Ireland puts another nail in the coffin of GDP statistics

Friday brought news on a subject that is genuinely troubling so let me hand you over to Bloomberg.

Ireland’s economy surged in the third quarter, boosted by rising exports and falling imports.

On the face of it this is good news for Ireland but you barely need to touch the surface to see that there is as Taylor Swift would put it “trouble,trouble,trouble”. Let us go to the Central Statistics office release.

On a seasonally adjusted basis, initial estimates indicate that GDP in volume terms increased by 4.2 percent for the third quarter of 2017. Real GNP increased by 11.9 per cent over the same period.

There are some obvious initial issues as we note that these are not annual numbers or even annualised ones but quarterly data. Those who doubt a first world economy can grow by 4.2% in a quarter then find themselves facing a mind-boggling 11.9% from the GNP measure. So let us steel ourselves and look at the annual data.

Initial estimates for the third quarter of 2017 indicate that there was an increase of 10.5 per cent in GDP in real terms in Q3 2017 compared with Q3 2016………Factor income outflows were 7.7 per cent higher than in the same quarter of 2016 resulting in an increase in GNP of 11.2 per cent year-on-year.

So we have double-digit growth on both measures but even more bizarrely pretty much all the GNP growth came in the latest quarter! So the economy did just about nothing for 9 months and then in the next quarter flew out of the water like the most athletic Irish salmon you have ever seen?

Detailed problems

The Irish Ivory Towers will be having a party as they observe a sea of export-led growth.

Exports increased by 4.4 per cent in Q3 2017 compared with Q2 2017 which when combined with an import decrease of 10.9 per cent meant overall net exports for the quarter increased by 63.1 per cent.

This meant that even countries like Germany or China would be jealous of the trade position.

The Balance of Payments current account, a measure of Ireland’s economic flows with the rest of the world, had a surplus of €14,488m (18.7% of GDP) in the third quarter of 2017.

However in the previous quarter there has been a deficit of 872 million Euros so what really drove the change which exceeded 15 billion Euros?

Service imports at €38,842m were down €8,625m over the same period in 2016.

As we look further we sign a sign of a particularly Irish issue.

These figures were affected by reduced levels of research and development costs, in particular intellectual property imports.

Let me hand you over to the official view on this.

These figures were affected by reduced levels of research and development costs, in particular intellectual property imports.

The numbers are a combination of mind-boggling and bizarre as we see that the R& D sector which is essentially intellectual property saw import growth from 19 billion Euros in 2015 to 47 billion Euros in 2016 but now has seen a quarter of only 3.6 billion. So slower than 2015 when the economy is apparently booming?

The issue of plummeting imports in an economic boom is a fundamental one and frankly on its own would have the Starship Enterprise on red alert.

A space oddity

A perhaps curious consequence of this provokes a wry smile. You see Ireland has moved into a current account surplus with the UK just as the UK Pound £ has fallen and made its exports more competitive. I will leave the Ivory Towers to explain that one.

A manufacturing boom

We have got used to seeing manufacturing declines in the western world and Ireland was in that camp with output falling from 45.2 billion Euros ( 2015 prices) in 2011 to 43 billion in 2013. But there was quite a boom to follow as we note that output was 92.4 billion Euros in 2016.  Actually the boom came in one-quarter because as the clocks recorded a New Year as 2014 ended then quarterly manufacturing was on its way from 10.7 billion Euros to 23.5 billion. Another way of putting the surge was that it was 101.4% higher than a year before.

Since then it has done very little having risen gently. The issue at hand is what is called contract manufacturing where the products may never have been within Ireland’s borders. Finfacts has reported this.

However, we reported in 2012 that Dell Products Ireland which closed its PC plant in Limerick in 2009 remained one of Ireland’s biggest exporters and manufacturers as it booked the output of its Polish plant in Ireland.

And this.

Data from the Fiscal Advisory Council (FAC) show that 2.5% of the 5.8% rise in Irish GDP (gross domestic product) in H1 2014, or 43%, came from contract manufacturing overseas, that has no material impact on jobs in the economy. Dell, the PC company, books its Polish output in Ireland for tax avoidance purposes.

We will have to see going forwards but the investment figures were not especially hopeful.

Capital formation declined by 36.0 per cent in Q3 2017 compared with the previous quarter.

This is an especially serious area because manufacturing produces actual things which we should ( especially in an information technology revolution) be able to count increasingly accurately. Instead we seem unable to count it at all. This affects many economic figures as there is something of a gap between monthly goods exports in the mid to high 20 billion Euros counted in the trade figures and the 40 billion plus in the national accounts.

Consequences

On the face of it the Fitch Ratings report was good news.

 On the basis of data up to 2Q, we estimate real GDP growth for this year of 5%. Early estimates for 3Q point to stronger GDP growth……..Fitch forecasts the general government debt-to-GDP ratio to fall to 65.8% by 2019, from 72.8% at end-2016 (1.1 percentage points of which is due to the sale of part of the state’s stake in AIB).

Even they had to admit though that the numbers are doubtful and it is hard to forget their catastrophic efforts in 2007 of pronouncing the Irish banking sector to be in good shape as you read this.

Fitch believes the health of the banking sector is improving, reducing risks to the Irish sovereign and economy. The ratio of non-performing loans (NPL) has fallen to 11.9% in 2Q17 from a peak of 25.7% in 2Q13.

Comment

Back in time I used to visit clients in Dublin at this time of year and would be looking forwards to the restaurants around St.Stephens Green and some Guinness. However back then building and development work was increasing this described below by the Tax Justice Network.

 The second big development has been the Dublin-based International Financial Services Centre (IFSC), a Wild-West, deregulated financial zone set up in 1987 under the “voraciously corrupt” Irish politician Charles Haughey:

The issue of tax is hard to avoid as money crosses Ireland’s borders in all directions but in particular seems to slip past the tax collectors. From Fortune.

The European Commission ruled last year that a tax deal that Ireland gave Apple was illegal, and that it owed the country $14.5 billion in back taxes. Ireland has been dragging their feet a little bit when it comes to collecting on that debt,

Unusual isn’t it for a country to not actually want tax? After all there are plenty of things it could be spent on. From the Irish Times.

In October 2014, when The Irish Times first interviewed some of Dublin’s homeless children, they numbered 680 in 307 families. Although Enda Kenny, then taoiseach, said no child should be homeless, their numbers have increased 256 per cent.

So how much economic activity is happening? The Central Bank of Ireland helps us out a bit.

GNI* excludes the impact of redomiciled
companies and the depreciation of intellectual
property products and of leased aircraft from
GNI. When this is done, the level of nominal
GNI* is approximately two-thirds of the level
of nominal GDP in 2016.

Please do not misunderstand me as there are signs of economic improvement in Ireland as for example tax revenues have risen and unemployment fallen. Yet in spite of the apparent economic boom the unemployment rate at 6.1% is above the pre crisis rate of 5% and that is in spite of those on government schemes. Thus the picture is complicated as we see enormous sums wash in and out of the Irish economy relegating the national accounts to a picture of tax avoidance more than economic activity in general.

 

 

 

 

Can Portugal trade its way out of its lost decade?

The weekend just gone has brought some good news for the Republic of Portugal. This came from the Standard and Poors ratings agency when it announced this after European markets had closed on Friday.

On Sept. 15, 2017, S&P Global Ratings raised its unsolicited foreign and local currency long- and short-term sovereign credit ratings on the Republic of  Portugal to ‘BBB-/A-3’ from ‘BB+/B’. The outlook is stable.

Bloomberg explains the particular significance of this move.

Portuguese Finance Minister Mario Centeno expects greater demand for his nation’s debt from a broader array of investors to spur lower borrowing costs both for the government and corporations, after the country’s credit rating was restored to investment grade status by S&P Global Ratings.

So the significance of their alphabetti spaghetti is that Portugal has been raised from junk status to investment grade. I will deal with the impact on bond markets later but first let us look at the economic situation.

Portugal’s economy

The key to this move is an upgrade to economic prospects.

We now project that Portuguese GDP will grow by more than 2% on average between 2017 and 2020 compared to our previous forecast of 1.5%.

This is significant because one of my themes on the Portuguese economy is that if we look back over time it has struggled to grow by more than 1% per annum on any sustained basis. This has led to other problems such as its elevated national debt to economic output level and makes it very similar to Italy in this regard. So should it be able to perform as S&P forecast it will be a step forwards for Portugal in terms of looking forwards.

If we look for grounds for optimism there is this bit.

We expect Portugal will maintain its strong export performance over the forecast horizon, reflecting solid growth in external demand and an uptick in exports.

Export- led growth is of course something highly prized by economists.

A solid external performance is likely to bring goods and services exports to around 44% of GDP in 2017, from below 29% just seven years ago.

Portugal has done well on the export front but S&P may have jointed the party after the music has stopped as this from Portugal Statistics earlier this month implies.

In July 2017, exports and imports of goods recorded year-on-year nominal growth rates of +4.6% and +12.8%
respectively (+6.7% and +6.6% in the same order, in June 2017)…….The deficit of trade balance amounted to EUR 1,057 million in July 2017, increasing by EUR 446 million when compared with July 2016.

Okay so worse than last year. I often observe that monthly trade figures are unreliable so let us move to the quarterly ones.

In the quarter ended in July 2017, exports and imports of goods grew by 9.0% and 13.4% respectively, vis-à-vis
the quarter ended in July 2016.

If we look back we see that if we calculate a number for the latest quarter then we now have had a year of monthly data showing a deterioration for the trade balance. Just to be clear exports have grown but imports have grown more quickly. So the monthly trade deficits have gone back above 1 billion Euros having for a while looked like going and maybe staying below it.

If we move to the other side of the trade balance sheet we see that imports have surged which will be rather familiar to students of Portuguese economic history ( as in a reason why they have so frequently had to call in the IMF). This year the rate of growth ( quarterly) has varied between 12.2% and 15.9% in the seven months of data seen.

There is a clear tendency for ratings agencies to be a fair bit behind the news and the export success story would have fitted better a year or two ago. Let us wish Portugal well as we note the recent growth has been in imports and also note that in general in 2017 so far the Euro has risen putting something of a squeeze on exports which compete in terms of price. The trade weighted exchange-rate rose from 93 in April to 99 now in round terms. So the gains of the “internal devaluation” which involved a lot of economic pain are being eroded by a higher exchange rate.

Debt

If you look at the economy of Portugal then the D or debt word arrives usually sooner rather than later. This is why an improved trade performance is more important than just its impact on GDP ( Gross Domestic Product). This is how it is put by S&P.

Estimated at about 236% in 2017, we view Portugal’s narrow net external debt to CARs (our preferred measure of the external position) as being one of the highest among the sovereigns we rate, albeit on a steady declining trend.

There has been deleveraging but of course this drags on growth before hopefully providing a benefit.

Data from the Portuguese central bank, Banco de
Portugal, indicate that resident private nonfinancial sector gross debt on a nonconsolidated basis was still at a high 217% of GDP in June 2017, down from 260% at end-2012.

So far I think I have done well in avoiding mentioning the ECB ( European Central Bank) but this is an area where it has really stepped up to the plate.

The ECB’s QE has helped to further bring down the government’s and corporate sector’s borrowing costs.

Although it does pose a challenge to this assertion from S&P.

While we view the high level of public and private sector indebtedness as a credit weakness, we observe that external financing risks have declined significantly reflected in a substantial improvement in the government’s borrowing conditions.

Maybe but you cannot ignore the fact that the ECB has purchased some 29 billion Euros of Portuguese government bonds as part of its ongoing QE programme. To this you can add purchases of the bonds of Portuguese corporates and of course the 91 billion Euro rump of the Securities Markets Programme which also had Greek and Irish bonds. If you read about lower purchases of Portuguese bonds it is mostly because the ECB already has so many of them. Last time I checked large purchases of something tend to raise the price and lower the yield.

According to the latest ECB data, the central bank acquired €0.4 billion of Portuguese government bonds in August 2017, hitting a new low since the beginning of the
PSPP. The peak was in May 2016, at €1.4 billion.

The banks

Even S&P is none to cheerful here pointing out that the sector remains on life support.

It remains reliant on ECB funding.

Indeed the prognosis remains rather grim.

Banks’  earnings generation capacity also remains under significant pressure given the ultra-low interest rates, muted volume growth, and still large stock of
problematic assets (about 19% of gross loans) and foreclosed real estate assets (including restructured loans not considered in the credit-at-risk definition) as of mid-2017.

Internal Devaluation

If you improve your position via an internal devaluation involving lower wages and higher unemployment then moves like this are simultaneously welcome and risky.

In our opinion, consecutive increases in the minimum wage, most recently by 5.1% in January 2017, accompanied by measures to offset some of the additional cost for employers, are unlikely to have weakened the cost competitiveness of Portuguese goods and services.

Comment

Portugal is a lovely country so let us look at something which is really welcome.

As such, the jobless rate has almost halved from its peak of 17.5% during 2013 and is currently at 9.1% (July 2017), in line with the eurozone average and lower than in France, Italy, and Spain.

Good. However this does not change the fact that Portugal has travelled back to between 2004 and 2005. What I mean by that is that annual GDP peaked at 181.5 billion Euros in 2008 and after the credit crunch hit there was a recovery but then a sharp downturn such that GDP in 2013 was 167.2 billion Euros. The more recent improvement raised GDP to 173.7 billion Euros in 2016 and of course things have improved a bit so far this year to say 2005 levels.

Why is there an ongoing problem? Tucked away in the S&P analysis there is this.

we consider that Portugal’s fragile demographics, weakened by substantial net emigration and a declining labor force, exacerbate these challenges. Low productivity growth would likely stifle the economy’s growth potential (though this is not unique to Portugal), without further improvements in the efficiency of the public administration,
judiciary, and the business environment, including with respect to barriers in services markets (for example, closed professions).

Let me end by pointing out the rally in Portuguese bonds today with the ten-year yield now 2.5% although having issued 3 billion Euros of such paper with a coupon of 4.125% in January it will take a while for the gains to feed in. Also let me wish those affected by the severe drought well.