Thursday, November 7, 2019

All sectors of the economy are now net lenders

Ireland’s economic history is one that has been pockmarked by concern for deficits that are too high or debts that might be unsustainable.  We have had numerous examples of both in the past fifteen years with large current account and public deficits and high debt levels across all sectors of the economy. 

While some concerns about debt levels remain, it now seems we are running unprecedented balance of payments current account surpluses as shown here in CSO data from 1970.

BoP Current Account 1970-2018

Data before 1970 would show persistent, and on occasion unsustainable, deficits.  The latest estimates from the CSO of the  the modified current account show it reaching 6.5 per cent of GNI* in 2018.  The patterns of Ireland’s current account from 1975 to 1990 and from 2005 to 2020 will not be dissimilar (see another lap for the Celtic Hare).  But this time the surpluses following the adjustment of living a way beyond our means are at a level not seen before.

EU15 BoP Current Account 2001-2018

In terms of the EU15, the turnaround in Ireland’s modified current account has seen us move from keeping company with Greece, Portugal and Spain in 2007 to near the levels of Denmark, Germany and the Netherlands in 2018.

We can try to get some insight into the underlying changes behind this transformation by looking at the net lending or borrowing from the institutional sector accounts.  Per the OECD:

Net lending/borrowing reflects the amount of financial assets that are available for lending or needed for borrowing to finance all expenditures – consumption expenditure, gross capital formation and capital transfers – in excess of disposable income.  If it is positive it is described as net lending and if negative, as net borrowing.

Due to internal and external distortions we have to do a small bit of cleaning up to get a view of the underlying changes.  The main internal distortion we will try to remove is the bank bailout, a large part of which was a capital transfer from the government to financial sector while the external figures are hugely distorted by the activities of MNCs and in particular the impact of IP onshoring and aircraft for leasing.  Something similar was done in section 7.3 of this recent paper from the Department of Finance.

So for the next chart it should be noted that:

^The impact of Other Capital Transfers (D.99) from general government to financial corporations are removed from both sectors;

* All the adjustment necessary to make the sectoral net lending figures consistent with the modified current account is applied to the non-financial corporate sector.  These adjustments mainly relate to R&D IP imports, aircraft for leasing and net acquisitions of non-produced, non-financial assets.

What we see is not going to surprise anyone. An unadjusted version is here.

Sectoral Net Lending and the Modified Current Account 2001-2018

Although the current account surpluses of mid-1990s had been eroded, up to 2004 the economy was in a position to fund the expansion in net borrowing by the household sector from domestic sources.  However, the continued increase in household borrowing meant this was not possible after 2004 and a significant balance of payments deficit opened up (this would have been funded through transactions which impacted the financial account of the balance of payments).

Household net borrowing as a ratio of GNI* peaked in 2006 by which time net borrowing by the non-financial corporate sector was growing (at least in the adjusted terms shown here).  The surplus that the government sector was running in 2006 could have partially funded this but fiscal policy led to this surplus vanishing in 2007 and the government sector ran a large deficit from 2008 as tax revenues evaporated and social transfer spending rose.

By 2009, the household sector was a significant net lender with these funds mainly used to reduce debts – a position it remains in a decade later.  2009 also saw the underlying deficit for the government sector reach its highest level during the crisis when it was just over 14 per cent of GNI*.  Over the next decade this deficit was gradually reduced and was finally eliminated in 2018.

Indeed, 2018 was the first year when all sectors of the economy were net lenders (% GNI*):

  • Households (2.2%)
  • Government (0.0%)
  • Financial Corporates (1.7%)
  • Non-Financial Corporates (adjusted) (3.1%)

One reason to pause before we get excited with highfalutin plans to spend the surplus is that, in the latest figures at any rate, almost half of it arises from the non-financial corporate sector and we really don’t know what is going on there.  Given the scale of the gross amounts in this sector revisions to the figure could be significant.

There is also the concern due to the impact Ireland’s booming Corporation Tax receipts are having on the government’s position and on the current account. Further, the extent to which the IFSC impacts the net lending of the financial sector is unclear.  That only leaves the household sector without a question mark.

The Department of Finance paper also urges caution with an expectation that increased investment by the household and government sectors will reduce the current account surplus:

The net lending position of the household and government sectors is likely to deteriorate in the coming years, however, due to the expected increase in investment in these sectors (that is unlikely to be fully offset by an increase in savings in these sectors). This will require monitoring as it could result in a deterioration of the current account balance.

This may be downplaying the risks of increased current or consumption expenditure being a source of the possible deterioration.  On the other hand, though, there may be sufficient income growth for the economy to absorb the impact of increased consumption and investment spending on net lending as has been the case in recent years.

One of the remarkable features of the Irish economy has been that recent growth has been so strong even as the government has been reducing its deficit and the household sector has been reducing its debts.  Our conclusion from April is probably still valid:

Eventually the deleveraging will stop.  Whether that leads to an increase in consumption or investment is hard to tell.  The vulnerable position of the government sector probably means that some caution in the household sector is warranted but whether this caution will persist remains to be seen.

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