Friday, July 31, 2015

31/7/15: Irish 1Q 2015 Growth: Quarterly Growth in GDP and GNP

Having looked at sectoral growth contributions for 1Q 2015 and trends in annual (y/y) growth rates in GDP and GNP, let's take a look at quarterly (q/q) growth rates.

On a quarterly basis:

  • GDP at constant prices was up 1.365% q/q in 1Q 2015, which is up on 1.235% growth recorded in 4Q 2014 and on 1.206% growth in 1Q 2014. So we have acceleration in quarterly growth in GDP. We now have five consecutive quarters of positive GDP growth with rates of growth all statistically above zero. Good news.
  • GNP, however, posted a decline in q/q growth of -0.762% in 1Q 2015, which contrasts with 3.43% growth q/q in 4Q 2014 and with 1.554% growth q/q in 1Q 2014. This is the first negative growth quarter for GNP after four consecutive quarters of expansion.

Chart above also shows how dramatically higher volatility in GNP growth figures has been in recent years. Over the entire history of the current series (from 1Q 1997), quarterly GDP growth volatility (measured by standard deviation) stood at 2.0076. This fell to 1.42225 over the period from 1Q 2011. So volatility in GDP growth declined over the recent period compered to historical. The opposite happened with GNP, which had historical volatility of 2.24441 and volatility since 1Q 2011 of 2.6658. So volatility increased for GNP.

Let's look at business cycle data. First, chart below shows contractions and expansions based on GDP q/q growth figures alone:

Next, using both GDP and GNP figures:

The two charts above reinforce the argument that we do indeed have a pretty robust recovery, with 4-5 out of the last 5 quarters on solid expansion trend based on both GDP and GNP, five on basis of GDP alone.

So on the net, the results on a quarterly basis are weaker than on the annual basis, with GNP posting an outright contraction. One consolation is that GNP decline of 0.762% q/q in 1Q 2015 is much shallower than Q4 and Q2 2013, as well as all other cases of declines from Q3 2008 on.

However, negative growth in GNP is worth looking closer at, which I shall do in subsequent posts, so stay tuned.

31/7/15: Irish 1Q 2015 Growth: Annual Growth in GDP and GNP

As promised in yesterday's post, I am continuing to cover the latest data on Irish National Accounts for 1Q 2015. In the first post, I looked at GDP at Factor Cost - the sectoral activity feeding into GDP headline numbers.

This time around, let's take a look at real GDP and GNP trends.

First - y/y growth  rates:

  • Sectoral activity (measured by the GDP at Factor Cost) added some EUR2.47 billion to the real GDP increase in 1Q 2015 compared to 1Q 2014. This resulted in total real GDP growth of 6.51% y/y in 1Q 2015, up marginally on 4Q 2014 annual rate of growth of 5.98% and significantly higher than 1Q 2014 annual rate of growth of 4.13%.  This is strong performance and the good news. 
  • From the top headline number, we now have third consecutive quarter (from 3Q 2014) when 4 quarters cumulative output is in excess of pre-crisis peak levels in real (inflation-adjusted) terms. Which is very good news too. Ironically, on GNP side, we now have four consecutive quarters of cumulated 4Q output in excess of pre-crisis peak. Overall, 1Q 2014 marks the seventh consecutive quarter of positive y/y GDP growth.
  • Meanwhile, GNP posted 7.27% growth y/y in 1Q 2015, which was, imagine that, slower than 9.00% expansion recorded in 4Q 2014, but faster than 4.30% growth in 1Q 2014. 
  • Normally, we would be exceptionally happy with this rate of GNP growth, but since 2013, GNP figures carry substantial 'pollution' from accelerated tax optimisation schemes known collectively as contract manufacturing. Still, faster growth in GNP than GDP suggests that a lot of growth this quarter is coming from organic, real growth on the ground, although we cannot tell how much exactly.
  • Overall, we now have the seventh consecutive quarter of y/y growth in GNP, which is good.

As long-term trends go, the chart below illustrates ongoing recovery in GDP and GNP

As far as the obvious point goes: there is a strong trend recovery in both series, which (sadly, I have to repeat this) is good news. One interesting thing to note is that trend for GNP recovery leads trend for GDP recovery. The reason for this is less pleasant than we like to think: instead of increasing contribution to activity from domestic economy, much of this lead is driven by changes in MNCs tax optimisation schemes, under which:

  1. External activity is being booked into Ireland under 'contract manufacturing' schemes; and
  2. Many profit-generative activities by MNCs are turning into cost-centre activities (booking higher costs into Ireland).

The latter point can be seen by looking at the relationship between GDP and net factor payments abroad, illustrated below in the form of declining share of GDP accounted for by profits & royalties repatriation abroad. This trend is likely to continue and accelerate as MNCs get to more aggressively use our latest tax 'innovation' - the knowledge development box.

Thus, the chart above gives us some, very indirect, indication of how dodgy are our GNP statistics becoming. Though, more on that in subsequent posts.

In addition to the net income outflows, the chart above shows the trend of declining GDP/GNP gap. Current 1Q 2015 GDP/GNP gap is at 18.07%, against the average over 2013-present of 17.28% and a 3mo average of 15.58%, which suggests two driving factors: higher GDP activity and increased outflow of booked profits, alongside exchange rates effects. The latter factor is important as it further compounds multiple distortions in the data from the MNCs.

In summary, evidence continues to show strong growth performance both in GDP and GNP in real terms, with some lingering questions as to the nature of this growth in relation to the MNCs activities here.

Stay tuned for quarterly growth analysis.

Thursday, July 30, 2015

30/7/15: Irish 1Q 2015 Growth: Sectoral Contributions

Some very strong headline figures on Irish growth in 1Q 2015 are out today from the CSO so I will be blogging on these in a number of posts today.

To start with, let's take a look at data on GDP composition at Factor Cost - in other words, contributions of various economic sectors to GDP on output side of the National Accounts. The analysis below references real GDP (adjusted for prices changes).

In 1Q 2015:

  • Agriculture, Forestry & Fishing sector posted growth in output of 5.8% y/y. This contrasts with growth of 21.0% recorded y/y in 4Q 2014 and with 16.5% expansion y/y in 1Q 2014. This is the slowest growth in the sector since Q3 2013. Overall, in annual terms, the sector accounted for 2.02% contribution to the overall GDP growth (Factor Cost GDP) or EUR50 million y/y (compared to EUR194 million added by the sector in 4Q 2014). The sector was the second smallest contributor to growth in GDP (at Factor Cost) in 1Q 2015 after Building & Construction. Quarterly growth in the sector was negative: in 1Q 2015 Agriculture et al sector shrunk (on seasonally-adjusted basis) by 30% compared to 4Q 2014 and this contrasts with 25.4% growth q/q recorded in the sector in 4Q 2014.
  • Industry (ex-Building & Construction) grew strongly in 1Q 2015, posting y/y expansion of 9.63% compared to 8.71% expansion in 4Q 2014 and 0.56% growth in 1Q 2014. This marks 1Q 2015 as the fastest growth quarter (y/y terms) since Q3 2014 and the second fastest growth quarter (y/y) since Q4 2010. As the result, the sector accounted for 39.1% of all growth recorded in GDP (at Factor Cost) in 1Q 2015. The sector was the single largest contributor to GDP (at Factor Cost) growth in 1Q 2015. A caveat here is that this sector growth is strongly influenced by the MNCs, especially Pharma, Bio and Medical Devices sectors, but more on this when I am covering external sectors performance in subsequent posts. Quarter on quarter growth in Industry (ex-Building & Construction) was much less impressive than annual growth rates. In 1Q 2015, Industry contribution to GDP actually was negative on q/q basis at -0.31% compared to 5.16% growth recorded q/q in 4Q 2014 and 3.35% growth recorded q/q in 1Q 2014.
  • Building and Construction sector posted positive y/y growth of 3.26% in 1Q 2015, which contrasts positively with a -0.16% contraction y/y posted in 4Q 2015. However, 1Q 2015 y/y growth was much weaker than 9.66% growth recorded in the sector in 1Q 2014. Overall, Building & Construction sector contribution to growth in GDP (at Factor Cost) stood at 1.38% in 1Q 2015 - the smallest positive contributor to growth in 1Q.
  • Distribution, Transport, Software & Communication (DTSC) sector made a strong contribution to growth in 1Q 2015, with activity up 6.5% y/y. The rate of annual growth is relatively steady in the sector, having posted growth of 5.4% in 4Q 2014 and 5.93% growth in 1Q 2014. The sector accounted for 29.1% of total growth in GDP (at Factor Cost) in y/y terms. The caveat applying to these figures is that the sector includes many ICT-related MNCs which have been recently posting growth in tax optimisation-linked activities. Quarterly growth in the sector was also positive, with 1Q 2015 activity up 2.11% on 4Q 2014, after posting growth of 1.05% q/q in 1Q 2014.
  • Public Administration & Defence (PAD) sector posted another quarter of annual contraction in activity, shrinking -5.52% y/y in 1Q 2015 after posting -3.09% decline in 4Q 2014. In contrast, the sector expanded by 2.21% in 1Q 2014. Overall, sector made negative contribution of -3.4% to annual GDP (at Factor Cost) growth in 1Q 2015. This marks the largest contraction in annual growth rates in the sector since 2Q 2012.
  • Other Services (including rents) sector posted another quarter of steady growth, rising 4.42% y/y in 1Q 2015, having previously posted growth of 4.40% in 4Q 2014 and 4.12% in 1Q 2014. Sector contribution to overall growth in GDP (at Factor Cost) was 30.1% - second largest after Industry ex-Construction.
Chart below summarises sectoral shares of GDP growth in 1Q 2015:

The above clearly shows that the bulk of growth in 1Q 2015 by sector must be compared against growth in exports to attempt to control for MNCs activities before drawing any conclusions about headline growth figures anchoring to the real economy. I will do this in subsequent posts, so stay tuned.

Overall, real GDP at Factor Cost posted growth of 6.1% y/y in 1Q 2015 - a healthy figure compared to 5.28% growth recorded in 4Q 2014 and to 3.87% y/y expansion in 1Q 2014. Thus annual rate of growth accelerated in 1Q 2015 compared to 4Q 2014 and to growth a year ago.  Overall, sectoral activity expanded GDP by EUR2.47 billion in 1Q 2015 compared to growth of EUR2.176 billion in 4Q 2014.

As chart above shows, annual growth rate is currently running above the period average (2012-present) and marks statistically significant rate of annual growth. Which is very good news.

On a quarterly basis, GDP (at Factor Cost) grew by a more modest 0.74% quarterly rate in 1Q 2015, slightly slower than in 4Q 2014 when it expanded 0.79% q/q and much slower than in 1Q 2014 when it grew at 1.57% q/q.  This marks 1Q 2015 as the slowest quarter over the 5 consecutive quarters and the second slowest in 8 consecutive quarters.

Longer-term trends:

Based on annual rates of growth and levels performance, Irish real GDP (at Factor Cost) is on a renewed positive trend. Once again - good news.

Stay tuned for more analysis of the National Accounts figures in subsequent posts.

Wednesday, July 29, 2015

29/7/15: Retail@Google: Key Trends on Consumer Demand

Google folks made their Retail@Google event publicly available via videos. Worth listening through on key trends in consumer demand and retail services. The full even pages are here:
- Day 1
- Day 2

My own contribution to the event is here: I am looking at 7 key themes of the future in consumer demand, driven by geography of growth, technology and consumer demographics.

Monday, July 27, 2015

27/7/15: Irish Property Prices: 2Q 2015

Latest data from CSO for June 2015 shows significant slowdown in house prices inflation across all segments of the market.

Monthly results are summarised in the table below

Using historical data, quarterly figures are pretty poor:

  • Dublin residential properties index in 2Q 2015 was 15.4% up on same period in 2014, which marks a major slowdown in growth from 21.9% y/y growth recorded in 1Q 2015.
  • Outside Dublin residential property prices rose 10.98% y/y in 2Q 2015, which is faster than 9.39% rise in 1Q 2015.
  • National residential prices were up 13.40% in 2Q 2015 compared to the same period in 2014, while 1Q increases were slower at 15.75%.
  • Compared to 2Q 2014, y/y growth fell in Dublin and Nationwide, but rose Outside Dublin

Finally, based on the first 6 months of 2015, here is the current residential price index for Dublin compared to long-term fundamentals price trends (at inflation and at ECB target rate):

So what is going on in the markets to drive prices inflation moderation?

  1. Poor affordability: wages growth did not keep up with prices inflation in recent years, which means that once the savings pool for downpayment cushions is exhausted, households will be finding it increasingly difficult to secure purchases at current prices. Affordability is also impaired by rising rents - which take larger and larger chunks of household income that could have gone to savings for a downpayment on mortgages.
  2. Households' purchasing power in the property market was also reduced significantly by new lending caps introduced by the Central Bank of Ireland back in February this year. Caps restrict mortgages to LTV ratios <80 15="" 85="" all="" be="" can="" for="" in="" issued.="" issued="" loans="" mortgages="" new="" of="" only="" other="" words="">80% LTVs. Additional caps apply to loan-to-income (LTI) ratios, with only 20% of new loans allowed to exceed 3.5x income. Irish house prices are currently at around 5x average / median income nationwide and 6x in Dublin Worth noting that CSO series for house price indices are based on 3mo average, so February changes can be expected to feed through into data from around April on. 1Q effect was largely anticipatory, while 2Q effect is now pricing CBI rules changes.
  3. Geographically - the above effects are compounded in Dublin where income ratios are more stretched and rents are higher and rising faster.

In line with the above, transactions volumes are slipping as well: in 1Q 2015 volume of transactions registered in Ireland was up 54% y/y - signalling buyers booking in pre-restriction mortgages. In 2Q 2015 this appears to have fallen (data is still incomplete) to a 17-19% growth rate y/y. Compared to FY 2014 average increase of 45% this rate of transactions growth is low, although in my view, the supply of quality properties in the market has also moderated significantly in recent quarters.

Are we going through another boom-to-bust sub-cycle here? I am not sure. All will depend on what prices will do over the next 12 months or so, with potential trend change (from downside to growth) around 1Q 2016. Too far to call.

27/7/15: IMF Euro Area Report: The Darker Skies of Risks

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang, while the second post presented IMF views and data on the euro area banking sector woes. The third post covered IMF projections for growth.

So let's take a look at the risks to the IMF's 'growth returns to Euro zone' scenario.

Per IMF: "Risks are now more balanced than in recent years when vulnerabilities dominated. On the upside, low oil prices, QE, a weaker euro, and rising confidence could bring larger than anticipated benefits. Downside risks include lingering weakness and low inflation, a potential
slowdown in emerging markets, geopolitical tensions, and financial market volatility, whether due to asymmetric monetary policies or contagion from events in Greece."

Now, let me translate this into human language:

1) Eurozone has no real drivers for current growth uptick (which is weak to begin with). Instead, all it got to brag about are: QE (extraordinary monetary policies); QE-induced weaker euro (beggar thy neighbours trade policies), some rising confidence (hopping mad global asset markets bidding everything up on foot of global QEs - extraordinary policies); and lastly - lower oil prices (that sign of global economy on a downward slide). Congratulations to all - hard work and enterprising are not required for this sort of growth.

2) Eurozone's abysmal growth is at a risk from:

  • 'lingering weakness' (aka structural non-reforms that Europe worked so hard to achieve since 2008, we are all in tears… so lots of sweat, not much of gain here) and 
  • 'low inflation' (a euphemism for consumers and investors on strike in this promised Land of Plenty); and 
  • 'potential slowdown in emerging markets' (that thingy that makes oil cheaper - take you pick, Euro area: get crushed by higher oil prices in presence of EMs growth or get squeezed by lack of EMs growth in presence of low oil prices), 
  • 'geopolitical tensions' (aka: Russkies not playing the ball with Good Europeans by refusing to buy their apples), and 
  • 'financial market volatility' (wait: what on earth have we been doing since 2007 other than fight the said financial markets volatility? Looks like lots of successes here, if the said volatility is still a risk), 'whether due to asymmetric monetary policies' (in other words, if the Fed hikes rates too early too fast) or 'contagion from events in Greece' (would that be the same Greece that has been ring fenced and repaired? most recently this month?).

You have to wonder: IMF effectively says all risks that were in the euro area in ca 2011 are still in the euro area in ca 2015…

Now, recall that some time ago I said that the next step for Europe will be a fiscal / political union with less democracy for all and more technocracy for the few? (link here). And IMF does not disappoint on this too.

"Beyond the near term, there should be a concerted effort to accelerate steps to strengthen the monetary union and European firewalls. Fully severing bank-sovereign links would require a common deposit insurance scheme with a fiscal backstop, a larger and fully funded Single Resolution Fund, and easier access to direct bank recapitalization from the ESM. The greater risk-sharing implied by these measures should be underpinned by a strengthened fiscal and structural governance framework which could require possible Treaty changes. These reforms are desirable in any case, but accelerated progress could help bolster market confidence in the face of recent events."

What have we learned from the above? Why, of course that the frequent claims by the EU officials that Europe now has fully severed contagion links between banks and taxpayers are… err… a lie. And that common claims by the European officials that we now have a genuine monetary union infrastructure is also a lie. And that to make these two claims not to be a lie we will need something/rather that requires 'possible Treaty changes'… which is of course a political and fiscal union. So kiss that national sovereignty and self-determination bye-bye… assuming you still believe such exist in the Euro Land.

Here is full IMF risks assessment matrix:

Now, do some counting: out of 7 key risks, four have either high probability of occurring or bear high impact if they should occur or both.

Now, all of the above still generates a positive outlook under the IMF forecasts - positive, meaning GDP growth over 1.2-1.4 percent, never mind GDP growth anywhere near that of the U.S.

But then the IMF goes slightly gloomier and paints a "Downside Scenario of Stagnation in the Euro Area". Here we are getting some traction with highly probable reality by the highly diplomatic Fund.

"Subdued medium-term prospects leave the euro area susceptible to negative shocks. A modest shock to confidence—for example, from lower expected future growth, or heightened geopolitical tensions—that lowers private investment could affect households via labor income and wealth. Expectations of lower inflation at the zero lower bound would keep real interest rates high. For countries with high public debt, risk premia could rise, amplifying the shock and raising the risk of a debt-deflation spiral. Policy space would be limited with short-term interest rates at the zero lower bound and public debt high in countries with large output gaps (Bullard, 2013)."

What the above really means is that, given we are already in the environment of zero policy rates and unprecedented money printing by the ECB, any further shocks will have nothing offsetting them on policy side as

  • Monetary policy has fired almost all its bullets already, and
  • Fiscal policy has no bullets because of already high levels of debt, whilst
  • Currency devaluation policy is not an option in the monetary union dominated by Germany.

Welcome to Hope Street where things can only go as smoothly as today, forever.

"An illustrative downside scenario, assuming lower investment for all euro area countries and increased risk premia for high debt countries, suggests that euro area output could be nearly 2 percent lower by 2020." Guess what: 2020 forecast growth is 1.5% (link here) which means that IMF is saying it will be -0.5% aka another recession.

"The main channels would be through higher real interest rates depressing investment and consumption as well as lower inflation and wage growth constraining adjustment within the euro area." Which means IMF is now fully buying into the Secular Stagnation (Demand Side) scenario I wrote about here.

"The impact would vary across countries with real interest rates higher in countries with weaker balance sheets. Fragmentation progress would reverse and public debt would increase more in high debt countries due to lower fiscal balances and nominal output. “Bad” internal rebalancing would follow, as current accounts in high debt countries would rise due to import compression. Lower inflation would worsen external imbalances, by forcing countries with large output gaps and imbalances to adjust through lower prices and employment."


So projections:

Double Yeeeeks!

27/7/15: IMF Euro Area Report: Growth, of European Standards

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang while the second post presented IMF views and data on the euro area banking sector woes.

Here, let's take a look at headline growth outlook.

Based on the IMF view: in the Euro area, "the recovery continues. After weakness through mid-2014, growth picked up late last year and has continued in 2015, driven by domestic demand. Private consumption remained robust, reflecting rising employment and real wages, while fixed investment has expanded moderately. Among the large economies, Germany continues to grow slightly above 1½ percent, while Spain is rebounding strongly. Italy is emerging from three years of recession, and activity in France picked up at the beginning of this year."

This sounds good. Until it ain't. Chart below shows that growth drivers remained in 1Q 2015 the same as in 4Q 2015:

And more: stripping the uplift in inventories, headline GDP growth in 1Q 2015 would have been worse than in 4Q 2014. And, despite collapse in oil (energy) prices and increase in consumption, imports have increased their drag on GDP growth.

Meanwhile, Industrial Production is virtually flat, as is Construction activity:

So the net medium-term result is bleak: "Despite the cyclical upturn, growth of only about 1.6 percent is expected over the medium term, with potential growth averaging around 1 percent. The output gap would close around 2020 with unemployment still near nine percent and inflation reaching 1.7 percent, somewhat below the ECB’s medium-term price stability objective. The picture is more disappointing in comparison to the U.S. with the per capita income gap now the largest since the start of EMU, and projected to widen further."

How much further? Oh, take a look at these:

A positive scenario uplift can only be expected from long-term and painful reforms. IMF lists them here:

"A scenario combining monetary easing, fiscal support under the SGP, and comprehensive structural
reforms would include:

  • Monetary easing. Current interest rate policy continues through 2020 and QE through September 2016.
  • Fiscal space within the SGP. For the eurozone, fiscal space available within the SGP could amount to 0.6 percent of euro area GDP. This includes (i) room under countries’ Medium-Term Objectives (MTOs) (0.3 percent of euro area GDP); (ii) SGP flexiblity that a few qualifying countries could use for structural reforms (0.2 percent of euro area GDP); (iii) windfalls from lower interest payments due to QE (0.1 percent of euro area GDP) for one-off investments or structural reforms for a few countries already meeting their MTOs; and (iv) growth-friendly fiscal rebalancing for countries with limited fiscal space to lower the labor tax wedge by two percentage points, financed by base-broadening measures.
  • Centralized investment. An increase in private investment of 0.2 and 0.8 percent of euro area GDP in 2015 and 2016 is assumed, which is equivalent to 1/3 of the targeted amount of European Fund for Strategic Investments (EFSI) projects.
  • Clean-up of bank and corporate balance sheets A fully functioning credit channel is simulated as a decline in corporate borrowing rates, by 80 basis points in Italy, 25 basis points in Germany and France, and 50 basis points in the rest of the euro area. This would bring the spread between selected and core countries roughly to pre-crisis levels.
  • Structural reforms. Gradual implementation of product and labor market-related reforms in the 2014 G20 Comprehensive Growth Strategy could increase total factor productivity (TFP) by about 0.1 percent in 2015, 0.5 percent in 2017, and 0.9 percent in 2020. The implied TFP changes would differ substantially among member countries, with France, Italy, and Spain enjoying the largest gains."

So combined effect of the above over the longer term: "The growth dividend of a balanced policy mix can be large. The EUROMOD module of the IMF’s Flexible System of Global Models (FSGM) points to a substantial growth dividend, particularly from fiscal policies and the improvement of the credit channel. Real growth for the euro area would increase by 1.3 and 1.4 percentage points to 2.7 and 3.0 percent for 2015 and 2016, and HICP inflation rate in these two years would rise to 0.6 and 2.1 percent. The output gap would close by the end of 2016, about four years faster than in the baseline, and unemployment would be 0.8 percentage point lower than in the baseline by 2016."

Which is, honestly speaking, laughable because of two points worth noting:
1) There is an ongoing and deepening reforms fatigue which is pushing the reforms horizon out toward the next downturn cycle (in other words, we are unlikely to see majority of real reforms to be enacted before the next recession strikes); and
2) Even with all things going the IMF way, unemployment will remain atrociously high. In other words, growth uptick even in the best case scenario is likely to be largely jobless.

So summary of growth uplift drivers is in the chart below:

Expect the expected: looser fiscal policy being the largest new contributor to growth in 2016; labour markets and product markets reforms being marginal - adding at most 0.25-0.3 percentage points to annual growth rates. The fabled 'credit conditions improvements' (banks doing their bit for growth) is expected to be minuscule (despite all the hopes attached to them by the likes of Irish authorities and all the resources of the state devoted in 2008-2011 to repairing them). And headline growth expectations for baseline scenario still resting at 1.7% and 1.6% GDP growth in 2016-2017.

Here is the summary of IMF projections out to 2020:

Yep, the first line of projections above shows perfectly well the poverty of low aspirations that Euro area has become, while the unemployment rate projections confirm the same. Everything else - all the talk about structural reforms, growth drivers and the rest - is pure unadulterated bull. Even in the age of massive QE, collapsed oil / energy costs, and improvements in [sliding back on] fiscal 'reforms', the euro area remains the sickest economy in the advanced world.

27/7/15: IMF Euro Area Report: The Sick Land of Banking

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang.

So here, let's take a look at IMF analysis of the Non-Performing Loans on Euro area banks' balance sheets.

A handy chart to start with:

The above gives pretty good comparatives in terms of the NPLs on banks balance sheets across the euro area. Per IMF: "High NPLs are hindering lending and the recovery. By weakening bank profitability and tying up capital, NPLs constrain banks’ ability to lend and limit the effectiveness of monetary policy. In general, countries with high NPLs have shown the weakest recovery in credit."

Which is all known. But what's the solution? Ah, IMF is pretty coy on this: "A more centralized approach would facilitate NPL resolution. The SSM [Single Supervisory Mechanism - or centralised Euro area banking authorities] is now responsible for euro area-wide supervisory policy and could take the lead in a more aggressive, top-down strategy that aims to:

  • Accelerate NPL resolution. The SSM should strengthen incentives for write-offs or debt restructuring, and coordinate with NCAs to have banks set realistic provisioning and collateral values. Higher capital surcharges or time limits on long-held NPLs would help expedite disposal. For banks with high SME NPLs, the SSM could adopt a “triage” approach by setting targets for NPL resolution and introducing standardized criteria for identifying nonviable firms for quick liquidation and viable ones for restructuring. Banks would also benefit from enhancing their NPL resolution tools and expertise." So prepare for the national politicians and regulators walking away from any responsibility for the flood of bankruptcies to be unleashed in the poorly performing (high NPL) states, like Cyprus, Greece, Ireland, Italy, Slovenia and Portugal.
  • And in order to clear the way for this national responsibility shifting to the anonymous, unaccountable central 'authority' of the SSM, the IMF recommends that EU states "Improve insolvency and foreclosure systems. Costly debt enforcement and foreclosure procedures complicate the disposal of impaired assets. To complement tougher supervision, insolvency reforms at the national level to accelerate court procedures and encourage out-of-court workouts would encourage market-led corporate restructuring."
  • There is another way to relieve national politicians from accountability when it comes to dealing with debt: "Jumpstart a market for distressed debt. The lack of a well-functioning market for distressed debt hinders asset disposal. Asset management companies (AMCs) at the national level could support a market for distressed debt by purchasing NPLs and disposing of them quickly. In some cases, a centralized AMC with some public sector involvement may be beneficial to provide economies of scale and facilitate debt restructuring. But such an AMC would need to comply with EU State aid rules (including, importantly, the requirement that AMCs purchase assets at market prices). In situations where markets are limited, a formula-based approach for transfer pricing should be used. European agencies, such as the EIB or EIF, could also provide support through structured finance, securitization, or equity involvement." In basic terms, this says that we should prioritise debt sales to agencies that have weaker regulatory and consumer protection oversight than banks. Good luck getting vultures to perform cuddly nursing of the borrowers into health.

Not surprisingly, given the nasty state of affairs in Irish banks, were NPLs to fall to their historical averages from current levels, there will be huge capital relief to the banking sector in Ireland, as chart below illustrates, albeit in Ireland's case, historical levels must be bettered (-5% on historical average) to deliver such relief:

Per IMF: "NPL disposal can free up large volumes of regulatory capital and generate significant capacity for new lending. For a large sample of euro area banks covering almost 90 percent of all institutions under direct ECB supervision, the amount of aggregate capital that would be released if NPLs were reduced to historical average levels (between three and four percent of gross loan books) is calculated. This amounts to between €13–€42 billion for a haircut range of between zero and 5 percent, and assuming that banks meet a target capital adequacy ratio of 13 percent. This in turn could unlock new lending of between €167–€522 billion (1.8–5.6 percent of sample countries’ GDP), provided there is corresponding demand for new loans. Due to the uneven distribution of capital and NPLs, capital relief varies significantly across euro area countries, with Portugal, Italy, Spain, and Ireland benefiting the most in this stylized example."

A disappointing feature, from Ireland's perspective, of the above figure is that simply driving down NPLs to historical levels will not be enough to deliver on capital relief in excess of the average (as shown by the red dot, as opposed to red line bands). The reason for this is, most likely, down to the quality of capital held and the impact of tax relief deferrals absorbed in line with NPLs (lowering NPLs via all but write downs = foregoing a share of tax relief).

Stay tuned for more analysis of the IMF Euro area report next.

27/7/15: IMF Euro Area Report: Debt's a Mean Bitch…

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day.

The first post looks at debt overhang.

Per IMF, low inflation environment in the Euro area is "pushing up real rates, more in countries with higher debt burdens"

And here's a handy chart from the Fund:

Note: Net debt is the total economy’s financial liabilities minus assets.

Broadly-speaking, with annual expected inflation at or below 1%, we have serious pressure on Portugal and Spain, where Government borrowing costs (and by some proximity, banks funding costs) have not declined as dramatically as in, say, Ireland. The second sub-group at risk are countries with lower debt ratios, but still high enough funding costs - Slovenia and Italy. Ireland is in a separate category, having enjoyed significant declines in cost of funding, without a corresponding improvement in debt ratios. In other words, for Ireland, so far, the challenge is less of day-to-day funding of debt, but the quantum of debt outstanding. Short-run sustainability is fine, but longer run sustainability is still problematic.

The problematic nature of debt carried across the euro area goes well beyond the sovereign cost of funding and into the structure of European banks balance sheets.

Per IMF: "A chronic lack of demand, impaired corporate and bank balance sheets, and deeply-rooted structural weaknesses are behind the subdued medium-term outlook:

  • Insufficient demand. Business investment continues to lag the cycle, remaining well below pre-crisis levels, reflecting weak demand, as well as high corporate debt, policy uncertainty, and tight credit. While overall unemployment has begun to recede, it remains above 11 percent, with long-term and youth unemployment near historic highs. Fiscal policy is broadly neutral, but is not providing offsetting support.
  • Weak balance sheets. The ECB’s comprehensive assessment (CA) found that banks had raised capital, but also saw NPLs continuing to rise, reaching systemic levels in some countries. High levels of NPLs and debt have held back bank lending and investment, limiting the pass-through of easier financial conditions. Europe’s experience contrasts sharply with that of the U.S. recently and Japan in the 2000s where, after their financial crises, aggressive NPL resolution helped support a faster recovery in credit.
  • Low and divergent productivity. Progress on structural reforms has been piecemeal and uneven across countries, as highlighted by the slow implementation of Country-Specific Recommendation (CSR) reforms under the European Semester. Productivity remains well below pre-crisis levels and lags the U.S., especially in important sectors such as information technology and professional services."

Note, I wrote extensively on the three factors holding back credit cycle before and recently testified on the subject at the Joint Committee on Finance, Public Expenditure and Reform, the Houses of the Oireachtas:

Here is a chart highlighting the state of NPLs across the Euro area, U.S. and Japan which shows just how dire are the conditions in European banking really are:

Even by provisions measure, Europe is a total laggard. Which means there is plenty more delve raging left in the system.

And here is the IMF chart on productivity:

Which really neatly highlights the debacle that is euro area productivity growth: we have a massive uplift in unemployment during the crisis. Normally, rising unemployment automatically induces higher labour productivity through two channels: by destroying more jobs in lower value-added sectors, and by destroying jobs of, on average, less productive workers. In Europe, of course, the former factor did took place, but there was no corresponding retainment of activity in the higher value-added sectors, and the latter factor did not take place because of inflexible labour markets (for example, unions rules preventing lay offs of less productive staff, basing any employment adjustments on superficial criteria of tenure and/or union membership/contracts structures). So net result: jobs destruction (bad) was not even contributive to improved productivity (bad). But things are actually even worse. Chart below shows the distribution of productivity growth by broader sector, comparing euro area and the U.S.:

This is truly abysmal, for the euro area, which managed to post negative growth in productivity in Professional Services, and undershoot U.S. productivity growth in everything, save agriculture (where U.S. already enjoyed significant pre-crisis advantage over the EU, which implies normally lower productivity growth for the U.S.) and Construction (where the U.S. has enjoyed more robust recovery since 2010 against continued decline of activity in the euro area).

Yeah, remember those flamboyantly delightful days of denial, when everyone was keen on repeating the Krugmanite thesis that 'debt doesn't matter'? In reality, debt overhang is such a bitch… especially when it comes to messing up value-added investment and productivity growth. But never mind - Europe is not about these capitalist concepts, with its Knowledge Economy (as measured by IT and Professional Services and Manufacturing) shrinking in both metrics compared to the U.S.

Stay tuned for more excerpts and analysis from the IMF report.

Sunday, July 26, 2015

26/7/15: That Seagull Flock Model of Public Governance: The Banking Inquiry

Second, following the previous post on Nama, is the Banking Inquiry news:

The Banking Inquiry also has now adopted the Seagull Model for public transparency and governance: there are scandals and tantrums left, right and centre of the political spectrum. The gig is, of course, less of a maritime evocation as it is with Nama, and more of the landfill nature, but you get the picture.

Some chronology on the matters at hand:

  • Back in mid-July there were reports that a whistleblower - someone working for the Inquiry - came forward in April 2015 with the allegations that "relate to alleged preferential treatment which the whistleblower feels was given in the workings of the investigation team to the Central Bank and the Department of Finance. It is suggested the Central Bank insisted on a whole series of redactions in documents that it supplied. It is also being suggested that the Central Bank, at a critical point, was allowed a lengthy meeting with the lead investigator." Now, for those who do not know this, the Inquiry has two teams of 'advisers' - one that goes over submitted evidence and distills it to the members of the Inquiry - as far as we know, that team is composed of the Oireachtas employees - and another that prepares questions to be put forward by the members - which includes former banks and finance sector employees. Note: this is an important bit for the subsequent link on the matter from today.
  • Sunday Times a week ago also carried some details of the whistleblower allegations, specifically alleging that a number of undocumented meetings took place between the Central Bank, Nama and senior investigators on the banking inquiry. Other sources also include Department of Finance into the august list of entities allegedly granted unprecedented access to pre-brief the inquiry investigators. The same Sunday Times article also claims that: "It is understood allegations have also been made to Marc MacSharry, a Fianna Fail senator and inquiry member, that a second investigator quit the banking inquiry team on May 13 this year, citing concerns similar to those raised by the whistleblower."
  • Check the timeline: April 27 whistleblower allegations filed, May 13 another Inquiry official resigns on similar concerns, July 15 whistleblower allegations are leaked to press, July 23 inquiry into allegations set up. Things become swift, in Ireland, only after the media gets the news. Never before.

    • So on foot of the publicly leaked allegations, it was decided to do the most Irish of All Things and… hold and Inquiry into the Banking Inquiry.  As an aside, while the previous FF/GP/PDs governments can be collectively accused of having Leadership by Quangos fetish, the current one can be assigned a monicker of Leadership by Inquiries.
    • And, in a typical Irish fashion, the Inquiry into the Inquiry (shall we call it IiI here?) will have terms of reference that will include hunting down the wrongdoing of leaking the allegations to the media. As reported here: "The Oireachtas tonight released the terms of reference for Mr Allen’s investigation. He will investigate allegations that false information was given to Oireachtas Committee members, and preferential treatment was given to certain witnesses. The investigation will also look at alleged conflicts of interest that it is claimed were not appropriately handled by the inquiry’s investigation team. Mr Allen will also be required to examine the allegations in the context of the legislation underpinning the Bank Inquiry. The leaking of information to a journalist named by the whistleblower will also form part of the investigation." We can get a good sense of where the findings will go: a new battle between politicos and journos. There will be war… 
    • But, fear not: we already have one outcome of the whistle blowing scandal: the whistleblower has been punished. Per same report "The whistleblower’s pay has been suspended since last week after, it is claimed, they refused a transfer from a section within the Banking Inquiry." That should teach everyone a lesson: Ireland tolerates no whistle blowing. Never did and never will. Get over it, folks, and keep on pretending we have a modern society with all the trappings of transparency and ethics. This was confirmed in the Irish Times report here: "After the allegations were made, the whistleblower claims that their duties as an investigator were transferred on April 27th. A “false announcement of my resignation” was made during the week beginning June 1st, and their desk was cleared. Notification of their salary being suspended was received on July 15th."
    • Of course the irony is that back in March, the Inquiry heard from Dr Elaine Byrne that whistleblowers need not only be protected, but rewarded for their actions. Ah, yes… back to Ireland, thus...

    • Last week, the Irish Times carried some select excerpts from the whistleblower communication. These are worth reading: "The whistleblower claims that the terms of reference for a review of the allegations to be carried out for the Houses of the Oireachtas Service by Senior Counsel Senan Allen while including consideration of the claim that certain participants received favourable treatment do not detail or substantiate the allegations which include “off-the-record telephone calls and meetings” and “improper pressure on certain investigators to exclude certain relevant witnesses”.” It is also alleged that there was “significant ongoing and detailed leaking of information by a certain investigator” to a national newspaper. And the whistleblower claims that they were “routinely instructed to disregard redacted material” emanating from an unnamed institution, which “in my view could have proven to be extremely relevant to the proper processing of the investigation”. The “instructions were relayed to me by superiors and included instructions to inform the Joint Committee of Inquiry that participants had complied with matters related to compelled documentation, when in my view, participants were not compliant”. The “participants” are believed to be the Central Bank of Ireland and the Department of Finance." And further: "The whistleblower claims they were prevented from engaging in “basic investigative work and from exploring valid lines of inquiry”. “I am extremely concerned that the timeframe given to Senan Allen to conduct this investigation will ultimately lead, particularly in light of the limited terms of reference and in conjunction with the limited term period for a review, to a sub-standard and wholly inadequate review that will not broach the complexity of the allegations raised by me,” the whistleblower added. “Furthermore, the terms of reference are silent on the requirement to investigate the origin, publication and distribution of the false and defamatory statements made about me in an official report dated May 6th produced by the Houses of the Oireachtas service.”

    All of this brings us to the latest round of revelations from the Banking Inquiry published today in the Indo. Ah, the pearls include:

    • That "Morgan Kelly, Professor of Economics at University College Dublin, who notably predicted the property collapse, has turned down an invitation to appear before the inquiry." Frankly, why am I surprised? Why would anyone be surprised. Morgan is a serious scholar and has little time for the farcical performances. 
    • And then there is the controversy over political hissy fits triggered by the offer from David Drumm to testify on the matters of his recollection of the meetings with former Taoiseach Brian Cowen. Which I covered yesterday here.
    • For the last bit, the juiciest fare so far: "…the whistleblower has claimed this investigator, who was deciding what documents from the banks should be entered in evidence, secured a new job with the Bank of Ireland while working for the inquiry. The whistleblower was "shocked" when it was decided to allow the investigator work out his notice period with the same access to bank documents after he had accepted the Bank of Ireland job offer." 
    Oh dear… Where does one go from this? To 2016 headlines about some Inquiry staff getting cushy jobs in the state bodies with allegedly cushy relationships with the Inquiry?.. What is next for the Cosy Planet 'Ireland'?

    26/7/15: It Rains, It Pours... And Next There Can Be a Deluge ...over Nama

    When it rains, it darn well pours… in the case of Nama and Irish Banking Inquiry, the rule is iron clad.

    First, Nama:

    Just yesterday I posted two links on most recent allegations concerning Nama in Northern Ireland. And today, we have a couple from the Republic.

    Per first link, apparently, "A furious row has erupted between developer Michael O'Flynn and Nama following his appearance before the Banking Inquiry." The row is about Mr O'Flynn's claim that he was pressured to sell assets to 'preferred bidders' over the top bidders.

    Nama says this is not true.

    We have no idea as to who to believe, although Mr O'Flynn has nothing to gain from making up anything about Nama, given he has now existed the wretched institution and is free to return to normal life. And Mr O'Flynn appears to have more to say about Nama that seems to be pretty much in accord with what other Namaed developers are saying and what Nama seems to be denying as well. "Mr O'Flynn said while the O'Flynn Group had formulated a business plan for Nama aimed at repaying all the money it owed, this had been rejected without any discussion in relation to its content".

    Which, of course, brings us back to that notion of value destruction that Nama should address before any inquiry into Nama attempts to address it.

    Recall that Nama required all developers to submit Business Plans. Following their reviews by Nama, Nama issued simple 'decline' letters, requiring new plans to be re-submitted. Nama subsequently rejected a vast majority of these as well. So far - pretty bad, but it gets worse. Nama rejections came with zero specific details given as to the exact reasons for the agency decision. These plans were prepared by professional teams (not by developers personally) and contained very detailed pricings, costings, analysis etc of assets covered by the plans, based on external evaluations, existent permissions and ventures, and so on. Nama appears to have offered no substantive reasons for the rejections of substantive plans. In the case of O'Flynn the allegation is now on the record. In at least five other cases that I am familiar with  the same has been also alleged and in some formed part of submission to the courts.

    The rejections of at least some plans led to Nama pursuing strategies for managing underlying assets that can be questioned in terms of their ability to deliver maximum value return to both the taxpayers and the original borrowers (Nama owes the latter the duty of care in relation to their assets). The shortfalls arising from Nama failure to execute reasonable plans was loaded, through personal guarantees, on the original borrowers. Which, effectively, means that for some reasons, undisclosed to anyone, Nama has opted to potentially dump vast amounts of risk and costs onto original borrowers. It would be damaging enough were this was done with at least a token of propriety in the form of explaining the rejection of the Business Plans. But it is doubly bad given that Nama seemed to have simply dismissed the Plans without any explanation.

    The second link is more distant to Nama operations than the first, so I won't cover it in any detail here. Still do enjoy Indo's "Daly's charity role is 'private'". Hint: keep an eye out for familiar names...

    No wonder the whole place at the higher reaches of the Grand Canal St is now resembling the flock of seagulls abandoned at sea by a fishing trawler: noise, feathers, chaos…

    Stay tuned for the Banking Inquiry shambles post next.

    Saturday, July 25, 2015

    25/7/15: Nama: Some Colder Winds from the North...

    Ah, the Dear Nama, the outpost of taxpayers interests, the Beacon of the New Ireland (not to be confused with the financial company of the same name) reborn by the FF/GP/FG/LP efforts over the recent years, efforts yielding path-breaking reforms in transparency and governance that the Beacon exemplifies.

    The shining light… that comes from the North and the South… right?…

    - Newsletter story about the [some might say unhealthy] curiosity in Nama taken by some Ministers up North. There are [comfortably, for coach spectators down South] now familiar household names, as well as now expected whig of [pungent not] airs of something going on. But all to be revealed in some hearings that "NAMA has already said that it will not attend…" Nothing is confirmed, of course, so all questions to the Newsletter, please.

    - And there is a blog posting something claimed to be documents with an enticing headline "Paddy Kearney released from Cerberus loan debt thanks to Robinsons ‘influence’ #NAMA". Probably about more hearings that Nama will not attend. But again peppered with the Northern names so familiarly comforting to the readers in the South. That said, as stated above, nothing is confirmed, so all questions to the Northern Irish folks, please.

    Yes, yes… keep in mind, the rates of return are what matters in Nama relation to us all… rest… why, yes - a roadkill of bad publicity.

    Meanwhile, talking of bad publicity [unrelated to Nama], Drummer is itching to give Brian Cowen a proverbial black eye: Which, of course, won't be allowed to happen, because the narrative of 'Bad Anglo, Good Public Servants' [including those very absent-minded and forgetful politicians... remember the horrible thing they did to Uncle Bert by dragging him into the spotlight of the Banking Inquiry? Good thing that went nowhere, fast...] must be maintained as the sole explanation for the bankrupting of the nation, done, of course, by Anglo… solely… alone… without anyone's help.

    You can follow trail of Nama-related stories on the blog from here: or via search facility. Enjoy. And remember, there is nothing to worry about in any of this…

    25/7/15: Irish Migration Policies: Welcoming the Skilled & the Enterprising

    My recent article for the Irish Independent on the topic of human capital, migration and Irish policies on attracting skilled labour and foreign entrepreneurs:

    Wednesday, July 22, 2015

    22/7/15: Paging from the Planet Debt...

    Ah, good old Europe... Austerity, Reforms, Structural Changes, Improved Competitiveness, Return to Growth... and rising, rising, rising debt.

    Per latest Eurostat release (see here), euro area Government debt/GDP levels have hit 92.9% of GDP in 1Q 2015, up on 92.0% in 4Q 2014 and up on 91.9% of GDP in 1Q 2014. Year on year, Government debt rose from EUR9.179 trillion to EUR9.433 trillion.

    Of the five most indebted (fiscally_ economies (excluding Ireland, which did not report 1Q 2015 GDP figures):

    • Debt fell in the case of Greece by 8.3 percentage points between 4Q 2014 and 1Q 2015 to 168.8% of GDP; 
    • Debt rose in the case of Italy by 3 percentage points to 135.1% of GDP;
    • Debt fell 0.6 percentage points in Portugal to 129.6% of GDP;
    • Debt rose 4.5 percentage points in Belgium to 111.0% of GDP;
    • Debt fell 0.7 percentage points in Cyprus to 106.8% of GDP.

    Italian debt is now at the highest level since the peak of Inter-war period in the 1920s:

    Source: @Schuldensuehner 

    Congratulations to the inhabitants of the Planet Debt...

    22/7/15: Another ECB Plasma Bag for Comatose Greek Banks

    Another lift for Greek banks' ELA via ECB - a EUR900 million click, as previously:

    Once again, the situation remains unaltered - Greek banks remain tied to ELA for funding, while capital controls cannot be lifted under small tick increases in ELA. In effect, we have a nurse replacing the empty plasma bag for a comatose patient. Nothing new, nothing dramatic...

    Tuesday, July 21, 2015

    21/7/15: Central Europe's Lesson: Fixed Euro or Floating Exchange Rates?

    The EU report on economic convergence of the Accession States of the Central and Eastern Europe (CEE10) makes for some interesting reading. Having covered two aspects of convergence: real economic performance and financialisation, lets take a look at the exchange rate regime impact on convergence.

    This is an interesting aspect of the CEE10 performance because it allows us to consider medium-term impact of euro on CEE10. 

    Basically there were two regimes operating in the CEE10 vis-a-vis the euro: fixed regime (with national currency pegged to the euro) or floating regime (with national currency allowed to float against the euro).

    First, recall, that "out of the five CEE10 countries which have adopted the euro by 2015, four (i.e. Estonia, Latvia, Lithuania and Slovenia) already operated under fixed exchange rate regimes in 2004. In their case, euro adoption did not represent an essential regime change with respect to the role of nominal exchange rate flexibility in the convergence process vis-à-vis the EA12." 

    Now, EU Commission would be slightly cheeky in making this statement, since while in the first order effect this is true, in the second order effect (expectations), this is not true - a peg to the euro could have been abandoned in a severe crisis, albeit less easily under the regime of ongoing financialisation of the CEE10 economies via foreign banks lending; however, once euro is adopted, no devaluation is possible even in theory. And this is not a trivial consideration, since policymakers know that should they mess up in the longer run, there will be a risk of peg abandonment, resulting in direct, transparent exposure of their policies-generated imbalances for all to see and in serious embarrassment vis-a-vis their European counterparts. In other words, the threat of devaluation as a feasible option could have actually acted, in part, to make peg regimes more stable.

    But let us allow EU Commission their assumption (undefined as such) and chug on...

    From EU own analysis: "Based on the GDP per capita in PPS data, there was no significant difference in the speed of real income convergence to the EA12 between fixers and floaters over the past decade, but there was a large degree of heterogeneity within both groups. Rather than the type of exchange rate regime, a more important relationship existed between the speed of catching-up and the initial income level, with less developed countries in general converging at a faster pace. Accordingly, the fastest growing economies were, among the fixers, the three Baltic countries and, among the floaters, Poland and Romania. In addition, Slovakia, which recorded one of the best catching-up performances, floated its currency until euro adoption in 2009 and the bulk of its real convergence over the past decade actually materialised before 2009." 

    What does this mean? That nature of growth during the period was similar for floating and fixed regimes: both were driven by catching-up of economies, most notably via capital investment. Being fixed to the euro or not, it appears, had no effect on rates of convergence.

    But, remember, euro is about stability, not growth. So the key test, really, is in volatility of convergence path, not the path itself. Per EU Commission: "The real convergence path of floaters was in general smoother than that of fixers. This was mainly due to the more pronounced economic overheating in the latter group prior to 2008, which then also led to a larger set back during the financial crisis." Oops… so staying closer to euro hurts. Having fixed rates, hurts. Bubbles got worse in countries with pegged rates. That is not exactly an endorsement of the euro-led regimes.

    There's a caveat: "Nevertheless, fixers were able to again largely close their GDP-gap to floaters by 2012, as they enjoyed an export-led recovery, supported by internal price adjustment, structural reforms and favourable export market developments." Yep, that's right: austerity and re-shifting of economy toward external sectors, rather than domestic demand is the miracle that allowed for the fixed rates regimes convergence. That, plus unmentioned, monetary policy activism. 

    Still, the view of boom-to-bust euro-driven economy for the fixed rates regime remains. Not that the EU Commission will acknowledge as much.

    "The extent of price level convergence over the last decade mainly reflected differences in the speed of catching-up. That said, the average household consumption price level of fixers remained close to that of floaters until 2008, but it became significantly higher in the post-crisis period, as comparative prices of floaters fell." In normal English: deflation hit fixers, while floaters avoided it. 

    Core conclusion (despite numerous caveats): "Floaters appear to have been in general able to benefit from their monetary autonomy to achieve a higher degree of price stability. In the pre-crisis period, faster growth and related overheating gradually drove up inflation in fixers significantly above the average inflation rate of floaters. Subsequently, larger output drops and the inability to depreciate against the euro implied that fixers generally also experienced more pronounced disinflation. From late-2010, inflation in the two groups developed quite similarly on average, but the variance was higher among floaters."

    So final note on interest rates. Remember - convergence of rates irrespective of risk is one of the poor outcomes of the euro introduction in the EA12, fuelling massive asset bubbles in Spain and Ireland, fiscal imbalances in Greece and so on. In CEE10: "Over the past decade the benchmark long-term interest rate on government bonds was higher on average for floaters than for fixers, both nominally and in real terms. This is partly a consequence of the higher average public debt level among the floaters, but to some extent it is arguably also related to more exchange rate uncertainty inherent in floating." 

    EU Commission grumbling acceptance of reality is almost entertaining: "Generally, it takes longer to regain cost competitiveness via internal price adjustment [something that fixed rates economies are forced to do] than via nominal exchange rate depreciation [something that flexible rate economies have access to] and the initial shock to the real economy is more severe. However, the internal adjustment is more permanent as it requires a structural solution to the underlying problems, whereas the temporary boost generated by nominal exchange rate depreciation can actually postpone the reforms necessary for further sustained catching-up." You'd think that flexible exchange rate economies just can't ever compete with fixed rates economies. In which case we obviously have a paradox: Denmark and Switzerland vs Italy and Spain (or for that matter Belgium and France).

    So the core conclusion is simply this: things are complex, but having a peg to the euro looks more dangerous in crises and in bubbles build up stages, than running flexible exchange rates regime. Who would have guessed?..

    21/7/15: Eastern Europe's post-2004 Convergence with EU: Financialisation

    In the previous post, I covered the EU's latest report on real economic convergence in Central & Eastern European (CEE10) Accession states. As promised, here is a look at the last remaining core driver of this 'fabled' convergence: the financial services sector (which drove the largest contribution to growth in pre-crisis period 2004-2008 and remained significant since).

    In summary: debt is the currency of CEE10 convergence.

    Let's start with Public Debt.

    As the above shows, CEE10 debt rose during the crisis despite GDP uptick. Rate of growth in debt was slower in CEE10 than in the original euro area states (EA12), which was consistent with stronger CEE10 performance in terms of fiscal balances and lower incidence / impact of banking crises.

    Scary bit: "The negative impact of the 2008/09 global financial crisis as well as the following euro-area sovereign debt crisis on financial conditions in the CEE10 revealed that, despite relatively lower general government debt levels (compared to the EA12 average), some CEE10 countries might still encounter problems to (re-)finance their public sector borrowing needs during periods of heightened financial market tensions as their domestic bond markets are in general smaller and less liquid".

    And that is despite a major decline in long-term interest rates experienced across the region:

    In addition, Gross External Debt has been rising in all CEE10 economies between 2004 and 2014, peaking in 2009:

    Which brings us to private sector financialisation. Per EU: "CEE10 countries entered the EU with relatively underdeveloped financial sectors, at least in terms of their relative size compared to the EA12. This was the case for both market-based and banking-sector-intermediated sources of funding. In 2004, the outstanding stocks of quoted shares and debt securities amounted on average to just about 20% and 30% of CEE10 GDP, compared to around 50% and 120% of GDP in the EA12. Similarly, bank lending to non-financial sectors accounted for just some 35% of CEE10 GDP whereas it reached almost 100% of GDP in the EA12."

    It is worth, thus, noting that equity and direct debt financialisation relative to bank debt financialisation, at the start of 'convergence' was healthier in the CEE10 than in the euro area EA12.

    Predictably, this changed. "As the government sector accounted for the majority of debt security issuance in the CEE10, bank credit represented the main external funding source for the non-financial private sector."

    "The CEE10 banking sectors have generally been characterised by a relatively high share of
    foreign ownership as well as high levels of concentration. The share of foreign-owned banks and the market share of the five largest banks (CR5) in CEE10 countries remained relatively stable over the last 10 years, on average exceeding 60%. There was however some cross-country divergence as Slovenia stood out with a relatively low share of foreign-owned banks, which only increased to above 30% in 2013. At the same time, the Estonian and Lithuanian banking sectors exhibited the highest levels of concentration, with their respective CR5 averaging 94% and 82% over 2004-14. On the other hand, the role played by foreign-owned banks is rather limited in most EA12 countries while their banking sectors are in general also somewhat less concentrated, with their CR5 averaging around 55% over the last 10 years."

    Which, basically, means that the lending boom pre-crisis is accounted for, substantially, by the carry trades via foreign banks: the EA12 banks had another property & construction boom of their own in CEE10 as they did in the likes of Ireland and Spain.

    "The 2008/09 global financial crisis …proved to be a structural break in the overall evolution of bank lending to the non-financial private sector in the CEE10. As the pace of credit growth in the pre-crisis period was clearly excessive and unsustainable, a post-crisis correction was natural and unavoidable. However, credit to the NFPS increased by "only" some 13% between May 2009 and May 2014, with bank lending to the nonfinancial corporate sector basically stagnating while lending to the household sector expanded by
    about 25%."

    Shares of Non-Performing Loans rose quite dramatically, exceeding the already significant rate of growth in these in EA12 across 6 out of 10 CEE10 states.

    The following chart shows two periods of financialisation: period prior to crisis, when financial activity vastly exceeded real economic performance dynamics; and post-crisis period where financial activity is acting as a small drag on real economic performance. This is try for both the CEE10 and EA12 economies, but is more pronounced for the former than for the latter:

    In summary, therefore, a large share of 'real convergence' in the CEE10 economies over 2004-2014 period can be explained by increased financialisation of their economies, especially via bank lending channel. As the result, much of pre-crisis convergence is directly linked to unsustainable boom cycle in investment (including construction) funded by a combination of bank debt (carry trades from Euro area and Swiss Franc) plus EU subsidies. These sources of growth are currently suppressed by long-term issues, such as high NPLs and structural rebalancing in the banking sector.

    The tale of 'convergence' is of little substance and a hell of a lot of froth… 

    21/7/15: Eastern Europe's post-2004 Convergence with EU: Unimpressive to-date

    EU Commission latest report on real economic convergence in the EU10 Accession states of Eastern and Central Europe (CEE10) sounds like a cheerful reading on successes of the EU and the Euro. The report overall claims significant gains in real economic convergence between the group of less developed economies post-joining the EU and the more advanced economies of the EU.

    However, there are some seriously pesky issues arising in the data covered.

    Firstly, consider the sources of convergence (growth) over the period 2004-2014.

    As chart above shows, in 2004-2008 pre-crisis period, Private Consumption posted significant contributions to growth in all EU10 economies )Central and Eastern European economies of EU12 group). This contribution became negative in 6 out of 10 economies in the period 2009-2014. It fell to zero in 2 out of 10 and was negligibly small in another one. Poland was the only CEE10 economy where over 2009-2014 contribution of personal consumption was positive and significant, albeit it shrunk in magnitude to about 40% of the pre-crisis contribution.

    Likewise, Gross Fixed Capital Formation (aka investment) contribution to growth also fell over the 2009-2014 period. In 2004-2008, investment made positive and significant contribution to growth in all CEE10 economies. Over 2009-2014, Investment contribution was negative for 7 out of 10 economies and it was negligible (near zero) for the remaining 3 economies.

    Thus, about the only significant factor driving growth in 2009-2014 period was net exports - the factor that does not appear to be associated with investment growth.

    As the result, overall growth rates have fallen precipitously across the region in 2009-2014 period compared to 2004-2008 period.

    Gross value added across all main sectors of the economy literally collapsed over the 2009-2014 period across all CEE10 economies, with only Poland posting somewhat decent performance in that period compared to 2004-2008.

    One thing to note here is that even during the robust growth period of 2004-2008, Agriculture - a significant sector for a number of CEE10 economies was largely insignificant as a driver for gross value added in all but one economy - Hungary, where agricultural activity strength in overall economic activity traces back to the socialist times (1970s reforms).

    Market services activity registered robust growth in 2004-2008 across the region predominantly on foot of major expansion of financial services.

    Adding farce of a comment to the real injury of the above data, per EU Commission report: "As a result of relatively higher GDP growth rates, CEE10 countries achieved significant real convergence vis-à-vis the EA12 between 2004 and 2014. The CEE10 average GDP per capita level in purchasing power standards (PPS) increased from about 50% of the EA12 level in 2004 to above 58% in 2008. After having declined somewhat in 2009, it increased gradually to some 64% of the EA12 level in 2014." Much of this convergence is really due to the decline in GDP in the rest of the EU, rather than to growth in GDP in the CEE10. Not that the EU Commsision would note as much.

    "However, there was a considerable cross-country variation with the pace of convergence in general inversely related to initial income levels. Considering the three most developed CEE10 economies in 2004, Slovenia has not enjoyed any real convergence, while the catch-up was also relatively limited in the Czech Republic and Hungary (as also pointed out by e.g.
    Dabrowski (2014)). On the other hand, relative GDP per capita levels in PPS increased by about 20 percentage points in Baltic countries, Poland, Romania and Slovakia. Nevertheless, Bulgaria, which started with the second lowest GDP per capital level in 2004, also only achieved a below-average pace of convergence of some 11 percentage points."

    In simple terms, the above means that the core drivers for any convergence would have been down to reputational and capital markets effects of accession, rather than to real investment in future capacity, skills and knowledge. Building roads, using Structural Funds, and getting Western Banks to lend for mortgages seems to be more important in the 'convergence' story than creating new enterprises and investing in real jobs.

    As the EU notes: "The rapid pace of economic convergence in the pre-crisis period partly reflected an investment boom. The average share of gross fixed capital formation (GFCF) in the CEE10 increased from below 25% of GDP in 2004 to above 29% of GDP in 2007 and 2008 while it remained below 24% of GDP in the EA12. This investment boom was stimulated by optimistic growth expectations and supported by external funding availability. …Although on average roughly half of GFCF consisted of construction both in the CEE10 and the EA12, housing accounted for only about fourth of construction activity in the CEE10, compared to more than 50% in the EA12. This could be interpreted as overall indicating a more productive investment mix in the CEE10 in the run-up to the 2008/09 global financial crisis." Or it can be interpreted as heavier reliance on EU Structural Funds and Convergence Programmes that pumped money into roads and public infrastructure construction. Which may be productive or may be irrelevant to future capacity, as all of us can see driving on shining new roundabouts in the middle of nowhere, Ireland.

    Nonetheless, "The contribution of investment activity to real convergence was not sustained in the post-crisis period. The average share of GFCF in the CEE10 declined to about 22% of GDP in 2010 and then remained broadly stable up to 2014 (while it declined to below 19% of GDP in 2013-14 in the EA12) as growth prospects were reassessed and private funding availability tightened but investment activity in the region was still supported by substantial inflows of EU funds. ...On the other hand, the decline was overall broadbased
    across all main asset types in the CEE10 while it was largely driven by a drop in housing
    construction in the EA12."

    On External Balance side, current account balances turned positive for the CEE10 only in 2013-2014, much of this due to contraction in domestic demand:

    Meanwhile, FDI collapsed across all countries, ex-Slovenia (where FDI figure for 2009-2014 is distorted to the upside by banking sector flows). As EU notes: "Although net FDI inflows remained positive in all CEE10 countries they on average amounted to some 2% of GDP in 2009-14 (after having exceeded 5% of GDP in 2004-08)."

    All together, the picture of economic convergence is there, but it is more characterised by convergence via financialisation and transfers (both public and private) than by organic growth. This conclusion is equally pronounced before and during the crisis period. Much of the 2004-2008 period convergence was driven by private debt accumulation and 2009-2014 period convergence was primarily driven by adverse growth environment in the rest of the EU, plus public debt accumulation. 

    Note: I will be blogging on debt issues in the next post, so stay tuned.

    You can access full report here: