The extra-ordinary volatility in GNP

Here are the quarterly growth rates of GNP from the latest CSO figures.

The largest quarterly growth rate in the series is the 12 per cent recorded in Q4 2016.  And this is followed by the largest quarterly fall – the 7 per cent drop recorded in Q1 2017.  The series have always been volatile but this is on a different scale altogether.

What is going on?  It is hard to know.  MNCs are undoubtedly having an effect and it could be that some of these distortions (intangibles, inversions etc.) are being amplified by the seasonal adjustment applied to quarterly data.  Do they wash out if we look an annual growth rates? Not really.

There is little that can be learned from these headline figures.  The CSO are working on producing modified measures, such as GNI*, on a quarterly basis which should be provide a better indication of what is going on.

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Ireland’s Positive and Improving Underlying Net International Investment Position

The last post looked at flows in the current account and concluded that this may be a good indication of what is happening to the current account balance once some of the distorting effects of MNCs are removed.

This post looks at the stock position and as is frequently the case with Irish macro statistics the starting position is heavily distorted.   The CSO publish figures that remove the impact of IFSC activities but some MNC distortions remain.  You can go through the detail if you want but here is where we end up – a measure of Ireland’s underlying net international investment position.

As can be seen this has been improving pretty much consistently since the current data series began in 2012.  The underlying NIIP became positive in 2014 and had since continued to become even more so.  The rest of the post shows how we get to this measure starting with the the overall net international investment position (NIIP) which is the balance of foreign financial assets and liabilities:

The impact of the IFSC is excluded from all the figures.  The impact of the IFSC on the net outcomes is relatively small but does have a massive impact on the gross figures with huge levels of financial assets offset by a similar level of financial liabilities.

In Q1 2017 our NIIP was minus –€375 billion. Ouch.  Even before the event which caused the level shift in Q1 2015 it was around –€180 billion and was improving at a very moderate rate.  But we need to go under the hood to get any idea of what is going on.  The first thing to do is look at the gross totals that give rise to the net figure shown above.  Here are our total foreign financial assets and liabilities.

Whoa!  By Q1 2017 we had €1.4 trillion of foreign liabilities and €1.0 trillion of foreign financial assets.  And this is excluding the effect of the IFSC – include that and the figures are €5.0 trillion and €4.5 trillion.

Anyway, let’s just take the non-IFSC figures which on their own seem completely oversized for the Irish economy. So who has external liabilities of €1.4 trillion?

And there is our pollutant.  Around 90 per cent of the foreign liabilities are due to the non-financial corporate sector.  Do Irish companies have €1.2 trillion of external liabilities?  No, but companies resident in Ireland do.  It is pretty safe to assume that almost of the external liabilities of the NFC sector arise through foreign-owned MNCs. 

The NFC numbers don’t tell us anything about the underlying position of the Irish economy.  There will be information in figures for the other four sectors shown above but the scale of the chart means it is hard to see what is going on.

There may be many factors driving the increase in MNC-related foreign liabilities but one will be the onshoring of intangible assets to Ireland.  The Irish-resident entity that onshores the intangible does so with money borrowed from another (offshore) entity within the MNC structure.

And we see much the same when we look at the €1 trillion of foreign financial assets.

Here nearly 80 per cent is due to the NFC sector.  Do Irish companies have €800 billion of foreign financial assets.  Again, no, but companies resident in Ireland do.  In this instance we are looking at liabilities owed to Irish-resident entities within foreign-owned MNC structures.  It is possible that this is related to redomiciled or inverted companies.  Again, the underlying position of the other sectors is hard to identify given the scale of the graph.

If we just isolate the external debt liabilities and assets associated with direct investment we see the following (there will also be equity liabilities and assets associated with direct investment).

They have got there by different paths but both the gross external debt and external debt assets related to direct investment were about €500 billion in Q1 2017.  As we have pointed out before these huge increases in direct investment debt liabilities and assets have not been reflected in increases in interest flows related to direct investment debts.

Anyway, that’s for another day.  What we want to do here is assess Ireland’s underlying net international investment position.  What the above shows is that to do this we need to remove the impact of the NFC sector which through the activities of MNCs is distorting the overall position.  This does remove the cross-border positions of genuine Irish companies but these are unlikely to change to general picture that emerges – though we can’t forget this.

So what is our Net IIP excluding NFCs?

Ah, that’s better.  The navy line gives our underlying Net IIP excluding NFCs (and also the IFSC).  This has shown steady improvement since the start of 2012 when the current data series begins.  It has gone from –€90 billion in Q1 2012 to +€80 billion in Q1 2017.  We have gone from a net liability position to a net asset position – we have more external financial assets than we have external financial liabilities.

Most of the improvement has been effected through the financial system.  In the early years of the crisis many of the external creditors of the banks were repaid with liquidity from the Central Bank which itself generated a negative Target2 balance.  While the banks had a relative small net position in 2012 the net position of the Central Bank, i.e the monetary authority, was –€91 billion at that time.  Since then the banks have reduced their reliance on central bank funding and the external position of the Central Bank has improved with that and stood at +€9 billion in Q1 2017.

Of the remaining sectors, financial intermediaries have a NIIP position of +€190 billion.  This, in large part, reflects the foreign financial assets of Irish-owned investment and pension funds.  The government sector has a negative position of –€129 billion representing the international nature of much of the borrowing it undertook in the crisis.  Add up all those and you get our underlying net international investment position of +€80 billion – which excludes the impact of NFCs (mainly MNCs).

So it seems the stocks as well as the flows in the Balance of Payments data is a positive indicator that continues to move in that direction.

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So, what’s going on with the Current Account?

Last week the CSO provided the first insight into the new * variables that will hopefully address some of the distortions in the National Accounts that have been created by PLCs who have redomiciled to Ireland and offshore activities relating to assets owned by Irish-resident companies linked to aircraft leasing and intangible assets. 

While much of what was published was a useful step in the right direction a clearer view of what is happening in the Current Account of the Balance of Payments was not provided.  The problems with the official measure of the Current Account are evident below.

After moving into deficit in the period from 2004 to 2007 the current account began to improve in 2008 but the improvement in 2009 and 2010 was much greater than the underlying performance of the economy would suggest.  The recent volatility is clear and this largely relates to the impact of the onshoring of intangible assets to Ireland.

To improve things we have been provided with a modified Current Account, termed CA*, that makes a number of important adjustments.  Per the CSO:

CA* is the current account balance (CA) adjusted for the depreciation of capital assets sometimes held outside Ireland owned by Irish resident foreign-owned firms, e.g. Intellectual Property (IP) and Aircraft Leasing, alongside the repatriated global income of companies that moved their headquarters to Ireland (e.g. redomiciled firms or corporate inversions).

The impact of the factors on the current account are shown in this table.

The rise in the income accruing the redomiciled PLCs which drove the rapid improvement in the current account in 2009 and 2010 can be seen while the huge jump in the depreciation related to MNC owned intangible assets that caused in the recent volatility in the Current Account is also readily seen.

So what happens if we exclude the income of redomiciled PLCs, or equivalently consider them to flow out as a factor outflow to their foreign shareholders, and treat the depreciation on certain IP and aircraft assets as an outflow as this arises from gross profits that accrues to non-residents and is linked to assets that may have no direct link with the Irish economy?  Making these adjustments gives us this:

Hmmm.  That’s not very good at all.  Yes, we do see some moderation of the improvement in 2009 and 2010 but recent figures do not make sense.  We would possibly have expected continued improvement in the Current Account for the last few years while the huge drop to a deficit of almost €30 billion in 2016 is not reflective of any underlying trend in the Irish economy.

So what are we missing?  Or maybe more accurately was remains in the modified Current Account that continues to distort the figures?  Adjusting for the depreciation of certain IP and aircraft assets is correct but no adjustment is made for their acquisition. 

Sometimes this assets are added to Ireland’s capital stock through a balance-sheet relocation (which has no impact on the current account) but other times the assets are acquired by an Irish-resident company and this transaction is recorded as an outflow in the balance of payments.  There is little doubt that the deficits shown in the modified measures for recent years are, in whole or in part, due to these acquisitions. 

Making an adjustment for the depreciation on these assets is appropriate for when these assets are here but we should also make an adjustment for how those assets get here if that has an impact on the Current Account.  So we need the net outright purchases in the balance of payments of the assets we are making a depreciation adjustment for.

We can get this from new Annex 4C of the Quarterly National Accounts.  This gives a modified Gross Fixed Capital Formation (in nominal terms) where the GFCF excluded from the modified measure are aircraft related to leasing and the onshoring of IP assets.  For some years the split between the two isn’t provided (as some quarters are suppressed) but we have their sum from the difference between the official and modified versions of GFCF.

We should get a better picture of the current account if we make an adjustment for the fact that all of this investment in aircraft for leasing and the purchase of IP assets will have required them to be imported and therefore counted as an outflow in the Balance of Payments.  Now, there may be some differences in how these transactions are valued for National Accounts versus Balance of Payments purposes but any differences won’t materially change the result. 

So lets make an adjustment to the modified Current Account published by the CSO last week to take account of the purchase of aircraft for leasing and certain IP assets.

That seems much better.  We have the deterioration from 2004 to 2007 and a fairly steady improvement before return to a small surplus in 2014.  The figures since then seem questionable with a rapid move to a large surplus with this measure showing a surplus of €13 billion in 2016.  If this is true then we are in a very strong position but it does seem implausibly large.

Here is this approach applied above to getting an underlying Current Account as a percentage of GNI*.

Are we running a current account surplus of seven per cent of national income?  It’s seems high.  A Current Account measure that seems to fit the underlying performance of the Irish economy up to 2014 but doesn’t thereafter isn’t of much use.  We want to know what is happening now.

The improvement in 2015 is likely partly due to €2.3 billion increase in Corporation Tax receipts seen that year, of which around 80 per cent was due to MNCs.  Corporation Tax did not grow to the same extent in 2016 so that cannot explain the continued improvement shown in this version of the Current Account.

There may be something happening within the income flow figures.  For example, the retained earnings of direct equity investment attributed to Irish residents increased by almost €3 billion in 2016 (from €10.9 billion to €13.8 billion) but as shown in the first table above the net foreign income of redomiciled PLCs only increased by €1 billion in 2016.  The impact of this €2 billion difference on the Current Account balance produced here is unclear. 

The 9.4 per cent nominal growth rate for GNI* also seems a bit high but it is probably not that far out of the ballpark.  It could be that there is another distortion on the income side that we need to be made aware of or it could be that our current external balance (along with our national income) really is improving at the rapid rate shown here but at least we’re only quibbling over a couple of percentage points of national income.  The figures published last week by the CSO allow us to get closer to what is really going on and it is a step to be welcomed.  More please.

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Some other trends in government revenue

The last post looked at the question as to whether the slow down in the growth of Exchequer tax revenue is reflective of underlying trends in the economy.  The conclusion was that while there has been a slow down in the growth of tax revenue it is due to factors that do not reflect underlying trends in the economy such as the 2015 level-shift in Corporation tax, the 2016 spike in Excise Duty and €2.2 billion of revenue reducing measures over the past three budgets.  Any concerns about the slowdown in tax revenue growth should be limited to the impact on the public finances rather than what it might imply for the economy in general.

Of course, Exchequer tax revenue isn’t the only source of government revenue though for a variety of reasons it attracts the most attention.  A broader measure of government revenue would include PRSI, other appropriations in aid collected by government departments and Exchequer non-tax revenue such as the Central Bank surplus, semi-state dividends, capital resources and income related to banking measures such guarantee fees and interest and dividends from certain banking assets.  So what is happening to these?

We have a divergent picture.  PRSI receipts have been growing steadily and in June recorded growth on a 12-month basis of 8.4 per cent.  For the year-to-date PRSI is 2.5 per cent or €116 million above profile in contrast to Income Tax which is €214 million behind profile.

The sum of Exchequer non-tax revenue and other appropriations-in-aid has been declining since the final quarter of 2014.  In November 2014, the 12-month sum of these revenues was €7.5 billion while for June 2017 the total was €5.0 billion.

This is due to falls in most of the items that are included in the category.  The surplus from the Central Bank with a general government impact was €1.4 billion in 2014 but was less than €1 billion this year.  €420 million of bank guarantee fees were collected in the year to January 2014 while the current total is less than one-tenth of that.  Around €500 million of dividends were collected by the Exchequer in both 2014 and 2015, last year it was less than €200 million.  Capital resources were boosted in 2014 by the €335 million received from the sale of Aer Lingus shares.  Other appropriations-in-aid have fallen from €4 billion to €3 billion though it is not clear why this is so or how it is linked to the expenditure of those departments.

The takeout is that while Exchequer tax revenue and PRSI receipts are growing, Exchequer non-tax revenue is falling.  This is a not surprise though.  Exchequer non-tax revenue to the end of June was €1,309 million compared to a profiled amount of €1,310 million.  Other appropriations-in-aid are also down year-on-year but are in line with expectations.

An issue may be when the growth rate of net expenditure is compared to the growth rate of taxation when it is known that non-tax sources of revenue are falling.  Using broader measures of central government revenue and expenditure may capture more information.

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Should we be concerned with the slowdown in tax revenue growth?

Exchequer tax revenue bottomed out in the middle of 2010 and has been on a fairly steady upward trend since then.

There has, however, been a bit of attention given to the “flattening out” that has occurred since the middle of 2016.  This is more apparent if we look at the annual changes in the moving sum depicted in the chart above:

Here we can see that tax revenues recorded their fastest recent growth in early 2015 (13.6 per cent in February) and while it was still above 10 per cent in mid-2016 there has been a steep fall in the growth rate since then with growth down to 3.5 per cent in May 2017.  Should we be concerned about this fall in the growth rate of tax revenues?

There are three reasons that can serve to ameliorate our concerns:

1. The level shift in Corporation Tax receipts in 2015,
2. A spike in Excise Duty receipts in early 2016,
3. The impact of €2.2 billion of revenue-reducing budgetary measures (of which €1.8 billion relate to Income Tax)

Corporation Tax revenues began to rise in the middle of 2014 but really ramped up in the second half of 2015. 

A level-shift from €4 billion to €7 billion occurred in a very short period of time and for the past 18 months or so receipts have been relatively stable at the new level.  This will obviously have had a dramatic impact on the annual growth rates.   The growth of Corporation Tax exceeded 50 per cent towards the end of 2015 and was still above 40 per cent in June 2016.  Since then the growth of Corporation Tax has fallen markedly as the rise to the new level washes out of the annual growth rates.

The other tax exhibiting a strange recent pattern is Excise Duty.  If we truncate the vertical axis we can highlight this.

Excise duties rose unexpectedly in early 2016 and have returned to somewhere near where they might have been had the steady upward trend seen since the middle of 2013 continued at the same rate.  The reason given for the spike is that excise duty from cigarettes increased markedly in advance of the expected introduction of plain packaging legislation.  The pattern for new car sales will also have contributed to the Excise Duty outturn.  The nature of the spike in early 2016 means that the annual changes in Excise Duty have turned negative.

Here are the annual changes in 12-month rolling sums of Corporation Tax and Excise Duty receipts:

What we see is that the growth rate of both have been falling since the middle of 2016 though obviously much more markedly in the case of Corporation Tax.  It is likely that these are driving the similar trend we see in overall Exchequer Tax receipts.  So let’s look at the growth of Exchequer tax revenue excluding these Corporation Tax and Excise Duty (notwithstanding that they are two of the big four ‘tax heads’):

The navy line is the pattern that has caused some recent concern.  The maroon line is the annual change excluding Corporation Tax and Excise Duty, and while this did fall during 2015 it has been relatively stable for the past 18 months or so, generally showing growth of between four and six per cent.  All the recent slowdown in the growth of Exchequer Tax revenue is due to Corporation Tax and Excise Duty.  Are the 2015 level-shift in Corporation Tax and the 2016 spike in Excise Duty reflective of underlying trends in the economy?

One tax that may reflect the underlying trends of the economy is Income Tax and this appears to have flat lined recently.  This was growing at between eight and ten per cent through 2015 and up to the end of 2016 but the improvement slowed in 2017 to less than half that amount.  The latest Fiscal Monitor shows that Income Tax to the end of May is only up 2.5 per cent on the same period of 2016.

One reason not to be concerned with this is that around €1.8 billion of measures reducing Income Tax were introduced across Budgets 2015, 2016 and 2017, of which the bulk related to the Universal Social Charge.  One way to assess this could be to compare the growth rate of PRSI (which hasn’t had significant policy changes from a revenue perspective in recent budgets) to the growth rate of Income Tax (which has). 

We see a large gap opening up in the past six months or so.  PRSI receipts have grown between eight and nine per cent year-on-year.  Income Tax revenues were growing at close to that level up to late last year but the growth has fallen to around three per cent now.  If this drop was reflective of underlying trends in the economy we could expect both Income Tax and PRSI to be similarly affected. 

The fact that they are not points to something else and the eight per cent growth of PRSI receipts reflects the underlying strong growth in the economy.  And in replying to a PQ the former Minister for Finance indicated that the PAYE component of Income Tax was up eight per cent in the first third of the year compared to the same period of 2016.  Again, this is in line with what we see in the labour market.

On the other side, VAT seems to be growing a little stronger than the underlying trends in the economy would suggest.  It might be something we come back to. As shown below, the growth of VAT on a rolling 12-month basis jumped at the start of 2017 and is now growing at nearly ten per cent.  Although seemingly positive maybe this is the one we should be concerned about.

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