Tuesday, September 23, 2014

23/9/2014: EI Conference: Domestically-Anchored Globally Open Entrepreneurship

Yesterday, I was asked to say a few words on the challenges and opportunities facing Ireland's economy in the near term future for the Annual Conference held by the Enterprise Ireland. Here are my comments.

"Ladies and Gentlemen,

I would like to thank you for this opportunity to speak to such a distinguished group of professionals who represent the organisation that is responsible for helping Irish indigenous enterprises to grow, develop new markets and increase their value added to the economy.

Global economic environment and Ireland

Let me start by briefly outlining the global economic environment in which Ireland operates today, focusing on both the immediate challenges and opportunities in the next 12-24 months, as well as further afield, into 2017-2020. It is worth stressing beforehand that opportunities and challenges go hand-in-hand and should not be viewed as opposing concepts. An opportunity not pursued is a challenge unmet. A challenge met is an opportunity pursued.

Firstly, analysts’ forecasts generally agree that the global economy is currently moving toward the post-crisis growth trend. The worst of the Great Recession is over, but pockets of structural weaknesses and real pain of economic displacement remain.

Our two major trading partners: the US and the UK are
Delivering rates of growth consistent with those at or slightly below the pre-crisis averages of 2.5-3%
But, this growth is still excessively reliant on monetary policy supports, rather than investment, productivity expansion, external trade growth and/or domestic consumption.
The problem of private and public debt overhang still looms, like a dark shadow, over both economies, presenting a risk of a slowdown in the rates of growth toward 2%.
These risks are even more material in the context of potential effects of the monetary policy tightening that the markets currently expect to take place some time in Q2-Q3 2015.

In the euro area, growth is showing some promise of a fragile acceleration starting with Q3-Q4 2014 and into H1 2015.
However, the rates of growth achievable in Europe remain below the already less-than-impressive pre-crisis trends.
Again, looking at consensus forecasts, we can expect growth around 1.2-1.5% in 2015, rising closer to 2% in 2016.
This assumes no significant adverse shocks from either external sources or from those originating in the euro area.
As with the US and UK, lack of investment, slow productivity growth, and debt drag on consumption represent the biggest challenges alongside fragmented financial markets and sovereign debt bubble that is putting a superficial shine on the dire state of public finances.
As with the US and the UK, growth is still reliant on monetary accommodation and is subject to significant forward risks once the accommodative stance by the ECB is reversed in time.

In the rest of the world:
Commodities dependent economies of Australia and Canada are facing significant risks of unwinding large asset bubbles and economic imbalances built up in boom years. Australia is more vulnerable here than Canada, both in terms of the extent of the bubbles in its domestic economy and its exposure to the slowdown in global demand for commodities, especially to downward pressures in demand coming from China.
Amongst BRICS, Brazil, China and Russia are facing structural pressures - all arising from different driving factors, but all substantial and extremely dangerous to regional and global growth prospects.
Brazil is in a recession and is running out of the road finding sufficient credit supply sources to continue funding public investment boom that sustained the economy.
China is facing a gradual de-acceleration of growth toward 5-5.5% per annum, in a 'good' or ‘benign’ scenario, and is nursing a substantial risk of a sudden break on growth if the investments bubble collapses rapidly.
Russia is amidst a geopolitical turmoil surrounding the Ukrainian crisis, but below these immediate concerns, structural growth slowdown is working to push post-crisis longer-term growth rates closer to 2-2.5% per annum.

Overall, we are looking at the global growth rates in the region of 3-3.5% and advanced economies growth rates around 1.5-2.5%.

Ireland’s position in the global environment currently represents an outlier. Stripping out superficial boost to growth in H1 2014 achieved primarily via reclassifications of the National Accounts, our economy is, at last, showing some changes in the previous post-crisis trend. Prior to 2014, our economic growth dynamics could be characterised as flat-lining with some short term volatility around near-zero growth trend. In more recent months, we are witnessing a gentle uplift in the flat trend, which is most certainly a heart-warming experience. Much of the positive momentum today, just as positive growth supports over recent years (since at least 2011) is down to our exports performance, especially in the indigenous sectors. This performance, strong as it may be, is only partially offsetting the negative trends in multinationals-supported exports of goods (the ‘patent cliff’) and is largely obscured in the national accounts by the superficial boom in MNCs-driven ICT services exports. Nonetheless, given much higher employment and national income intensities of indigenous exports, this domestic exports growth is one of the core drivers, in my view, of the improvements in Irish economy.

Looking beyond 2014, we are likely to see continued upward momentum in the Irish economy, albeit still at subdued rates. Growth of 2.5-3%, once we strip out changes in the National Accounts methodology is possible for 2015 and 2016, should we stay the course on fiscal consolidation and reforms, and assuming we are not heading for a new credit and real estate investment bubble. Trade prospects for Irish exporters should remain relatively robust, but rates of growth in our exports to our traditional partners are likely to come under some pressures, while our exports penetration into new markets are at the risk due to the factors mentioned above.

Global trade will suffer in the 'slow burner' global growth environment. Margins are likely to fall, growth is likely to slow down or remain capped at around 3.5%, and the process of trade regionalisation will accelerate, in part driven by higher volatility in the exchange rates, regionalisation of financial services and credit markets, and by on-going shifts in global supply chains. All of the above factors will present significant challenges for our indigenous exporters.

However, the said challenges will also present some significant opportunities for Ireland. And in the longer term, gradual unwinding of the debt overhang in the advanced economies over 2015-2020 will strengthen both the traditional trade channels from Ireland into North American and European markets, while continuing to open new channels to middle income economies of Asia-Pacific, Latin America and BRICS.

What does addressing these challenges and capturing the related opportunities require from the Irish perspective?

The key issues, both on the threat side and in terms of opportunities, over the next 2-5 years will be the following:

1) Shifting economy toward more intensive indigenous growth. Currently, shares of exports and domestic consumption supplied by domestic producers are insufficient to address the threats to Ireland's FDI-based development model. In simple terms, Ireland needs to replicate the successes in the area of FDI, delivered over recent decades with the help of IDA, in a new area, the area of driving up indigenous firms growth and creating, attracting, retaining and enabling a new economy in Ireland: economy based on high quality human capital, world class open model of entrepreneurship, and increased focus on high value added strongly differentiated activities.

2) This challenge is coincident with tax regime reforms that started with G20 and G8 push last year and will continue, in my opinion, beyond the OECD's "Action Plan on Base Erosion and Profit Shifting” that will be unveiled in 2015.

3) Parallel to these, regionalisation of trade is shifting large-volume supply chains closer and closer to end-users. This dis-favours Ireland as a basis for real activity and requires addressing this risk by increasing our product/service differentiation.

4) Related to the above, there is an urgent need to focus on increasing value added in our indigenous agricultural, manufacturing and services sectors, both for domestic markets and exports. So far, we have pursued an early stages development strategy to deliver competitiveness - a strategy of wage moderation. This is driving down domestic demand, but also capping our ability to Create, Attract, Retain and Enable a deeply integrated base of top quality human capital. The result of racing to the bottom in wages costs is holding back indigenous innovation, but also the rate of adoption of innovation and productivity growth in the MNCs and larger indigenous enterprises sectors, reducing quality of production, specialisation and supply in the public and private sectors. It is also supporting growth in wealth inequality and suppresses our economy's ability to meet future challenges mentioned earlier. Ironically, wages competitiveness is also creating huge imbalances in the stock of human capital in Ireland, promoting accumulation/concentration of human capital in firms with superficially high (tax arbitrage-supported) productivity MNCs and restricting flow of human capital to indigenous innovators.

5) A major opportunity, yet to be fully tapped, is presented by focusing on an open entrepreneurship model that favours high value added manufacturing and internationally traded services. We are still less active in the global race for entrepreneurial talent than we should be. And we are lagging in projecting Ireland as thought- and policy-leader in this space. We must make Ireland synonymous with entrepreneurship and openness, not with tax arbitrage opportunities. And we must make Ireland’s ‘brand’ visible to would-be entrepreneurs, investors and trading partners around the world.

6) Related to the point above, there are multiple opportunities open to Ireland to compete more aggressively in developing an economy based on value added through user-experience and industrial design, product and service innovation, creativity and, yes, the perennially talked-about R&D. Ireland lags in presence in the world markets in terms of recognisable brands, products, end-user services that are ambassadors for this economy's productive capacity. With exception of Ryanair, Kerry Group and a handful of others, like Dairymaster, too few of our companies have direct reach into global supply chains with offers that are differentiated sufficiently to withstand regionalisation of trade. The added risk arising from the lack of defined differentiation for our producers in the global markets is the added exposure to the exchange rates volatility and thus to the monetary policy shifts that are likely to come over the next 12-24 months. It is heartening to know that Enterprise Ireland's work has been and remains one common support base for the majority of our most successful companies. But it is depressing to know that our policies on migration, taxation, trade facilitation, R&D and enterprise investment remain focused more on FDI and the adjoining sub-sectors, such as ICT Services, and not on a consistent building up of the entrepreneurship and human capital bases here.

7) Last, but not least, we are facing a continued challenge of growing successful early stage enterprises beyond the tipping point of EUR10-15 million revenues. Scaling up of Irish indigenous firms is neither sufficiently supported nor incentivised by our tax systems, equity and debt markets or by our policy frameworks. Hence, too many of successful Irish early stage companies are prematurely terminated via sales with a resulting loss of Irish 'brand' identity in global marketplaces. This also induces unnecessary volatility in the domestic markets for skills, talent and know-how.

The above list of 7 point is by no means exhaustive, but the key, unifying point of the above opportunities and challenges is singular: Ireland needs to move to a more domestically-anchored, globally open model of enterprise based on high value added outputs generation.

More open system of entrepreneurship and a greater focus on actual productivity, higher levels of products and services innovation, design and creativity are becoming the differentiators for our competitors, like Singapore, Hong Kong, Korea, Chile, the Netherlands, Switzerland, Belgium, Sweden, Denmark, Austria and even the UK and Germany. The same drivers are also being actively embraced by the newcomers to this competition, such as UAE, Slovakia, Estonia and others.

What does the above mean in practical policy terms? 

How do the above challenges and opportunities translate into tangible actions by the Government and the enterprise support agencies, such as Enterprise Ireland?

We, economists, usually talk in terms of 'first best' policies – policies that are optimal from the point of view of economic efficiency – neglecting political and social dimensions of the policies. I do not intend to break away from this tradition. But some of the policies suggestions I put forth here are currently feasible, and more importantly, the objective of achieving a more entrepreneurship-driven and value-added growth is now simply imperative.

Firstly, we need to open up our migration system to entrepreneurs. Not just the so-called identifiable high-potential entrepreneurs, but to a wider range of entrepreneurs.
This means not only issuing more residency permits for entrepreneurs coming from abroad and issuing them faster.
It also means more actively recruiting entrepreneurs from the ranks of our foreign and domestic students and by projecting our thought leadership in this area worldwide.
And it means making entrepreneurs and human capital residency here more meaningful, more closely integrated with the open-borders policies of the EU, and more reflective of the needs of modern commerce for travel, cross-border cooperation and work.

Secondly, we need to move Ireland into the position of being extremely visible internationally in the space of creating, attracting, retaining and enabling entrepreneurs and key talent. We lack international thought leadership in this area to identify this economy and society with pro-entrepreneurial culture and ambitions and not tax arbitrage opportunities.

Thirdly, we need to enhance dramatically entrepreneurial skills training and supports.
Enterprise Ireland already does very important work here, but the scale of its programmes can and should be expanded.
To free resources for more specialist, high-level training and supports, we need to move more general training into our education system. We need to start giving our children basic entrepreneurial skills earlier in their lives and provide tangible supports for younger entrepreneurs coming out of our schools, colleges, ITs and universities.
We need to clearly and visibly position Ireland as a platform for trading into the EU and North American markets for entrepreneurs from outside the EU, not just for established MNCs. Again, positive experiences of IDA (working with the MNCs) and Enterprise Ireland (working with numerous indigenous exporters) are a great encouragement and a good foundation to build upon.
But, as mentioned already, our thought leadership in this area is still lagging. And the scale of our programmes remains too shallow and too narrow to-date to deliver a game changing shift in our entrepreneurship support systems.
To compete in global markets, we will need active programmes to coach and nurse foreign and domestic entrepreneurs and SMEs on how to access foreign markets with their goods and services.
But we will also need programmes facilitating foreign entrepreneurs integration into the Irish system: from simple supports in terms of accessing basic services here, to tax supports, to legal supports and so on.

Fourthly, we need to drastically revamp our systems for accessing development and trade finance funding. We had volumes written about this in recent years by the Irish Exporters Association and other organisations and indeed by the analysts, like myself. And the Government has reacted positively to some of the proposals, despite the funding difficulties faced by the Exchequer. But, the proverbial carriage is still stuck in the same puddle of dysfunctional banking system and equity markets.

Fifthly, we need to stop penalising self-employment and sole-proprietorship in terms of income taxation and start rewarding early stage entrepreneurial endeavours. Our current model is "Higher Tax for Lower Benefits" and it is rewarding pursuit of PAYE job security and penalises pursuit of enterprise. An alternative currently on the table is a model of "Higher Taxes for Similar Benefits" which will continue to do basically the same injustice to early stage entrepreneurs. Addressing this imbalance between risk-adjusted returns to entrepreneurship and PAYE employment we need to eliminate self-employment penalty and streamline the system of tax compliance for the self-employed.

Sixth, we need to re-couple domiciling of innovation and use of innovation at business level. This applies to the MNCs trading from here, but also to Irish firms. The levels of innovation in our economy are still insufficient. The levels of meaningful utilisation of innovation, R&D and IP in this economy are still below where we would like to see them. We need to create a favourable regime for the firms that both on-shore innovation into Ireland for IP purposes, and deploy it on the ground here. This is tricky, I admit. But it is necessary.

Seventh, growth in the value-added of exports of indigenous firms cannot be contemplated in the environment where we are promoting volumes of sales over value, as, for example, in some agricultural sector outputs. We have to relentlessly drive up margins on our goods and services by pursuing higher valuations for our goods and services, even when such a drive implies increased business and investment risks.

Once again, the above are hardly an exhaustive list of things that must be done for Ireland to succeed in increasingly more competitive global environment.

The key themes that permeate the above remain, however, the same as before: Ireland needs to move to a more domestically-anchored, internationally open model of enterprise based on high value added outputs generation.

More open system of entrepreneurship and a greater focus on actual productivity, exponentially higher levels of products and services innovation, design and creativity, and more aggressive transition of enterprises to higher value added production are becoming the real differentiators for our competitors.

We must lead them, not follow.

23/9/2014: Nationalist Revival and the end of the Age of Great Moderation

Recently, I was asked to comment on the issue of emerging nationalism in the European and Eastern European (especially Russian and Ukrainian) context. Here is a paper that was produced for the discussion: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2499254

23/9/2014: Irish factory Gate Prices: Deflation and Inflation in August

CSO's latest data on monthly factory gate prices shows that producer prices rose 0.3% in August 2014 m/m and fell 2.0% y/y, moderating a y/y drop of 2.4% recorded in July 2014.

Exports prices rose 0.4% and home sales prices were down 0.3% m/m. However, y/y exports prices are now down 2.1% and home sales prices are down 1.4%.

Noting the effects of European agricultural products trends associated with Russian counter-sanctions, dairy products prices were down 2.4% m/m and meat and meat products prices fell 0.4% m/m. Outside sanctions impact, Beverages prices rose 2.7% y/y, basic pharma products prices fell 4.5% y/y.

Capital goods prices rose 1.3% y/y and 0.3% m/m, while energy prices fell 13% y/y, petroleum fuel prices were down 2.3%.

Given moments in inputs prices and outputs prices, business margins appear to be pressured by: forex valuations (primarily driving exports prices changes to the downside) and by ongoing domestic deflation in the private sectors. Margins were supported by some decreases in the inputs costs (energy) and offset by the increases in prices of capital goods.

Chart below shows the overall downward trend in producer prices for manufacturing sectors that has been established now from roughly Q3 2012.

But never mind the above... all is rosy based on Irish PMIs readings...

Monday, September 22, 2014

22/9/2014: Where TLTROs dare to go?..

Last week I wrote about the disappointing nature of the first round of TLTROs by the ECB (http://trueeconomics.blogspot.ie/2014/09/1892014-quite-disappointing-tltro-round.html). Now, some more evidence that TLTROs are at best replacing / swapping liquidity in LTROs maturities without materially changing the nature of the banks assets holdings. Remember, the objective of TLTROs is to inject funds into corporate lending, not sustain or increase flows of funds into sovereign debt markets... which means sovereign yields should not be falling in connection to TLTROs.

So guess what's happening?

H/T for the chart to @DavidKeo

The chart above shows several things:

  1. Both Spanish and Italian yields are falling across all maturities in excess of 1 year.
  2. The margin from lending to the Spanish and Italian Governments (yield on bonds less cost of TLTRO funds) is lower across all maturities post TLTRO issue than before.
  3. Margin declines are not uniform across maturities, and generally steeper at longer maturities. 
Are the banks taking up TLTROs pushing up prices of Government debt?.. That would mean more disconnection between the monetary policy objectives and outcomes, right?..

Sunday, September 21, 2014

21/9/2014: Irish Corporate Tax Policy: Some Leadership Needed

Earlier this week I gave a comment to TheCorner.eu on the issue of Irish corporate tax reforms and challenges:

21/9/2014: Ireland's Performance: Some Gains, Some Pains

Last week I gave a quick interview to Swiss Dukascopy TV. The link is here: https://www.youtube.com/watch?v=V9Qi9r-7PSE

Here are some of my notes for the programme.

Q: Ireland’s unemployment rate fell to five-year low of 11.5 per cent. Fitch restored its A grade to the Irish economy. Noonan believes the upgrade reflects significant progress made in repairing the economy. 

Ireland has shown some significant improvements in unemployment and jobs creation areas and the economy is now growing, at least in official accounts terms, in part driven by changes to GDP and GNP accounting standards. These are well-documented and there is little point of dwelling on the figures.

However, less noticed is the fact that the latest figures for jobs market and population trends remain worrying.

Unemployment, officially, eased to 11.5% as you mentioned. But broader unemployment remains stubbornly high at 21.6% if you include underemployed, discouraged workers and all others who want a job, but cannot find one. If you add to this figure net emigration of working age adults and those who are not counted as unemployed because they are engaged in State Training Programmes, underlying ‘jobless’ rate reaches even higher. Another problem is that the declines in broader measures of unemployment from the peak are running at just about 1/2 the rate of official unemployment rate declines.

People are still dropping out of the labour force. Official Participation rate fell from 60.5% in Q2 2013 to 60% in Q2 2014. This below historical average of 60.8%. The Dependency ratio rose, albeit marginally, in H1 2014 compared to H1 2013. Over the last 3 years of the recovery, dependency ratio remained unchanged at the levels well above historical averages, some 7% above the average currently.

The problem is that the economy is generating jobs, but these jobs are either lower quality - when they cover domestic sectors of the economy and especially agriculture, or high quality jobs in the internationally-trading sectors, where employment is generally being created for younger, international workers. As the result, long-term unemployment amongst older workers is stubbornly high.

So Irish economy is an economy of two halves: one half is the economy that is saddled with high debt burdens, slow growth and in some cases, continued contraction. Another half is the economy with more robust growth. The problem is much of the latter half is imaginary economy of Services MNCs shifting profits through Ireland with little impact on the ground. The first half - the suffering one - is the real economy.

Q: Ireland has lost nearly a quarter of a million young people in five years due to emigration. This is one reason why some are skeptical about the recovery as they believe that there are still not enough jobs. Do you think we have seen enough evidence, which shows significant improvement in the labour market?

Latest emigration figures are somewhat positive for Ireland. We have recorded a decline in net emigration in 12 months through April 2014. This fell from 33,100 in 2013 to 21,400 in 2014. Much of this is down to two factors: some jobs creation in the economy is helpful, but also due to immigration increase from the countries outside the EU. This is good news. Bad news is that this is the 5th year of continued net emigration from the country, matching previous record back in the late 1980s and 1990s. In numbers terms, things are worse than then. In 5 years of 1987-1991, 133,700 Irish residents left the country, net of those arriving. In the 5 years through 2014, the number is 143,800.

So the crisis is easing, but it still is a crisis. And increasingly, people who leave today are people with decent jobs, seeking better career and pay prospects abroad, fleeing high cost of living and taxes. This means we are losing higher quality human capital.

Q: What other positive improvements in the economy are you expecting to see and do you see any downside risks remaining?

On the positive side, we are seeing continued gains in activity in core sectors of the economy. Especially encouraging are the signs of ongoing revival in manufacturing. Services, when we strip out the superficial figures from the MNCs, such as Google, Facebook, Twitter etc, are still lagging, but I would expect this to pick up too. Investment is rising - not dramatically, but with some upward support forward. Much of this down to booming local property markets in Dublin. This is ok for now, as we have a massive lag in terms of supply of housing and even commercial real estate that built up over the years of the crisis. There is a risk of a new bubble emerging in the resale property markets, but this bubble is still only a risk.  Part of investment increase is also down to reclassification of R&D spending from being counted as a business expenditure prior to Q1 2014 to now counted as business investment. However, some indicators (PMIs and imports flows in capital goods and machinery categories) are pointing to a pick up in investment.

The downside risks are banks, retail interest rates cycle (potential for higher cost of servicing existent debt pile in the real economy - a risk that is still quite some time off), credit supply shortages (credit continues to decline in the economy and now we are seeing some downward pressures on deposits too). Beyond this, there is a risk of misallocated investment - investment flowing not to entrepreneurial activity, but to re-sale property markets - something that Ireland is always at a risk of.

I suspect that Irish economy will continue to grow at higher rates than the euro area for the next 12 months. But this growth will continue to come in at levels below where we need to be to actively deleverage our private sector and public sector debts.

Q: And what are the main trends we are witnessing in the Irish bond market right now? 

There is basically no longer any connection between economic fundamentals - as opposed to monetary policy expectations - and the sovereign debt markets in the euro area. Take Credit Default Swaps markets, for example: Irish CDS are at around 53-54 mark, implying cumulative 5 year probability of default of around 4.62%. That is for a country with debt/GDP ratio of over 120% and relative to the real economic real capacity measured by GNP at around 135%. Take a look at Italy, with moderately higher public debt levels and more benign private sector debts: Italy is running at a probability of default of 8.29%.

The markets expectation is for the ECB to deploy a traditional QE on a large scale through its Assets Purchasing Programme - currently being developed.

Problem is: eurozone (and Ireland with it) is suffering from a breakdown in lending mechanism, lack of transmission of low policy rates to retail rates and credit supply. This is not going to be repaired by a traditional QE. It is, therefore, crucial that the ECB deploys a functional ABS purchases programme and scales up its TLTROs and better targets them.

Irish bond yields were, for 10 year paper, down to around 1.8 percent in August from 2.23 percent in July. Yields declines are in line with the rest of the euro area and its ‘periphery’. Has there been any significantly positive news flow to sustain these valuations? Not really. We are in a de facto sovereign bond markets bubble. It can be sustained for some months ahead, but sooner or later, monetary tightening will begin, currency valuations will change, and with this, the tide will start going out. Who will be caught without their proverbial swimming trunks on, to use Warren Buffet's analogy? All economies with significant overhang of private debt - first, second, economies with significant government debt overhang. Now do the maths: Ireland is one of the more indebted economies in the world when it comes to private debt. And we have non-benign sovereign debt levels. We simply must stay the course of continued reforms in order to prepare for the potential crunch down the road.

Overall, Ireland is clearly starting to build up growth and employment momentum, even when we control for the accounting standards changes on GDP and GNP side. But risks still remain, of course. The next few months will be crucial in defining the pre-conditions for growth over 2015-2016. A steady push for more structural reforms, especially completing the unfinished work in protected domestic sectors and developing and deploying real, sustainable and long-term productivity enhancing changes in the public sector will be vital.

Thursday, September 18, 2014

18/9/2014: Irish GDP & GNP Q2 2014: Headline Numbers

In the previous post (http://trueeconomics.blogspot.ie/2014/09/1892014-irish-gdp-q2-2014-sectoral.html) I covered sectoral decomposition of Irish GDP. Note, referenced activity in the above post and GDP are 'at factor cost', omitting taxes and subsidies.

Here, let's take a look at full valuations of real GDP and GNP, both seasonally-adjusted (allowing q/q comparatives) and seasonally un-adjusted (allowing y/y comparatives).

Starting with seasonally un-adjusted series.

Total real GDP (in constant prices) in Q2 2014 stood at EUR45.763 billion which is 7.72% above the levels recorded in Q2 2013 and marks second consecutive quarter of y/y growth (in Q1 2014 GDP expanded by 3.81%). Q2 2014 y/y growth rate in GDP is highest since Q1 2007 which is a huge print!

Profit taking by the MNCs accelerated to EUR8.016 billion in Q2 2014from EUR7.864 billion in Q2 2013 and GNP rose to EUR37.747 billion posting a y/y growth rate of 9.03% in Q2 2014, marking fourth consecutive quarter of GNP growth. The Q2 2014 y/y growth rate was the highest since Q2 2006. The level of GNP in Q2 2014 was the highest for any Q2 since Q2 2007. So we have another huge print here.

GNP/GDP gap at the end of Q2 2014 stood at 17.5%, which is worse than the gap of 16.9% in Q1 2014 but an improvement on 18.5% gap in Q2 2013. Excluding taxes and subsidies, private GNP/GDP gap reached 19.0% in Q2 2014 compared to 20.1% in Q2 2013. This means that while growth is improving domestic economic conditions, these improvements are not tracking in full overall economic activity.

In seasonally-adjusted terms, Irish economy's performance was more moderate, albeit still strong, than in y/y growth terms discussed above.

Q/Q, GDP grew by 1.54% in real terms in Q2 2014, marking a slowdown in growth from 2.79% q/q growth in Q1 2014. However, Q2 2014 marks second consecutive growth period and the first time we have posted a GDP outcome above EUR45 billion (EUR45.611 billion in fact) in any quarter since Q2 2008.

Q/Q GNP marked fourth quarter of expansion in a row with Q2 2014 uplift of 0.61% on Q1 2014, ahead of Q1 2014 growth of 0.38%. However, Q2 2014 growth was second slowest in last 4 quarters. In level terms, Q2 2014 seasonally-adjusted real GNP came in at EUR37.983 billion which is the best Q2 reading since Q2 2008. So despite growth moderation, levels performance is still relatively good.

Here are two charts plotting relative performance by quarter in terms of GDP and GNP compared to historical average growth rates for each decade.

More analysis to follow, so stay tuned.

18/9/2014: Irish GDP Q2 2014: Sectoral Decomposition

Quarterly National Accounts for Q2 2014 for Ireland have been published by the CSO and the numbers are so-far encouraging. I will be blogging on these through out the day, so stay tuned.

In this first post on QNA results for Q2 2014, let's take a look at the seasonally un-adjusted data (allowing for year-on-year comparatives) for real GDP by sector:

All sectors output rose 7.4% y/y in real terms in Q2 2014 marking second consecutive quarter of growth and significantly outperforming 3.3% growth y/y recorded in Q1 2014. Q2 all sectors output is now at EUR42.157 billion which is the highest reading for any quarter on record.

compared to Q1 2011 output now is 10.8% higher and we are running at the rate of output some 6.3% above the 2006-2007 quarterly average.

The above is undoubtedly good news.

Sectoral growth rates (y/y) breakdown as follows:

Summary of the above charts:

  • Agriculture, Forestry & Fishing sector posted a massive rose in output of 13.9% y/y in Q2 2014 coming on foot of an already significant growth of 9.3% y/y in Q1 2014. This marks fourth consecutive quarter of growth in the sector, with sector activity now up 58.1% in real terms on Q1 2011 and 28.3% ahead of 2006-2007 quarterly average.
  • Industry activity rose 6.47% y/y marking the first quarter of increases. Activity shrunk 5.09% in Q1 2014. The sector performance has pushed output 6.6% above Q1 2011 levels but is still running 5.74% below 2006-2007 quarterly average. Still, good news is that growth is back.
  • Distribution, Transport, Software & Communication sector expanded by 11.3% y.y in Q2 2014 after posting growth of 10.6% y/y in Q1 2014. This marks second consecutive quarter of growth in the sector. Sector activity is now up 3.11% on Q1 2011 and is still down 2.51% on 2006-2007 levels.
  • Public Administration and Defence sector grew 3.75% y/y in Q2 2014, marking second consecutive quarter of y/y growth in a row. In Q1 2014 the sector grew by 3.67% y/y. Despite all the austerity, sector activity is now up 1.62% on Q1 2011 but overall activity is down 8.9% on 2006-2007 quarterly average.
  • Other Services sectors posted growth of 2.7% y/y in Q2 2014 and 3.9% growth in Q1 2014. Q2 2014 marked 13th consecutive quarter of positive y/y growth in the sector. Sector activity is up 9.6% on Q1 2011 and is 8.75% ahead of 2006-2007 quarterly average.
  • Building & Construction sector posted growth of 8.99% y/y in Q2 2014 which comes after 7.63% growth in the sector in Q1 2014 and marks 7th consecutive quarter of growth. Good news, however, are moderated by the realisation that levels of activity in the sector are still running 53% below those of 2006-2007 although sector has managed to grow output by 4.4% on Q1 2011.
  • Transportable Goods Industries and Utilities sector posted y/y growth of 6.3% in Q2 2014, compensating for the decline of 5.9% registered in Q1 2014. Sector activity is now 6.7% ahead of Q1 2011 and 3.13% ahead of 2006-2007 quarterly average.
Key conclusion: strong performance in growth y/y in key sectors of the economy in Q2 2014 showing no sector contracting against 2 sectors contracting y/y in Q1 2014. As expected, Q2 output came in with stronger readings than Q1 and indications are Q3 2014 is likely to be also ahead of Q1 expansion rates.

Stay tuned for more QNA data analysis here.

18/9/2014: Quite a disappointing TLTRO round 1

So ECB's first tranche of TLTROs allotted at EUR82.6 billion - which is disappointing to say the least. Announcement is here: http://www.ecb.europa.eu/press/pr/date/2014/html/pr140918_1.en.html

Prior to the allotment, the following were forecast:

  • Credit Agricole: EUR100 billion (EUR200 billion into December tranche)
  • Goldman Sachs: EUR200-260 billion in September and December TLTROs and EUR720-910 billion in overall programme
  • Morgan Stanley: EUR250 billion in September & December TLTRO tranches and EUR100-400 billion for tranches 3-8
  • Nomura EUR115 billion in September and EUR165 billion in December
  • JPMorgan EUR150 billion in September
  • Barclays EUR114 billion in September and EUR154 billion in December.

My own view on the subject as follows (from a comment given yesterday for international publication).

Note that the take up today has been disappointing for all above expectations (my own included), suggesting that traditional LTROs roll-overs dominated decision on TLTRO demand. This means that going into AQR reviews by the ECB the banks are reluctant to expand their corporate lending balance sheets and the loading now is on much heavier take up of TLTROs in December. In the mean time, low take up in this tranche can put some added pressure on ECB to deploy its ABS purchasing programme.


The key difference between TLTROs and LTROs is in the targeted nature of TLTROs. Conventional LTROs (despite the fact that term 'conventional' can hardly apply to these rather exceptional instruments) are unrelated to the balancesheet exposures of the banks and are designed to simply inject medium-term and long-term liquidity into the banking system as a whole. Thus, in the environment of deleveraging and uncertainty with respect to future losses, LTRO-raised funds flow to government securities with lower / zero risk-weighting and high liquidity. The effect is to reduce yields on Government securities, without providing any meaningful uplift in lending to the real economy. De facto, LTROs helped alleviate the sovereign debt crisis on 2010-2011, but also resulted in increased credit markets fragmentation and did nothing to reduce credit supply pressures in the real economies of the euro area countries. TLTROs - via targeting levels of real credit exposures to non-financial corporations - are holding a promise to shift funds into credit markets for companies, with weighting formula favouring banks with greater exposures to such lending. If successful, TLTRO programmes can incentivise banks to lend on the basis of risk-return valuations, which can, in theory, also alleviate the problem of financial markets fragmentation by attracting euro area banks into lending in the so-called 'peripheral' economies.

At this stage, both demand and supply of credit in the majority of the euro area economies are well outside the fundamentals-determined levels. The financial markets are severely fragmented and the ongoing deleveraging of the banks and companies balancesheets still working through the credit markets. This means that any forecast for TLTROs uptake and effectiveness are subject to huge uncertainty. My view is that we are likely to see rather cautious take up of the TLTRO funds in the first round, with many lenders dipping into the funding stream without full commitment. We are looking at the take up of around EUR100-150 billion in Thursday TLTROs. One reason for this is that the first tranche of TLTROs is likely to go into replacing maturing 3-year LTRO funds rather than new expansion of the banks balancesheets. To-date, banks repaid some EUR649 billion of LTROs, with EUR370 billion outstanding. Close-to-redemption LTRO funds need replacement and TLTROs are offering such an opportunity, albeit at a cost (TLTROs are priced 10bp higher than LTROs but offer longer maturity). All-in, the banks are likely to go for roughly EUR300 billion of TLTROs (with total potential allotment of EUR400 billion available, the cost will be the main factor here), with under half of this coming in September and the balance in December. Another reason pushing TLTROs demand into December, rather than September, is the ongoing ECB review of the banks (AQR analysis).


ABS measures are going to aim to address the size of the ECB balancesheet, while providing support for effective yield on loans to the real economy. In this, well-structured ABS purchasing programme can provide support for TLTROs by increasing incentives for the banks to lend funds to corporates. However, excessive focus in the ABS programme on quality of assets and risk pricing can posit a risk of increasing fragmentation in the markets, as such focus can drive a significant wedge in pricing between corporate yields in the core economies of the euro area and the 'periphery'.

I do not see the ECB deploying traditional QE programme at this point in time. The reason for this is simple: yields convergence in the Sovereign markets is ongoing, levels of yields are benign, and demand for sovereign assets remains strong. However, if TLTROs and ABS programmes prove to be successful, we may see banks exits from low-yielding sovereign debt (core euro area) and from high yield, but now significantly repriced peripheral debt (profit taking). Unlikely as this might be at this point in time, if such exits prove to be aggressive, the ECB will have to provide support for sovereign yields and a small-scale QE can be contemplated in this case.

In general, however, it is clear from Mr Draghi's recent speeches and statements that he sees two key problems plaguing the euro area economies: the problem of high structural and cyclical unemployment and the problem of low private investment. Both of these problems continue to persist even as the sovereign debt yields have fallen dramatically, suggesting that government spending stimulus and investment programmes are unlikely to repair what is structurally a longer-term set of weaknesses in the economy.

Wednesday, September 17, 2014

17/9/2014: Belarus v Ukraine: Income per Capita

Someone just asked me a question as to what is the relative income in Belarus vs Ukraine. Here is the data on GDP per capita basis (PPP-adjusted to reflect exchange rates and price levels differences) for main CIS countries (click to enlarge):

Note: as Ukraine is now a programme country for the IMF, forecasts end at 2014.

Sorted. Enjoy.

On related note, here are some other comparatives including Belarus and Ukraine: http://trueeconomics.blogspot.ie/2014/09/992014-russias-risks-are-up-but-still.html see table at the bottom of the post.

17/9/2014: Letting Go Ireland's Tax Arbitrage Model Will be a Painful Process

OECD has put forward their proposals for new international tax rules that, in theory, could eliminate tax-optimisation structures that have allowed many multinational companies (such as Google, Apple, Pfizer, Amazon, Yahoo and numerous others) to cut billions of dollars off their tax bills. The proposals were prompted by the G20 request issued last year and the measures announced this week have already been agreed with the OECD’s Committee on Fiscal Affairs (44 countries).

The proposals form just a part of the overall international tax reforms package called “Action Plan on Base Erosion and Profit Shifting” that will be unveiled in 2015 and is commonly known as BEPS.

There are two pillars in the current announcement.

The first pillar addresses only some of the abuses of dual-taxation treaties that generally aim to prevent double taxation of companies trading across the borders. The OECD is proposing to make amendments to its model treaty package that would prevent cross-border transactions from availing of tax treaty reliefs whenever the principal reason for the transaction is to avoid tax liability. This is a principles-based change, recognising the spirit or the principle of the dual-taxation treaties. De facto, the aim is to prevent the situation where preventing dual taxation leads to the scenario of dual non-taxation.

As with all principles-based reforms, the devil will be in the fine print of the actual regulations and economist's mind is not the best guide for sorting through these. From the top, were the measures to succeed, profits shifting via the likes of Ireland to tax havens will be if not fully stopped, at least significantly impaired. The result will be putting at risk tens of billions of economic activity booked via Ireland. In some cases, practically, this will mean that activity will be re-domiciled to other jurisdictions, where it really does take place. In other, however, it will become subject to tax in the country that stands just ahead of the tax haven in the pecking order of revenues flows. Ireland might actually benefit here, since our tax regime is still more benign than that offered in other countries.

To support the first pillar, however, the OECD also wants to restrict the amount of profits that a company can report in its intra-company accounts when these are based offshore. In effect this will put a cap on how much of their activity companies can attribute to the intra-company transactions or to force companies to redistribute profits generated by intra-company divisions across the entire group.

This is likely to undermine our ability to gain from re-allocation of revenues mentioned above. For example, suppose a company has a division based in Ireland that holds the company IP. The division is highly profitable, despite being very small: revenues it earns from other parts of the company operating around the world are covering the alleged cost of IP. If these profits were capped and/or required to be redistributed around the world to other divisions of the same company, the incentive for the company to retain its IP in tax optimising location, such as Ireland, will be gone no matter what our tax rate is.

The second pillar relates to the rules on tax residency. In particular, the OECD said that the existent rules that allow companies to operate facilities in a country without registering tax residency there should be abolished. The result, if adopted, will be to force companies like Google, Apple and Amazon to pay taxes on activities carried out in larger European states in these states by removing the channel for profit shifting to Ireland and other countries. The OECD is explicit about this by insisting that companies with 'significant digital presence' in the market should be forced to declare tax residence in that country.

Ireland's official response to this threat is that majority of MNCs trading from here do have significant presence here in form of large offices and big employment numbers. This is a weak argument for two reasons. One: Irish operations are relatively small for the majority of MNCs, compared to their global workforce. Two: majority of Irish operations of MNCs are sales, sales-support, marketing and back office. In other words, these support larger markets workforce.

The first pillar of the proposal is likely to impact sectors such as phrama and tech, where significant profits are generated by IP, trademarks and patents and these are often held off-shore in what are de facto shell subsidiaries not registered for tax purposes in the countries where actual activities of the company are based.

The second pillar is even more damaging to smaller open economies such as Ireland, because it mirrors the old EU proposal for CCCTB basis of corporate taxation. This pillar will likely push activities that are registered in countries like Ireland back into the countries where actual transactions take place, favouring larger economies over smaller ones.

For example, take a US company running sales support centre in Ireland servicing Spain. This activity is supplied by Spanish-speaking, largely non-Irish staff that has been imported into Ireland not because they are more productive here or have better human capital or face lower costs of employing, but because their presence in Ireland allows the company to book sales in Spain into Ireland. In fact, absent tax arbitrage, it would probably be cheaper for the company to employ these workers in Spain.

Back in 2013, Reuters reported that 3/4 of the largest US MNCs in tech sector channeled their revenues from sales across the EU into Ireland and Switzerland, avoiding reporting these activities in the countries where actual customers resided.

If OECD proposals are implemented to reflect the spirit of the reforms, the tax arbitrage bit of the abnormal return on locating labour-intensive activities in Ireland will be gone. This, by itself, may or may not be enough to put those jobs on the airplanes back to Spain, Italy, Germany, France and elsewhere. But if other countries start making themselves more competitive in labour costs, tax and regulatory regimes, defending Ireland's competitive proposition will be harder and harder.

This process - of erosion of Irish competitive advantage - will be further accelerated by the OECD proposals on tax data sharing and clearance which envisages massive increase in the data reporting burdens on the multinational companies. The cost of compliance and audits this entails will be large and increasing in complexity of companies' structures, leading to more incentives for them to rationalise and streamline their operations worldwide. A tiny market, like Ireland, much more efficiently serviceable via the larger economy like the UK, is unlikely to win in this race.

OECD proposals can have a pronounced effect on economic growth, employment and financial health of a number of countries, including Ireland, Luxembourg, Switzerland, and the Netherlands because the proposals will force MNCs to change their global operations structures and move jobs out of tax optimisation states toward the states where real activity takes place.

From Ireland's point of view, closing off of the loopholes can have a dramatic effect on the ground if it is accompanied by other trends, such as renewed corporate tax rate competition that can challenge our attractive headline rate of 12.5%, erosion of Irish regulatory and supervisory regimes competitiveness, increase in cost inflation and other inefficiencies. Instead of competing on being a tax arbitrage conduit, Ireland will have to start competing on the basis of real economic fundamentals, such as skills, public policy, public goods and services, private markets efficiencies, etc.

Ironically, the threat of the elimination of tax arbitrage opportunities can result in Ireland becoming more competitive and more successful over time, assuming the Governments - current and subsequent - play it smart.

Tuesday, September 16, 2014