Arthur Beesley provides a helpful report on the government’s emerging four-part support request for the banking system (see article here; related front-page article here). I think the plan is based on a broadly correct diagnosis of the challenge of restoring the creditworthiness of both the banks and the State; it is also realistic in not demanding policies that involve large expected net transfers.
With all that was going on in Brussels, the fourth-quarter QNA release got less attention than might have been expected. As usual, the numbers don’t all point in one direction. And also as usual, the quarterly numbers must be treated with caution given their volatility and propensity for revision.
The annual declines in real GDP (1 percent) and real GNP (2.1 percent) received the most coverage. But the annual numbers can give a misleading picture when the economy is at a turning point. A better measure is the percentage change over the same quarter of the previous year. I linked to these graphs on the thread following the release. The noticeable turnaround in real GNP is encouraging (up 2.7 percent on quarter four of 2009); less encouraging is the 0.6 percent decline in real GDP, with the overall performance dragged down by a poor final quarter.
The final graph in the set shows again the “two economies” reality of recent Irish growth performance. The only thing that I would add is that the underlying potential growth of the economy is a critical factor for our capacity to pull out of the debt crisis without default. Recognising the likely impact of the austerity measures on domestic demand, I think the picture is consistent with the (ESRI) view of solid underlying export-driven growth potential.
The main bad news in the release relates to the performance of nominal GDP. The Budget 2011 forecast for nominal GDP in 2010 was €157.3 billion. The actual nominal GDP turned out to be €153.9 billion – a 2.1 percent shortfall over the budget day forecast. Readers might recall that the €157.3 billion was itself the result of an earlier downward revision (see Philip Lane’s explanation here).
If that nominal shortfall carried over to 2014, the deficit would have to be reduced by an additional €94.1 million to meet the 2.8 percent of GDP deficit target for that year. This back-of-the-envelope calculation ignores the impact of any additional deficit reduction on GDP. Of course, there are even more severe implications if we are required to hit the higher intermediate targets along the way (for these targets see Table 6, p. D19 here; see p. D9 for the Budget 2011 nominal GDP projections). For example, an extra €316 million would have to be taken off the deficit to meet the 9.4 percent deficit target for 2011. It should be noted, however, that the poor performance for nominal GDP mainly reflects an eyebrow-raising quarter-on-quarter drop in the final quarter (down 6.6 percent, seasonally adjusted), and could be even more than usually subject to revision.
It has been apparent for some time that proposed design of the post-2013 ESM — notably preferred official creditor status and arrangements for creditor bail-ins — is undermining peripheral country creditworthiness. The so-called bailout mechanisms have the rather grotesque feature that they can suck a country in once it begins to show enough vulnerability.
At the moment, markets do not want to lend to Portugal in large part because markets expect Portugal will enter the bailout mechanisms, increasing the risk they will be caught up as junior creditors in later accelerated bail-ins. This could end up happening well before 2013; hence the surge in our 2-year yields. These fears are likely to be self-fulfilling, despite the resistance of the Portuguese government (no doubt informed by watching what happened to Ireland). As we are learning more by the day, once in, it is damn hard to get out. Peripheral yields have shot up every time the ESM became that bit more certain (latest news on the agreement here). With the evidence so clear, it is hard to understand how European leaders persist with a solution that could end up destroying the Eurozone. The interest rate issue appears a sideshow by comparison.
The FT has a couple of good articles that nicely capture that damage being done to our and others’ creditworthiness (see here and here). A flavour:
Investors warned they could boycott peripheral eurozone bond markets as reform of the region’s bail-out fund sparked fears of a sovereign default in Europe.
Irish three-year bond yields leapt close to a full percentage point at one point on Tuesday, while the cost of borrowing for Portugal and Greece also shot up on worries that one of these countries would have to restructure their bonds.
European finance ministers finally drew up plans to make investors share the burden of potential sovereign defaults beyond the summer of 2013 in a deal hammered out on Monday night. Concerns centre on the preferred creditor status given to European Stability Mechanism, the permanent eurozone rescue fund, which takes up the reins from the temporary fund, in the middle of 2013.
Investors warn that this will mean they will be the last in the queue for the recovery of money in the event of a default. One fund manager said: “We will definitely not buy peripheral bonds now, not with the uncertainty this has created.”
Tamara Burnell, head of sovereign and financials analysis, M&G Investments, said: “This agreement will not do anything further to encourage investors to buy peripheral bonds.
Drawing on the international literature on the costs of default, newly elected Fine Gael TD Paschal Donohoe has written an interesting pamphlet on the option of a unilateral default (see here). Whether you agree with his conclusion or not, it is great to see people of Paschal’s calibre in the new Dáil.
The pamphlet is referenced in Daniel McConnell’s article today in the Sunday Independent (see here). Daniel comes out strongly for a default-now position. He draws heavily on the Prime Time programme on default in supporting this position. One of those quoted is Philip Lane. Not too surprisingly, the short snippets that could be used in the report do not do justice to Philip’s nuanced position. If you haven’t had the opportunity to view Philip’s interview, I think it is well worthwhile to view in full. While recognising the seriousness of the situation, I think he gets the balance just about right (full interview here).
The next milestone in Ireland’s crisis resolution efforts will be the March 31st stress tests. In addition to revealing important information to financial markets, the results of the tests are likely to impact the political debate about the appropriate crisis resolution strategy, not least the contentious issue of default. At the moment, there appears to be a lot of confusion about what the stress tests are all about, which is important to clear up in advance to prevent the release being counterproductive in terms of the political debate. I offer some thoughts after the break, but I hope others will weigh in on the thread.