Wednesday, October 24, 2012

The ‘Underlying Deficit’ and the banks

This week the Department of Finance have released the Autumn Maastricht Return and a useful information note which includes this table.

EDP Table A

Ireland entered the Excessive Deficit Procedure (EDP) in April 2009 and the deadline for restoring the deficit to below the 3% of GDP Maastricht Limit was subsequently extended twice.  The current deficit limits come from a December 2010 Council Recommendation and were set at

  • 2011: 10.6% of GDP
  • 2012: 8.6% of GDP
  • 2013: 7.5% of GDP
  • 2014: 5.1% of GDP
  • 2015: 2.9% of GDP

It seems that the actual deficit for 2011 of 13.4% of GDP was hugely in excess of the 10.6% of GDP limit set under the EDP.  However, the information note highlights that part of the reason for the 2011 deficit was because “[a] significant amount of this deficit arises from capital injections into financial institutions that took place in July”.

The information note then presents the underlying deficit which “excludes the effect of capital injections into financial institutions in 2009, 2010 and 2011 and gives a better picture of the balance of receipts and expenditures of general government.”  This was presented in next table.

EDP Table B

Ireland’s underlying deficit for 2011 was estimated to be 9.1% of GDP well below the 10.6% limit set under the EDP.  So using the underlying deficit Ireland “met the deficit target”.

For 2012, it can be seen that General Government Balance and the underlying deficit are the same (8.4% of GDP) as there are no planned deficit increasing capital injections for the banks this year.  With the EDP deficit limit of 8.6% it can be seen that for 2012 Ireland is in line to “meet the deficit target”.

However, direct capital injections are not the only impact the banking-related measures that have been introduced over the past few years have on the general government balance.  If one is trying to get “a better picture of the balance of receipts and expenditures of general government” then it would be prudent to remove all the temporary effects on the bank bailout on the general government balance.

We can get the impact of the banks on the 2012 General Government Deficit from two sources:

1. From the September Exchequer Statement we must include the following receipts and expenditures:

Non-Tax Revenues:

  • Central Bank Surplus: €958 million (usually around €200 million)
  • Guarantee Fees: €799 million
  • Contingent Capital Interest: €300 million

Non-Voted Expenditure*

  • Interest: some portion of national debt interest (€4,065 million to date)
  • EBS Promissory Note: €25 million (no general government balance impact)

(*There is also €1,300 million for the purchase of Irish Life but that is classed as a financial transaction rather than expenditure as the Exchequer added an asset worth an equivalent amount (apparently)).

Determining how much of the debt interest that will be paid this year is due to bank bailout is difficult as borrowing is not made for specific or earmarked purposes.  We could as easily say that the bank bailout money came from Income Tax while social welfare payments came from borrowing as say the bank payments came from borrowed money. 

However, it is pretty clear that the bank payments have increased the Exchequer Borrowing Requirement over the past few years.  Here are the payments that have been for the banks from the Exchequer Account since 2009.

  • 2009 – Anglo Irish Bank: €4,000 million
  • 2009 – National Pension Reserve Fund: €3,000 million
  • 2010 – Irish Nationwide: €100 million
  • 2010 – Educational Building Society: €625 million
  • 2011 – Irish Life and Permanent: €2,300 million
  • 2011 – Promissory Notes: €3,085 million
  • 2011 – Bank Recapitalisation Payments: €5,268 million
  • 2012 – Irish Life Limited: €1,300 million
  • 2012 – Promissory Notes: €25 million

The total amount of these payments comes to €19.7 billion.  Using an assumed interest rate of 4.5% this would imply an annual interest bill of just under €900 million.  There is also interest on the €3.4 billion bond that was issued in March to make this year’s €3.06 billion Promissory Note payment to the IBRC.  This will contribute €140 million to the 2012 interest bill.

It is clear that the Exchequer interest bill from the bank bailout will be around €1,000 in 2012.

Using all of the above figures it can be seen that with additional revenues of around €1,850 and additional expenditures of €1,050 million the Exchequer Balance is probably around €800 million lower than would be the case if the full impact of the banking measures was removed.

2. The NPRF performance update for the six months of the year says:

On 20 February 2012 Bank of Ireland paid a preference share dividend of €188.3m in cash.

On 14 May 2012 Allied Irish Banks paid the preference share dividend of €280m

The NPRF has received €468 million so far this year from the banks (though the AIB dividend was paid in the form of 3,623,969,972 ordinary shares.)  

All told, the effect of the banks is to reduce the 2012 General Government Deficit by around €1.3 billion.    As shown above Ireland run a 2012 general government deficit of €13.6 billion which will be around 8.4% of GDP and below the Excessive Deficit Procedure limit of 8.6% of GDP.

However, if the full impact of the banking-related measures was omitted to calculate an alternative underlying deficit for 2012 the deficit would be €14.9 billion (actual deficit of €13.6 billion less than €1.3 billion gain from the banking-related measures).  This would be  an estimated 9.2% of GDP.

This underlying deficit excluding the impact of the banks means Ireland would be in breach of the 8.6% limit set out under the Excessive Deficit Procedure.  The Council Recommendation says that:

the projected annual deficit path does not incorporate the possible direct effect of potential bank support measures.

It is not specified what this means.  It could be argued that increases in national debt interest and central bank surplus income are indirect effects of the bank support measures (but it is also the case that these roughly offset each other). However, receipts of nearly €800 million of bank guarantee fees and €300 million contingent capital (subordinated bond) interest are surely direct effects of the bank support measures and should be excluded from the EDP calculation.

If that was the case Ireland would not be below the 8.6% of GDP limit set for 2012.

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