Tuesday 21 October 2014

Colm McCarthy: The recovery has not begun, all spin aside

Positive news abounds, but all we have to really go on are figures and the data doesn't lie

Published 13/01/2013 | 05:00

Economic recovery is essential if debt burdens are to be sustainable, if employment is to grow and if the decline in living standards is to be arrested. While recovery in 2013 is possible, there is no hard evidence that recovery is under way.





There is a real boom, though, in one sector of Irish manufacturing, namely the manufacture of good news stories to usher in the new year. Industrial promotion agencies have been releasing their year-end statements, detailing their job-creation achievements. Strong export performance has been lauded, by exporters. The heavily-indebted Government has sold some extra debt. Official forecasts see the beginning of recovery in 2013 and a successful exit from the EU/IMF programme by year's end. How much of this is credible, and how much is spin?

Nobody knows whether the Irish economy will begin to recover in 2013, no matter how confidently their forecasts are presented. There is no way of knowing. All that is known is the latest batch of proper statistics from the Central Statistics Office, and they show that no actual recovery has commenced. The main figures are as follows:

Employment: The table gives the most recent data from the household survey, in thousands, up to the end of the third quarter of 2012.

Total employment continues to fall, although at a slower pace than in the early years of the crisis. Employment in industry is falling. Numbers have held up in the sector consisting of health, education and public administration, mainly funded from the public purse.

The rest of the economy, including agriculture and the large private-services sector, continues to contract. The year-end announcements of job-creation successes need to be seen against the background of these most recent comprehensive figures for the economy as a whole.

Retail sales: The data for the Christmas period are not yet available. After a fall of 6 per cent in volume in 2008, sales fell a further 14 per cent in 2009 and have been essentially flat ever since.

Industrial Output: Output in industry is now back to 2005 levels and was particularly weak in the three months to November, the latest data available.

Unemployment: The unemployment rate was down to around 4.5 per cent in 2007. It rose to 14.6 per cent by the end of 2010 and has fluctuated around this level ever since. Without the safety valve of emigration, unemployment would today be about 20 per cent.

Exports: A sustainable recovery needs to be led from the export sector, since domestic demand will likely be weak for several more years. Export volumes fell slightly in the third quarter of 2012 and have been essentially flat over the last two years.

To be clear, there is no broad-based recovery in the volume of exports, press releases notwithstanding. Within the broad export figures there has been weakness in the exports of goods, offset by recorded increases in the exports of services.

Unfortunately some of these services exports seem to be a statistical illusion: large multinationals based here are routing a large portion of their European sales volumes through Ireland for tax mitigation reasons, as they are legally entitled to do. But the result is that some of them now appear to be producing incredible figures for output-per-employee, and the apparent buoyancy in services exports is partly a creature of transfer-pricing.

The best measure of overall performance is called real gross national product, which nets out the substantial outflows through profit repatriations and other intra-firm transfers by multinationals. Real GNP peaked in the final quarter of 2007, fell like a stone through to the end of 2009 and has been essentially flat ever since.

None of these observations about the absence of recovery to date implies that recovery in 2013 is not possible. They should, however, serve as an antidote to the excessive spin over the last few weeks designed to create the impression that recovery has already commenced.

The National Treasury Management Agency sold €2.5bn in five-year government bonds during the week at an interest rate of about 3.2 per cent. They also sold €1bn in a debt instrument of Bank of Ireland, which they held consequent on the government rescue of that bank. The Government now holds cash balances of about €23bn, on deposit at interest rates below one per cent. These funds cover all borrowing needs for 2013 and some of the 2014 requirement. The NTMA plans to borrow €7.5 additional billions over the rest of the year.

The disposal of the Bank of Ireland bond helps to reduce (a little) the intertwining of the State's finances with those of the crippled banks. If banks and sovereigns are to be disentangled, they should not be significant holders of one another's debt. The €2.5bn issue of bonds at 3.2 per cent interest involves a 'negative carry' (the excess of the interest rate paid over that received on the excess deposits) of somewhere between two per cent and 2.5 per cent.

Governments normally keep substantial cash balances but the negative carry is now so large for Ireland that one must question whether these balances have become excessive. The budget deficit for 2013 is adversely affected through last week's operation by an amount which comfortably exceeds the savings from some of the more controversial budget cuts announced in December.

The NTMA bond sales have been presented as a component in the strategy of effecting an exit by the end of 2013 from the EU/IMF financial rescue programme. Debt sustainability for Ireland from 2014 onwards requires that three pre-conditions be met.

The first is that the ongoing budget deficit is eliminated over the next few years. Progress since the large fiscal gap emerged in 2008 has been painfully slow and the Government has unwisely tied its hands through pre-election commitments on public-service pay, income tax and social welfare. Getting the deficit down will be more difficult in the absence of recovery.

The second necessary component is a deal on debt relief. On Friday details emerged of a new EU Commission report on Ireland. The headline writers picked, understandably, on the report's unhappiness with expenditure control in the health service. But the Commission authors were also forthright on debt relief. They drew attention to the possibility that further bank recapitalisation may be necessary and urged that EU leaders deliver on debt relief promises made last year.

The EU Commission, it must be noted, has changed its tune considerably since 2010, when its officials were vociferous in support of the European Central Bank line and the protection of the Irish State's balance sheet seemed to concern only the IMF.

The third requirement for Ireland, which affects other indebted countries too, is that world bond markets remain sanguine about sovereign lending. It is just six months since the eurozone almost came off the rails in a bond-market panic focused on Spain and Italy, and there are plenty of banana skins down the road which could spark a re-run.

The first of these is the election in Italy, which is likely to produce a Left-oriented government reluctant to stick with budget consolidation. Spain may miss its fiscal targets this year, there will have to be another Greek default at some stage and there is the ongoing risk that more problems will emerge in Europe's fragile and unreconstructed banking system.

There is thus no certainty that Ireland can emerge successfully from the programme, or that any country that does emerge might not need official lender support again at some stage in the future.

Finally there could be interesting developments in the protracted talks over a rescue package for Cyprus, whose banking system is in serious trouble. It would appear that haircuts for senior unsecured bank creditors, or even for depositors, could be part of the package, measures which were unthinkable for Ireland just a couple of years ago.

Sunday Independent

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