By Constantin Gurdgiev.
January’s IMF review of the economic situation in Ireland rained a heavy dose of icy water over the overheating Government spin machine, and much of the IMF concerns centre around exactly the same themes that were highlighted in these
very pages last month.
Top of the IMF worries list is growth.
Budget 2015 assumed GDP expansion of 3.9 percent in 2015, with 3.4 percent average growth from 2016 through 2018. The Central Bank is now forecasting 3.7 percent for 2015. The IMF forecasts growth of 3.3 percent in 2015, 2.8 percent in 2016 and “about 2.5 percent thereafter”. In simple terms, 2015-2018, the cumulative discrepancy in the forecast for growth between the IMF and the Government is now just shy of 3.3 percentage points. Put differently, based on IMF forecasts, the Irish Government may be significantly overestimating the economic prospects for the country.
It is interesting to note that the IMF assessment of the Budget 2015 measures contradicts the mainstream Irish media and Irish Left’s view. The IMF had this to say about the measures: “Income tax cuts that increase the already strong progressivity of the system are the main items. While not significant to the revenue intake, reductions in property taxes by 14 local authorities, including Dublin, are a setback for collections from this recent broadening of the tax base”. Doing away with tax breaks is fine, if it is done in an environment of falling distortionary taxes. Still, coupled with elimination of the property capital gains relief, Budget 2015 hardly represented a transfer from the poor to the rich, but rather a net tax increase on the upper earners, especially the self-employed professionals, relative to the lower waged.
The drivers behind the IMF’s sceptical view of our prospects are those discussed in this column before. Export growth is likely to be much shallower than the Government expects, while domestic demand is still suppressed by massive debt for households and companies. Consider the IMF’s estimates for public debt.
First, public debt fell from 123 percent of GDP in 2013 to 111 percent of GDP at the end of 2014. Impressive as this change might be, it is driven by one-off changes and not by any significant debt drawdowns. Consolidation of IBRC into General Government accounts and its subsequent liquidation first pushed Irish Government debt up by 6.2 percent of GDP (€12.6 billion) in 2013, and then reversed most of the same in 2014. All in, IBRC’s liquidation shaved six percentage-points off our 2014 debt-to-GDP ratio. Furthermore, changes in the EU accounting rules raised our 2013 GDP by 6.5 percent. Stronger economic conditions and the smooth exit from the Troika Programme have meant that the Irish Government was free to spend some of the borrowed cash reserves on buying out IBRC-linked bonds held in the Central Bank. This drawdown of previously borrowed cash contributed to a 4 percentage-point drop in our debt-to-GDP ratio. For all the Government’s bravado, last year’s economic recovery contributed only 1.75 percentage points to the debt decline or roughly one sixth of the overall improvement.
Still, barring adverse shocks, we remain, for now, on course to drive the debt-to-GDP ratio below 100 percent before the end of 2019.
As the IMF notes, however, a temporary drop of two percentage-points in the forecast nominal GDP growth rates for 2015-2016 would push our debt-to-GDP ratio to 117 percent in 2016. On the other hand, a one percent rise in primary spending by the Government would push the public deficit to 3.6 percent of GDP in 2015 and 3.0 percent in 2016, instead of the Government’s projections of 2.7 percent and 1.8 percent, respectively.
The IMF is concerned that the Irish Government is suffering from ‘adjustment fatigue’, and that this may increase when the upcoming political pressures of the general election start looming. The danger is that “…medium-term fiscal consolidation is at risk from spending pressures, requiring the adoption of a clear strategy to enable the restraint envisaged to be realised. … As the public investment budget is already low, current expenditures will have to bear the brunt of spending restraint, while ensuring the capacity to meet demands for health and education services from rising child and elderly populations. Nominal public sector wages and social benefits must be held flat for as long as feasible and the authorities will need to continue to seek savings across the budget”.
Somewhat predictably, the Irish authorities have offered no strategy for fiscal management beyond 2015 and no expenditure policy solutions that can address these risks. Instead of sticking to promised costs moderation, the authorities told the IMF that increased current spending, including on higher public-sector wages, can be offset by “discretionary revenue measures”.
In other words, should the Government want to fund pre-election giveaways to its preferred social partners (aka workers in the public-sector) it can simply hike taxes on less favoured groups. A slip of the veil revealing the ugly nature of our politics-captured economic strategy.
Politics is now firmly displacing economics in both the way we set our forecasts, and how we interpret the data.
Take, for example, our reported near five percent growth in2014. Various recent ministerial statements extolled the virtues of the Government that made Ireland “the envy of Germany” as the best performing economy in Europe. Largely ignored in the official rhetoric was that much of this growth came from “contract manufacturing outside Ireland that is dominated by a few companies”. The problem is that none of it has any real connection to Ireland and, as the IMF notes, much of it “could quickly turn”.
Private domestic demand, excluding aircraft leasing and investment in tech services-linked intangibles, rose by closer to three percent. Again, according to the IMF this figure may be a more realistic estimate of the real recovery. In other words, somewhere between 30 and 40 percent of the recorded growth in 2014 was down to just one accounting trick. And multinationals had plenty of other accounting tricks up their sleeves that no one is bothering to count.
Even the three percent domestic-growth estimate is inconsistent with the data on household finances. Stripping out gains in household net worth attributable to the property markets, households’ financial positions hardly improved in 2014. Mortgages in arrears constitute 23.7 percent of all house loans outstanding, when measured by the balance of loans – down from 25.6 percent a year ago. Based on Central Bank data, at the end of Q3 2014, some 244,816 mortgages accounts (amounting to €46.1bn) were either in arrears, in repossession, or at risk of arrears – roughly 4,500 more than a year ago. Based on Department of Finance data, 85 percent of all accounts in arrears ‘permanently restructured’ at the end of November 2014 involved arrears solutions that result in higher debt over the lifetime of mortgage than in the absence of restructuring.
Based on Central Bank data, Q3 2014 household deposits in the Irish banking system stood at €85.9bn, slightly down on €86.0bn a year ago.
In part the above figures manifest an improvement in the banking sector’s performance at the expense of households. In the first half of 2014, Irish banks recorded their first positive return on assets since the beginning of the crisis, and the net interest margin (the difference between the bank lending rate and the cost of funding) rose to a crisis-period high of 1.5 percent. But credit growth remained negative, contracting at a rate higher than in 2011.
In simple terms, the banks continued to bleed their clients dry at a faster rate than the recovery was making them stronger, and there was preciously little observable improvement in households’ financial positions compared to 2013. Certainly not enough to justify a sense of rapid economic growth.
The IMF isn’t undiplomatic enough to say that, but the Fund is clearly more concerned than the Irish authorities at this imbalance. As they should be: the Central Bank internal stress-testing project that new mortgages being issued by the banks will attract interest rates rising to over 6-6.5 percent over the lifetime of the loan.
Of course, the Central Bank is myopic when it comes to telling us what effects such rates would have on existing corporate and household loans. But give it a thought. Currently, the average mortgage on the market is paying interest rates below two percent per annum.
Nevertheless 17.3 percent of all mortgages accounts are officially in arrears, and 34.3 percent of all mortgage loans are either in arrears, subject to repossession, or restructured.
Should the interest rates double, let alone triple, what mortgage default rates on currently performing mortgages can we expect? What amount of economic growth do we need to shore up our household finances sufficiently to escape the interest-rate squeeze that even the Central Bank admits might arise in the foreseeable future? Can the current trends in the recovery – that are leaving households out in the cold, while superficially inflating official GDP figures – deliver any sense of sustainability to our economic performance. •
[February 2015]
