Monday, July 16, 2012

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.

Friday, July 13, 2012

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.

Bond RatingsIt 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?

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.
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.

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%.

Bond Yields 1Y 13-07-12

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.

Thursday, July 12, 2012

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

Tuesday, July 10, 2012

Extending the Excessive Deficit Deadline

One of the few concrete decisions discussed at last night’s Eurogroup meeting and made at today’s European Council meeting was that which extended the deadline for Spain to meet the 3% of GDP deficit limit. 

The decision is relatively insignificant in the overall scheme of things and pushes the timeline for Spain to end its “excessive” deficit from 2013 to 2014.  At the start of the EDP it was 2012.  This is really only catching up with reality as there was little chance of Spain having a deficit below 3% of GDP next year anyway. Ireland’s experience in the Excessive Deficit Procedure has seen also this extension happen twice. 

The first Council Recommendation to Ireland under the EDP was adopted on the 27th April 2009 and said that:

On the basis of the macroeconomic outlook of the Commission services' January 2009 interim forecast, the Irish authorities should put an end to the present excessive deficit situation by 2013.

This was revised later that year by a subsequent Council Recommendation to Ireland which was adopted on the 2nd of December 2009:

Recognising that Ireland’s budgetary position in 2009 resulted from the interplay of the severe recession and the free play of automatic stabilisers on the one hand and significant consolidation efforts on the other (as part of which some moderate recovery measures were taken), which is an appropriate response to the European Economic Recovery Plan, the Irish authorities should put an end to the present excessive deficit situation by 2014.

This lasted a year and the current Council Recommendation to Ireland under the EDP was adopted on the 7th of December 2010:

Recognising that Ireland's worsening budgetary position in 2010 resulted from the impact of the financial crisis on government revenue and the financial sector, requiring the implementation of very large financial sector support measures, the Irish authorities should put an end to the present excessive deficit situation by 2015.

This Council Recommendation laid out the deficit limits to apply each year to 2015

Specifically, to this end, the Irish authorities should:

(a) implement measures such that the general government deficit does not exceed 10,6 % of projected GDP in 2011, 8,6 % of GDP in 2012, 7,5 % of GDP in 2013, 5,1 % of GDP in 2014 and 2,9 % of GDP in 2015, where the projected annual deficit path does not incorporate the possible direct effect of potential bank support measures

Today the Council also released their latest opinion on how they think we are doing.  The opinion, such that it is, is below the fold.

Five-year yields

As expected last night’s eurogroup meeting of eurozone finance Ministers didn’t deliver a whole lot in public.   It wasn’t expected to.  All the statement really shows is the timetable to implement some of the decisions taken at the EU summit on June 29th. 

In the context of EU decision-making the proposed timetable for an ECB-centred eurozone banking supervisory structure is lightning fast.  It remains to be seen what can be delivered by the proposed end-2012 deadline.

Here are some five-year government bond yields as calculated by Bloomberg (as of 10:45)

Monday, July 9, 2012

To guarantee or not to guarantee

It is not surprising that there has been some confusion in the aftermath of the recent euro summit statement.  One such issue is whether direct bank recapitalisations from the ESM will require a sovereign guarantee from the country involved.  If true, this, of course, means that the ESM involvement would not “break the vicious circle between banks and sovereigns”.

On Friday, Reuters carried this report which said:

Direct ESM bank aid needs sovereign guarantee-official

BRUSSELS, July 6 (Reuters) - Any risks attached to financial assistance given directly to banks by the euro zone's ESM permanent rescue fund would remain the responsibility of the country requesting it, a senior euro zone official said on Friday.

The official, speaking on condition of anonymity because of the sensitivity of the discussions, said that if the European Stability Mechanism were to take an equity stake in a bank it would only be "against full guarantee by the sovereign concerned".

"There is some degree of mystification going on here ... in the broader public who think that under current rules the ESM could all of a sudden end up owning Bankia with the full risk of Bankia on the balance sheet of the ESM," he said, referring to the Spanish lender. "This is very much not the case.

"Does it still remain the risk of the sovereign or does it become the risk of the ESM? It remains the risk of the sovereign because you have the counter guarantee of the sovereign."

He later signalled, however, that this may change once a new supervisory structure for banks were put in place.

"In the very distant future ... if we have a single euro zone supervisor supervising all banks ... if there were to be direct bank recapitalisation would this still require a counter guarantee of the sovereign, my understanding is that it would not," he said.

The official said that the benefit of lending directly to banks would be that it would not add to the country's national debt. "It cuts out the effect of that loan on the debt to GDP (Gross Domestic Product) ratio for the sovereign," he said.

Today, Reuters carried this report:

Euro zone can help banks directly once supervisor set up

Direct recapitalization of euro zone banks will not require sovereign guarantees as soon as the bloc has established a new banking supervisory body, the European Commission said on Monday.

A senior euro zone official said on Friday that sovereign guarantees could only be dropped "in the very distant future.

"I would like to clarify that there will be no need for sovereign guarantees for banks being directly recapitalized by the ESM," said Commission spokesman Simon O'Connor, referring to the bloc's permanent rescue fund.

"The ESM will be able to decide by a regular decision once the single supervisory mechanism is in place to adopt an instrument that would allow for the direct recapitalization of banks."

A bank supervisor could be operational sometime next year.

It should be pretty clear that both reports say exactly the same thing.  The difference is that the first puts the emphasis on the period before a eurozone bank supervisory structure is put in place and the second puts the emphasis on the time after such a supervisory structure is put in place.  There is nothing that is contradictory between the reports.

However, in the period prior to the set up banking supervisor there is actually no need for guarantees as the loans will first be maybe to the Member State’s government and then passed onto that country’s banks.  This is what is initially going to happen with the Spanish bank bailout.  The general principle of the June 29 euro summit statement is that once the banking supervisor is in place this funding will be revisited and the loans to the banks may be transferred to the ESM with no reference to a guarantee from the Spanish government.

All this was covered in detail in today’s midday briefing from the European Commission.  Almost all of the 20 minutes (beginning at around 2:15) in this recording of the press briefing deals with the bank recapitalisation/sovereign guarantee issue (which actually is a bit of a non-issue).


UPDATE:  Having been asked what is the issue if the sovereign guarantee is a non-issue this exchange from a 1am press briefing after the eurogroup meeting provides some insight.  The following exchange took place from 29:45 in this video.

Matina Stevis, Wall Street Journal

“Can you please tell us in no uncertain terms, are you in a position to say today, that the ESM will not request any guarantee in any form from sovereigns when it injects capital and receives equity in rescued banks? Will it request some guarantees or full guarantees for this equity share that it will take on its balance sheet or will the risk be shared with the sovereign somehow?”

Klaus Regling, CEO of the EFSF and incoming MD of the ESM Board

“Well the first point, as you know, the ESM is not operational so we are planning now everything for the bank recapitalisation in the case of Spain via the EFSF and that was discussed today.”

Ollie Rehn, VP of the Commission in charge of Economic and Monetary Affairs

“On the ESM and direct bank recapitalisation. I think the word and concept “direct” is a very clear concept. This direct bank recapitalisation, not indirect through the sovereign, but there is a very clear and necessary condition. It is that there has to be an effective and well-functioning single supervisory mechanism of banks that are part of this arrangement of direct bank recapitalisation.”

Thomas Wieser, President of the Eurogroup Working Group

“Just to complete what was said by the two previous speakers. And then there will be no sovereign guarantee required.”

The key is now a “well-functioning single supervisory mechanism of banks” but it is unlikely the crisis will wait 12 to 18 months (or maybe even longer) for this to come into being.

Wednesday, July 4, 2012

Mid-Year Exchequer Returns

The end-June Exchequer Statement was released yesterday.  Here are the relevant documents.
The media reaction to the release has been glowing with examples of headlines being:
The Department of Finance are pretty upfront about all this and do provide all the necessary information required to explain why tax revenue is ahead of profile.  What is absent in all the media reports is any explanation as to why revenue is up. 

If this excess was completely unanticipated it would be a very positive development.  There have been a number of factors such as delayed Corporation Tax receipts and reclassified PRSI contributions that slightly complicate an analysis of the 2012 tax figures

Each year a monthly profile of tax revenue for the year is provided by the Department of Finance and the Tax Profile for 2012 that was published on the 10 February.  By the end of June it was expected that tax receipts would have accumulated to €16,025 million. 

As a result of a delay meaning that some 2011 Corporation Tax was actually paid into the Exchequer Account in 2012 and the reclassification of some PRSI receipts as Income Tax a revised profile was released in early May.  The updated figure was that €16,507 million of tax would be collected by June with the increase accounted for by the Corporation Tax and PRSI issues.

Just two months later we have learned that the actual amount of Exchequer tax revenue to the end of June is €17,014 million.  The difference is the €507 million excess referred to in the media.  However, given that the Department’s revised tax profile began in April it seems unusual that tax revenue for the next three months has come in €507 million ahead of target.  Or this is how it might appear.

In the original profile it was expected that €8,136 million would be collected between April and June.  In the revised profile the equivalent figure was actually slightly lower at €8,112 million.  The outturn shows that €8,293 million was actually collected between April and June. 

Tax revenue in the period since the new profile was released is €181 million ahead of target.  So how come it is being reported that tax revenue is €507 million ahead of profile?

To the end of March the actual amount of tax collected was €8,722 million.  As the March Exchequer Statement was released on the third of April we can assume that this fact was known when the revised tax profile was released a month later on the second of May.  This revision indicated that April was expected to see €2,059 million in tax collected.  Adding this forecast for April to the March outturn would give a cumulative forecast to the end of April of €10,781 million.  The revised profile actually has a figure of €10,430 million.

So the Department knew that €8,722 million had been collected by the end of March and expected that €2,059 million would be collected in April but included a figure of €10,430 million in the revised profile.  It seems that the revised profile was based on a cumulative figure to the end of March of €8,396 million rather than the €8,722 million that was known to be collected; a difference of €326 million.

Adding this to the €181 million that tax in the April-June period actually was ahead of profile gives the €507 million ‘excess’ reported today.  Of the excess €326 million was completely anticipated because it arises from using a figure at the start of the profile that is lower than reality.

This is not to say that tax revenue is not performing well; it is.  The budget had a 2012 forecast of €35,825 million (up on the €34,027 million collected in 2011).  Because of the corporation tax and PRSI issues this was revised up to €36,375 million.  The performance in the first six months of the year suggests that this can be achieved.  

In fact, using actual the March figure (€8,722 million) and the revised total for April to December (€28,005 million) means that the Department of Finance now expect tax revenue in 2012 to be €36,727 million.  This is a good performance but why not come and say that this is what they expect?

When the revised profile was released on May 2nd it seems reasonable to suggest that this would be based on the known figures at that time.  By May 2nd the March tax return was known (and the April figure was also released the same day).  Starting a profile that is €326 million below the known figure for March is a little odd but lowering the bar in this manner does mean we can expect to hear plenty of “tax revenue is ahead of target” for the next few months.   Tax revenue is rising but, at this stage, most of it is anticipated..