Retail Sales Index Falls Again

The May Retail Sales Index was released by the CSO earlier today.  The up-down volatility in the series that was seen around the turn of the year has now been replaced by downward momentum.

Both the value and volume series are now down to the minimums there were recorded last December.  The drop to these levels in December was largely influenced by the extreme cold weather that the country experienced.  There is no such meteorological explanation for the return to these levels in May.

Unsurprising, the annual changes are moving further away from zero.  Value is now 3.5% behind last year and volume 5.1% down on last year.  We had expected that the annual comparisons around now would be negative even if the index had managed to stop falling. It hasn’t and the annual drops are getting larger.

The recent volatility is highlighted by the monthly changes but the jumps from positive to negative have been replaced by a series of negative monthly changes.  It must be all those pesky savers!

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Presentation – Ireland’s Public Debt Crisis

Here are the slides I used for a presentation in UCC on Ireland’s Public Debt Crisis.

Ireland's Public Debt Crisis

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What are we saving?

There has been a lot of discussion following from Michael Noonan’s comments last week that “what we really need is for people to go into the shops and start buying again”.   Stephen Kinsella has a good post on this.  As a follow up to this it is useful to consider just what it is Irish people are saving.  To start here is a highly stylised and artificial example.

Consider that society is made up of two groups and that the disposable income of each group is 50.  The first group is the Thrifty Group. Of their disposable income they spend 40 and save 10.  The second group is the Profligate Group. They spend their income of 50and also borrow an additional 10 to increase their consumption to 60.

In this first period aggregate disposable income is 100 and total consumption is 100.  The savings rate is zero.

We then move to the second period.  The situation and behaviour of the Thrifty Group does not change.  They continue to have a disposable income of 50, spending 40 and saving 10 of this.  We will also assume that the disposable income of the Profligate Group does not change but they are now unwilling/unable to borrow to fund their consumption and they spend their entire disposable income of 50.

In this second period aggregate disposable income is 100 and total consumption is 90.  The savings rate is 10% but this was driven by a change in borrowing behaviour.  There has been no change in savings behaviour.

Finally, consider a third period.  Again we will assume no change for the Thrifty Group but now the Profligate Group have to pay back the money they borrowed in Period One.  We will assume that this requires a repayment of five, thus reducing their consumption to 45.

In this third period aggregate disposable income is 100 and total consumption is 85.  The savings rate is now 15% but again it is not because of any increase savings behaviour.

In Ireland the savings rate has shot up in recent years. 

The suggestion from Michael Noonan is because this is as a result of an increase in savings behaviour.  It is true that a gap has emerged between household disposable income and household consumption.

Although the data in this graph only go to 2009 all indications are that this continued into 2010 and will likely continue in 2011 and 2012.  In economics, the definition of savings is disposable income that is not spent. 

In 2008, both disposable income and consumption expenditure were around €90 - €92 billion.  In 2009, household disposable income fell slightly but consumption expenditure dropped from €90 billion to €81 billion.  The assumption is that this €9 billion is money that households could have spent, but are now choosing to save.  As we saw with our stylised example above, this could be a factor of borrowing rather than saving.

If we look at household financial accounts we see that this is more than likely the case.  First here are household deposits.

During 2006 to 2008 when the savings rate was low household deposits were rising.  When the savings rate shot up in 2009, the increase in deposits slowed and had even begun to decline slightly during the end of 2010.   This is an aggregate of deposits.  It is likely for some households that precautionary deposits are increasing while for other households deposits are decreasing as they use them to offset significant reductions in income.

The savings rate might be a hefty 12% but this is not been seen in household deposits.  Michael Noonan may want people to go out shopping but they do not have an extra savings to draw on, household deposits are falling.

So where is the 12% savings rate going?  Well, as explained above it could be driven by a fall in new borrowings.  The Credit, Money and Banking Statistics from the Central Bank show that household credit is now contracting.

The drop in growth of consumer credit is evident and since 2008 has moved from growing at 18% per annum to falling at 18% per annum.  Even if household income and savings amounts had remained unchanged this huge turnaround in consumer credit would have seen consumption expenditure fall.

Finally here is the aggregate amount of loans owed by households.

Since peaking in the middle of 2008, the amount owed on household loans has fallen from €203 billion to €185 billion.  Short-term loans have fallen from €14 billion to €9 billion.

The household sector may have a savings rate of close to 12% but there are no swelling deposits that could be used to boost consumption.  The savings rate has shot up for two reasons:

1. Households are no longer borrowing to fund their consumption expenditure.
2. Households are paying back the loans they previously used to fund their consumption expenditure.

One issue that cannot be addressed here is whether people are paying back these loans in an accelerated fashion.  The Financial Regulator produces data on mortgage arrears, those behind on their repayments.  It would be useful if we could get even a snapshot of those who are in mortgage advances, those ahead on their repayments. 

There may be households who are saving by paying down loans quicker than in the original contract.  It is difficult to say if this is true but the total amount of loans outstanding to households is falling quite rapidly.  It must be stated that it is falling from a huge height and is still 120% of GDP, well north of international averages.

So what impact is this huge savings rate having on household deposits? Very little.  What extra money is available for consumption? Not much.  There may be some money that is currently being used to accelerate the repayment of debt. This will continue for the medium term and once households have repaired their balance sheets they will be in a position to increase consumption relatively quickly.  It will take more than words from the Minister for Finance to get the tills rolling again.

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What can we default on?

Our continued insistence on paying unguaranteed debts in the banks has seen the State pour €46 billion into the six covered banks so far, with a further €18 billion or so to be provided as part of the ongoing recapitalisations.  Of this €64 billion, about €16 billion will have come from money that was built up in the NPRF, so by the end of this year the bank bailout will have created about €48 billion of debt.

There are many who view this as an unsustainable debt for the State to carry and that default is inevitable.  Personally I am still of the view that a sovereign default can be avoided but that does not mean that such a course of action should be discounted.   It is not inevitable but that does not mean it should not be considered as a policy option.

At the end of this year the General Government Debt will be around €170 billion.  In increasing order of importance that will be made up of the following components:

• Retail Debt: €15 billion
• Promissory Notes: €28 billion
• EU/IMF Borrowings: €41 billion
• Government Bonds: €86 billion

This €170 billion of debt will be about 108% of GDP.  The potential for substantial savings appears to be limited.  The €15 billion of retail debt is Prize Bonds, Post Office Bonds, Savings Certificates/Bonds and the National Solidarity Bonds.  It is very unlikely that there will be a default on these.

At the end of the year there will be €28 billion of Promissory Notes outstanding.  These are used by Anglo, and to a lesser extent, INBS as collateral with the Central Bank of Ireland to obtain Emergency Liquidity Assistance (ELA).   If payment is refused on these Promissory Notes, Anglo will not be a position to repay the ELA it is drawdown from the CBoI.  If that is the case who picks up the tab?  The answer is on page 104 of the CBoI’s 2010 Annual Report:

In addition, the Bank received formal comfort from the Minister for Finance such that any shortfall on the liquidation of collateral is made good.

The €28 billion of Promissory Notes seem an ideal candidate when considering a default as this money will disappear in the zombies that are Anglo and INBS with absolutely zero return for the State.  The problem is that it looks very difficult to escape the liabilities that are being covered by these Promissory Notes.

Default on the EU/IMF borrowings is a non-runner as these institutions have priority status on our list of creditors and are legally guaranteed to get their money back.  It may be possible to reschedule the repayment of these loans.  This repayment is due to begin in 2015.  Such a rescheduling would not be far removed from a default event but it would not reduce the aggregate amount of debt we are carrying.

That means we are down to the outstanding sovereign bonds that were issued prior to our shut-out from markets towards the end of 2008.  A full list of these can be seen here.  At the end of this year there will be €85 billion of these bonds outstanding. 

If a default is going to be worthwhile it would have to reduce our debt/GDP ratio to something around 75% that would mean the aggregate debt would have to be reduced from €170 billion to around €120 billion.

To make these €50 billion of savings it seems the only realistic possibility is to enforce significant haircuts on our outstanding government bonds.  This would have to be of the order of 60% across all government bonds to make the default worthwhile.  If the haircut is less than 60% it is hard to see how the savings to be made could offset the inevitable fallout of a default. 

It is unlikely that such a haircut could be introduced, but if it was it is more than a little incongruous that those who invested in senior bonds from our delinquent banks are getting their money back, while those who invested in the bonds of the country could be forced to carry losses.  Like lots of developments in the response to the crisis, this does not add up.

However, it does not seem that default could generate the required savings to make it a viable policy option.  We are not going to default on out retail debt.  The construction of the Promissory Notes makes it very difficult to escape from the liabilities they cover.  The EU/IMF have preferred creditor status and are virtually guaranteed to get repayment on their loans.  That leaves, our government bonds. 

The yields on these indicate that markets know that this is where the risk lies.  Current market prices have an in-built 40% write-down included in them.  The haircut would need to be half as large again to make it worthwhile.

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Per Capita Consumption Resumes Fall

The release of the Q1 2011 National Accounts yesterday has sparked a variety of responses such is the inconsistency in the figures between differing quarterly changes in GDP and GNP as well as substantial revisions to the annual figures to 2010.

Here is a chart that uses two CSO data series:

1. Quarterly estimate of private consumption at constant market prices (seasonally adjusted)
2. Quarterly estimate of the population aged 15 plus from the QNHS

Although the CSO may not approve we will use these to create a rather crude measure of per capita consumption.  There are probably a number of difficulties with this approach which was prompted by a comment on recent falls in the Retail Sales Index.  Is the index falling because people are spending less as a result of decreased incomes or is the index falling because there are less people to spend as a result of outward migration?  We attempt to address that here.

So what do we see when we divide 1 by 2?

After flat lining for four quarters from the end of 2009, this series turned downward in the final quarter of 2010 and this has continued into 2011.  Per capita consumption fell 1.7% in the quarter and is down 2.5% on the year.  We can see that the most severe fall occurred during 2008 and we are now 11.5% below Q1 2008. 

It did appear that through 2009 and 2010 the worst of the fall was behind us but the start of 2011 undermines that view with per capita consumption resuming its downward path. This will not be to the approval of Minister for Finance, Michael Noonan based on this report.

In an appeal aimed at those Irish people who are holding a total of €134bn in savings accounts, Mr Noonan said it was time to return to normal shopping habits.

"What we really need is for people to go into the shops and start buying again,'' said Mr Noonan in a message to those who had the cash to spare.

“If that starts, with tourists visiting our shores stimulating the retail side, and is followed by our own ordinary citizens going about their shopping and beginning to spend again, then we begin to lift out of the crisis," he said.

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