independent

Wednesday 16 April 2014

Colm McCarthy: Look at the numbers – hoping for the best is an exercise in futility

TOUGH TALK: ECB President Mario Draghi talks with Finance Minister Michael Noonan at a November Eurogroup meeting in Brussels while IMF managing director Christine Lagarde looks on

THE financial rescue programme for Ireland signed in November 2010 is about to enter its final year. It could play out well or badly.



During the week, the IMF released a nervous assessment of Ireland's economic and financial prospects while the Central Statistics Office issued weak macroeconomic data for the quarter to September.

Taoiseach Enda Kenny responded by reiterating his confidence that Ireland will exit the EU/IMF rescue programme on schedule at the end of 2013, having secured a deal on bank-related debts from the EU and the European Central Bank.

In his Christmas message, he also drew attention to (unspecified) signs of economic recovery.

While the IMF report does not dismiss the possibility of a successful programme exit as envisaged by the Taoiseach, it does not express categorical confidence either. Indeed, it is permeated with caution and contains a lengthy recitation of downside risks. The macro data from the CSO were disappointing yet again and revealed no concrete signs of the long-awaited recovery.

First, the IMF. This is the key paragraph: " ... substantial challenges remain and prospects for Ireland to durably exit official financing are strongly shaped by the timing and effectiveness of the delivery on European commitments. Public debt is expected to peak just over 120 per cent of GDP and Ireland continues to face significant sovereign-bank linkages owing to the high cost of bank support and potential contingent liabilities from bank loan losses if growth were to remain weak in coming years.

"Delivery on European commitments, especially direct bank recapitalisation, is therefore critical to ensure Ireland continues to deepen its access to markets in order to exit ongoing reliance on official financing."

This needs a little decoding. The IMF are saying that the 'European commitments' need to be delivered on, otherwise Ireland will not be exiting the programme on schedule.

They would not be saying this if they thought European delivery could be relied upon, so we may take it that they do not trust the Europeans to deliver.

In this they are doubtless cognisant of the continuing foot-dragging over Greece and the apparent European strategy of doing as little as possible, and at the last moment.

The IMF authors have chosen the unambiguous phrase 'European commitments', which is most revealing. There is by now a well-established pattern of back-tracking on apparent EU summit commitments and there have been numerous statements from European politicians and ECB officials since the June 29 Brussels summit which support the scepticism of the IMF as to European intentions.

Ireland needs more by way of relief from bank-related debt than a fudged postponement deal on the payment of the promissory notes arising from the bailouts of bondholders in the closed (Anglo-Irish and Irish Nationwide) banks. The rest of the bank-induced debt, relating to banks still functioning, can at this stage only be relieved through retrospective mobilisation of the European rescue fund. The unsecured creditors of these banks have already been paid, in part at European insistence, as have creditors of the banks already closed down.

The IMF authors appear to lack confidence that European commitments on this point, which would have the effect of lowering the debt burden, will be honoured. To put it in stark terms, the expressed confidence of the Taoiseach and the Minister for Finance on this crucial point is not shared by the IMF.

They go on to pinpoint remaining 'sovereign-bank' linkages. Even though the surviving banks have been re-capitalised, the State remains on the hook if things take another turn for the worse, since no European support mechanisms have been mobilised. Notwithstanding the endless summits, the bank-sovereign doom-loop has not been broken by any European policy action. If the Irish economy fails to recover as vigorously as everyone hopes, Nama will struggle to collect on its portfolio of property loans and the banks will see loan losses continue to mount.

The State remains on the hook should the banks, or Nama, need further support. Weak economic growth (or none) will make budget targets hard to hit anyway. In drawing attention to these contingent liabilities, the IMF are reminding us that a disappointing economic performance will do damage under two headings, not just one.

This brings us neatly to the macro data released by the Central Statistics Office. They relate to the third quarter of 2012 and show yet again that there is simply no evidence of economic recovery.

The recent Budget was based on an assumption that economic growth next year would be 1.5 per cent, to be followed by 2.5 per cent in 2014 and 2.9 per cent in 2015. Nothing in the actual data suggests that this happy sequence is about to commence.

The current crisis in Ireland began to show up in the macro data early in 2008. For six quarters, up to the middle of 2009, the level of economic activity fell like a stone, eventually stabilised, but has been essentially flat ever since.

The figures released by the CSO show real GDP was barely higher, in the third quarter of 2012, than it had been more than three years earlier, in the second quarter of 2009.

Forecasting is a barely respectable corner of the economics business and there has been a long history of woeful inaccuracy. In Ireland official forecasts have been far too rosy since the crisis began.

See the accompanying table for the numbers from the December 2009 Stability Programme Update, prepared by the Department of Finance and the basis for that month's 2010 budget.

In 2010, the economy contracted by a little less than the forecasters expected. But in 2011 and 2012, the forecasts were way too high and the 2009 forecasts for 2013 and 2014 are far higher than the same people now expect for those same years. Cumulatively, real GDP in 2014 could be 12 per cent or 13 per cent below what was expected back when the 2009 budget was framed. In December 2009, the debt ratio for 2014 was expected to be just 81 per cent of GDP. The fact that it will be about 120 per cent is due in large part to huge unforeseen bank bailout costs but also to macro forecasts that were far too optimistic. It is not unfair, even with the benefit of hindsight, to blame people for relying on poor predictions.

Macro forecasts are almost always wide of the mark. There is no known methodology in macroeconomics which offers acceptable forecast accuracy, and there are good reasons for expecting that none will ever be created. In these circumstances it is surely time to abandon the spurious precision of these number-crunching exercises. Why not produce a budget based on zero growth just to see what it looks like? Is it not prudent to plan on the basis of moderate expectations, leaving room to be surprised on the upside?

The available data contain no evidence of any actual pick-up in Ireland and the IMF predicts a slowdown across Europe next year. The prospect of continuing zero growth is therefore real.

If economic recovery is disappointing, the likelihood is that budget deficit targets for 2013 will not be achieved. This risk is heightened when so many of the Budget expenditure savings are aspirational.

But in addition, as the IMF are at pains to point out, weak economic performance will raise the threat of extra bail-out costs in the financial sector as more people lose their jobs and give up on mortgage repayments.

The first few months of 2013 will reveal whether the EU and ECB are serious about debt relief for Ireland. If it transpires that they are not, as all previous form would indicate, and that a sudden spurt of economic growth is not coming to the rescue, the Government will need an alternative strategy.

Successful re-entry to the sovereign bond market on the scale required would be challenging even with debt relief and economic growth.

It is time to explain to our European colleagues that there are plausible scenarios in which, despite sticking to the terms of the EU/IMF programme, Ireland could fail to exit reliance on official lenders at the end of 2013. Nothing can be done about economic growth, but the extent of debt relief, including relief from debts improperly imposed as a matter of eurozone policy, is for the EU and ECB to decide.

Sunday Independent

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