Month: October 2010

Sticking to 2011 Deficit Goal of 10% Requires €7 Billion Adjustment

Despite all the focus in the past few days on 2014 and European Commission, the key issue facing us right now is the how to convince sovereign bond markets that we are back on a stable fiscal path. Without access to the bond markets, you can be sure that the EU will be imposing the 3% target on us whether we like it or not.

Last December, the government told the EU that our general government deficit would be 11.6% in GDP in 2010 and 10.0% in 2011. So the questions we should now be asking are whether we should still aim to achieve the 10% target and, if not, what are the consequences of missing this target.

Michael Noonan appears to have said yesterday that the Department of Finance briefings called for €7 billion in adjustments. The department is now saying that “Given the current working macroeconomic forecast, indicative deficits were set out for consolidation packages of the order of €3bn, €4.5bn and €7bn.”

Fair enough, they could have set out a no-billion in cuts scenario for all it matters. However, as far as I can see, only the €7 billion scenario sees us meeting the 10% target and this likely explains why Noonan emphasised the €7 billion figure.

This isn’t rocket science. There are four elements to this calculation, none of which are complex or require access to secret figures:

1. Lower GDP: Last year, the government projected that €3 billion in adjustments would get the deficit to 10% of GDP. However, they were projecting GDP in 2011 to be €170 billion. Now, both the Central Bank and the ESRI are projecting GDP in 2011 to be closer to €160 billion. So, hitting the 10% target now requires a deficit of €16 billion rather than €17 billion. Hence, an additional €1 billion in adjustment, bringing the total required adjustment to €4 billion.

2. Promissory Note Interest: The 2009 budget figures did not include the interest on the promissory notes, which appears to be 5% on average. This adds €1.5 billion to next year’s deficit, bringing the total required adjustment to €5.5 billion.

3. Lower Tax Revenues: Tax revenues for 2010 are on target. However, last year’s budget projected a €9 billion increase in nominal GDP in 2011. The Central Bank are currently projecting a €5 billion increase in nominal GDP next year while the ESRI are projecting an increase of only €3.6 billion. Undoubtedly, any credible projection for next year will feature lower tax revenues. In my ongoing calculations (updated here to also include the ESRI’s GDP forecast) I’ve subtracted €1 billion from tax revenues next year. This brings the cumulative adjustment required up to €6.5 billion.

4. GDP Effects of Larger Adjustment: Unfortunately, if additional adjustment of this magnitude is required, then the GDP baseline in the ESRI and CB forecasts are probably too high. Hitting the 10% target will probably require about €7 billion in adjustment.

I’m happy to be corrected about any of these above points but, particularly when one factors in Noonan’s comments, I think it’s reasonable to assume that €7 billion is required to meet the original 10% target.

Is meeting the 10% target really necessary? Might an adjustment of €4 billion to €4.5 billion—perhaps getting us to somewhere between 11.5% and 12% of GDP—be ok if it was accompanied by an impressive-looking four year plan?

It might be but then again it might not. I’d be inclined to recommend assuming the latter. The current EU-agreed plan is already our second plan (there was a previous one in which we reached 3% in 2013). Ripping up this one, so we can start again with a third plan where, after years of cutting, we’ve still only got as far as a 12% deficit next year, doesn’t sound to me like the kind of plan that’s going to work.

So, that’s the debate that needs to be had. Wishful thinking involving only €4 billion in adjustments and still hitting the 10% target just isn’t helpful.

A side-issue in all of this is what exactly the government is (and has been) up to in relation to the budget figures. In relation to point one above, as Philip has pointed out, most of this downward revision in GDP stemmed from the CSO’s annual revision released this summer. Indeed, the Central Bank were projecting nominal GDP in 2011 of €163.7 in July, already over €6 billion short of the original budget projection.  So the government has presumably known the 2011 adjustment requirement was drifting outwards due to this factor for a number of months.

On the second point above, since the government started issuing the magic promissory notes early this year, they will have known about the effect of this on the budget figures for some time.

It seems clear, then, that the government were clinging publicly to a figure of €3 billion in adjustments long after they must have known that this figure wasn’t tenable (e.g. as late as the mid-September Fianna Fail think-in the €3 billion figure was being held to).

Equally, it could be argued that yesterday’s dismissal of Noonan’s comments from, among others, the Taoiseach, also served just to obscure the full scale of the fiscal problem that we face.

Update: I’m not sure if this story pre- or post-dates what I wrote above. It says that “Government sources have firmly ruled out a €7 billion adjustment for 2011.” If so, it looks like they have ruled out meeting their previous target for next year of a deficit of 10% of GDP, though it may be some time before they admit this.

Climate Change Bill

In Q4 2009, the Dept Environment published a Framework for the Climate Change Bill 2010 promising a Heads of Bill by Q1 2010. The Oireachtas Joint Committee on Climate Change and Energy Security decided not to wait for that and published a draft bill. This was “published” to members of the press last week, and has been made available to all this week.

There are two significant differences between the Government’s sketch and the Oireachtas’ draft. First, the Oireachtas sets a target for energy efficiency whereas the Government does not. Second, the Oireachtas puts an Taoiseach in charge whereas the Government puts the Minister of the Environment in charge.

Energy efficiency is a means to an end. Setting an energy efficiency target is therefore inappropriate. Greenhouse gas emissions are primarily from agriculture, energy and transport — that is, beyond the control of the Minister of the Environment. It is therefore appropriate to put an Taoiseach in charge.

The Oireachtas’ draft is considerably more detailed and specific than the Government’s sketch (as you would expect). It is long on creating bureaucracy but short on details how emissions would be cut.

Oireachtas and Government agree that the target for greenhouse gas emissions in 2050 is 20% of the 1990 level.

If we run Hermes/IDEM/ISus out to 2025 and extrapolate trends from there, assuming a 2% annual growth of the economy between 2025 and 2050, we find emissions of 49 million metric tonnes of carbon dioxide equivalent in 2050 — 87% of 1990 levels. 60% is from fossil fuel combustion, and 36% from agriculture.

If we double the rate of decarbonisation of the economy (3.3% for energy, 2.8% for construction, 0.2% for methane, 0.9% for nitrous oxide between 1990 and 2025 in the baseline), 2050 emissions fall to 44% of their 1990 levels.

If we triple the rate, emissions go to 29%. If we quadruple the rate, emissions go to 22%.

Quadrupling the rate of technological progress (broadly defined) is very hard — particularly since Ireland’s baseline rate is rather high compared to other countries.

If we do away with agriculture, 2050 emissions would be 56% of 1990 levels. Doubling the rate of progress in energy and construction would reduce emissions to 17%.

Doubling the rate of technological progress is hard. Methane- and nitrous-free agriculture is not easy either.

It strikes me that 80% emission reduction by 2050 is on the ambitious side.

I would think that it is better to implement realistic policies than to set unrealistic targets.

UPDATE:

He_who_shall_not_be_named pointed out that the Oireachtas draft also has a target for 2020: -30%. We have repeatedly pointed out that the -20% target for that date cannot possibly be met without draconian measures such as a prolonged depression or a ban on cows. -30% is, of course, even more difficult.

Covanta writes off Poolbeg investment

(H/T to Joe & Valerie)

Covanta has written off its entire investment on the Poolbeg project in its 3Q results, citing the “political and regulatory environment” in Ireland. That’s just the sort of language we want in a SEC filing.

According to RTE, Covanta still intends to build the incinerator but does not feel bound to do so.

I’m not sure whether this is more bluff by Covanta, prudent accounting on their part, or a sign that Minister Gormley will after all waste a substantial sum of money, raise waste charges for everyone, and condemn the country’s waste to landfill for years to come.

Ghost Estate Report

From the Department of the Environment “Mr Michael Finneran, T.D., Minister for Housing and Local Services, and Mr. Ciarán Cuffe, T.D., Minister of State, with Special Responsibility for Planning, Sustainable Transport & Horticulture’, today (21 October, 2010) published a National Housing Development Survey.”

In other words, the Ghost Estate report has been published. For reasons best known to themselves, the DoE has only released a summary (link to a Word document here) so far. Is it so difficult to generate a PDF and stick it on the website?

Anglo SubDebt Buyback Offer Announced

Anglo Irish Bank have announced buyback offers for their subordinated bonds. The holders of the €1.5 billion in dated subordinated notes have been offered 20c on the euro, so this will cost the bank €300 million. The holders of the undated perpetual preferred securities (about €700 million outstanding according to page 56 of Anglo’s interim report) are being offered 5c on the euro, at a cost of about €35 million.

It appears that those signing up for the offers also have to vote to give the bank “the right to redeem all, but not some only, of the Existing Notes of each Series at an amount equal to €0.01 per €1,000.” In other words, if a majority of the bondholders acccept the deals on offer, then those who don’t accept will get essentially nothing.

It is disappointing that there has been no statement explaining this decision on the Department of Finance website. With €335 million of taxpayer funds being offered, the public should get a full explanation of why this is money well spent.