Showing posts with label Irish exit. Show all posts
Showing posts with label Irish exit. Show all posts

Friday, January 10, 2014

10/1/2014: Ambrose Evans-Pritchard on Euro area's miracle of recovery


A very good article by Ambrose Evans-Pritchard on the fallacy of European 'leaders' view of the peripheral countries economic stabilisation: http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100026365/barroso-triumphant-as-jobless-europe-wastes-five-precious-years-of-global-recovery/

Some caveats:

  1. AEP argues that Ireland had the capacity to withstand domestic blowout caused (as he correctly states) by the monetary policy mismatch. His argument for this is that "Ireland is highly competitive (second best in EMU after Finland on the World Bank gauge)." The problem, of course, is that WB competitiveness indicator is superficial - it hardly reflects the reality on the ground when it comes to credit supply (non-existent in the economy, yet highly ranked in WB study), openness of domestic markets (not measured), access to public procurement (not measured), extent of domestic indirect taxes (not measured), security of domestic property rights (pensions or insurance contracts, anyone?), etc etc etc. 
  2. AEP argues correctly that Ireland has high levels of exposure to international trade. And this is sustaining the macro-level recovery in the economic aggregates (GDP etc), but this has virtually no effect on the ground - the domestic economy is stagnant and most of the improvements that do take place are down to Malthusian contraction: emigration, jobs destruction, tax and charges hikes, rip-off via state-controlled prices and other measures that continue to shift private sector resources to fund the Exchequer. Ireland has had virtually no real reforms in the way domestic (public and private) business is conducted.
  3. AEP acknowledges some of the above problems, saying that "But even if Ireland can make it without debt restructuring (and that is not certain), the underlying erosion of the workforce through hysteresis from mass unemployment – and from mass migration to the UK, US, and Australia – has greatly damaged the long-term growth potential of the economy." This is spot on. One qualifier, however - Ireland already had three rounds of debt restructuring: two rounds of restructuring Troika debts (terms extensions and rate reductions) and one round of restructuring banks-linked debt (Promissory Notes). These provided, in some cases real and in some temporary, relief to the fiscal funding side of the equation. It is, however, in no way certain that we will not need more restructuring.


Key is that AEP 100% correct in saying that:
"At the end of the day, Ireland was forced by the EU authorities to take on the vast liabilities of Anglo-Irish to save the European banking system in the white heat of the Lehman crisis, and the EU has since walked away from its pledge to help make this good. The Irish people have been stoic, disciplined, even heroic. They have survived this mistreatment. To cite it as a vindication of EU strategy sticks in the craw."

And per future, I couldn't have said it better myself:
"Europe is one external shock away from a full-blown deflation trap, and one recession away from an underlying public and private debt crisis. Nothing has been resolved. Aggregate debt ratios are higher than they were before the austerity experiment. In the end there will still have to be a "Brady Plan" like the Latin American debt write-offs at the end of the 1980s, but on a far larger scale and with far more traumatic effects on the European body politic. So celebrate today while the sun is still out, and dream on."

Let me add that Europe is one internal shock away from the above too. All that is needed is a massive wave of financial repression to derail the common currency's faltering monetary structure and push the banking sector back into contraction. The debt levels - private and public - are dramatic enough for the economy to succumb to either external or internal shocks. And one certainty we have is that shocks do happen.

Thursday, December 26, 2013

26/12/2013: Don't Bank on the Banking Union: Sunday Times, December 15


This is an unedited version of my Sunday Times column from December 15, 2013.


Over the last week, domestic news horizon was flooded by the warm sunshine of Ireland's exit from the Bailout. And, given the rest of the Euro area periphery performance to-date, the kindness of strangers was deserved.
Spain is also exiting a bailout, and the country is out of the recession, officially, like us. But it took a much smaller, banks-only, assistance package. And, being a ‘bad boy’ in the proverbial classroom, it talked back at the Troika and played some populist tunes of defiance. Portugal is out of the official recession, but the country is scheduled to exit its bailout only in mid-2014, having gone into it after Ireland. No glory for those coming second. Greece and Cyprus are at the bottom of the Depression canyon, with little change to their misery.

In short, Ireland deserves a pat on the back for not being the worst basket case of the already rotten lot. And for not rocking the boat. Irish Government talks tough at home, but it is largely clawless vis-à-vis the Troika. Our only moments of defiance in dealing with the bailout came whenever we were asked to implement reforms threatening powerful domestic interests, such as protected sectors and professions.

However, with all the celebratory speeches and toasts around, two matters are worth considering within the broader context of this week's events. The first one is the road travelled. The second is the road that awaits us ahead. Both will shape the risks we are likely to face in the medium-term future.


The road that led us to this week's events was an arduous one. Pressured by the twin and interconnected crises - the implosion of our banking sector and the collapse of our domestic economy - we fell into the bailout having burnt through tens of billions of State reserves and having exhausted our borrowing capacity. The crater left behind by the collapsing economy was deep: from 2008 through today, Irish GDP per capita shrunk 16.7 percent, making our recession second deepest in the euro area after Greece. This collapse would have been more benign were it not for the banking crisis. In the context of us exiting the bailout, the lesson to be learned is that the twin banking and growth crises require more resources than even a fiscally healthy state can afford. Today, unlike in 2008, we have no spare resources left to deal with the risk of the adverse twin growth and banking shocks.

Yet, forward outlook for Ireland suggests that such shocks are receding, but remain material.

Our economic recovery is still fragile and subject to adverse risks present domestically and abroad. On domestic side, growth in consumer demand and private investment is lacking. Deleveraging of households and businesses is still ongoing. Constrained credit supply is yet to be addressed. This process can take years, as the banks face shallower demand for loans from lower risk borrowers and sharply higher demand for loans from risky businesses. On top of this, banks are deleveraging their own balance sheets. In general, Irish companies are more dependent on banks credit than their euro area competitors. Absent credit growth, there will be no sustained growth in this economy. Meanwhile, structural reforms are years away from yielding tangible benefits. This is primarily due to the fact that we are yet to adopt such reforms, having spent the last five years in continued avoidance of the problems in the state-controlled and protected domestic sectors.

On the Government side, Budgets 2015 and 2016 will likely require additional, new revenue and cost containment measures. Post 2016, we will face the dilemma of compensating for the unwinding of the Haddington Road Agreement on wages inflation moderation in the public sector and hiring freezes.
To-date, Irish economy was kept afloat by the externally trading services exporters, or put in more simple terms - web-based multinationals. Manufacturing exports are now shrinking, although much of this shrinkage is driven by one sector: pharmaceuticals.

Meanwhile, the banking sector is still carrying big risks. Heavy problems of non-performing loans on legacy mortgages side, unsecured household credit and non-financial corporates are not about to disappear overnight. Even if banks comply with the Central Bank targets on mortgages arrears resolution, it will take at least 18-24 months for the full extent of losses to become visible. Working these losses off the balance sheets will take even longer.
Overall, even modest growth rates, set out in the budget and Troika projections for 2014-2018, cannot be taken for granted.


This week, the ongoing saga of the emerging European Banking Union made the twin risks to banks and growth ever-more important. The ECOFIN meetings are tasked with shaping the Bank Recovery and Resolution Directive, or BRRD. These made it clear that Europe is heading for a banking crisis resolution system based on a well-defined sequencing of measures. First, national resources will be used in the case of any banks' failures, including in systemic crises. These resources include: wiping out equity holders, and imposing partial losses on lenders and depositors. Thereafter, national funds can be used to cover the capital shortfalls and liquidity shortages. Only after these resources are exhausted will the EU funds kick in to cover the residual capital shortfalls. This insurance cover will not be in the form of debt-free cash. Instead, the funding is likely to involve lending to the Government and to the banks under a State guarantee.

When you run through the benchmark levels of capital shocks that could qualify a banking system for the euro-wide resolution funding under the BRRD, it becomes pretty clear that the mechanism is toothless. For example, in the case of our own crisis, haircuts on bondholders under the proposed rules could have saved us around EUR15-17 billion. In exchange, these savings would have required bailing in depositors with funds in excess of the state guarantee. It is unlikely that we could have secured any joint EU funding outside the Troika deal. Our debt levels would have been lower, but not because of the help from Europe.

This last point was made very clear to us by this week’s events. After all, our historically unprecedented crisis has now been 'successfully resolved' according to the EFSF statement, and as confirmed by the European and Irish officials. The 2008-2010 meltdown of the Irish financial system was dealt with without the need for the Banking Union or its Single Resolution Mechanism.

With a Banking Union or without, given the current state of the Exchequer balance sheet, the buck in the next crisis or in the next iteration of the current crisis will have to stop at the depositors bail-ins. In other words, banking union rhetoric aside, the only hope any banking system in Europe has at avoiding the fate of Cyprus is that the next crisis will not happen.


Second issue relates to the continued reliance across the euro area banks on government bonds as core asset underpinning the financial system. In brief, during the crisis, euro area banks have accumulated huge exposures to sovereign bonds. This allowed the Governments to dramatically reduce the cost of borrowing: the ECB pushed up bonds prices with lower interest rates and unlimited lending against these bonds as risk-free collateral.

The problem is that, unless the ECB is willing to run these liquidity supply schemes permanently, the free lunch is going to end one day. When this happens, the interest rates will rise. Two things will happen in response: value of the bonds will fall and yields on Government debt will rise. The banks will face declines in their assets values, while simultaneously struggling to replace cheap ECB funding with more expensive market funds.

Given that European Governments must roll over significant amounts of bonds over the next 10 years, these risks can pressure Government interest costs. Simple arithmetic says that a country with 122 percent debt/GDP ratio (call it Ireland) and debt financing cost of 4.1 percent per annum spends around 5 percent of its GDP every year on interest bills, inclusive of rolling over costs. If yield rises by a third, the cost of interest rises to closer to 6.6 percent of GDP. Now, suppose that the Government in this economy collects taxes and other receipts amounting to around 40 percent of GDP. This means that just to cover the increase in its interest bill without raising taxes or cutting spending, the Government will need nominal GDP growth of 3.9 percent per annum. That is the exact rate projected by the IMF for Ireland for 2014-2018. Should we fail to deliver on it, our debts will rise. Should interest rates rise by more than one-third from the current crisis-period lows, our debts will rise.


The point is that the dilemmas of our dysfunctional monetary policy and insufficient banking crisis resolution systems are not academic. Instead they are real. And so are the risks we face at the economy level and in the banking sector. Currently, European financial systems have been redrawn to contain financial exposures within national borders. The key signs of this are diverged bond yields across Europe, and wide interest rates differentials for loans to the real economy. In more simple terms, courtesy of dysfunctional policymaking during the crisis, Irish SMEs today pay higher interest rates on loans compared to, say, German SMEs of similar quality.

Banking Union should be a solution to this problem – re-launching credit flowing across the borders once again. It will not deliver on this as long as there are no fully-funded, secure and transparent plans for debt mutualisation across the European banking sector.



Box-out:

Recent data from the EU Commission shows that in 2011-2012, European institutions enacted 3,861 new business-related laws. Meanwhile, according to the World Bank, average cost of starting a business in Europe runs at EUR 2,285, against EUR 158 in Canada and EUR 664 in the US. Not surprisingly, under the burden of growing regulations and high costs, European rates of entrepreneurship, as measured by the proportion of start up firms in total number of registered companies, is falling year on year. This trend is present in the crisis-hit economies of the periphery and in the likes of Austria, Germany and Finland, who weathered the economic recession relatively well. The density of start-ups is rising in Australia, Canada, the US and across Asia-Pacific and Latin America. In 2014 rankings by the World Bank, the highest ranked euro area country, Finland, occupies 12th place in the world in terms of ease of doing business. Second highest ranked euro area economy is Ireland (15th). This completes the list of advanced euro area economies ranked in top 20 worldwide. Start ups and smaller enterprises play a pivotal role in creating jobs and developing skills base within a modern economy. The EU can do more good in combatting unemployment by addressing the problem of regulatory and cost burdens we impose on entrepreneurs and businesses than by pumping out more subsidies for jobs creation and training schemes.

Sunday, November 17, 2013

17/11/2013: Ireland to Remain Subject to EU/ECB Oversight post-Exit


On may occasions I have stated that Ireland will remain subject of the enhanced supervision by the EU and ECB of its fiscal policies following our exit from the 'Troika bailout'.

Minister Noonan this week confirmed as much: http://www.irishexaminer.com/ireland/troika-to-keep-eye-on-ireland-for-20-years-249851.html

Here's the relevant legislation governing our required compliance:

Regulation (EU) No 472/2013 of the European Parliament and of the Council
of 21 May 2013
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32013R0472:EN:NOT
pdf link: http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:140:0001:0010:EN:PDF

Emphasis in bold is mine:

Article 14: Post-programme surveillance

1. A Member State shall be under post-programme surveillance as long as a minimum of 75 % of the financial assistance received from one or several other Member States, the EFSM, the ESM or the EFSF has not been repaid. The Council, on a proposal from the Commission, may extend the duration of the post-programme surveillance in the event of a persistent risk to the financial stability or fiscal sustainability of the Member State concerned. The proposal from the Commission shall be deemed to be adopted by the Council unless the Council decides, by a qualified majority, to reject it within 10 days of the Commission's adoption thereof.

2. On a request from the Commission, a Member State under post-programme surveillance shall comply with the requirements under Article 3(3) of this Regulation and shall provide the information referred to in Article 10(3) of Regulation (EU) No 473/2013.

3. The Commission shall conduct, in liaison with the ECB, regular review missions in the Member State under post-programme surveillance to assess its economic, fiscal and financial situation. Every six months, it shall communicate its assessment to the competent committee of the European Parliament, to the EFC and to the parliament of the Member State concerned and shall assess, in particular, whether corrective measures are needed...

4. The Council, acting on a proposal from the Commission, may recommend to a Member State under post-programme surveillance to adopt corrective measures. The proposal from the Commission shall be deemed to be adopted by the Council unless the Council decides, by a qualified majority, to reject it within 10 days of the Commission's adoption thereof.


Note: you can track my analysis of the 'exit' announcements following the links posted here: http://trueeconomics.blogspot.ie/2013/11/15112013-beware-of-german-kfw-bearing.html

Friday, November 15, 2013

15/11/2013: Beware of German (KfW) Bearing Gifts?..


As reported in today's press, Ireland has secured a sort-of backstop to its exit from the bailout via an agreement with Germany's state- and local authorities-owned KFW Development Bank (see: http://www.irishtimes.com/news/politics/kfw-is-a-public-bank-providing-development-loans-at-lower-interest-than-commercial-rates-1.1595460 and http://www.irishexaminer.com/ireland/bailout-a-calculated-political-gamble-that-just-might-not-pay-off-249727.html). This was blessed by Germany (http://www.independent.ie/business/irish/merkel-backs-ireland-bailout-exit-without-overdraft-29754656.html). And it may or may not qualify as a backstop for the Exchequer (see speculative analysis here: http://www.irishexaminer.com/archives/2013/1115/ireland/bailout-exit-declaration-exaggerated-half-truth-249716.html).

One can only speculate as to the possible conditionalities imposed by Angela Merkel and her potential coalition partners on Ireland under the exit deal, but here's an interesting parallel development that has been unfolding in recent weeks.

Per reports (see for example this: http://uk.reuters.com/article/2013/11/14/uk-eu-banks-idUKBRE9AD0X820131114 and this: http://uk.reuters.com/article/2013/11/15/uk-eurozone-banks-backstops-idUKBRE9AE08G20131115 and this: http://uk.reuters.com/article/2013/11/14/uk-ww-eu-banks-idUKBRE9AD15520131114 and this: http://www.irishtimes.com/business/economy/spd-rules-out-deal-on-banks-legacy-debt-1.1595352 and this: http://www.euractiv.com/euro-finance/germany-opposes-rescuing-ailing-news-531713):
  1. Germany is clearly stating and re-stating its position on use of EU funds to recapitalise the banks (forward from the stress tests to be conducted). The position is 'No Way!' Wolfgang Schauble is on the record here saying "The German legal position rules out [direct bank recapitalisation from the ESM, the eurozone bailout fund,] now…That's well known. I don't know if everyone has registered that." So it is 'No! No Way! I said so many times!' stuff.
  2. Euro area Fin Mins are moving toward using national (as opposed to European) funds to plug any banks deficits to be uncovered in the stress tests.
  3. SPD Budget Spokesperson clearly states that his party is firmly, comprehensively against use of euro area bailout funds to retrospectively recap banks (the seismic deal of June 2012 is, in their view, not even a tiny wavelet in the tea cup).

Now, Ireland is the only country seeking retrospective recap and it is bound to have come up in the Government talks with Germans and the Troika in relation to bailout exit.

Put one and one together and you get a sinking feeling that may be retrospective recaps were the victim of the Government 'unconditional' solo flight from the Troika with KfW sweetener to comfort the pain of EUR64 billion in possible retroactive aid in play?..

Note: I am speculating here. It might be just that the Germans (KfW) decided to simply recycle their trade surpluses into another property err... investment bubble inflation in the peripheral states cause they just were so delighted with the way we paid off their bondholders. Or it might be because they are keen on burning some spare cash. Or both. Or none. If the latter, the reasons might be that it bought them cheaply something they want... How about that retroactive banks debt deal? It's pretty damn clear they want that off the table, right?

You can read my analysis of the exit here: http://trueeconomics.blogspot.ie/2013/11/15112013-exiting-bailout-alone-goods.html and see Ireland's credit risk score card here: http://trueeconomics.blogspot.ie/2013/11/15112013-ireland-some-credit-risk.html and fiscal risk assessment here: http://trueeconomics.blogspot.ie/2013/11/15112013-primary-balances-government.html.