What is going on?

Another day, another drop in Irish bond yields.  The 10-year yield from Bloomberg is now at 7.58%, down from 7.88% yesterday.  Here it is for the past month.

The yields have dropped all week and the graph above excludes today’s fall as shown here.

Yields fall below 8%

It might only be temporary but the 10-year yield as calculated by Bloomberg has just fallen below 8% for the first time since start of November 2010.  Yields are now lower than they were when the EU/IMF programme for Ireland was announced later that month.

Retail Sales continue down

The CSO have just published the August update of the Retail Sales Index.  As is usual we will look at ‘core’ retail sales which strips out the effect of the motor trades, which make up 21% of the August Index. 

Core retail sales fell yet again in August as can be seen here.

Compared to July, retail were 0.8% lower by value and 0.5% lower by volume.  For the eight months so far this year there have been three months when retail sales have risen and five months when retail sales have fallen.

The annual comparison also deteriorated in August.  By value retail sales are 2.9% lower than they were a year ago; by volume they are 3.7% lower.  We have to go back to May 2010 to find the last instance when one of the measures was positive.

Public and Private Pay – Again!

The latest release from the CSO of the Earnings, Hours and Employment Costs Survey didn’t attract a huge amount of attention when published a few weeks ago.  Here are the figures that tend to get the most attention since the survey started back in 2008.

In the three years to the second quarter of 2011, average gross weekly earnings in the private sector have fallen from €637 to €612 (a drop of 3.9%).  Over the same time period average weekly earnings in the public sector have fallen from €931 to €901 (a drop of 3.2%).  We will multiply these weekly amounts by 52 to get an annual earnings figure for the “average” private and public sector worker.

For the private sector this equates to an annual wage of €33,104 in 2008 and €31,818 in 2011.  Using a basic tax calculator it can be shown that a single male with no additional credits or allowances would have seen his net pay fall from €28,421 in 2008 to €26,199 in 2011 – a drop of 7.8%.

For the public sector the annual equivalents are €48,387 in 2008 and €46,856 in 2011.  The same tax calculator shows that net pay would have fallen from €37,003 in 2008 to €30,590 in 2011 – a drop of 17.3%.

The 47% gap in gross average earnings between the public and private sector narrows to 16% when converted to net pay in this hugely simplified example.  Of course, there are major caveats excluded from this comparison.  The private sector worker here is making no pension contributions.  The public sector worker is contributing to a pension that will be worth more than the contributions could support.  Job security cannot be accounted for when using gross and net earnings.  The largest reason for the reduction in earnings in the economy has been job losses in the private sector.

All these factors, and more, are important when analysing wages in Ireland and just because they are excluded above is not an indication that they should be discounted.  The example is merely a device to give some insight into the changes that have occurred to pay packets over the past three years; the fall in the public sector has been over twice the fall in the private sector. 

This doesn’t mean that public sector pay should not continue to fall by more than private sector pay. A staggered wage cut from 0% for those at the bottom (with possibly even some increases) rising to maybe a cut of 12.5% through to the top of payscale (and maybe even more targeted than that), along with forthcoming general changes in income tax could bring the average fall in net pay in the public sector to 25% (with most of the latter burden shared by those above the average wage). 

A 25% cut in net pay would be a huge contribution from the public sector but what needs to be remembered is that we are already two-thirds of the way there.  At times this seems to get forgotten in the ongoing pay debate.

Yields hit 2011 low; fall to 8.2%

Just a day after we said ‘bond yields hold steady’ this happens:

The Irish ten-year yield as calculated by Bloomberg has fallen below 8.3% – this the is lowest it has been for all of 2011.  After a month of oscillating between 8.5% and 8.8% the drop to 8.2% is to be welcomed.  Whether it will be maintained is another thing and even at 8.2% they will still have to drop by around half until we can sustainably borrow from these markets.  Still, it is another step in the right direction.

The yields in the NTMA’s Daily Report of Outstanding Bonds shows that the actual yields on the bonds are even lower, with most below 8%. Click to enlarge.

Bond Yields hold steady

There has been little to say about Irish bond yields for the past month or so, except that they have been holding steady.  From the 1st of September the 10-year yield as calculated by Bloomberg has closed each day in a range from 8.5% to 8.8%.   This is well down at the 14% peak from mid-July but still above level that would make returning to borrowing from these markets feasible.

We cannot use the "steady as she goes” description for the rest of the bailed-out PIG countries.  Greek yields are off the chart as they hurtle ever closer to default.  Portuguese bonds have not reacted favourable to the recent market turmoil. There is now clear light between the yields on Irish and Portuguese government bonds as show here.

This chart from Bloomberg represents the relative performance of Irish and Portuguese bonds over the last three months.  The yields for both countries were just below 12% at the time the series begins at the end of June.  Both rose in the run-up to the July EU summit and fell in the immediate aftermath with the proposed interest rate reductions. 

However, by the start of August the drop in Portuguese yields had stalled at around 11% while Irish yields fell right through to the end of August and only stalled at 8.5%.  Since the start of September Irish yields have hovered at that mark, while Portuguese yields have edged back up and are back over 12% today.

It is useful to see this gap emerge between the yields but it will only be beneficial is this is because of a falling green line rather than a rising red line in the above graph.  Hopefully, we have a better plan than “we’re sticking to our knitting” as Richard Bruton says at the end of this interview on CNN.

“The IMF made me do it”

The above is sure to be a common refrain over the coming months as the government sets about introducing it’s first budget in December.  Over the summer a €100 household charge was announced and when introducing it Minister for the Environment Phil Hogan said:

“I’d prefer not to be introducing any charges but I’m obliged because we have ceded our economic sovereignty as part of the EU/IMF agreement, to bring in a property tax.”

The suggestion is that the charge is only being introduced because of the EU/IMF programme.  This fails to acknowledge that the originator for the idea was the ‘Four Year National Recovery Plan’ published by the Department of Finance on the 24th of November last year under the previous government.  This is lifted directly from the 140-page document.

The IMF didn’t come up with a €100 household charge to be imposed from 2012; we did that ourselves.  In fact the greater amount of the IMF programme for Ireland comes from the Four Year Plan that we produced ourselves.  In a press conference when the IMF intervention in Ireland was announced at the end of November, Ajai Chopra said when asked to rate Ireland’s future prospects:

“What we’re doing right now is helping in this process and making it more robust. We’re augmenting it in some places, and we’re providing a backstop in financing. But the key thing that this is […] a program that is largely designed by the Irish authorities, we’re augmenting what they did already, and the thing that has impressed me most in this regard is the sense of common purpose. The thinking ahead and making a contribution to the solution. So, it’s been very impressive what they’ve done.”

In a subsequent interview on December 17th once the details of the IMF programme has been finalised, Chopra said:

“The fiscal adjustment program is based on the government's 4-year program for national recovery. […]  There may be some adjustments to these policies, but our experience is that if the policies are not owned by the country, they tend not to be implemented strongly enough. In sum, we see this a program that is an Irish program that is a national response that is owned by Ireland.”

The Four-Year Plan from the DoF laid out in general the direction of our budgetary policies until the end of 2014.  Apart from the hugely optimistic growth forecasts that were in the plan it was largely endorsed by the IMF.  The €3.6 billion of tax rises and expenditure cuts that is due in the December budget was also proposed before the IMF programme was agreed.

The IMF accepted the €15.8 billion of proposed tax rises and expenditure cuts over the duration of the plan but did not accept that it would bring the annual deficit under 3% by 2014 (or even 2015 for that matter).

The Four-Year Plan provides some specifics of the measures to be introduced.  Although the following table provides cumulative figures it shows the breakdown of the €1.7 billion of current expenditure cuts to be introduced for 2012.

It was proposed to save €0.4 billion on public service pay, €0.6 billion on social protection expenditure and €0.6 billion on “other expenditures”.  On the tax side the following details were provided.

There’s Phil Hogan’s ‘Site Value Tax’ and other measures.  We can expect the price of fuel to go up in the first week of December.  Even more detail of the tax increases was provided in this table.

It is likely that the greater majority of the measures to be introduced in December will have had their genesis in the Four-Year Plan.  While this was published prior to any IMF intervention in Ireland, it is now accepted that the IMF were in contact with Ireland well in advance of the announcement of the formal agreement on the 28th of November.  Again, Ajai Chopra provides the details:

“So, over the months, we’ve been in touch, we’ve talked on the phone, we followed the developments, we’ve tried to understand the various steps that the authorities have taken. And then last week, as you know, after the Eurogroup meeting in Brussels, a small team was invited to come here for short, technical discussions. So, following the technical discussions, the authorities decided they had the basis and the need to request us to (inaudible) together with them a package of policy measures that we could support with our financing.”

The IMF had be “in touch” for months prior to the end of November and may have had some input into the design of the Four-Year Plan, but that document was published in the absence of any formal agreement with the IMF and is primarily what we agreed to do ourselves. 

Claiming that “the IMF made me do it” may make for a catchy political sound-bite but we need to face the reality of the mess we are in and accept to responsibility to solve it.  Creating public animosity with the only institutions willing to lend to us by trying to blame them for the tax rises and expenditure cuts to be introduced is not a useful approach.

GDP forecasts

Yesterday’s quarterly national accounts have brought some welcome positive news to Irish economic analysis. It is far still far from certain that this will be transformed in positive momentum and these preliminary figures are subject to revision.  For example, back in June the CSO estimated that GNP fell by 4.3% in the first quarter of the year.  In yesterday’s figure that has been scaled back to a drop of 3.0%.  Anyway let’s take the figures at face value.

The most recent growth forecasts for 2011 from the DoF, IMF and ECB are that real GDP will grow by 0.8%, 0.4% and 0.6% respectively.  For the first six months of 2011, real GDP has been 1.3% ahead of the level recorded for the same period in 2010 (€81.3 billion versus €80.3 billion).  If this performance continued into the second half of the year the 2011 outturn would be ahead of the three forecasts above.

Of course, there is no guarantee that this growth will continue and the global outlook is turning ever more grim.  In order to meet the DoF forecast, GDP for the second half of 2011 must be 0.3% up on the level recorded in 2010.  This is a significant slowdown on the 1.3% seen so far this year and seems achievable.

For the IMF growth target to be met, GDP in the second half of the year can be 0.5% lower than that recorded last year.  Although a slowdown in the second half of the year is probable it is unlikely that a 1.3% increase would turn to a  0.5% decrease. 

For the first time in quite a while it appears that Ireland is about to overshoot official growth forecasts.  This appearance could quickly evaporate with data revisions or global turmoil but let’s not be too downbeat.  The news is good.

Quarterly National Accounts

The CSO have just released the Q2 2011 Quarterly National Accounts.  At first glance they seem to be a reasonably positive set of figures as shown by the headline GDP numbers

Here is a set of  updated graphs with today’s data. 

National accounts 2011 q2

 

A short recording discussing of the basic trends is posted below the fold.

Bond yields, prices and turnover

Yields on Irish government bonds have been going through a period of relative tranquillity for the past three weeks are so.

After surging above 14% in mid-July, the 10-year yield as calculated by Bloomberg fell rapidly for the next six weeks.  Since the start of September the 10-year yield has been below 9% and finished today at 8.593%.  The yield is still only back to where it was at the start of the year and will need to fall to 6% (and most probably lower) before a broad return to borrowing from bond markets can be undertaken.

The swings in the 2-year bond yield have been even more dramatic.  These peaked at over 23% in mid-July and are now down to 9%.  This can be readily shown by looking at the daily closing price of the Irish government bond that is due to mature in January 2014.

If you could find a seller this bond, with a €100 maturity value on the 15th January 2014 and a 4.0% coupon, could be bought for less than €70 for a short time in mid-July.  If the bond and interest are repaid in full this €70 investment would be worth around €110 – hence the yield of more than 20%.  The price of this bond has been around €90 for the past month.  Still attractive – but only if you think the Irish government can find the €12 billion it needs to repay this bond in January 2014.

Finally, on bonds here is an update of a chart we have looked at before – the Irish Stock Exchange turnover of Irish government bonds.

Although volumes in September are a little lower than they were in August, they are still ahead of the very low rate levels seen for much of the first seven months of the year.

Debt projections edge downward

This week has seen the release of three separate outlooks on the Irish economy.

• ESRI: Irish Government Debt and Implied Debt Dynamics
• IMF: Third Review under the Extended Arrangement
• EC: Economic Adjustment Programme Summer 2011 Review

The nominal GDP forecasts until 2015 are largely consistent.

The forecasts of the Primary Balance (the government balance excluding interest costs) are also fairly consistent.  It should be noted that these forecasts are all dependent on substantial budgetary adjustments (expenditure cuts and tax rises) being introduced over the next few years continuing with Budget 2012 in December.

Apart from the IMF’s forecast for 2015 there is little to separate them.  We have looked at the IMF 2015 forecast in more detail before.  The cumulative primary deficits to 2014 are €15 billion for the ESRI, €16.6 billion for the IMF and €15.5 billion for the EC.

The remaining part of the General Government Deficit is the annual interest cost incurred by the State.  It is here that a divergence begins to emerge.

Both the IMF forecast that the cumulative interest bill over the next five years will be around €47 billion.  The total from the ESRI is €39 billion.  The ESRI’s forecast is based on a 2% interest rate reduction on all €45 billion of our borrowing from the EU as part of the rescue programme.  The IMF and EC have not factored in savings on the full amount.

In fact when compared to the last IMF Review in May, they have increased their forecast of the interest bill for the next five years from €45.7 billion to €47.4 billion.  The EC has also increased it’s forecast of the cumulative interest expenditure from €45.2 billion to €46.7 billion since it’s last review also in May.

All indications are that our interest bill will be reduced but the assumptions used by the IMF and EC and the fact that they have yet to account for the July 21 interest rate changes has resulted in their forecasts of this expenditure item increasing.  We can expect this to fall in subsequent reviews.

Here are the General Government Debt forecasts. First in nominal terms.

And as a percent of GDP

All show the debt stabilising by 2013 though it is worth repeating that this is based on the implementation of continued budgetary cuts over the coming years.  All of the projections are that the debt to GDP ratio will stay below 120%.  Previously the IMF has been forecasting that the debt would peak at 125% of GDP.  This peak forecast has been, and continues to be, revised down as this graph in the IMF review shows.

When the EU/IMF programme was initiated the IMF were projecting that Ireland’s 2015 GGD would be around 122% of GDP and a very gradual rate of decline.  Using preliminary estimates of the impact of the lower EU interest rate is now forecast to be around 114% of GDP which a slightly accelerated rate of decline.

This is still a huge debt level but if we were still projected to follow the full blue line above it is difficult to see how our debt would ever become sustainable.  The green dotted line shows that the debt ratio is now projected to peak at a lower level and fall slightly faster. 

Getting money back from Anglo?

On the release of Anglo Irish Bank’s half-year results to the end of June 2011, chief executive Mike Aynsley said the following:

"I would be cautiously confident that we are going to get a better result then we had previously expected," chief executive Mike Aynsley told reporters on Friday.

The nationalised lender expects to have shut down by 2020 and Aynsley said he believed the final capital bill for the bank would come in a range of 25-28 billion euros.

"I think it is going to be towards the end (bottom) of that range," Aynsley said.

This all seems ok but note the focus on the “final capital bill for the bank”.  We have provided €29.3 billion of capital to Anglo; Aynsley reckons they will need €25 to €28 billion (with the hope that it will be closer to €25 billion); so there will be a “capital surplus” to be returned to the State.  Good news? Maybe not if we take a closer look at the “total bill for the bank”.

It would be good news if we were “only” providing €29.3 billion to Anglo.  As it is we will be providing much more.  The outstanding balance on the Promissory Notes earn interest for Anglo which must be paid by the State.  As we saw previously the interest rate on some of these notes is very high.  Here is a table from earlier.

The annual interest rate ranges from just over 4% for Tranche 1 to nearly 9% for Tranche 4 when the 2011/12 “interest holiday” is factored in.  The accumulated interest bill over the lifetime of the  Promissory Notes is anticipated by the Department of Finance to be over €13 billion as shown in this Information Note.  We can expect that almost €11 billion of this interest will accrue to Anglo.

This €11 billion is interest income for Anglo and is not capital so is counted as operating income.  Mike Aynsley expects the nationalised Anglo to have an operating loss of €25 to €28 billion in its lifetime.  We can use the June 2011 Income Statement (page 22) to see the huge role of the Promissory Note Interest in determining this loss.  Here is an abbreviated version of the income statement

Anglo reported a loss of €105 million for the first six months of the year, but the largest single income item for Anglo is the €644 million of interest it received from the State for the Promissory Notes.  Without this inflow Anglo’s losses would be much higher.  If this is true for this six month period, it is also true for the remainder of Anglo’s lifetime.

Mike Aynsley might feel that while nationalised that Anglo will generate a loss of €25 t0 €28 billion and will therefore be in a position to return some of the €29.3 billion capital poured into the bank.  But this loss is only possible because of the €11 billion of interest that the State is providing to Anglo.  

The fact the the State must pay interest to Anglo as a result of putting in capital through the device of a Promissory Note is in contrast to some of the capital injections into the functioning banks which see the banks pay an interest rate to the State.

It is clear that without this Promissory Note interest income Anglo losses would be greater than Aynsley’s assessment and would probably be around the €29.3 billion we have provided or, depending on interest rates, even closer to the €34 billion “worst case scenario” that was suggested at the time the Promissory Notes were provided to Anglo. 

To say there may be a “capital surplus” to be returned to the State is technically true.  To say it is because losses are lower than expected is not. 

UPDATE: Here is a table that summarises a discussion in the comments.  The interest totals used here are just the cumulative totals from the Department of Finance Information Note.  All numbers are in billions of euro.

The €13.1 billion interest is based on the assumption that the Promissory Notes and interest will be repaid on a linear basis of €3.1 billion per year until 2025. The €18.4 billion interest cost on the money used to fund the Promissory Notes is based on an interest rate of 4.7% for the period to 2025.  Both of these assumptions are subject to change.

Could Ireland’s 2014 debt be €190 billion?

The ESRI has a new research article out from John Fitzgerald and Ide Kearney on projections of Ireland’s public debt.  It can be read here.

ABSTRACT
This article examines the debt dynamics facing the Irish State over the period 2011 to 2015. The analysis takes account of the reduction in interest rates on EU borrowing agreed at the EU Council meeting in July 2011 and it makes very conservative assumptions on the interest rate available after 2013. The base case estimates suggest that the net debt to GDP ratio will peak at between 100 and 105 per cent of GDP in 2013 and that it could fall back to 98 per cent by 2015. The related gross debt to GDP ratio would peak in 2012 at between 110 and 115 per cent of GDP before falling back to between 105 and 110 per cent of GDP by 2015.  This is much lower than had been assumed in official figures earlier this year, partly because the cost of bank recapitalisation was lower than anticipated and also because of the reduction in EU interest rates.

Here is Table 8 on page 22 which contains the elements on interest to us – projections of Ireland’s General Government Debt. Click to enlarge.

The prediction is that the 2014 General Government Debt will be just over €191 billion.  It is not so long ago since we were questioning suggestions that it would be €250 billion by 2014.  However, €191 billion is much lower than all official estimates from the DoF, IMF and EU.

In this note, written in May, we estimated that the 2014 General Government Debt would be €208 billion.  With a previously expected deficit of €5 billion for 2015 this is an implied forecast of €213 billion for 2015.  This is nearly €19 billion more than the estimate provided by the ESRI.  We know that €250 billion is too high but is something close to €190 billion too low?

Here is a summary of our 2014 estimate of the General Government Debt.

There is a number of quick things we can do to reconcile the €208 billion figure here with the €191 billion figure provided by the ESRI.

1. The above table assumed that the final cost of the 2011 bank recapitalisations would be €20 billion.  It was actually €17 billion.  The ESRI add €7 billion to the debt for the recapitalisations rather than the €10 billion used above. 
2. The lower interest rates agreed at the July 21 EU summit reduces the projected deficits from 2011 to 2014.  This reduced the debt by a further €2 billion.
3. The ESRI assume that €7 billion of our accumulated cash reserves are used to meet expenditure over the 2011 to 2014 period.  The above table assume that our cash reserves of €16 billion at the end of 2010 are held intact.
4. The ESRI assume that €3 billion of “contingent capital” provided to the banks in 2011 is returned to the Exchequer in 2014.  This is not assumed in the above table.

The four elements account for €15 billion (3 + 2 + 7 + 3 = 15) of the €17 billion difference between the two figures.  The remaining €2 billion is accounted for through interest losses on holding €16 billion of cash and other minor discrepancies.  It is very possible that our 2014 General Government Debt will be €191 billion.

There may be some who will accuse the ESRI of making some “nice” assumptions but the only one that has a significant doubt attached to it is number 4.  It is fairly certain that the reduced interest rate will apply to all Ireland’s EU borrowings,  the 2011 bank recapitalisations did cost €17 billion and we have €16 billion of cash that can easily absorb a drawdown of €7 billion.

I would prefer to see our cash balances held (even if it does incur an interest cost) as a buffer against any further negative shocks to the economy. It is also a bit early to be forecasting that the banks will be in a position to return to the €3 billion of contingent capital in 2014.  They may be but it is far from guaranteed.

Accounting for the changes that have happened since May  (lower interest rates and lower bank costs) the revised estimate of the 2014 General Government Debt is €203 billion.  Whatever hope there is that it will be €190 billion (it actually might!) there is very little chance that it will be €250 billion (it still might be but it is very very unlikely).

Deposits in Irish banks

The pattern of the total deposits in all banks operating in Ireland paints a dramatic picture.  Since August 2010 deposits have fallen from €893 billion to €577 billion.

The fall has been dramatic but it has not been confined to domestic banks.  Deposits in other banks (mainly those operating in the IFSC) have also fallen and these have little effect on the domestic economy.

Deposits in domestic banks have fallen from €524 billion to €349 billion and it can be seen that this has mainly occurred in the six covered banks (AIB, BOI, EBS, PTSB, Anglo, INBS).  While deposits in non-covered domestic banks (Ulster Bank, National Irish Bank, Investec etc.) have fallen, it has not been as pronounced as in the covered banks.

The main driven of the fall in deposits in the covered banks has been the withdrawal of deposits from outside the eurozone.  Eurozone deposits have remained low.  Deposits from Irish residents have been trending down but seem to have taken an accelerated drop in July.

After falling dramatically in the six months after the expiry of the original bank guarantee deposits from non-residents in the covered banks have been relatively stable in 2011 and actually increase by €1 billion in July.  We have already examined the reason for the drop in Irish resident deposits in the covered banks.

In July the government moved nearly €20 billion of deposits out of the covered banks and used this money to recapitalise the banks.  Apart from this somewhat artificial movement deposits in the covered banks were unchanged in July (down €0.3 billion).