is clear that the Department of Finance was expecting a much greater bounce. Over the last three months of the year tax revenue went from being €160 million ahead of target to €873 million behind target. If we omit the measures introduced in the Jobs Initiative that did not exist when these targets were set it is likely that tax revenue is around €1,200 million or 3.5% below target.

In each the last three months of the year tax revenue was more than €330 million behind the DoF forecast. It was hoped that there would be a rise of €1,383 million to €10,962 million of tax receipts in the final quarter. It is not clear why the DoF expected a 15% rise in tax revenue in the final quarter of the year but receipts were actually €9,929 million, almost 10% below target.

For the year as a whole three of the four main tax heads are significantly below their target and the overshoot in Excise Duty is a relatively inconsequential €3 million.

The tax to strongly outperform the target for it set last January is Stamp Duty and this is only because €457 million was collected from a 0.6% private sector pension levy that was only introduced in May. On that basis of what was to be collected at the time the forecast was made Stamp Duty is also below target.

If we look at the last quarter of the year when it all went wrong.

There is some cover for the almost 25% underperformance of Corporation Tax, but even if the €261 million of delayed receipts are added in Corporation Tax receipts would still be 10.8% behind the target for the quarter. The largest taxes for the quarter were forecast to be Income Tax and VAT and these were both almost 10% below target.

To be fair the performance in December was slightly better.

Although there is plenty of red in the table most of the shortfall is due to the Corporation Tax issue. There is no such explanation for the large undershooting of tax receipts in October and November that is reflected in the quarterly table above.

For 2012 the Department are forecasting a 5.3% increase in tax revenue.

This is largely based on a €1.2 billion increase in Income Tax receipts during the year. Budget 2012 contained no Income Tax measures so this €1.2 billion increase will have to be the result of the carryover from the measures introduced in the 2011 Budget (estimated at €600 million) and a general upturn in Income Tax receipts (accounting for the remaining €600 million). I can’t say that I can see that coming down the track.

Mortgages in Irish Banks (and their interest rates)

2011-12-29T22:05:00.001Z

A previous post looked at loans in Irish banks. Here will we confine ourselves to mortgages and will start from this graph in the earlier post.

The Central Bank report Private Household Credit and Deposits Statistics which allow us to look at this in a little more detail. Here is the same graph (going back to 2003) from the Household Credit series. The data is quarterly and runs to Q3 2011 so does not include the shifts that occurred in October 2011 that guided the previous post.

In general, the series from the two graphs are similar though the securitised series in the latter graph shows a ‘jump’ in the second quarter of 2009 that is not evident in the first graph. As there is no corresponding decrease in “on balance sheet” loans it is not clear what was securitised (if anything).

It can be seen that banks in Ireland began securitising mortgages in the middle of 2006 and stopped by the end of 2009 (apart from €17 billion that was “derecognised” in October 2011 of course!)

The benefit of the household statistics is that we can look a little deeper into this although most of the data series only start from the fourth quarter of 2010. We can, however, get the breakdown of the “on balance sheet” loans for house purchase back to 2003.

Most of the significant step decreases can be explained by increases in securitised loans although the drop that can be seen at the end of 2010 is as a result of Bank of Scotland (Ireland) leaving the Irish market.

The more detailed series are only available for four quarters. There has been little movement in the series over this period so there is little value in graphing the series. Here is the most recent data for September 2011 in tabular form.

First, the total amount of loans for house purchases.

The €102 billion total of residential mortgages in September 2011 is significantly lower than the €114 billion reported in the Financial Regulator’s Residential Mortgage Arrears Statistics for the same time. The primary reason for the difference is the absence of Bank Scotland (Ireland)’s mortgage loan book from the above figures.

We are also provided with a breakdown of the €132 billion of mortgages by interest rate type: standard variable, tracker and fixed for different periods.

More than half of mortgages in Ireland are tracker-rate loans linked directly to the ECB base rate. With the ECB rate now back to 1% the repayments on these loans are now much lower than when these loans were taken out in the 2006 to 2008 period. Finally, we can get a breakdown by interest type for residential, buy-to-let and holiday home mortgages.

Here is a breakdown of the €102 billion of residential mortgages by interest rate type.

Just over half of residential mortgages on are on tracker rates. If the €10 billion or so of mortgages in the former Bank of Scotland (Ireland) were included this proportion would be even higher as most of its mortgage book comprised tracker-rate loans.

The proportion of buy-to-let mortgages that are on tracker rates is even higher.

Although they make up a very minor part of the overall market here is the same data for holiday home and second home mortgages.

Loans in Irish Banks

2011-12-29T14:59:00.001Z

Here we will give a look at the asset side of the balance sheets of Irish banks, looking specifically at loans and in particular at some large changes that seemed to have occurred in October based on the most recent release of the Central Bank’s Money, Credit and Banking Statistics.

First up, is the total amount of loans on the balance sheets of the domestic banks, broken into the covered group (AIB, BOI, IBRC and PTSB) and the non-covered group (Ulster Bank, National Irish Bank, etc. and also credit unions).

There has been a fall in the amount of loans on the balance sheets of the covered banks. Some of this is due to repayments on existing loans exceeding the amount of new loans issued but most of the drop from a peak of €513 billion in July 2009 can be explained by the transfer of over €70 billion of developer loans to the National Asset Management Agency (NAMA) and the sale of loans to other banks.

The total amount of loans the covered banks had was steady at around €400 billion from May of this year but there was another sharp drop to €377 billion in October. It would be possible to explain this drop in a chart or two but we will use the drop as a reason to have a fuller look at the loans on the balance sheets of the banks.

Loans in the non-covered domestic group peaked at €165 billion in October 2008 and have fallen by more than half since then, although for 2011 loans in the non-covered domestic group have been relatively steady. In January they were €79 billion and by October they were also €79 billion. From January to November 2010 these loans fell steadily from €113 billion to €99 billion.

The large drop in December 2010 (from €99 billion to €79 billion) can be explained by departure of Bank of Scotland (Ireland) from the Irish market. The loans still exist but they were transferred to Bank of Scotland’s parent group in the UK and no longer appear on the Central Bank of Ireland’s aggregate banking balance sheet statistics.

From here on we will focus on the €377 billion of loans on the balance sheet of the covered banks. It is important to note that these are non-consolidated figures, that is they just cover the Irish operations of the banks. Here is the Irish/non-Irish resident split of the loans.

Loans to Irish residents peaked at €364 billion in June 2009. Repayments but mainly transfers to NAMA saw this fall under €300 billion May of this year. Loans to non-Irish residents from the covered banks have fallen from €156 billion in June 2010 to €102 billion now.

The large drop in October from the first graph can be mainly attributed to the drop from €294 billion to €275 billion in loans to Irish residents, though loans to non-Irish residents also fell (from €108 billion to €102 billion).

Looking at loans to Irish residents (because it is the largest drop but also because we don’t have this breakdown for loans to non-Irish residents) gives a further insight into this drop.

Loans on the balance sheets of the covered banks to the private sector (households and businesses) peaked at €256 billion in October 2008. They then showed a consistent fall over the next three years at stood at €178 billion in September 2011. From here the big fall in October 2011 can be seen with a drop to €157 billion.

The exposure of balance sheets of the covered banks to Irish private sector loans has fallen by nearly 40% in the past three years. The increase in loans to general government are the €30 billion of Promissory Notes given to the IBRC during 2010.

To get a further insight into the changes to private sector loans we have to move away from the balance sheet data and move to the data presented on overall credit in Ireland. This is credit forwarded by all credit institutions and not just the covered banks but the covered banks make up about two-thirds of the total. Here are the private sector loans to the household, non-financial corporation, financial intermediary and insurance on the balance sheets of all banks operating in Ireland going back to the start of 2005.

It is clear that that the reason for October drop is to be found in the household sector. The drop in business loans from a peak of €170 billion in August 2008 to €87 billion now is almost fully explained by the transfer of developer loans to NAMA.

The next step is loans by purpose for the household sector.

There seems to have been a huge drop in loans for house purchase (residential and investment) to the household sector over the past few years from a peak of €128 billion in May 2008 to €81 billion in October 2011, with a €17 billion drop in that month alone.

Of course, Irish households are not repaying debt at that rate and a drop of €17 billion in one month is absurd. The transaction data provided by the Central Bank show that loans for house purchase to the household sector declined by €319 million in October. The €17 billion drop is on the balance sheets of the banks not the households (and is down to one of the covered banks as we have seen above).

So what gives? The next table from the Central Bank gives outstanding amounts (including securitised loans). Here are loans for house purchase to the household sector.

This explains what has happened in October. Loans for house purchase on the balance sheet of the covered banks fell but only because securitised loans increased by the same amount.

We can see that the total amount of loans to the household sector from bank operating in Ireland stopped rising in 2008 and has been falling gradually since then. The stepped drop at the end of 2010 is again explained by the departure of Bank of Scotland (Ireland) from the Irish market.

The Information Note from the Central Bank to the October Money, Credit and Banking Statistics gives mention of this securitisation in a footnote of page 2:

This is due to a credit institution derecognising loans from the statistical balance sheet that had been securitised, in line with the methodology applied by the reporting population in general.

Hmmm. One the covered banks didn’t realise that it had been reporting €18 billion of securitised loans on its balance sheet that shouldn’t have been there at all. How very reassuring. So what did it replace the €18 billion of mortgages on its balance sheet with? If we go back to the aggregate balance sheet data of the covered banks we can probably infer the answer.

There was an €19 billion rise in the holding of securities issued by the Irish private sector. This has risen quite significantly recently with most of the rise occurring when the banks received NAMA bonds for their developer loans in 2010. It was largely steady for the past year until the almost vertiginous rise in October which as we have seen is as a result of “a credit institution derecognising loans from the statistical balance sheet that had been securitised”. It now seems they had €18 billion of bonds they didn’t know about as well!

The above graph also shows that the banks hold about €16 billion of bonds in Irish banks. It is not clear how many of these are from the covered banks or in fact if much of it is the banks’ holding of their own bonds. The rise in the banks’ holding of Irish government bonds can also be seen and stood at €12 billion in October. This is about 14% of the total stock of Irish government bonds.

I can’t say that there is much to be learned from digging into this non-securitised / securitised shift in October. It is hard to say who is now carrying the risk of these loans. It is probably a company linked to the bank as it is unlikely they would have overlooked a transaction with an external third party.

Investment, Depreciation and the Capital Stock

2011-12-20T13:46:00.001Z

Last Friday’s release of the Q3 Quarterly National Accounts contained some interesting figures but the standout one was the 20% drop in Investment that occurred in the quarter. Investment is now down more than two thirds on its peak and is the main reason for the fall in the Irish economy over the past four years.

In fact, if we do an unusual dichotomy for the national accounts and break it into expenditure on “Goods and Services” and expenditure on “Capital Formation” we see that the former has held up while the latter is down nearly 70%.

The distinction is a little crude but “Goods and Services” is made up of C + G + NX:

C – Personal Consumption of Goods and Services
G – Net Expenditure by Central and Local Government on Current Goods and Services
NX – Net Exports of Goods and Service (Exports minus Imports)

In the third quarter of 2007 these summed to:

€22.8 billion + €7.5 billion + (€37.9 billion – €33.4 billion) = €34.7 billion

The most recent figures for the third quarter of 2011 the figures were:

€20.0 billion + €6.4 billion + (€40.5 billion - €29.7 billion) = €37.3 billion

There have been reductions in expenditure by households (-12%) and government (-15%) but these have been offset by an increase in net exports (+70%). For the period 2007 to 2009 this was as a result of falling imports rather than rising exports but for the past 18 months or so the improvement in net exports has been as a result of increased demand abroad for goods and services produced in Ireland. Overall demand for goods and services is up €2.6 billion over the four years.

“Capital Formation” is just I from the National Accounts: Gross Domestic Fixed Capital Formation. Over the period used above quarterly investment fell €5.6 billion from €9.1 billion to €3.5 billion.

Quarterly GDP fell 7.6% from €43.5 billion in the third quarter of 2007 to €40.2 billion in the third quarter of 2011. Using the dichotomy we have applied here this is largely explained by the collapse in capital expenditure. To explore further the nature of the fall in investment see this post on patterns of investment over on irisheconomy.ie. The general idea is fairly clear - it is mainly a story of households and housing.

Two weeks ago the CSO released the 2010 update of the Estimates of the Capital Stock of Fixed Assets. Here is a graph of the value of the stock of fixed capital (excluding land) in 2009 prices.

The capital stock increased consistently from 1995 to 2008 and this is true for the overall capital stock and the capital stock excluding dwellings (other buildings, roads, transport equipment, other machinery and equipment, cultivated assets, computer software).

Of course, it is not that there was no investment in 2009 and 2010. There was €25.3 billion of gross capital formation in 2009 and €19.0 billion in 2010, but this was just enough to cover the amount the consumption of the existing stock of fixed capital (depreciation) so the increase in the net capital stock was much less.

[The investment figure here is form the National Income and Expenditure Accounts and the depreciation figure is from the Estimates of the Capital Stock of Fixed Assets. There may be some non-overlapping between the definition of fixed capital/assets used in each but it is unlikely to change the overall conclusion.]

The fall in investment has continued and in real terms 2011 is 15% behind 2010 so it is clear that investment this year will not be sufficient to cover depreciation. For the first time since the series began the real value of the capital stock in Ireland will fall. The picture is equally bleak if we exclude dwellings (with land excluded in all of the analysis here).

For most categories investment in 2010 exceeded the level of depreciation estimated by the CSO, but the gap has gotten substantially narrower and for 2011 will be negative in many cases.

The depreciation for Dwellings and Other buildings includes the costs associated with the transfer of land and buildings but a breakdown under gross investment or depreciation is not included. The Net Investment under Dwellings and Other Buildings could be larger if conveyancing costs were included in the gross investment figure (as they are in the depreciation figure). It should also be noted that the gross investment figure for Other Buildings and Construction includes land rehabilitation but land is not included in the depreciation figure.

The negative net investment figure for other machinery and equipment is large but a lot of this could be explained by the almost stalling of activity in the construction sector. It be argued that a lot of the machinery and equipment here is out of use rather than depreciating and will never be replaced.

For 2011, it is likely that gross fixed capital investment will struggle to get much over €16 billion (in 2009 prices). It is €12.6 billion for the first three quarter of the year. The 2010 depreciation figure of €16.2 billion is unlikely to the much changed for 2011. An increase in the capital stock for 2011 is unlikely and the prospects are that a similar outcome will occur in 2012.

Finally here’s net investment as a percent of GDP.

Wealth (and Taxing Wealth) in Ireland

2011-12-16T02:46:00.001Z

Wealth has been getting a lot of attention in Ireland recently particularly in relation to the claim that it would be possible to raise €10 billion per annum from a 5% wealth tax on the wealthiest 5% of the population as detailed in the Budget Submission of the United Left Alliance and repeated on an almost nightly basis on television and radio.

The adult population of Ireland is around 3,400,000 so the 5% that are liable for this tax would be 170,000 people. In order for the €10 billion total to be achieved these people would have to be pay an average of an additional €60,000 in tax every year.

The ULA’s budget submission also envisages an additional €5 billion of income tax to be raised from those earning in excess of €100,000. According to data from the Revenue Commissioners in 2009 there were 110,000 tax cases reporting an income in excess of €100,000. The average income in this category is €180,000, but two-thirds of those who earned more than €100,000 earned less than €150,000. In order for the €5 billion target to be achieved those earning more than €100,000 will be required to pay an average of an additional €45,000 of income tax.

This is an addition to the €60,000 average income tax that this group paid. In 2009, this excludes payments made because of the Health Levy and also PRSI contributions. Anyway, the focus here is on the potential to raise €10 billion from a wealth tax.

Back in February the United Left Alliance were proposing that €6 billion a year could be raised from a wealth tax. Just ten months later they have increased this to €10 billion.

The original claims were based on a 2006 report by Bank of Ireland Asset Management on The Wealth of The Nation. The current claims are based on the Global Wealth Report (and accompanying Databook which has the details on Ireland) from Credit Suisse. For 2011, the report estimates that the average net wealth per adult in Ireland is $181,434 (median equals $100,351). With an adult population figure in the report of 3,403,000 that puts total net wealth in Ireland at $617 billion.

The Credit Suisse report estimates that there are around 70,000 millionaires in Ireland (and four billionaires). This means that around 100,000 of those in the top 5% have a net wealth of less than €1 million. Net wealth is

Financial wealth + Non-financial wealth - Debts = Net wealth

This figures under each heading are:

Financial wealth $435 billion
Non-financial wealth $484 billion
Debt $302 billion

We are not given an exchange rate to convert this into € but the euro has recently been around 1.30 to the dollar but was probably trading higher when this report was written. If we use an exchange rate of €1 = $1.40 that would give:

€310 billion + €345 billion - €215 billion = €440 billion

The estimate is that there is €655 billion of gross assets in Ireland and €440 billion of net wealth. The 2006 figures from the earlier Bank of Ireland report are:

€270 billion + €695 billion - €161 billion = €804 billion

The figures provided by Credit Suisse for financial wealth and debt are not that distant from the official figures given in the CSO’s Institutional Sector Accounts. This puts financial assets of the household sector in Ireland for 2010 at €311 billion and household financial liabilities at €194 billion. The asset figure is almost identical to the Credit Suisse figure but the liability figure is a little higher than the CSO’s.

The CSO put total financial wealth in the household sector at €117 billion. The following gives the breakdown of the assets and liabilities that gives rise to this figure.

The Bank of Ireland report puts the 2006 total of financial assets at €270 billion and exclude life assurance reserves from their total. Credit Suisse have a figure of €310 billion but the composition of this is not given.

To get a measure of overall wealth we need to add non-financial assets to those listed above. The Bank of Ireland report includes residential (€671 billion) and commercial (€24 billion) real estate in the €695 billion total for 2006 in that report, but seem to exclude land and other assets. Even putting an approximate value on all of these assets is extremely difficult.

It is not clear what Credit Suisse include as non-financial wealth but is it “principally housing and land” and they provide a figure of €345 billion but there is no way of knowing how this is derived.

The CSO do not provide an estimate of non-financial wealth in Ireland but the organisation’s Action Plan under the Croke Park Agreement states that “there is demand for a … survey
of household Income, Wealth and Assets.” It is not clear when this will be delivered.

And finally onto the distribution. Credit Suisse estimate that 5% of adults (175,000) have 46.8% of the €440 billion of the net wealth they estimate that is in the country. This is equal to €206 billion and would be an average of around €1.17 million per person.

A division of this by financial and non-financial assets is not provided and it is unclear what the asset allocation across this €206 billion is. Apart from the nebulous concept of “wealth” in the ULA document it is not clear what should be taxed. It will take a little more than an amendment to the Finance Act proposing that “a 5% tax be imposed on the wealth of the wealthiest 5% of the population”.

It is also not clear how sound this wealth distribution is. The Credit Suisse report says that it has wealth distribution data for 22 countries and uses this data to infer distributions for the other 140 countries in the report. Ireland is one of the countries that they claim to have wealth distribution data for and this is from 2001. The 2001 data and the 2011 estimates are summarised in the following table.

The series are reasonably consistent. The 2001 figure is that the bottom 50% have 5.0% of the wealth. For 2011 the reported figure is 4.8%. In 2001 it is indicated that the top 10% has 56% of the wealth, in 2011 it is 58.9%. For the top 1% the figures are 23.0% and 28.1%.

But where did the 2001 data come from? The report says the data is from Inland Revenue Statistics and to go see Ireland (2005). I doubt the UK’s Inland Revenue have data on the distribution of wealth in Ireland and we know that the Revenue Commissioners do not. The Inland Revenue may have data on Northern Ireland and they have lots of neat stuff here.

So what is this reference to Ireland (2005). From the bibliography this is:

Ireland, P. (2005): “Shareholder Primacy and the Distribution of Wealth”, Modern Law Review, 68: 49-81.

You can read this article here but the only mention of Ireland is because of the name of the author – Paddy Ireland. There are no wealth distribution statistics for Ireland in the article. None, but the reference has the words “Ireland”, “wealth” and “distribution” in it!

This report by the some of the same authors has almost the same wealth distribution as those shown in the top of the above table. The only issue is that there are for the UK in the year 2000. See table 7 on page 37.

There is another wealth distribution provided for Ireland in this report but this is claimed to be from 1987 and cites a 1991 publication by Brian Nolan, The Survey of Income Distribution, Poverty and Usage of State Services. However I think they actually a 1991 publication for the Combat Poverty Agency, The Wealth of Irish Households: What Can We Learn from Survey Data? (32mb!). Anyway here is the 1987 data which is confirmed on page 69 of the Combat Poverty Agency report.

When using the 1987 data this earlier report says “it is hoped that the shape of wealth distribution in these countries was reasonably stable from the late 1980s to the year 2000”. By 2001, in the Credit Swisse report they are saying that the wealth share of the top 1% was 23.0% up from 10.4% in the 1987 data. Not very stable. Of course, this 23.0% is a UK figure so we cannot put much weight on it.

In fact, without any evidence to support the claims in the report we cannot put any weight on it at all. Hopefully in time the CSO will address this data deficiency. The Nolan (1991) data is from a survey which will tend to underestimate the wealth of high and very high net worth individuals as they will be under-represented in the sample. Any information on the 2011 distribution of wealth in Ireland is little more than a guess.

A 5% tax on €206 billion would yield an impressive €10.3 billion but the proposal must specify what is to be taxed. The possibilities are:

Cash
Current Accounts and Deposits
Life Assurance Reserves
Direct Equity Investment
Business Equity
Pension Fund Equity
Land
Commercial Property
Residential Property
Other Assets

Putting a 5% tax on cash, current accounts, bank deposits and life assurance reserves seems practically impossible. The value of equities or private business comes from the dividends or incomes that these assets can generate and this are taxed under the income tax code. We have introduced a 0.6% annual pension levy for private pensions. A land tax is possible but unlikely and a residential property tax (or more particularly a site value tax) is due to be introduced by 2014. Determining what other assets should even be included makes taxing them difficult (yachts, racehorses, art, antiques, cars, jewellery, …)

All this is not to say that a wealth tax does not have merits. There have been moves away from wealth taxes in the past 15 years with many European countries abandoning them but France maintains the ‘Solidarity Tax on Wealth’. This is liable on net assets above €800,000 and was paid by 1% of taxpayers in 2007. See here and here for details (thanks to the Wikipedia entry) with more here and here.

The tax raises about 1.5% of general government revenue in France and is at a rate of around 0.5% of taxable net assets for the majority of those who pay. The ULA proposal seems to be to set these at a level ten times larger in Ireland – t0 raise 15% of revenue at a rate of 5% of net assets – and to levy it on five times as many people.

There is no way that this can be realistically achieved. The numbers on which the claim is based are questionable but to push the proposal to such drastic lengths is absurd. If we got €1 billion from a wealth tax it would be a start.

Do we want miss the budgetary targets?

2011-12-13T12:53:00.001Z

The measures put together for last week’s budget(s) has the stated aim of getting the General Government Deficit down to 8.6% of GDP. Although we know neither the final deficit nor the nominal GDP figure it is currently forecast that the deficit will be around 10.1% of GDP this year.

The original Four-Year Plan published last November targeted a 2012 deficit of 7.0% of GDP but this was based on very optimistic assumptions which had the deficit falling to below 3% of GDP by 2014. When the EU/IMF deal was brokered a few weeks later the timeframe for getting the deficit under 3% was pushed out to 2015 and at the ECOFIN meeting of 7 December 2010 a deficit limit of 8.6% of GDP for 2012 was set.

The 2011 Budget was announced the same day and still forecast a deficit for 2012 of 7.3% of GDP. It wasn’t until the Stability Programme Update in April of this year that the 8.6% deficit figure for 2012 made an appearance in Irish documents.

Much has been made of the fact that at 10.1% of GDP the deficit for this year has come in “below target”. This was not so much below target as below the 10.6% limit set by the ECOFIN meeting last December. The target from last year’s budget was that this year’s deficit would be 9.4% of GDP. The deficit is very much larger than the target.

This year the deficit limit was 10.6% of GDP, the target was 9.4% of GDP and the outcome will likely be somewhere in the middle. Next year the limit is 8.6% of GDP and the target is also 8.6% of GDP. While there was room for significant slippage this year (and the GGD is almost €800 million larger than forecast in last year’s Budget) there is absolutely no room for slippage next year.

If growth is slightly lower than expected or the measures introduced don’t have the anticipated impact than it is very likely that the deficit will come in above 8.6% of GDP. This year we had the capacity to absorb such downward developments; next year we have none.

The reduction in the EU interest rates agreed last July will make reaching the 8.6% target a little easier. These are estimated to save around €900 million in 2012. If these were applied statically to the projections from the April SPU then the deficit target for 2012 would be around 8.0% of GDP. This would have been a better target for 2012 but slippages elsewhere have fully absorbed the interest rate gains. Even with €900 million of savings announced in July the deficit target for 2012 is still at the 8.6% of GDP it was last April.

As a result of the interest rate savings we might be able to get fairly close to the 8.6% of GDP limit set by the EC. How we will fare on the IMF targets are less clear. The IMF does not make targets based on the overall general government balance and does not make them very far in advance.

The IMF budgetary targets are in terms of the primary exchequer deficit. This is the deficit on the Exchequer Account excluding interest payments. The IMF’s Third Quarterly Review (table 2, page 54) sets an indicative target for the end-June 2012 primary exchequer balance of €7.4 billion. Up the the end of June 2011 the primary exchequer balance was €8.4 billion (exchequer deficit of €10.8 billion less €2.4 billion of exchequer interest payments).

The IMF targets are not affected by the interest rate reductions announced last July. The primary exchequer deficit has to improve by €1 billion in June 2012 relative to its performance 12 months previously.

In last December’s budget tax revenue was forecast to be €34.9 billion for 2011. It is now clear that tax revenue of around €34.2 billion will be achieved. And this was only possible with the addition of €0.5 billion from the private sector pension levy announced in the May Jobs Initiative. On a ‘like-for-like’ basis, tax revenue for 2011 is around €1.2 billion behind last December’s target.

Just like the EC limit there was significant room for slippage when it came to the IMF target. Last June when the primary exchequer balance was €8.4 billion, the limit set by the IMF was €10.1 billion. We were well within the limit and had enough room to absorb the deterioration seen in tax revenues in the final quarter. Once again we have decided to eliminate this capacity and made the limit our target. The margin for error on the downside is zero.

Some of the numbers in last week’s budget do not stack up. The Minister for Finance admitted that the 2% VAT increase would not bring in €670 million over a full year because the estimate did not account for a fall in demand. The is an extra €160 million forecast to be brought in as a result of changes to CGT and CAT. This is equally unlikely. The €200 million gain from increases in Excise Duty also seems optimistic. These make up the bulk of the €1,000 million of new tax measures announced last week.

Many of the expenditure measures are equally woolly. Here is a list of “savings” included in the €1,400 million of current expenditure cuts from the Summary of Budget Measures.

Enhance fraud and control activity.
Continued focus on delivering reductions in the price and volume of goods and services procured by the health services.
Savings from anticipated lower disease incidence and operational changes.
Miscellaneous Savings on the Vote
Achieve a reduction in non-pay administration costs through increased efficiencies.
Reduce costs associated with operation of the Mahon Tribunal.
Efficiencies and changes to business processes.
Streamlining the State’s employment rights bodies.
Rigorously review of every area of expenditure.
Introduce new efficiencies mainly through the use of IT.
Programme savings through efficiencies.
A range of measures to improve programme efficiency are being considered.
Introduction of efficiencies.
Efficiency measures in Revenue, Office of Public Works and savings in legal fees in Law Offices.
General savings in Departments of Arts, Heritage & the Gaeltacht and Communications, Energy & Natural Resources.

The arithmetic might add up to a budget with €3.8 billion of “adjustments” but the reality is likely to be somewhat different.

After a year of being “the best in the bailout class” are we actually looking to exceed the deficit limits set down by our external funding partners? Is there political capital to be gained from missing these targets?

Inflation edges higher

2011-12-08T12:18:00.001Z

Today’s CPI release from the CSO reports that the headline rate of annual inflation rose from 2.8% in October to 2.9% in November. As has been the case since inflation returned to positive territory in the middle of 2010 this continues to be mainly driven by just two categories; energy products and mortgage interest.

The price of energy products are up 13.7% in the year, while the price of mortgage interest is up 17.8% in the year. These make up 15% of the index and removing them gives a measure of ‘core’ inflation. Core annual inflation in November was 0.66%, up from 0.55% in October.

On mortgage interest, it is important to realise that the CPI measures the price of mortgage interest and not necessarily the cost. The price of mortgage interest change but the cost to most households may not change if this change is not also applied to existing mortgages. This has happened in Ireland for the past 18 months or so. Mortgage variable rates have been increasing far more than tracker rates and these form most of the mortgage interest price in the CPI.

The mortgage inflation rate in the CPI overstates the average increase in mortgage rates as it reflects mainly the rates that have been rising by more(standard variable rates) and largely omits the rates which rose only slightly (tracker rates). Almost half of all mortgages are on tracker rates. This is explained in a Information Note to the CPI release.

In line with normal practice for a fixed base price index, the 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. Users should take this “weighting effect” into account in interpreting the mortgage interest related movements in the index.

Social welfare expenditure to fall by €88 million

2011-12-06T00:34:00.001Z

Today seems like an appropriate time to update this. The 2012 expenditure of the Department of Social Protection was subjected to €475 million of “savings measures” today. It is projected that the full effect of the measures announced today but which will come into effect over the next three years will be €811 million.

In 2011 it is estimated that expenditure on social welfare payments from either the Department of Social Protection or the Social Insurance Fund will be €20,030 million. With the measures announced today the forecast for 2012 is €19,942 million – a fall of €88 million.

Here are the expenditures by six main headings for 2011 and 2012.

The actual payments under each heading were detailed in the previous post on this issue. It can be seen that most of the expenditure increases are for pensions and in particular the contributory pensions paid from the Social Insurance Fund.

Around €45 million of the 2012 savings announced today are as a result of reduction in Child Benefit for third and subsequent children. Even with this the aggregate amount of Child Benefit is forecast to increase (albeit by just €8 million) from €2,067 million to €2,075 million.

The large drop is income support payments from the Social Insurance Fund is evenly split between a fall in Jobseeker’s Benefit and Redundancy and Insolvency Payments. The fall in Jobseeker’s Benefit is because entitlements expire after 12 months. Recipients can switch to the means tested Jobseeker’s Allowance paid by the Department of Social Protection where expenditure is forecast to increase by more than €150 million.

In 2009, the outturn for social welfare payments was €19,959 million. As shown above it is forecast to be €19,942 million in 2012. This is a drop of 0.08%. Next year, social welfare payments will be 99.92% of what they were in 2009.

It is clear there have been significant adjustments to social welfare expenditure and these cuts continued today. However, there has been no reduction in overall expenditure. Rather, the same amount of money is being spent but it is going to more people (more children, more pensioners, more unemployed) so, on average, people are getting less.

Back to ten percent?

2011-11-24T13:31:00.001Z

Here is the one-day performance of the Irish government bond nine-year yield as calculated by Bloomberg.

So much for bond yield tranquillity! And this is not too different to what was happening on November 24th 2010 only this time we’re going one percentage point higher.