Why €6 billion?

How did it transpire that the planned ‘adjustment’ in the upcoming budget jumped from the €3 billion announced last year to the €6 billion announced last week? 

I think we can attribute the increase to three factors.

1. Reduction in the level of nominal GDP (partly as a result of the increased fiscal contraction).
2. Continued deterioration of the public finances.
3. Reduction of the planned General Government Balance as a percentage of GDP from 10% to 9.3%.

We can look at these in more detail to see the size of these effects.

1. Reduced nominal GDP (€1 billion)

Last December the DoF forecast the nominal GDP in 2011 would be €169.9 billion.  Ten months later this forecast is down to €161.2.  With the original forecast this would have allowed a GGB of €17 billion to meet the then published target of 10%.  Sticking with this target and the revised GDP figures would allow a GGB of €16.1 billion.  This means a reduction in the planned deficit of close to €1 billion.

Some of this reduction is due to revisions of GDP figures by the CSO.   For example when first published the 2009 GDP figures were €163.5 billion.  Following the methodological revision the revised figure for 2009 GDP is €159.6 billion.  (See the 2009 figure given in Table 2 of the National Accounts releases linked above.)  The CSO revisions have increased the adjustment by about €0.4 billion!

The remainder of the €1 billion adjustment here is due to reduced inflation expectations (depressing nominal GDP) and the growth effects of the increased budgetary adjustment.  The greater the adjustment, the greater the drag on GDP, the greater the adjustment must be to meet a stated target.  Quite the vicious circle.

The sum of these effects is an additional €1 billion adjustment to meet the 10% target.

2. Continued deterioration of the public finances (€1 billion)

Back in December with the €3 billion adjustment the DoF forecast a current budget deficit of €13.8 billion for 2011 and a capital budget deficit of €4.2 billion.  The latest forecasts are that the €3 billion adjustment would give rise to an current budget deficit of €14.25 and a capital budget deficit (excluding the interest on the so-called promissory notes) of €4.9 billion.  Combined this give an Exchequer deficit of just over €1 billion more.

The deterioration in the current budget deficit is because of a forecast drop in current revenue (€33.9 billion to €33.5 billion).  In the capital budget there is an increase in non-voted expenditure (€0.8 billion to €1.1 billion) likely due to increased interest payments on our growing national debt.

3. Reduction in planned GGB to 9.3% of GDP (€1 billion)

The “four-year plan” to reach the 3% GGB target by 2014 outlined back in December, stated that the target for 2011 was to get the GGB down to 10% of GDP. 

It we stuck to the 10% target it would allow a GGB of €16.1 billion.  Changing the target to 9.3% means the allowable (in the sense of the target) GGB can be of the order of €15 billion.  Moving the goalposts sees another €1 billion added to the planned adjustment.

So there it is.  Each of these three factors contribute €1 billion to the adjustment.  €1 billion because the nominal GDP forecast has been revised downwards.  €1 billion because the ailing public finances are showing further deterioration. €1 billion because we decided the above wasn’t enough pain, and we want to show the EU/bond markets/IMF/Greeks  how tough we really are by cutting another billion just for the hell of it.

And all this to reduce the GGB from 10% to 9.3%.  Seems like an awful lot of effort just to move a number by 0.7 percentage points.  And of course this is only because we have “delayed” the interest to paid on the promissory notes used as part of the bank bailouts.

Shortfalls – on a lighter note

The admission by the Dept of Education that spending on new school construction projects was behind target for 2010 generated a heated response.  One report begins:

MARY Coughlan's Department of Education has yet to spend almost half of its 2010 budget for building new schools and classrooms.

Only €381m of a total annual allocation of €712m has so far been spent on capital projects by the department this year.

With less than two months left in 2010, much of the remaining amount is expected to be returned to the Department of Finance.

Some 10pc of the surplus can be carried over to 2011 but any remaining funds will be returned.

Education chiefs have attributed the shortfall to massively reduced building costs.

How are we to view such ‘shortfalls’?  More reaction from the media here and here.  Reproduced here are two views from across the Irish Sea.

Alan Clark:  The following is an extract from Diaries by Alan Clark.

“We had one of the PES [Public Expenditure Survey] preliminaries today. … Was finally goaded by Fred Bayliss, the Under Secretary, who appears to be our Chief Accountant. He mumbled along, ‘… looks as if there is going to be a shortfall as our overall provision is £408 million and at present we are going to be pushed to get expenditure over £335 – 360 million’.

That’s not a f**king ‘shortfall’ I thought, or at least not my idea of one. It slowly sank in that he was rambling round for suggested ways of getting last-minute expenditure authorised so as to ‘approach more closely our provision’. ‘Look, Fred, Ministers in this Department are members of a government which is dedicated to – whose raison d’etre, you could say, is – the reduction of public expenditure. Surely it’s a matter for congratulations?’

Ah no, don’t you see – ‘It’s important to get as close as possible to last year’s provision in order to have a firm base from which to argue increases this year …’ This was crazy. Nightmare. Kafka. … Icily I asked in what other Departments of State ‘is this kind of budgetary practice prevalent’? ‘All of them,’ they shouted triumphantly. General Laughter, of the tee-hee kind.” (Alan Clark, 1994, Diaries, London: Orion Books, pp. 39-40)

Yes Minister: The following is an extract from the episode ‘The Economy Drive’.

Humphrey: He told you £32 million?

Bernard: Yes, Sir Humphrey.

Humphrey: I’m aghast.

Bernard: So am I. I mean, its incredible we didn’t know.

Humphrey: Oh, I knew about it.

Bernard: Then why are you aghast?

Humphrey: I’m aghast it got out. It means we get less money from the Treasury next year. Oh, good Lord, it’s after half past five. Sherry?

Bernard: Yes, thank you.

Humphrey: You still look worried Bernard?

Bernard: Well, yes. Surely, we want to save money?

Humphrey: Bernard, you know perfectly well there has to be some way to measure success in the Civil Service. British Leyland measure their success by the size of their profits. Or, to be more accurate, they measure the size of their failure by the size of their losses. But, we don’t have profits and losses. We have to measure our success by the size of our staff and our budget. By definition a big department is more successful than a small one.

Bernard: Are you saying that the North-West Regional Controller boobed by saving so much money?

Humphrey: Well of course. Nobody asked him to. Suppose everyone did it. Suppose everyone went around saving money irresponsibly all over the place.

HT: JC

Forecasting the components of GDP

The new growth projections from the DoF are worth a little more study.  It is clear they have revised down their overall growth forecasts.  Here we make a comparison to the forecasts made in the December 2009 Stability Programme Update (Table 4) and the November 2010 Economic and Budgetary Outlook (Table 2).

The listed figures for 2009 are taken from the CSO.   The two DoF documents provide forecast growth rates of the “components of real GDP”.   The forecast levels for 2010 and 2011 are based on the actual outturns from the CSO and the forecast real growth rates from the DoF.   We can use this to compare the changes in the DoF forecasts from December 2009 to those made this week.

Back in December 2009, the DoF forecast that over the two years 2010 and 2011 the domestic economy would shrink by 3.8% in real terms.  The November 2010 forecasts predict a total deterioration in the domestic economy in these two years of 6.9%.  This is substantially worse.

For the annual forecasts made for consumption, investment and government expenditures for the years 2010 and 2011 we can see that the Department has downgraded five of the six growth forecasts.  The only predicted improvement is in household consumption expenditure in 2010 which previously was expected to fall by 3.0% but this has been tempered to a fall of ‘only’ 1.7%.  All other forecasts have been downgraded.

This is particularly through of investment expenditure in 2011.  The previous forecast increase of 4.5% has been completely reversed to a continued decrease of 6.0%.  This change alone counts for more than half of the increased deterioration forecast for the domestic economy.  The overall picture painted of the domestic economy is extremely bleak.

What changes have been made to the trade components of GDP?

And, suddenly the future looks so much brighter.  The forecasts for exports, in particular, and imports all show increases.  The forecast export growth in 2010 jumps from a stagnant 0.4% to a rampant 6.3%.  For 2011 the forecast improves from 3.4% to 5.0% export growth.  The forecast increase in imports for 2010 is from a decrease of –2.8% to an increase of 2.8%.  Very little change is seen in 2011 imports.

The net effect of these changes is that the contribution of trade to GDP is forecast to increase from €24.4 billion in 2009 to €34.4 billion in 2011.  This would have a huge positive effect on the GDP growth rate, virtually cancelling out the drag the domestic economy places in the growth rate.

[Aside: I’m not sure whether it is coincidence or not but the forecast further deterioration of the contribution of the domestic economy to GDP of €4.2 billion is almost perfectly offset by the forecast further improvement in the contribution of trade the GDP of €4.2 billion.  I sure hope this is a coincidence.]

For the period 2010-2011 the DoF now forecast that exports will increase by €16.7 billion with an accompanying increase in imports of €6.7 billion.  This raises a number of concerns. 

First as we have pointed out our exports are dominated by a few sectors.  Nearly 60% of our merchandise exports come from chemicals with half of this coming from the pharmaceutical exports alone.  Of our service exports, nearly 40% is derived from the export of computer services.  These high-value sectors have the capability of skewing our exports figures but large increases in the value of exports may not be accompanied by significant increases in employment.

Second, it is hard to imagine how we can increase exports by €16.7 billion and only have an accompanying increase in imports of €6.7 billion.  The Information Note states that “imports are projected to increase in line with final demand”.  Only a portion of Irish imports are based on domestic demand.  This is apparent when we note that imports in 2009 were €120 billion and while consumption was €84 billion. 

A lot of our imports aren’t used for consumption, but for rather production and a great proportion of those are used in the export sector.  A fairly crude regression of the first differences of imports on the first differences of consumption and exports on quarterly data from 1997Q1 to 2010Q2 using seasonally adjusted constant price data can be seen here.

For example, much of our exports are in the pharmaceutical sector that are based on the processing of compounds and ingredients that are imported.  Also, because of a historical lack of R&D in Ireland the patents and copyrights for many of the products which form the bulk of our exports (chemicals and computer services/software) are held abroad.  Any increase in exports in these sectors requires a proportionate increase in imports through royalty payments. 

It is likely that the €16 billion would require somewhere in the region of an extra €12 billion in imports.  This growth in imports would wipe out the tentative positive growth forecast by the DoF and see GDP continue to fall over the next two years.

Increases in exports (and less than proportionate increases in imports),  is the factor that is holding the positive DoF forecasts together.  The forecast increases in exports may come about, but because of the distribution of our exports they are unlikely to have much of an impact on our unemployment.  It does appear that the DoF is aware of this as, although they have forecast positive GDP growth for 2010 (+0.25%) and 2011 (+1.75%), they have forecast a further contraction in employment in 2010 (-4.00%) and 2011 (-0.25%).

Placing all our eggs in the export basket may appear to help us reach the 3% GGD target by 2014 but this will primarily be achieved through an increase in denominator in the debt/GDP ratio.  The prospects for the domestic economy remain bleak.

Bond Yields continue to soar

Breaking through 6% in the middle of September was significant, breaking through 7% a week ago was significant but now it seems we’re hurtling towards 8%, and no Information Note seems to be stemming the tide.  Here’s a few screenshots lifted from Bloomberg.

Markets were closed by the time the four year adjustment and growth projections were released yesterday.  How has the reaction been in this morning’s early trading?

It is that this report posed to the FT website last night didn’t help.

Clearing house warning to Irish bond traders

Fears over the health of the eurozone bond market intensified after one of Europe’s biggest clearing houses warned investors they could be compelled to stump up substantially more money to trade in Ireland’s debt.

LCH.Clearnet told members they might be required to deposit more cash to trade in Irish sovereign bonds, a move that is being widely interpreted as a signal that the organisation will act next week.

LCH.Clearnet has contacted members in the past few days to say that, under newly introduced rules, it has the power to impose a 15 per cent “haircut”, a cash deposit to help indemnify against default risk, against Irish bonds if it determines that the risk of the Irish government defaulting has increased.

A spokesperson for the clearing house said: “We have the ability to do so should we decide to do so.”

Any move by LCH.Clearnet to increase Irish debt margin requirements could undermine the Irish banking system.

Irish 10-year yields rose for the eighth day on Thursday, jumping 19 basis points to a fresh record of 7.49 per cent since the launch of the euro.

Getting back to reality?

The 10-page Information Note on the Economic and Budgetary Outlook 2011-2014 has caught the media attention.  The key issues have been the commitment to a budgetary of adjustment of €6 billion in the December Budget (with €3 of spending cuts for every €1 of tax increases) and the postponed of interest payments on the Promissory Notes issued as part of the bank recapitalisation programme. 

Although the note lacks specifics on budgetary actions it does give an insight into the assumptions and predictions the DoF is using for it’s budgetary analysis.  The most recent set of forecasts came from last December’s Stability Programme Update and we considered these in a recent post.

One of our main beefs was with the “positive macroeconomic forecasts” used.

The DoF has now brought their growth forecasts back a little closer to reality and we have the following updated projections.

Laying these on our previous graph gives us the new growth path.

The downward drop in the 2009 figure to the end of the solid lines is attributed to “revisions by the CSO to the level of GDP in 2009 and to previous years (a methodological change)”.  The dashed lines form the DoF projections and they are now clearly lower.  So the DoF must have a closer grasp of reality and on which to base their analysis.  Or maybe not.

For 2010 the DoF is now projecting nominal GDP of €157.3 billion and a growth of ‘just’ 0.25%.  However, half year figures for 2010 have already been released.  These tell ue that nominal GDP for the first six months of the year was €78.1 billion.  To get the annual forecast of the DoF, nominal GDP in the last six months of the year has to be €79.2 billion.  While an annual growth forecast of 0.25% might seem modest this actually needs a growth of 1.4% in the last six months of the year relative to the first six months.  This might happen (driven mainly by chemical exports) but is an accelerated growth rate for the latter half of this year nonetheless.

Moving to 2011 we see that the DoF has ‘slashed’ its real growth forecast from 3.3% to 1.75%.  Again it might appear that this more modest growth forecast is appropriate.  However, the December 2009 forecast was based on a 2011 budget ‘adjustment’ of €2 billion.  We are now told that this will be €6 billion.  The extra €4 billion adjustment, if fully implemented, will act as a considerable drag on the growth rate.  Determining the exact growth effects of this austerity is not an exact science, but assume the effect of it could possibly be of the order of a 2% reduction in the growth rate.  [This would happen if the €4 billion fiscal adjustment resulted in a drop in GDP of about €3 billion, which in itself may be optimistic depending on how the additional adjustment is achieved – tax or spend].

Anyway let’s assume the €6 billion package cuts a further 2% off the growth rate.  This means that the updated growth forecast could be 3.3% minus 2.0% equal to 1.3%.  This would be with no revision whatsoever of the underlying growth prospects.  The actual updated growth forecast for 2011 is 1.75%.  The DoF hasn’t forecast a fall in the growth rate for 2011 – it has just forecast an increase!! But the increase is camouflaged by the impact of the additional €4 billion adjustment just announced.

Back to reality? Not quite.

Oops!

The Minister for Finance in last December’s Budget said:

“A Cheann Comhairle, the worst is over. The international economy has exited recession. Recent indicators suggest that economic activity in this country is turning the corner, and my Department is now expecting a return to positive growth within the next six to nine months.

The effort demanded of every citizen in this Budget is substantial, but it is the last big push of this crisis. Further corrections will be needed in the coming years, but none as big as today’s.”

This “last big push” was a total ‘adjustment’ of €4 billion.  It has just being announced that the targeted ‘adjustment’ in the upcoming Budget will be of the order of €6 billion. 

October Exchequer Returns

The tax returns for October were released earlier today.  The relevant documents are:

• Exchequer Statement
• Analysis of Taxation Receipts
• Analysis of Voted Expenditure
• Information Note

The early headlines are positive with the information note from the DoF stating that “the overall Exchequer position for the first ten months of the year means that the Budget Day targets remain valid.”  At first glance it does appear that the possible good news we saw in September’s figures has carried through to October.

The drop in tax revenue relative to last year continues to ease and at 5.3% was the lowest annual drop seen this year.  When looking at the monthly revenues, we can see that October followed on from September’s increase and was €135 million or 5.6% on the tax revenue collected in the same month last year.

By looking at the performance of the individual tax heads we can see the breakdown of the €1.4 billion tax shortfall relative to last year.

All the main tax heads (Income Tax, VAT, Corporation Tax, Excise Duty) are down on last year.  The largest absolute drops are in Income Tax and VAT which combined are over €1 billion down on last year.  Of the top four tax heads the largest relative decline is in Corporation Tax which is 7.3% down on last year.  Excise Duty has the smallest absolute and relative declines of the main tax heads and is still clinging to last year’s levels.

So where did the €135 million increase in tax revenue for October come from?

This doesn’t paint the positive picture the aggregate figures suggest.  The key driver of the upturn in October was a surge in Corporation Tax receipts which were 92% ahead of the 2009 figure.  If we exclude Corporation Tax the other seven tax heads shown a decline of €83 million or 3.8% of the €2.2 billion they brought in last year.

This is the second month in a row in which Corporation Tax receipts were 90% ahead of the 2009 figure. See here.  It is difficult to determine if these increases will transfer into an increase in the amount of Corporation Tax corrected for the year or whether they are down to timing issues as companies make their preliminary tax returns.

In September, monthly Income Tax receipts has shown the first annual increase for 2010.  However, this was quickly reversed in October and as we can see Income Tax receipts were 5.0% down on last year’s figures. See full table here.

As per usual, much of the focus will not be on the true comparison of 2010 tax revenues to 2009 revenues, but on the false comparison of 2010 tax revenues to the Department of Finance forecasts.

And indeed it is true.  Tax revenue is now €243 million or 1.0% ahead of Department of Finance targets.  Every time you hear this remember that compared to last year tax revenue is down €1.4 billion or 5.6%.  Here are the monthly figures that have gotten us to the ‘positive place’

Tax revenue has been ahead of Department forecasts for each of the past three months which has brought about the 1.0% increase.  If we sum the past three months, the DoF predicted that tax revenue would fall by 4.7% compared to last year while the outturn has revealed that for these three months revenues rose by 1.9% compared to last year.

The main reason for taxes coming in ahead of target is the unexpected surge in Corporation Tax receipts which are now 22% ahead of target.  Five of the eight tax heads are now ahead of target with the notable exception being the poor performance recorded by Income Tax.

In October alone Corporation Tax was €238 million (121%) ahead of target.  See here.  Excluding Corporation Tax the other sum of the other seven tax heads is behind target and we do not yet know how permanent these increases in Corporate Tax revenues will be.

The Information Note provided by the Department states that “a shortfall in DIRT receipts in the month of October accounts for a large proportion of the overall income tax shortfall.”  Income Tax is €361 million behind target.  I cannot see how DIRT receipts in October can have much to do with that.  To September, Income Tax was already €337 million behind target.   We do not have details of these DIRT receipts in October but their impact on the “shortfall” of Income Tax receipts must be limited when 93% of the shortfall had occurred before the start of October.

[A report by Sean Whelan on RTE news stated that the shortfall in DIRT receipts was of the order of €150 million.  If this is true it would suggest that Income Tax receipts outside of DIRT, performed quite well possibly maintaining September’s gain.]

Here are the graphs (click smaller images to enlarge):