Friday, October 19, 2012

The Level of National Indebtedness

Writing in today’s Wall Street Journal, Eddie Hobbs has an article under the banner ‘Don’t Expect a Celtic Comeback’.  The overall thrust of the piece is true.  At best, we are at the end of the Celtic Collapse and the future direction of the economy is still uncertain.  Here, though the focus will be on a paragraph early in the article on the level of Irish indebtedness.

The myth of Irish pluck continues today, even amid the financial crisis. Prime Minister Enda Kenny recently graced the cover of Time magazine. But according to data from the International Monetary Fund, Ireland has displaced Japan as the world's most indebted economy. Government, household and nonfinancial company debt add up to 524% of Irish GDP. (The Central Bank of Ireland uses a different basis for calculating the debt of nonfinancial firms; its estimate for total debt would be lower than the IMF's.) Funding this gargantuan load at an average cost of 4.5% would swallow nearly 24% of GDP—in other words, Ireland's entire industrial output.

If the numbers used here were true then the Irish economy would be completely swamped by debt and would not even be treading water.  There is no way that an economy with a GDP of  €161.7 billion in 2012 would be able to carry a debt of €847 billion and an imputed annual interest bill of €39 billion.  As will be shown below the actual figures are around €500 billion and around €16 billion and these figures are determined from data hinted at in the article but then rather inexplicably ignored.

Although not attributed in the WSJ it appears that the numbers used come from this recent post over on the Trueeconomics blog.  The Irish economy is in dire straits but anything that suggests that the income of the economy needs to be compared to a debt mountain of close to €850 billion and an interest bill of nearly €40 billion is not grounded in reality.  We have a massive debt problem but not that massive.

The figures used comes from the recent release of the IMF’s Global Financial Stability Report.  The table can be seen on page 2 of chapter 2 and a spreadsheet of the data used in the table is here

As soon as the report was released I suggested that the debt numbers in relation to Ireland would be misinterpreted and today’s WSJ has confirmed my fears.  No breakdown of the 524% figure was provided in today’s article but using the IMF data linked above (and the IMF’s nominal GDP forecast from the World Economic Outlook) we can see that the breakdown is:

2012 Gross Debt Levels

One is immediately drawn to the €467 billion gross debt attributed to the non-financial corporate or business sector.  This is more than 55% of the total debt figure.  There is little dispute or misunderstanding about the gross debt position of the household sector and after some wild claims about the government debt around the start of the EU/IMF programme, outside of a few coverage issues (NAMA, IBRC), the extent of our public debt is now fairly well established. 

Although there are some caveats noted below the headline figures above accurately reflect the broad difficulties in the household and government sectors and even though both are worthy of further examination the initial emphasis here will be on the non-financial corporate figure as it provides the bulk of the 524% of GDP headline figure.

This is something I have already addressed across various outlets such as on here and here, on here and this site here, here and here.  Parts of these are worth repeating.

Last March, the CSO and the Central Bank made a joint presentation to the Oireachtas Finance Committee on the issue of non-corporate debt in Ireland (transcript).  The slides provided by Michael Connolly of the CSO are particularly information.  Here is the CSO data on non-financial debt from 2001 to 2010 on which the IMF data are based.

NFC Debt and GDP

The series shows that at the end of 2010, the CSO measure of non-financial corporate debt was just under €350 billion.   However, as is illustrated in the graph the most dramatic rise in debt occurred after the peak of GDP in 2007.  At the end of 2007 business debt was just over €200 billion but it then surged to the €350 billion figure shown above.   The IMF project that this will have further increased to more than €450 billion in 2012.

The huge increase after the bubble had burst and, more importantly, after the banks had ‘shut up shop’ suggests that there was something other than lending to Irish businesses driving the increase.  A subsequent chart explains the increase.

Lenders to NFCs

It can be clearly seen that the increase since 2007 is down to increased lending from Treasury operations, with indicates that the increase in gross debt is down to MNC activities rather than domestic firms becoming more indebted.  One final chart from the excellent CSO presentation show that the net financial position of the non-financial corporate sector has not significantly deteriorated, i.e. the increase in debt liabilities has been offset by an increase in financial assets.

Net Financial Position of NFCs

All this was summarised  nicely by Michael Connolly during his presentation to the Dail Finance Committee:

Michael Connolly: “We referred to the numbers increasing dramatically after 2008. What we see is that the treasury companies in the IFSC are lending substantial amounts of money to their affiliates in the non-financial corporate area. They are managing the international cash management for the multinationals. The lending by the treasury companies to multinationals in this country is increasing each year, certainly after 2008. We also find that they are lending to each other. I refer to affiliate lending between affiliates in the same corporate group. We then also see that borrowing from abroad, which is listed on the top bars in the chart, is increasing too.”

“When we look at bank borrowing, we see that borrowing from banks has been decreasing since 2008. That is all I have to say. I am just trying to provide context and to shed light on the big macro numbers that come out for this sector.”

“What I am telling the committee is that when one looks at the detail of the overall scale of debt for this sector, it is nowhere near as serious for the real economy of this country as one might imply at first sight. When one looks at the detail, it is really about a globalised, internationalised economy which has very large debt but also has very large assets. The two are off-setting one another when we take a net view on it. Of increasing importance is the interlinkage between some of the multinational corporations we have in the sector and their treasury affiliates in the financial sector. It is difficult to look at numbers in isolation because everything is intertwined.”

So how much debt is actually being carried by the business sector in Ireland?  This was helpfully answered by the presentation from Joe McNeill of the Central Bank at the same Oireachtas meeting.  The WSJ indicated that the Central Bank had an alternative measure of corporate indebtedness and given the problems with the gross, non-consolidated data assembled by the CSO shown above it is not clear why the Central Bank data was ignored.

Credit Advanced to NFCs

The figures are taken from this dataset on the Central Bank website and the surge of lending to the construction and real estate sector is very evident.  Lending to other more cash-flow based business sectors does not follow the same pattern.

The data show that lending from Irish banks to non-financial enterprises in Ireland peaked at €175 billion in the third quarter of 2008.  This is the extent of non-financial corporate lending by Irish banks and is the debt that matters for the Irish economy.  Most of the €467 billion that opens the piece has little relation to the actual economy.  There are a number of reasons for the dramatic drop since the September 2008 peak.

  1. As is continually pointed out access to credit is tight in the Irish economy so repayments on existing debt will have exceeded the issuing of new debt.
  2. There will have been some write-down of business loans.
  3. Bank of Scotland (Ireland) ceased operating as a bank in December 2010 and its €15 billion business loan book (mainly property loans) was transferred to Certus, a debt collection company.  These loans still exist but they are omitted from the above chart.
  4. Most importantly, €74 billion of developer loans were transferred from five of the covered banks to the National Asset Management Agency up to the end of 2010.  Again, most of these loans exist but are omitted from the above series.

During the Finance Committee session Joe McNeill revealed that once items 2, 3 and 4 were accounted for the reduction in business lending as a result of transactions alone (drawdowns and repayments) has been around 6% per annum since 2008.  The dataset shows that business lending, excluding property-related sectors, has fallen from €60 billion at the end of 2008 to €39 billion in June 2012.   This is close to the rate of decline indicated by the Central Bank.

At a time when the gross non-consolidated figures from the CSO suggest that the lending to non-financial corporates in Ireland has increased hugely it should come as no surprise to see that when it comes to the ‘real’ economy it has actually declined.  The CSO figures track the Central Bank data up to 2007 and the huge divergence since then is explained by MNC activities as detailed by Michael Connolly.

It is possible that Irish non-financial corporates could have sourced loans from banks based outside Ireland and that they could have raised finance by issuing bonds directly rather than drawing down a loan.  There are not many Irish businesses who would be in a position to do this.  The €175 billion from the Central Bank data will be the bulk of Irish non-financial business debt as both of the above factors unlikely to have been more than €10 billion.  

These will be included in the gross figure provided by the CSO and has the first chart about shows this figure was around €200 billion at the peaking of the economy/credit bubble in 2007 before the distortions from the MNC sector skewed the figures.  With the reductions to non-property lending and some repayments and writedowns of property lending it is likely that gross lending to the Irish non-financial corporate sector is no more than €170 billion in 2012, and is probably lower.

At the peak, banks in Ireland had issued €115 billion of loans to property-related sectors.  Most of this is still included in the €170 billion figure but it is pretty clear that all of this won’t be repaid.  The covered banks transferred about €50 billion of developer loans in Ireland to NAMA and crystallised losses of around €30 billion in the process.  This loss was covered by government recapitalisations and a lot of this money is now included in the gross government debt.

This means that if we use a €190 billion figure for gross government debt and a €170 billion figure for gross non-financial corporate debt we are actually double counting around €30 billion of property debt.  Either the developers will repay the full €50 billion they owe on their Irish loans to NAMA (they won’t) or the government will make good the losses through the bank recapitalisations and the Promissory Notes (they will). 

The same is true for probably another €20 billion of non-NAMA property, mortgage, consumer and other loan losses that remain as part of the gross debts on the covered banks’ balance sheet.  These loans will not be repaid and, in time, will be written down, but as a result of last March’s stress tests the banks have been recapitalised to cover these future losses so for the moment the debts are counted as household and corporate debt in the banks and also as government debt.  Just like the developer loans they will only be paid once.

A better estimate of the level of gross indebtedness of Ireland in 2012 is likely to be:

  • Household: €189 billion
  • Government: €190 billion
  • Corporate: c. €171 billion
  • Total: €550 billion

The non-financial corporate debt is an estimate based on Central Bank data.  And as we have noted above the figure for the Government Sector has been inflated to cover losses on loans in the household and corporate sectors that will not be repaid.  All told, Ireland is looking at a massive debt overhang of around €500 billion.  We don’t need to highlight the dangers of this excessive debt level by trying to pretend that the total is €850 billion.

And huge amounts of this debt won’t be repaid.  All told the covered banks have been provided with enough capital to cover close to €100 billion of loan losses.  The non-covered banks comprise about one-third of the Irish banking market and they have already made provision for close to €25 billion of loan losses

These losses need to be worked out but over time it is likely that close to one third of the €350 billion that was lent into the private sector during the credit bubble will not be repaid.  These make the gross figures look large now but repayments and writedowns will reduce it.

It is also true that looking at gross indebtedness only gives a part of the picture.  The IMF data show that as well as having €189 billion of financial debt the household sector has financial assets of €308 billion and thus a net financial position of plus €109 billion.   It should also be noted that around €32 billion of the debt relates to buy-to-let mortgages which have offsetting non-financial income-generating assets.  There are severe difficulties in this sector including negative equity and loan arrears as highlighted by provisional details released this week

It should also be noted that around one-third of the household sector debt is in incredibly cheap tracker-rate mortgages.  This reduced the interest burden of the debt.  More on this below.

The government has €190 billion of gross debt but has an offsetting cash mountain of nearly €23 billion, still has around €6 billion in the discretionary portfolio of the National Pension Reserve Fund, owns Irish Life the pensions and life assurance business as well as semi-state enterprises, has a €3 billion subordinated bond in the covered banks and is currently in negotiation to try and sell the state-owned equity in the viable banks to the ESM.  All these can offset the gross debt figure. 

The IMF put the net debt position of the government sector at €167 billion but a lower figure could be justified.  The net financial position of the non-financial corporate sector is around negative €100 billion as shown above.  The aggregate net financial position of the government, household and business sectors in Ireland is around minus €150 billion.   This is a long way from a gross debt figure of €850 billion.

Finally the WSJ piece said that:

Funding this gargantuan load at an average cost of 4.5% would swallow nearly 24% of GDP—in other words, Ireland's entire industrial output.

This is wide of the mark.  24% of GDP is around €40 billion.  Eurostat provide figures on the amount of interest paid in the sectoral non-financial accounts.  It is available as item D.41g in ‘non-financial transactions’ here.  The most recent figures for Ireland are from 2010 and the total interest paid by sector was:

  • Household: €6.3 billion
  • Government: €4.9 billion
  • Corporate: €4.9 billion
  • TOTAL: €16.1 billion

This was 10.4% of 2010 GDP and as shown here puts Ireland above the EU average but with an interest burden that is comparable to Belgium’s and lower than those of Greece and The Netherlands among others.  Even with increases in government debt since 2010 (and there have been reductions in household and corporate debt to somewhat offset that) it is clear that an article with an imputed interest bill of €40 billion is over-stating the true position by more than a factor of two.

There is no need for this exaggeration.  A €500 billion debt burden and a €16 billion interest bill are awful enough.

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