Much of this morning’s media coverage of the latest ESRI Quarterly Economic Commentary (summary here) has focused on the ESRI’s projection that the 2010 general government balance will be a deficit of 19.75 percent of GDP, which is the sum of the ‘underlying’ deficit of 11.5 percent of GDP and the capital transfer into Anglo/INBS of 8.25 percent of GDP. (Based on the reasonable assumption that Eurostat will adjudicate that the infusions into these banks indeed are capital transfers rather than financial investments.)
This is not really a surprise – the scale of the bank bailout was announced back in April and the accounting issues were dealt with on this site at that time (see here and here). In terms of investor sentiment, the bad news should have been incorporated at that time. Sophisticated investors will understand the distinction between non-recurrent capital transfers and the underlying deficit and also the distinction between accrued liabilities and this year’s funding needs (the use of promissory notes limits the extra funds required this year).
However, beyond the accounting issues, the increase in the government’s liabilities remains a substantial economic and financial cost. In terms of the trajectory for the public finances, debt sustainability requires that an increase in liabilities is met over time with a higher primary surplus – the government will need to raise more taxes and/or cut spending to service the extra liabilities (unless serendipity means that the extra liabilities coincide with a matching upward revision in the forecast for GDP growth).
The next version of the government’s multi-year fiscal framework will need to specify how the opposing forces of the improvement in GDP forecasts and the increase in debt liabilities feed into plans for taxes and spending.
The government has announced lending plans to SMEs from Bank of Ireland and AIB. It has also released the quarterly report of its Credit Reviewer, John Trethowen. Mr. Trethowen has concluded that he has “found no evidence of bank lending policies which constrained the supply of credit to viable businesses in either of the banks.” If this is correct, then the two banks have formulated plans to deal with a problem that apparently does not exist.
In judging these plans, it would be nice if we were provided with information that distinguished stocks and flows. Of the two plans, AIB’s strikes me as slightly more useful in stating that it has “total lending of over €13bn to SMEs at year-end 2009”. This puts the commitment to €3 billion per year in 2010 and 2011 in “new or additional credit” in some context. One would like to believe that this is a commitment to have total SME lending from the bank at €16 billion by the end of the year but I’m guessing this doesn’t have to be the case: Expiry of old loan agreements could, for all we know, match the €3 billion in new and additional credit.
What would be really useful here would be comprehensive statistics on SME lending in Ireland. It is my understanding the Central Bank are preparing to publish such statistics. Hopefully, these will be more useful in assessing the situation than the assurances of the banks or, with respect, Mr. Trethowen.
Though as I write the official release has yet to appear here, the FT is already reporting that the ECB only acquired about €1 billion in sovereign bonds last week, down from the €4 billion or so seen in previous weeks and the €16 billion that occured during its first week. The winding down of the program was quasi-predicted here a few weeks ago.
One interpretation of what has happened with this program is that the ECB reluctantly launched the program despite some internal disagreement to ease tensions in sovereign debt markets, and that once the Stabilisation Mechanism funds were put in place, they have been quick to head for the exit.
Increasingly, it seems unlikely that the ECB will at any point engage in large-scale purchases on the secondary market aimed at keeping access to the primary market open for a specific country such as Ireland. Rather, a closing primary market will instead lead to a country to tapping the Stabilisation Mechanism funds.
Of course, one cannot completely rule out the ECB will re-activate the program on a larger scale if tensions start to mount again. But I wouldn’t bet on it.
Update: Official announcement confirms the figure at 796.5 million.
The latest Daft house price report is now available here. Ronan Lyons discusses the report here and also discusses the need for a property tax.
The report shows asking prices down 36% from peak. Since asking prices during the boom tended to be less than purchase prices while the opposite seems to be the case now, I reckon it’s fair to view this figure as consistent with an actual decline in prices of over 40% since peak.
Are we near bottom? Nothing ever stops real estate vested interests from assuring everyone that things are stabilising and it’s a great time to buy. However, I reckon we still have further to go. The recent Honohan report informed us on page 83 that the (quite sensible) McQuinn-O’Reilly model indicated that house prices were 33% over-valued in 2007:Q2 relative to what could be justified by disposable income and mortgage rates.
This would justify a decline of one-third in house prices even if incomes hadn’t changed. However, nominal GNP has dropped by about 17% since house prices peaked while income tax rates have been increased. Headline mortgage rates are lower now for those on tracker mortgages but the more relevant measure is probably the cost of financing for the marginal new buyer and these are a good bit higher. One also has to factor in that people will need to make allowance for rate hikes to come.
Taken together, I think a peak-to-trough decline of about 60% wouldn’t be too surprising.
Update: John the Optimist reminds me that an overvaluation of 33% corresponds to 25% decline (100/133) which is fair enough. However, to be honest, I was being deliberately understated in the original post. Add in 17% for the decline in GDP, 10% for the effect of increased tax rates, and who knows what for tight mortgage credit and rate hikes to come and one can easily justify greater than 60%.