Evening Echo 16/07/2012

Here is the text of an article written last week that was published in tonight’s Evening Echo.

Our banks now just worth €12bn

In the course of the past four years Ireland has poured €64 billion into the recapitalisation of just six banks: AIB, BOI, EBS, PTSB, Anglo and INBS.  Just over €1 billion was received in return for the sale of around one-sixth of Bank of Ireland so this leaves the total recapitalisation bill at around €63 billion.

Of the €63 billion that has gone into the banks, €35 billion has been provided to Anglo and Irish Nationwide.  These dead banks have been merged into the Irish Bank Resolution Corporation (IBRC).  The bulk of this money was provided via €31 billion of Promissory Notes issued in 2010, while €4 billion of cash was provided to Anglo in early 2009 when we were still in the notional realm of “the cheapest bailout in the world”.

Discussions to change the repayment of this money have been ongoing for months.  The aim for Ireland is to try to delay the repayment at low interest rates for a very long time, say 25 years, to allow growth and inflation the opportunity to reduce the real cost of these banking failures.

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Eurozone sovereign bond ratings

Today’s downgrade of Italian government bonds by ratings agency Moody’s was a little unexpected.  Here is a table of the rating of all 17 eurozone members with the three main ratings agencies, Standard and Poors, Fitch and Moody’s. 

The ratings classifications along the left hand side are used by S&P and Fitch (though they do give them different descriptions) while those on the right are used by Moody’s.

It is starting to get a little crowded at the towards the bottom of the investment grades.  Greece and Portugal have “junk” status with all three agencies.  Ireland was given a similar status by Moody’s this time last year.  Twelve months later than could be viewed as a premature move by the agency.

S&P have Ireland at the same ratings notch as Spain and Italy while with Fitch Ireland is one notch below Italy and is actually one grade above Spain.  This relative ranking is not maintained by Moody’s which has below both (two notches below Italy and one below Spain).

The only other instance where there is not a consistent relative ranking across the three agencies is Malta’s rating with S&P.  Both Fitch and Moody’s have Malta as least as high or above all of Estonia, Slovakia and Slovenia.  S&P have Malta below all three.

Moody’s could, of course, come into line with the other two in the relative ranking of Ireland, Italy and Spain.  However to do this, Moody’s would, of course, have to bring Italy and Spain to “junk” status as this is the only way they could have a rating equal to or below Ireland’s current Ba1 rating with them. 

This could happen but the junking of either Italy or Spain would be a major event.  Alternatively, Moody’s could upgrade Ireland to investment grade status but an increase in the sovereign bond rating of any eurozone country would be an equally noteworthy event. 

There is little to suggest that such an upgrade is warranted unless it was to acknowledge that the initial downgrade to “junk” status was a bit hasty.  And ratings agencies could never make a mistake, could they?

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The Return of the Domestic Economy?

Yesterday’s release of the Q1 2012 Quarterly National Accounts by the CSO has generated a slew of conflicting news stories.

• RTE: CSO’s figures show Irish economy shrank 1.1% in the first quarter
• Irish Times: Domestic economy expands for the first time in two years

Of course, these stories focus on different measures from the release.  As is well known

GDP = C + I +G + (X – M)

The RTE story leads with the overall real GDP figure while the emphasis in The Irish Times headline is on the domestic components of GDP (C + I + G) which says:

THE DOMESTIC economy grew for the first time in two years in the first three months of 2012, according to figures published accidentally yesterday on the website of the Central Statistics Office.
Yesterday’s figures on the economy show that domestic demand grew by 1.5 per cent between the first three months of 2012 and the final three months of 2011.
Domestic demand includes spending by consumers, the Government and companies. It excludes exports and imports.

The 1.5% figure can be seen in the bottom right corner of Annex 3B on page 12 of the release.  Domestic demand in 2010 prices was nearly €40 billion in Q1 2007.  This has fallen by around a quarter and at the moment quarterly domestic demand is around €30 billion.  This is made of €20 billion Consumption expenditure, €6 billion Government expenditure on goods and services and €4 billion of investment.  Here are the quarterly real changes in these for Q1 2012 which were covered in more detail in a second piece in The Irish Times.

• Consumption: –2.1%
• Government: + 2.2%
• Investment: +11.6%

Consumption is the largest and most important component of domestic demand and this fell by 2.1% in the quarter.  This was the largest seasonally adjusted fall since Q1 2009.  Government expenditure on goods and services actually rose by a similar percentage but because G is more than three times smaller than C its effect was quite small.

The reason for the rise in Domestic Demand in Q1 was the 11.6% jump in investment.  The 1.5% rise in Total Domestic Demand was equivalent to rise of €453 million.  The 11.6% rise in Investment was the result of a rise of €469 million.

The growth in the domestic economy was entirely driven by a rise in Investment.  So what did we invest in?  It is hard to see an increase in confidence and sentiment in the domestic economy visible that could explain such a jump in investment.  That would be because the rise in investment had very little to do with what would be considered the domestic economy.  We bought large airplanes! (weight > 15,000kg)

In the first three months of 2012 Ireland imported 29 large aircraft worth €1.4 billion.  This can be seen in point 790.42 on page 189 of the March Trade Statistics.  We imported 25 aircraft worth just over €1.3 billion from the US with another 3 aircraft worth €70 million coming from Brazil.  This compares to 20 aircraft worth €1 billion in the first three months of 2011 and just 3 aircraft worth €80 million in the final three months of 2011.

The seasonal adjustment of the data will account for some of the large difference between Q4 2011 and Q1 2012 but there was still a €400 million increase between the start of this year and the same period last year.
From the trade data, these aircraft imports will feed through to Investment in transport equipment in the Domestic Demand data.  Investment did jump in Q1 2012 but it was because aircraft leasing companies based in Ireland bought some aircraft rather than any real improvement in domestic economic conditions.  As this story shows this distortion of domestic demand figures is going to continue.

Absent this propping up by aircraft leasing companies it is likely that Investment would have registered a similar change to Consumption, i.e. a drop.  Yesterday’s release does not herald the return of the domestic economy. Tweet

A Year of Bond Yields

It is now a year since the Irish government bond 9-year yield as calculated by Bloomberg peaked at 15.5%.  As of today it is just under 6.3%.

The peak last July was the result of uncertainty in the run-up to the July 21st EU Summit.  There were strong rumours that Private Sector Involvement (PSI) and bond writedowns would be a feature of all bailout programmes.  Greek and Portuguese yields shot up similarly.

As it was, PSI was limited to Greece while Ireland and Portugal were ‘rewarded' with significant reductions in the interest rates on their EU loans.  Irish yields dropped precipitously in the weeks after the summit, in part driven by the decision to limit PSI to Greece and also because of purchases by the covered banks who used some of the recapitalisation money they received last summer to buy Irish government bonds.

This has proven to be a good investment for the banks.  The most recent Money and Banking Statistics from the Central Bank show that the covered banks holdings of Irish government bond are worth €16.3 billion.

The yields fell to around 8.5% by early September and stayed around there until Spanish  borrowing costs exploded in late November.  The Irish 9-year yield briefly threatened to return to the 10% mark, but the jump in late November was followed by a steady decline to 7% over the next two months.  This fall began a couple of weeks before the ECB launched its Long Term Refinancing Operations (LTRO) that provided close to €1 trillion to eurozone banks.

For the next three months the yield hardly budged from 7% before a step-up to 7.5% in mid-May following further Spanish uncertainty.  The announcement at EU summit on the 29th June last of possible direct bank recapitalisation by the ESM and the mention of some retrospective action in the case of Ireland saw the yield drop to 6.3% where it has been since.

One thing is clear over the year: changes in Irish government bonds yields have very little to do with domestic developments.  All the big changes over the past year have been driven by external or official events.  Economic data in Ireland has largely been moribund over the period with no discernible upward or downward pattern.

Uncertainty was of the biggest determinants of the yields.  Uncertainty about the size of the hole in the banks pushed Ireland out of bond markets and into an EU/IMF rescue programme.  Uncertainty about the possibility of PSI pushed the yields nearly 16% last July.

There is still a good deal of uncertainty: will the budget deficit continue to fall?  what do the recent EU statements mean for Ireland?  where will the growth come from?  We must wait to see what the answers will bring.  It will take some more ‘good news’ to bring the yields to 5% and lower which makes sustainable borrowing costs more likely.

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Nominal GDP and the Maastricht Criteria

Today’s National Accounts release from the CSO has generated a lot of reaction.  One peripheral issue is the impact of the figures on the government debt and deficit outcomes.  Back in April, Eurostat published the initial notification of these figures.  The reported 2011 figures for Ireland were:

• General government deficit: 13.1% of GDP
• General government debt 108.1% of GDP

On the same day the Department of Finance released an Information Note which stated that the ‘underlying deficit’ was equal to 9.4% of GDP.

These were based on a preliminary estimate of Ireland’s nominal GDP for 2011 of €156.4 billion.  Today’s figures from the CSO put the actual figure at €158.9 billion.  This has the following impact on the ratios:

• General government deficit: 12.9% of GDP
• ‘Underlying’ deficit: 9.2% of GDP
• General government debt: 106.5% of GDP

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