Wednesday 18 September 2019

Brendan Keenan: 'Debt mix may spell trouble and we may regret lack of progress on cutting ours'

Rising public debt means a hit to revenues could send lenders’ confidence plummeting and cause a global shock to the world’s economies. Photo: Stock image
Rising public debt means a hit to revenues could send lenders’ confidence plummeting and cause a global shock to the world’s economies. Photo: Stock image
Brendan Keenan

Brendan Keenan

If you want some early Christmas cheer, try the new report on the economy from Goodbody Stockbrokers. It is hard not to say, "Ho-ho-ho!"

The key figure is that, with the year almost gone, growth forecasts have been raised to a merry 6pc for 2018.

The really magical bit is that analyst Dermot O'Leary finds little sign of overheating, despite the surge in growth and its components.

This is not some leprechaun figure built around multinational activities. It is an estimate of 'core domestic demand' - the firm's preferred way of avoiding foreign-based activities.

The most important driver is consumer spending, which grew by 4.4pc in the 12 months to June.

As the biggest part of the economy, such spending is also potentially the biggest driver of overheating.

Goodbody sees this growth as sustainable, because it is not driven by credit as was the case in the 2000s. On the contrary, it is accompanied by record levels of household deposits in the banks.

Nor is it a figure for spending per person but one which reflects the strong growth in employment.

The second driver is investment, which surged by around 20pc in the first half of the year. This is also a pared-down figure, excluding stuff such as aircraft leasing, and is based mainly on core business investment and construction.

Both are growing strongly, although construction is one area where foreign borrowing is supplying much of the finance. A lot more will be needed if the housing shortage is to be met and much of it will have to sell for less than €350,000 to meet central bank rules and protect people from future debt traps.

Ah, debt. Given time, good fortune, and especially the necessary doubling of residential construction, there's no doubt the economic temperature will give cause for concern

For now, the dismal science must do what it can to dampen animal spirits. There is always Brexit, but we will be hearing enough about that elsewhere. That leaves debt.

It is one area where a bit of complaining can be justified. It is less clear how much. After the Irish banks' good results in the ECB stress tests, and the current level of savings by households, the debt question is essentially a question of the public finances.

That was also largely the case in 1980, and that ended badly. The popular comparison then was with Poland - at that time a Communist country, so not like for like. Later, South Korea got a turn but they knew what they were borrowing for.

Now Ireland itself is pretty much the debt record holder. But its government is no longer borrowing; merely carrying the admittedly large burden of past borrowing. When another pared down measure, modified gross national income (GNI*), is used, debt is still above 100pc. But at least it will drop below that psychological barrier next year.

This debt ratio is the measure the country is legally obliged to follow under EU rules; except they measure it by the much more generous GDP, under which Ireland is approaching the desired limit of 60pc.

If that really is the safe level, we have a long way to go in terms of the more realistic GNI*.

But does it have to be that low to be safe?

As with Poland back then, much has been made of the amount of debt per man, woman and child - about €40,000. It sounds pretty terrible but it is not much use without knowing income, and expected income, per person. Irish incomes are also among the highest in the world - although it is the expectations of future income we have to think about.

Other measures may be more useful. It is too easily forgotten that, where government finances are concerned, the important thing is the interest on that €40,000 rather than the sum itself, which can be endlessly replaced with new loans.

That makes interest costs as a percentage of government revenues one of the better measures of the debt burden. It is also one of the best from the citizens' point of view, since they provide the revenues.

In the depth of the Great Recession, 12 cent in every euro of government spending went on interest payments. Now it is down to seven. Budget plans are to have it level off at five cent in the euro in the next few years.

One thing which would have surprised observers in the 1980s is that the interest rate cost is now bundled into the assessments of the public finances. It used to be considered pretty satisfactory if government budgets balanced before interest payments - maybe even if they were in balance before capital spending and interest payments.

Bitter experience has since suggested this was not good enough. If interest rates exceeded the rate of growth, governments themselves fell into a trap above certain levels of debt. The dreaded 1970s stagflation made reductions in the debt burden impossible. One hundred per cent of national income would certainly have been above those danger levels.

But it is a very different story now - good growth and no inflation worth mentioning. Governments pay less to borrow than at any time in more than a century - even those with high levels of debt. Modest growth exceeds the typical cost of 10-year loans; rapid growth works wonders.

In these circumstances, the present method of including current, capital and interest spending in the deficit looks safely conservative. The Irish Government has made the most of this situation, staying close to, but not above, fiscal balance and allowing surging growth to reduce the debt burden.

Even though this year's budget once again pencilled in a minuscule reduction in the deficit, the debt ratio looks like falling by nine percentage points.

The older method of excluding interest costs still has its uses, because it shows the finances of actually running the country, although you have to hunt a bit to find this 'primary balance' in the budget data.

It is different from the more prominent debt ratio and deficit. While the first shows progress and the second is steady, the primary balance has declined from an average surplus of almost 2.5pc of national income in the last five years to a target of 1.5pc in the current five.

Any significant hit to revenues would wipe that out.

Such a hit could easily come but would it be dangerous? By danger, one means a loss of confidence in the Irish public finances among lenders in the bond market, leading - not to bankruptcy - but higher than average interest rates.

One reason it might is the global level of public debt. As noted in an analysis by the ratings agency Moody's last week, debt in the rich economies is bigger than the levels seen at the end of the bubble in 2008, although well down on the peaks reached fighting the recession.

But three of the biggest, the USA, Japan and Italy, face rising ratios, given their limited progress in reducing deficits, while there has no progress in emerging markets, where debt burdens have grown steadily.

Their interest costs are rising even faster and are forecast to reach 10pc of revenues next year. It is a mixture which could spell general trouble. "The rise in yield-seeking cross-border capital flows has created fertile conditions for a confidence shock to reverberate throughout the world's economies," Moody's say.

Ireland's own credit rating shows it ahead of the other stressed Euro economies of Spain, Italy, Portugal and Greece, in that order, but it is some notches worse than what would qualify as a "flight to safety" in the event of such a confidence shock.

Whatever happens, the Irish die is already cast with the decision not to move into overall surplus. Any such shock is likely to come before much more progress can has been made on the debt front.

We can hope - not entirely unreasonably - that enough progress has been made to avoid serious trouble in the bond markets and the resulting austerity. A more significant question may be the long-term costs of a rapidly ageing population.

At present debt and deficit levels, there is little scope to meet those by borrowing.

A young country with extraordinary rates of growth may yet regret that it did not put more aside - not for a rainy day but for the ordinary days we know are coming.

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