Friday 20 September 2019

Seamus Coffey: David McWilliams’ analysis of private debt is stark ... but it also 100pc wrong

DAVID McWilliams wrote an article for Wednesday’s Irish Independent under the heading "Private debt so enormous that default is only option". The conclusion is stark: In Ireland, given the magnitude of the debt, it is very clear to me that only a fraction of this household and corporate debt will be actually paid off. The figures scream default.

The figures in the piece do indeed scream default, but the figures are wrong. 100pc wrong.

Studies have shown that an appropriate maximum ratio of mortgage debt to gross household income is around four. The data provided in the McWilliams article indicate that total debt in Ireland is more than eight times Gross National Product, a widely used measure of national income. For countries it has been argued that they should not have a debt greater than three times national income.

If Irish debt were eight times national income, Ireland would indeed be bust and there would be no way the debt could even be carried, never mind paid off. With such a debt burden default would indeed be an inevitable outcome.

However, Irish debt is actually around four times national income and using figures 100pc greater than this is misleading. The data come from the Bank of International Settlements (BIS) who try to use gross and unconsolidated data as a measure of overall indebtedness. This can lead to unusual results.

For example, the debts of the financial sector in Greece are put at 7pc of GDP; for Ireland the figure is 259pc of GDP. There are many reasons to expect differences between Ireland and Greece but it is not reasonably to believe that Irish banks are 40 times more indebted than their Greek counterparts.

The reason for the difference is the type of debt measured by the BIS. They try to get a measure of the external liabilities of the banking system. The biggest source of external liabilities in Ireland is the IFSC in Dublin. The IFSC has little or no link to the domestic economy and much of the debts are unconsolidated intra-company debts.

For example, a German bank will have a subsidiary in the IFSC. The subsidiary in Dublin will have huge loans to the parent institution in Germany. These loans will be counted as debt in Ireland but have nothing to do with Ireland and could be eliminated by a few taps on a keyboard by an IFSC-resident bank.

In general, it is actually best to ignore the debts of the financial sector when measuring the debt of a country as financial sector debts generally only arise to fund the debts of the other sectors of the economy; the household, business and government sectors. It is the size of the debts in these sectors that should be of concern.

By focussing on these it still appears that Ireland is grossly over-indebted. The figures suggest that the Irish debt mountain is still over five times national income and into the range of what is unsustainable. For Greece the figure is just over two and half times national income, while for Germany it is less than two.

The main reason for the high figure in Ireland is the supposed debts of the non-banking business sector. The BIS data put this at more than two and a half times national income. By this data, businesses in Ireland have as much debt as the entire Greek economy. Again the structure of the Irish economy and the gross, unconsolidated nature of the BIS data must be considered.

In the aggregate sense, business in the Irish economy is dominated by a small number of multinational companies (MNCs). Although, these companies are make up only a tiny proportion of the total number of businesses and employ about 5pc of the workforce they have a disproportionately large impact on our economic statistics.

For example, 90pc of Irish exports are from the MNC sector. Just as the intra-company debts of the IFSC influences the financial sector data, the figures for the Irish corporate sector are equally influenced by the presence of the MNCs. These debts exist in Ireland but they do not have to be paid by Irish people.

A far better measure of the indebtedness of the Irish corporate sector comes from the Central Bank of Ireland who provide a regular data series called ‘Credit Advanced to Irish Resident Private-Sector Enterprises’. This is the loan liabilities of Irish companies.

The BIS data suggest that the debts of the Irish business sector or over €300 billion. Irish business would never be able to generate sufficient profit to be able to carry this debt. However, the Central Bank of Ireland data show that, excluding the financial sector, business loans in Ireland peaked at €175 billion in September 2008.

Of this, a massive €115 billion was provided to the construction, development and property sectors. Excluding financial and property loans, business debt in Ireland peaked at €60 billion and the tightening of credit has seen that fall to around €45 billion now. Irish business does not need to repay debts of over €300 billion, but a figure of closer to 15pc of that total.

The €115 billion lent to the construction and property sectors has caused huge problems. We know that much of this money will never be repaid and losses on these loans have been added to the government debt through the bank bailout.

If these loans were repaid, government debt would be significantly reduced. They won’t, and government debt will be excessively high. The issue is one of double counting. If the developer loans are being counted in the business sector and the bank bailout is being counted for the government sector, then the same debts are being counted twice. Either the developer repays the loan to the bank/NAMA or the government makes good the loss in the bank. They will not be paid twice.

There is one correct figure in the original analysis and that is the level of household debt. Household debt in Ireland is the largest in the world. This is an inescapable fact and one that is putting a huge drag on the economy.

However, Irish household debt is also very cheap. About one-third of household debt is in incredibly cheap tracker-rate mortgages. The repayments on these are now far lower than when these loans were taken out between 2005 and 2008. In that time the ECB rate has gone from 4.25pc to 1.00%. The average interest rate on these loans is around 2pc..

Irish household debt is more than twice the level of household debt in Greece. However, in 2010, Greek households spent the equivalent of 4.1pc of GDP on interest payments whereas in Ireland the figure was 3.5pc of GDP. Irish households have the burden of huge capital amounts but this is alleviated by substantially lower interest payments.

In fact, for the economy as a whole, Ireland made interest payments of 10.4pc of GDP in 2010. In Greece the figure was 12.1pc of GDP. If Ireland’s debt was almost three times larger than Greece’s as suggested then one would expect our interest burden similarly larger. It is not. That alone is enough to cast huge doubt on the usefulness of the BIS data. In fact the average amount of interest paid across the EU was 8.6pc of GDP. Ireland is above that but not by much.

Rather than using incorrect figures I would put the level of debt in the Irish economy at the end of 2011 as roughly the following:

Household Debt: €186 billion

Government Debt: €167 billion

Business Debt: €145 billion

This is almost €500 billion and is four times Ireland’s Gross National Product. This is an excessive level of debt.

Over the past three years more there has been a reduction of more than €20 billion in household debt. Repayments and write-downs have seen an even larger reduction for business debt. These repayments and write-downs are going to continue. The government sector continues to accumulate debt and steps must be taken to slow down this process.

Ireland has a huge amount of debt. However, we do not need false figures to give a misleading indication of the position we are in. Ireland needs to pay down or see an increase growth income that will bring the debt ratio down from its current four to below three times national income. This is a difficult but not an impossible task.

Seamus Coffey is a lecturer in economics at UCC and a blogger at http://economic-incentives.blogspot.com

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