Saturday 25 February 2017

Not much done and an awful lot more to do in righting ship of State

The incoming administration will have to grapple with many pressing issues, including our 'Top Ten' outlined below

1. Banking crisis -- can the system be downsized?

Not since Brian Lenihan assumed office in May 2008 has an Irish Finance Minister faced such a gloomy banking landscape.

Irish banks are unable to fund themselves on the capital markets, cannot hold onto their corporate deposits and critically are undercapitalised when one considers the level of impaired loans they are carrying.

Solutions to these problems are either too expensive (more capital injections) or have no European support (forcing losses on senior bondholders).

There is an EU/IMF plan to revive the Irish banking system by forcing the banks to sell assets and reduce their leverage. But to date, details on how this will work have been sketchy.

If the banks are forced to sell or transfer assets off their balance sheets, where will the assets go and will it cause a capital shortfall back on bank balance sheets?

There is also the problem of the ECB's support for Irish banks, which amounted to over €132bn at the end of 2010. How does an incoming Irish Government think it can unwind this exposure?

Unfortunately, the future Minister for Finance will have to work closely with the EU and the ECB on finding some solution to this problem.

There is also the €51bn exposure of the Irish Central Bank to the Irish banks which will have to be unwound at some point and Citibank recently said it believed the Irish Central Bank itself would have to be recapitalised so it has a cushion against potential losses on this exposure.

There is also the leftover remains of the old Irish banking system in the shape of Anglo Irish and Irish Nationwide.

While these are both officially in wind-down, that does not mean they will not need additional capital in the future depending on the performance of their remaining loan books.

The final issue on the banking front is the consolidation agenda where EBS and Irish Life & Permanent are facing uncertain futures.

For three years now there has been talk of a third banking force, but minimal progress has been made and the new minister needs to provide some level of competition for AIB and Bank of Ireland in future.

There is also the immediate issue of recapitalising the banks. AIB, Bank of Ireland and EBS all have to get to 12pc core Tier 1 equity shortly and one of the first tasks of the minister will be to ask the Central Bank to force this demand on the banks.

But even with bond buybacks and cost cutting, the banks are still painfully short of the capital required.

2. Mortgage arrears -- new thinking needed

THE mortgage crisis among thousands of homeowners is intensifying and the last government failed to come up with policies to address the issue fully. The numbers behind this crisis are sobering.

More than 45,000 mortgages are in arrears and up to 40,000 mortgages have been re-scheduled. This means that potentially 95,000 mortgages are in direct trouble, while 350,000 other mortgages are technically in negative equity.

These numbers speak of a genuine crisis not previously seen in the Irish housing market, even in the 1980s when unemployment peaked at 17pc.

In an ideal world, debt would be written down and the burden concentrated among young families alleviated. But the Irish banks are not strong enough to engage in direct mortgage write-downs.

Schemes to aid distressed mortgage holders through direct support are likely to be hugely expensive.

There is also strong resistance to helping mortgage holders in arrears from those who are still paying their mortgages. This moral hazard argument means that government interventions in this area could be hugely unpopular. 3. Interest rate on the EU/IMF loan package

While it would only save about €675m a year, the idea of re-negotiating the 5.8pc blended interest rate on the EU/IMF package has gained traction with the public and in some respects with the markets, too.

The next administration, at least politically, will have to deliver on their promise to slash the rate, to below 5pc at least.

The 5.8pc is below market rates for Irish bonds on the secondary market, but with Ireland running deficits for several more years, such a rate is ultimately unsustainable, unless growth prospects improve beyond current forecasts.

The issue of the interest rate is due to be discussed with Ireland's EU partners in March and the new Government will have to show some movement from the key player, Germany, if the promises of the election campaign are to be made good.

4. Corporation tax to be defended

Some EU countries want a minimum corporate tax rate, others want what is known as the Common Consolidated Corporate Tax Base (CCCTB), while others want full-scale tax harmonisation across the economic bloc.

For Ireland, complete defence of our 12.5pc rate is the only option if the industrial base of the country is to be protected.

A failure to protect the rate, so beloved of US foreign direct investment in particular, would count as a public failure for the new Government.

But the problem is that corporation tax is being discussed in a Europewide context as part of the so-called "grand bargain'' being hammered out by Germany and France.

If the new Irish administration manages to negotiate down the interest rate on the EU/IMF loan, would that then trigger follow-on concessions by Ireland over corporation tax?

Arguably, lowering the rate on the bailout package is less important than preserving Ireland's unique corporation tax regime, but the new Government may have to give a little on one to gain concessions on the other.



5. Tax: a lot more to do

The opposition parties have given unwise promises about tax to the electorate that an incoming Finance Minister will now have to square with reality.

For example, the EU/IMF programme envisages €3.7bn of tax rises between now and 2014. Where are these tax rises going to come from?

The options are limited unless income tax increases yet again.

But it will be necessary to add other taxes, including VAT and a property tax. Budget planning for the new Government will start after the summer and the EU/IMF programme is demanding at least €1.5bn of tax increases in 2012 alone.

That is going to give a significant economic and political headache to the incoming Minister for Finance.

Tax increases have unpredictable effects on economic growth, but they all tend to be negative.

Property taxes are also politically toxic and tend to anger the middle classes, but the previous Government promised the EU/IMF to introduce such a measure in an attempt to make the tax base of the future less prone to shocks.

6. Quinn insurance

Sean Quinn is hopelessly in debt and Anglo Irish needs to take over Quinn Insurance to at least make some inroads on reducing his €2.8bn of borrowings. The Anglo/Quinn deal needs the specific sanction of the Minister for Finance.

Is the new minister going to allow Anglo Irish Bank, an institution in wind-down, to spread its tentacles into the insurance industry on the basis that it can recover some of this astonishing sum?

The other alternative is to let a private-sector player take over Quinn Insurance and breathe new life into the insurance market.

Anglo's bid has received only lukewarm support from the regulator and a ministerial decision against the bid would probably get support from Matthew Elderfield.

But on the other hand it is likely to be met with fierce opposition in Cavan where many of the Quinn Insurance employees live. There is also the issue of allowing Anglo to get at least some of the money back via such a transaction.

7. Commercial rents -- only way is down

Fine Gael and Labour have given commitments on the issue of commercial rents, with both parties keen to halt the traditional practice that rents can only move upward when they are renewed.

This commitment will advantage retailers, but disadvantage property investors, with significant impacts on the commercial property market.

The first problem is that NAMA has a large amount of commercial property, and having to lower the rents on these properties will result in lower revenues at the loan agency.

The ban on upward-only rent review will also dent pension funds, insurance companies and even the Irish banks, with many of their borrowers dependent on rental income that, at the very least moves in line with inflation.

Already a key property deal at Liffey Valley has fallen apart due to the uncertainty over rents.

The new minister will have to find a way to get foreign cash into the Irish commercial property market, but how does one do that if rents are no longer moving only in one direction?

8. Croke Park agreement -- time for a change

The EU/IMF programme is a charter for further public expenditure cuts. The problem is the Government's room for manoeuvre is reduced due to commitments given in the Croke Park agreements. These are significant -- no compulsory redundancies, no further pay cuts between now and 2014 and no redeployment if terms and conditions are worsened.

The outgoing Government swapped these concessions for other more nebulous concessions by the unions. Yes the agreement talks about "efficiencies'', redeployment, upskilling and productivity gains, but so far few tangible savings across the economy have resulted from these promises.

The incoming Government will have to revisit Croke Park in some form and Fine Gael in particular has a bold agenda in relation to the public sector.

While the party is opposed to any compulsory redundancies, getting savings via other routes is going to be difficult, and asking public servants to "get more, from less'' could put the incoming Government on a collision course with the trade union movement as early as later this year.

9. Exit strategy from the EU/IMF

The new Finance Minister has to put Ireland on a firm exit route from EU/IMF assistance.

The first step in this would be getting Ireland to return to the bond market, even if just for short-term borrowings, like treasury bills.

The NTMA, somewhat optimistically, envisages Ireland returning to the bond market within two years, while the EU/IMF think three years is more likely.

Many economists think Ireland could be receiving EU/IMF assistance for up to five years, maybe even longer.

At present Ireland and its banks are both locked out of credit markets and many economists believe a default is more likely for Ireland than long-term resurrection. But this is the key test for any Irish Finance Minister; can he or she restore Ireland's economic sovereignty?

The best way to restore this hard-won sovereignty is to get Ireland back into the European bond market, preferably at rates below 5.8pc being charged by the EU/IMF.

It's a huge ask, unless growth starts to go beyond current forecasts which are anaemic for at least the next two years.

Nevertheless, after five years the next minister can reasonably set a target of getting Ireland back into the credit markets.

10. Growing your way out of a crisis

In some ways this is the biggest challenge of all facing the new minister and his cabinet colleagues.

The outgoing Government is expecting the economy to grow this year by 1.75pc, and -- forecasts in the years beyond this are for growth of between 3.2pc and 3.6pc. Most private sector economists are less bullish.

Slippage in growth rates means more austerity. It also means even less chance of lowering the catastrophic unemployment rates which are even more elevated among younger age groups.

Fine Gael has made jobs its key political pitch, but sparking growth is, in the eyes of many economists, a matter for the private sector, not the State.

The new minister, though, has to provide the framework and create the conditions for the private sector to create jobs.

Ireland has to start developing new industries and keep the hi-tech US investment flowing. Protecting the corporate tax rate is integral to these efforts.

Without growth other initiatives of the incoming Government -- job creation, bank rescues, re-entering the bond market --grind to a halt.

Expanding the economy is the hardest achievement for any minister to pull off, but it is also the most long-lasting achievement if it can be done.

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