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News : Irish Economy Last Updated: May 12, 2011 - 10:08 AM

Irish Economy 2011: ESRI says ECB should provide Ireland with interest-free loan of €40-50bn to “overcapitalise” banks
By Michael Hennigan, Founder and Editor of Finfacts
May 11, 2011 - 7:30 AM

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Irish Economy 2011: The Economic and Social Research Institute (ESRI) says the European Central Bank (ECB) should provide Ireland with an interest-free loan of €40-50bn to “overcapitalise” the Irish banks.

The institute says in its Spring Quarterly Economic Commentary that attempts at EU and ECB level to contain the banking crisis within the countries most directly affected do not take account of the spillover effects of the initial problem in the solution currently in place. What is needed is an EU or Eurozone solution that does not place the whole of the burden of recapitalising banks onto national budgets already stretched by recession.

The ESRI says the data show clearly the unbalanced nature of the covered commercial banking institutions operations with a loan to deposit ratio of 1.74, with loans additionally financed by interbank borrowing. The figure for this at €167.8bn consists primarily of borrowing from both the ECB and the Central Bank of Ireland. The total outstanding borrowings from the ECB and the Irish Central Bank have remained at these levels, totalling some €170bn at end February. As a consequence, the covered commercial banking institutions operating in the Irish market face a funding crisis which makes it difficult for them to engage in normal commercial lending.

The institute says there are several possible approaches to EU centred restructuring. The simplest would be an interest free loan from the ECB to the Irish Government, guaranteed by the latter, sufficient to overcapitalise the banks. The two aspects, i.e. external funding and overcapitalising, would give the exercise credibility and would allow the banks to return to the interbank market, to reduce their indebtedness to the ECB and the Irish Central Bank, to begin providing additional credit to the economy. An alternative would be for the ECB to undertake the recapitalisation directly and to convert the funds used for recapitalisation into equity with a view to future sale of the assets.

Economy in Transition

The economists say the economy is in transition from where growth was led by domestic demand to one where export growth by both multinational and local firms will become the engine of growth. This transition is underway as domestic firms in the tradable goods sector have sought to replace falling domestic demand by sales in overseas markets. Output and exports from traditional firms increased in 2010, with exports from the food and drink sectors in particular rising by 11% in value terms. This is very similar to the experience of the 1980s, when exports led growth, and the reverse of what happened in the 2000s when the strong growth in domestic demand led firms to shift their emphasis from exports to the domestic market.

However, the value of food exports is in a market where some global food commodity prices have hit record levels.

While in 2010 the shift to exports was not sufficient to counteract the decline in domestic demand following a rise in the personal savings rate and the 2010 contractionary budget, the economists expect some very modest growth this year with GNP (GDP) rising by about ½%, and strengthening in 2012 to 2%. This year the stimulus is coming entirely from the external sector (both service and merchandise exports) as domestic demand will fall again, along with investment and government current expenditure. The ESRI expects household expenditure to rise very modestly during the year, following what looks like a slight rise in household spending in the first quarter. Households have been reducing their indebtedness very sharply since 2008 and some households may now be satisfied with their net debt position. Consequently, the institute expects a decline in the savings rate in 2012. Domestic demand will be very slightly positive in 2012, while external demand will grow by 7½% in both 2001 and 2012.

The Consumer Price Index (CPI) is forecast to increase by 2½% this year and the EU Harmonised Index of Consumer Prices (HICP) to rise by 1½%. The pattern will be very uneven during the year as oil prices are rising in the first half of the year but could fall back in the second half. Of greater importance may be shifting by consumers to lower priced products and outlets as price variations across goods and services remain very large. The deflator for total household consumption is expected to remain at the 2010 average level in 2011, but to increase by about 1% in 2012.

Total employment will fall again in 2011, but at a much slower pace than in recent years. Unemployment will be higher on average than in 2010, but the extent of it will be moderated by migration. The ESRI says the extent of the latter will become clearer when the first 2011 census results become available. Nevertheless, it is worth noting that there are emerging skill shortages in some of the fast growing services exports sector.

Prof Joe Durkan said cutting the deficit more quickly would enable Ireland to re-enter the markets sooner, in turn restoring international confidence.

He suggested property and higher car taxes, and universal water charges to increase revenues.

The economist also said it was time to consider abandoning the Croke Park Agreement, as it had under-delivered. Instead, he favours imposing an additional average 10% pay cut in the public sector.

Prof Durkan said he is 20% overpaid .

The ESRI economists said the capital spending budget of €6bn should be cut, including the scrapping of the Dublin Metro North rail project.


The overall volume of exports of goods and services increased by 9.4% in 2010, following declines in 2008 and 2009, and was 4.2% above the previous peak level in 2007. Merchandise exports increased by 7.7% in volume terms. Table 1 below shows the level of exports of goods in 2009 and 2010 and the percentage change by category. The data indicate an increase of 6.1% in total merchandise exports in 2010, with considerable variation on growth rates across categories.

Modern sector exports (corresponding to Chemicals, some part of Machinery and Transport equipment and Miscellaneous), which are primarily produced by multinationals, account for the bulk of merchandise exports. The ESRI estimates that the value of these exports increased by 4% from 2009 to 2010, while all other exports increased in value by 12.5%. In effect, the growth rate of non-modern exports exceeded that of modern sector exports. These other exports are produced in the main by indigenous and traditional firms. Table 1 shows these growth rates; for example, food exports (the value of live animal exports is very small) increased by 11.2%, while beverage exports rose by 9.9% and similar increases were recorded by other traditional sectors.

This suggests that traditional sector firms have increased output which has gone into export sales and was facilitated by the improvement in competitiveness over the past three years and by an improvement in other costs relative to competitor countries. The economists say this is the classic ‘expenditure shifting’ that governments hope for when reducing domestic demand to correct a payments deficit or when correcting a budget deficit leads to a reduction in domestic demand.

Overall, exports of goods and services are forecast to rise by 7.5% in both 2011 and in 2012 in volume terms.

The ESRI's David Duffy says statistics on mortgage arrears from the Central Bank shows a steady rise in the number and proportion of mortgages in arrears. Of the 786,164 private residential mortgage accounts in Ireland, 44,508 or 5.7% were in arrears for more than 90 days at the end of December 2010. This represents an increase of 15,905 from the end of 2009, and continues earlier trend increases in the number of mortgages in arrears. In December 2006 it was estimated that 11,252, mortgage accounts were in arrears for more than 90 days (1.2%).

The latest release also includes data showing that 59,229 mortgages have been restructured by lenders as part of forbearance measures to assist borrowers facing difficulty. A move to an "interest only" mortgage accounts for the largest proportion of restructures (38.3%), while reduced payments (paying greater and less than interest only) account for 28.3% of restructures. Other types of restructuring include term extension (12.2%) and arrears capitalisation (11.9%). A payment moratorium accounts for just 4.3% of restructures to date, while other forms of restructuring account for another 4.9%. Taking account of an overlap between restructured mortgages and mortgages in arrears shows that 79,713 mortgage accounts are either in arrears greater than 90 days or have been restructured, amounting to 10.1% of mortgage accounts.

Analysis by the Irish Banking Federation shows that the repossession rate in Ireland is low when compared to the UK; for example, there were 13 repossessions per 100,000 mortgages here compared to 69 per 100,000 mortgages in the UK in Quarter 4, 2010.

Finfacts reports that according to Eurostat, the EU's statistics' office, over 40% of owner-occupied houses in Ireland have no mortgages compared with about 12% in Sweden and less than 10% in the Netherlands.

Summary Quarterly Economic Commentary, Spring 2011
Joe Durkan, Cormac O'Sullivan (ESRI)

  • We see the economy as being in a process of transition from one where domestic demand was the driver of growth to one where exports will play an important part in economic recovery. Firms in several traditional sectors are seeking markets abroad to compensate for depressed domestic demand. Meanwhile exports of multinationals continue to grow as competitiveness is regained.

  • The data for 2010 show this transition is well underway, with exports from traditional firms increasing by 12.5%. We expect this to continue with these exports rising by 7.5% both this year and next, while modern sector exports rise by 5%. Exports of services will continue to increase rapidly as new firms locate here and existing firms expand.

  • We expect domestic demand to remain very weak this year, with investment and government expenditure declining and household expenditure static. Household expenditure fell over the course of 2010 but we expect it to increase gradually during 2011 and to rise by 2% in 2012. The current weakness in domestic demand is due primarily to the negative effect of contractionary fiscal policy.

  • GNP (GDP) is forecast to increase by ½ (2)% this year and by 2 (3)% in 2012. Our forecast for unemployment is 14 ¼% this year and 14% in 2012, with the declines from current levels reflecting migration. Consumer prices (CPI) are expected to rise by 2½% this year, with the HICP increasing by 1½%. However, the implicit consumption deflator, which takes account of changing consumer expenditure patterns, may remain virtually unchanged this year. The balance of payments is forecast to record a surplus this year and next.

  • The public finances are also in a process of transition to a new lower level of expenditure and revenue. The official budget targets, modified by the extra cost of bank restructuring this year, are achievable. If the profile set out by government is maintained, then public debt will be sustainable. However, given the need to return to financial markets in the near future, we consider that attempts should be made to eliminate the budget deficit faster than is currently envisaged.

  • While the recent bank restructuring should be more than adequate to restore the capital base of the covered banks, we consider that the attempts at EU and ECB level to contain the banking crisis within national borders ignore the spillover effects of the initial problem. We suggest that an EU or Eurozone solution is needed that does not place the whole of the burden of recapitalising banks onto national budgets already stretched by the recession.

  • In our General Assessment we reiterate the need for fiscal consolidation, but we also emphasise the importance of strengthening the competitive position of firms so that export growth can be maintained and increased. Water charges, property taxes, and a reformed car tax regime can provide additional funding for government, and also create the opportunity for reducing costs to business.

  • The existence of a balance of payments surplus this year and next creates the opportunity for the government to raise funds at a domestic level. Realising domestic funds may require an imaginative approach focused on the type of instruments that appeal to savers.

Summary and Research Articles

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