Friday, June 26, 2015

The State of the PCAR Banks

The three banks in which the State continues to hold a stake are AIB, BOI and PTSB (collectively the PCAR banks).  Here is a summary of their aggregate balance sheet position for the past five years.

PCAR Balance Sheet

The main changes are pretty clear.  Their aggregate balance sheets have declined by just over €100 billion since the end of 2010.  On the asset side this has mainly been achieved by a reduction is loans due (repayments, write-offs, NAMA transfers and other sales).  The big move on the liability side has been a reduction of €80 billion in the amount owed to the Eurosystem.  Customer deposits are up around €15 billion while debt liabilities are down around €30 billion.

Net equity in the banks is currently around €23 billion with a combined CT1 ratio of 14.5%.  The loan-to-deposit ratio has fallen from 192 per cent to 123 per cent.

Here is their aggregate income statement for the past five years.

PCAR Income Statement

As has been widely reported the banks “returned to profitability” in 2014 (well AIB and BOI did at any rate).  The €1.6 billion positive net income was mainly driven by provisioning behaviour which declined from €4.5 billion in 2013 to just €0.3 billion in 2014 with the banks writing back provisions in relation to some elements of their loan books.

Selling banks with €22.6 billion of net equity and €1.6 billion of net income in their most recent year should generate substantial funds but the amounts will be unclear as long as the problem of dealing with non-performing loans (€45.7 billion or 23.3 per cent of gross loans) remains.

Thursday, June 25, 2015

Debt in Ireland is around 260 per cent of GDP and falling

At the end of 2014 the level of ‘real economy’ debt in Ireland was reported as being:

  • Household Debt: €157.7 billion
  • Government Debt: €203.3 billion
  • Non-Financial Corporate Debt: €303.4 billion
  • TOTAL DEBT: €664.4 billion

Household debt is the total loan liabilities of the household sector, government debt is the total of general government debt under the Maastricht criteria and NFC debt is the total consolidated loan and non-equity security liabilities of the corporate sector (excluding financials). The NFC figure is for 2013 as a consolidated figure for 2014 has yet to be reported but the non-consolidated data that is available does not show much change on 2014.

It mightn’t be by much but the massive total has begun to come down.

Total Debt

Of course it is important to consider the size of the debt in relative terms so here it is a per cent of GDP.

Total Debt to GDP

If we look at the pattern by sector we do not see too many surprises. Note that the 2014 reduction in general government debt is related to the liquidation of the IBRC.

Debt by Sector

The exception to this is the pattern of the red line – NFC debt – which continued to increase after the ending of the boom and showed rapid acceleration in 2011.  The reason for this is the large presence of MNCs in Ireland.  Data from the CSO now allows us to decompose NFC debt in Ireland into two categories and “uses the residency of the ultimate controlling parent as the basis for distinguishing between Irish-controlled and Foreign-controlled enterprises.”  This gives the following pattern:

NFC Debt by Owner

The difference between the two lines reflects the impact of foreign MNCs on the NFC debt figure for Ireland and it can be seen that this gap widened considerably in the last few years.  The debt attributed to foreign-parent NFCs in the Irish data was equivalent to 107 per cent of GDP in 2013.  Again the data do not yet go to 2014 but it is likely that the debt of Irish-parent NFCs did not change much in 2014.

The CSO also note that:

In the period since 2009 several large multinational corporations have relocated their head offices to Ireland, thus becoming an Irish Parent in this analysis. However, their impact on the scale of Private sector debt during this time is relatively small due to the fact that the debt instruments (debt securities and loans) play a minor role in the structure of their balance sheets which are predominately composed of equity liabilities vis-à-vis the rest of the world.

Here are the sectoral debt levels but only including the ‘Irish-parent’ component of NFC debt.

Debt by Sector - Irish

If we get a relative measure for these using GDP we see the following (the pattern is much the same whether one uses GNP or some hybrid measure though the levels will be different):

Debt by Sector to GDP - Irish

Depending on what happened to the debts of Irish firm in 2014 (probably not a lot) the total at the end of 2014 would have been around 260 per cent of GDP.  This is a large amount of debt but is now on a sustainable path.  There are two further points that buttress this.  First, the interest rates on much of this debt are very low and, second, there are two sides to a balance sheet.

And to conclude here is the total (which assumes that the total debt of Irish-parent NFCs was unchanged in 2014):

Total Debt to GDP - Irish

Figures for Irish debt of 400 per cent of GDP (or 500 per cent of GNP) are sometimes bandied around.  Even larger figures can be mustered up using non-consolidated data. 

Here we note that a 400 per cent figure relates to 2012 and is only possible with the inclusion of the debts of foreign-owned MNCs which do not have to be paid from Irish income.  The use of a figure that is three years out of date and makes an error equivalent to our entire GDP offers little.

Wednesday, June 24, 2015

The rise in aggregate wages and employee numbers

We know that employment growth as measured by the QNHS is now the most reliable ‘snapshot’ indicator of the performance of the Irish economy.  There are so many quirks to every observation of GDP and GNP that renders many patterns in them meaningless.

Total employment reached its nadir towards the end of 2012 and has been growing for the 30 months since.

Total Employment

The rough summary of employment is:

  • Peak: 2,147,000 in Q2 2008
  • Trough: 1,836,000 in Q3 2012 (down 311,000 or 14.5% from peak)
  • Current: 1,930,000 in Q1 2015 (up 94,000 or 5.1% from trough, still 10.1% below peak)

But what impact has this recent rise in employment had on earnings?  Here is compensation of employees received by the household sector.

Wages Received

The rough summary for quarterly earnings is:

  • Peak: €21,017 million in Q4 2008
  • Trough: €16,996 million in Q1 2011 (down €4,021 million or 19.1% from peak)
  • Current: €19,679 million in Q4 2014 (up €2,683 million or 15.8% from trough, still 6.3% below peak)

It can be seen that earnings fell further and have recovered faster.  This can be seen if we compare the annual changes in both.

Annual Changes in Employment and Earnings

Earnings fell faster but have been growing at around 5 per cent for the past year compared to around 2 per cent for employment growth.

The final issue is who has been paying the wages.  Here are wages paid by the corporate, government and household sectors.

Wages Paid

Unsurprisingly, the corporate sector is by far the largest source of employee compensation and most of the growth comes from here.  Employee compensation from the government sector continues to decline (slowly) and payments from the household sector are rising (but from a low base).

If we index the above series we can get a better idea of the relative trends.  We will set them all equal to 100 in Q4 2008 when the total reached its peak.

Wages Paid (Index)

Although there is some volatility it can be seen that the relative decline in compensation paid by the corporate and government sector were roughly in line through 2011 and 2012.  The series diverge from the start of 2013 with the red line rising and green line continuing its gradual decline. [It should also be noted that the green line does not reflect the Public Sector Pension Levy.]

The relative fall in wages paid by the household sector was the largest (possibly related to the self-employed and the nature of certain employments in the construction sector) but that too has been rising since the start of 2013.

Of course, these are aggregate data and take no account of the underlying employment totals.  So while aggregate earnings in the public and private sector may have tracked each other during the downturn, these reductions were achieved through different means.  This can be seen if we look at the number of employees in each sector.

Pub and Priv Employee Numbers

And it is perhaps more easily identified if we index each. We will set them equal to 100 in Q2 2008.

Employee Numbers Index

Employee numbers in both the public and private sectors fell in 2009 and 2010 but private sector employee numbers fell much more rapidly up to the middle of 2011, from which time they began to show a tentative increase with these becoming more consistent from the beginning of 2013.  The ‘bump’ in public sector employment at the start of 2011 relates to Census 2011 but apart from that it has been a steady decline in numbers since 2009. 

As can be seen the relative fall in employee numbers in both sectors relative to the middle of 2008 is now identical – though the paths there were very different.

Private sector employee numbers reached a trough in Q1 2011 and have grown 94,500 (or 8.5%) since.  Public sector employment did not reach a trough until Q3 2014 (local minimum?).  Since then it has grown 2,700 (or 0.7%) since.  The annual changes for each are:

Annual Changes in Pub and Priv Employees

Although aggregate earnings to private sector employees are clearly rising, the story is not so cheery if we look at self-employed earnings.  The series shown below includes a bit more than self-employed earnings but it does not show the same increase that was for employee compensation shown above.

Mixed Income

There is a hint of an increase over the past the two years – but no more than that.

Wednesday, June 17, 2015

Exports: Dipped in Chemicals but Driven by Dollars

This week’s monthly External Trade data from the CSO showed that goods exports in April reached an all-time high of €9.2 billion.  Here are the monthly export and import figures for goods since January 2010.

External Trade

The rise in exports has also seen the trade balance increase though the recent movement in imports is also important.

Trade Balance

As is well understood around 60 per cent of Irish exports come from one sector: chemical and related products and it is this sector which accounts for the recent surge in overall exports.  Chemical exports in the first four months of 2015 are 26 per cent greater than in the equivalent period in 2014.

Chemical Exports

So what explains this recent increase in pharmaceutical exports?  Typically we could look to Industrial Production data to track what is being produced but those figures data (and for the pharmaceutical sector in particular) are polluted by the effect of external ‘contract manufacturing’.  Here are the monthly industrial production indices for chemical and pharmaceutical products since the start of 2010.

Chemicals Industrial Production

The ‘volume’ index measures the output actually produced in a given month, while the ‘turnover’ index measure output sold in a given month (regardless of when it was produced).  Both measures show a 50 per cent year-to-date increase but a lot of the rise (and volatility) is due to the impact of ‘contract manufacturing’ – this is manufacturing that takes place elsewhere but is booked in Ireland because key parts of the value-adding risks, functions and assets are based here. 

There might have been an increase in pharmaceutical output produced in Ireland (and only goods which physically leave the country are included in the External Trade data) but we can’t see that from the noisy Industrial Production figures.

Is there something else that accounts for the increase in chemical exports? Yes, prices. Or more particularly the currency in which those prices are denominated.  A huge amount of the pharmaceutical output produced in Ireland is generated by US MNCs and these companies price their products in dollars in their transfer pricing agreements.  And what has happened to the USD-EUR exchange rate recently?

Dollar Euro Exchange Rate

Yip, the dollar has appreciated by about 20 per cent against the euro since the middle of 2014.  Thus dollar-denominated prices will have a higher nominal euro value.  And that is precisely what we see if we look at the industrial price index for pharmaceuticals.

Pharma Industrial Prices

Since the middle of 2014 the wholesale price of pharmaceuticals has risen by 15 per cent (which was likely driven by the depreciation of the euro).  It is this factor which accounts for most of the recent rise in the value of pharmaceutical exports shown in the External Trade data.

Will this have much of an impact on GDP? Real GDP growth should not be affected by the price/currency factors shown above.  And there probably won’t be much impact on nominal GDP as the increased value of goods exports pushing up the balance of trade will be offset by increased outbound royalty payments (which will also be dollar denominated) that will reduce the balance of services.  The net effect will be small.  And of course the impact on GNP will be nil unless there is an increase in employment and/or corporation tax payments – but somebody is paying more Corporation Tax.

Tuesday, June 16, 2015

The dissolving global consensus on BEPS

The OECD’s Base Erosion and Profit Shifting (BEPS) project has moved at a rapid pace over the past 18 months or so.  That is possible in the early stages of such a process where the emphasis is on designing proposals which are due to be presented in full during the autumn.  It is now clear that the chances of full implementation of the proposals is low.

The key opposition comes from the United States and was in full view last week.  It started with a letter from Sen. Orrin Hatch and Rep. Paul Ryan to Treasury Secretary Jack Lew who made clear that Congress ultimately determines U.S. tax law:

Congress is tasked with writing the tax laws of the United States, including those associated with cross-border activities of U.S. companies. Regardless of what the Treasury Department agrees to as part of the BEPS project, Congress will craft tax rules that it believes work best for U.S. companies and the U.S. economy.

Hatch and Ryan expressed concerns about a number of BEPS proposals including country-by-country reporting and changes to the definition of permanent establishment.  However it was over the next two days at the 2015 OECD International Tax Conference in Washington that BEPS faced a barrage of U.S. opposition.  Unilateral actions taken by some countries, such as the U.K.’s Diverted Profits Tax (DPT), were also subject to criticism as reports of the conference indicate. 

The US Treasury position was outlined by assistant deputy secretary Robert Stack who is their lead person for international tax.  On BEPS he was pretty frank:

“The US is extremely disappointed in the output and our collective failure in the BEPS project to do more and do better work than we've done.” 

He said that the unilateral moves of the UK and Australia “point in a disturbing direction” and added that:

“One of the premises [of BEPS] was, if the OECD didn’t write the rules, countries would go their own way. Well, here are two of our closest friends going their own way. How long until others follow? And what recourse will governments have once they do go their own way?”

“Regular folks in those countries, squeezed during a time of austerity, deeply resented reports that multinationals—largely reported as U.S. multinationals—could achieve very low rates of tax.”

“These moves put a spotlight on the degree to which political pressure can trump policy.  I find it hard to believe the tax experts in both governments don't recognize the technical weaknesses of their legislation.”

[The UK and Australia] “are shouting out loud that they believe they will not get their estimation of the income they deserve, either under the current agreed rules, or under any rules, to come out of the BEPS process.”

“Goods or services are provided in their jurisdiction and there is some activity in the jurisdiction related to the sale of those goods or services.  However,  introductory international tax law classes teach that this very issue is addressed directly and explicitly by the PE rules in a bilateral tax treaty. If countries want to change the PE rules they should negotiate a new treaty with the treaty partner.”

“The use of commissionaires, fragmentation and splitting of contacts can in certain circumstances run afoul of the purposes of the convention but [the UK and Australian approaches] focus not what happens in the country, but what happens outside the jurisdictions and are based on a theory that a taxpayer who follows the very specific PE provisions in a treaty can somehow also be acting in contravention of the objective and purposes of the treaty.”

[The UK and Australia] “appear to think they are entitled to more than the income from the assets, functions and risks actually in their jurisdiction.  They will know that BEPS has been eradicated only when they have been able to reach beyond their shores and pull in revenue from things happening elsewhere.  This only takes us further down the road in which a taxpayer is at the mercy of whatever a tax auditor decides is the right amount for a taxpayer to pay.”

Unlike Hatch and Ryan, Stack said that the country-by-country reporting proposals are an “extraordinarily successful effort” but did side with them when raising concerns about the proposed changes to the definition of permanent establishment.  On this it is notable that the U.S. is not participating in the work to design a multi-lateral instrument which is intended to allow the implementation of some of the BEPS proposals without the need to re-negotiate thousands of bilateral tax treaties.

Stack set out a U.S. wish list for BEPS with the first item being pretty clear: slow down BEPS.  This was taken further by other US speakers at the conference who said that the US should only have one position: stop BEPS.  Some of the exchanges were sparky with the consensus that Pascal Saint-Amans has frequently referred to being notably absent.

Robert Stack’s counterpart at the U.K. Treasury, Mike Williams, responded to Stack’s comments are countered that the problem was not unilateral action by some countries but a divergence in approach between the rest of the world and the U.S.

“Looking beyond BEPS, a key challenge will be being able to cope with divergence. Divergence, candidly, in a number of instances between the U.S. and the rest of the world. You can see where the divergence comes. The U.S. has a bigger economy and, in a sense, inevitably a less open economy, and that in a sense drives policy.”

The exchanges were summarised by a contributor from the South African Revenue Service with the comment:

“I was reminded of a movie I once watched and the man said he thought the marriage was fine until his wife asked for a divorce.  The last two days, for me, have brought to the fold that maybe the marriage doesn't seem to be working that well, and maybe some counseling is needed."

One source of disagreement was a U.S. insistence that their be prescriptive rules rather than indicative guidelines.  Going back to Robert Stack he said:

“How much revenue do [other countries] need to get, determined according to what rules? Or do the rules even matter anymore? And if the rules don’t matter, what is the role of a standard-setting body such as the OECD? Do we really need a standard-setter to say tax administrators can use the pornography test for tax avoidance — ‘We know it when we see it, and we’ll get you if we want to’?”

Again the U.K.’s Williams offered an alternative perspective

"If you do go for detailed rules, how do you make them work in the very different circumstances of many different countries? If the rules are very detailed, and they do have to take into account circumstances in different countries, how do you keep them up-to-date?

We do have to coexist, and there are choices about how that coexistence happens. We could cooperate, in which case we'll have to be respectful of other countries' viewpoints and practices. In that context, we have to be clear that the rest of the world has a viewpoint, and isn't going to buy into the U.S. rules.

Or, alternatively, we don't accommodate, we don't cooperate, in which case there will be more chaos, there will be more controversy, which will almost certainly lead to more double taxation. I would urge U.S. businesses to reflect on that."

When referring to countries’ attempts to garner more tax revenues, Stack drew the link between value added and tax receipts:

“Countries need to acknowledge the sometimes unpleasant reality that very often, there’s not much value added in their jurisdictions, so their desire for outsized tax receipts based on relatively minimal operations is in the end a pipe dream.”

Williams said that “the U.K. supports the BEPS project's goal of taxing profits where the economic activities generating them take place, with that jurisdiction having the sovereign choice of taxing, or not taxing, the profits.”  But is he referring to production or consumption? 

The theme of taxing rights was taken up by Pam Olson, a former U.S. Treasury official now at pwc who, when referring to issues that clearly have resonance for Ireland (and are being investigated by the EU), said that:

“The ‘stateless income’ that is so often referred to is in fact the un-repatriated profits of U.S. companies. ... The reality is stateless income isn’t stateless at all — it’s ours, and we have merely delayed taxing it until it’s repatriated. It is nothing for the rest of the world to be obsessed over.

We need to explicitly have the conversation that we are having only sub-rosa.  Where should the line between source and residence taxation should be drawn? We took that off the table, but you can't take it off the table.

The last two days, if it wasn't clear to people before, there has been a dissolving global consensus.”

Indeed.  Though mainly in the US.