John Finn, MD of Treasury Solutions Ltd, says that he is concerned that Ireland has not learned the lessons of a decade ago and if Ireland was one of the companies that Treasury Solutions has advised in its debt management and financing, he would urge prudent investment management, sound evaluation of capital investment opportunities and the establishment of solid, robust borrowing arrangements.

">

Familiar feeling as Irish government spending plans unsustainable, says treasury expert

John Finn, MD of Treasury Solutions Ltd, says that he is concerned that Ireland has not learned the lessons of a decade ago and if Ireland was one of the companies that Treasury Solutions has advised in its debt management and financing, he would urge prudent investment management, sound evaluation of capital investment opportunities and the establishment of solid, robust borrowing arrangements.

Familiar feeling as Irish government spending plans unsustainable, says treasury expert

John Finn, MD of Treasury Solutions Ltd, says that he is concerned that Ireland has not learned the lessons of a decade ago and if Ireland was one of the companies that Treasury Solutions has advised in its debt management and financing, he would urge prudent investment management, sound evaluation of capital investment opportunities and the establishment of solid, robust borrowing arrangements.

WHAT follows here is a summary of a recent article distributed to clients of The Treasury Hub. The last time that I wrote an article like this was in June 2006. Back then I pointed out that the Celtic Tiger wasn’t so strong when one looked at some basic economic data. Alas, I revert to a similar theme again.

We are all aware that the recovery from the financial crisis has been stronger than anticipated but it has also been uneven (sectorally, geographically and in socio-economic/demographic terms).

Firstly, let’s have a look at the good stuff. Unemployment rate of 5.4% was last seen in 2008, numbers employed are at highest ever (2.27m), Government budget as % of GDP is zero (last seen in 2007), Government debt:GDP is 64.8% (last seen in 2009), balance of trade is highest on record.

However, let’s scratch a little below the surface. Youth unemployment is still stubbornly high at 13.4% while rents are at an all-time high. €1,500 per month will rent you a studio apartment in Dublin but also equates to the repayments on a 20-year year mortgage of €270,000 at the current 5-year fixed rate. Meanwhile despite much larger numbers at work, house ownership peaked at 81.8% in 2004 and is now 69.5%...moving closer to international averages in a country that had the highest level of unoccupied housing 8-9 years ago but now has historic homeless figures. How did that happen?

Debt:GDP is no longer a useful metric. Using Debt:GNI we come in at 105%. And even using the (inflated) GDP metric, private debt:GDP which was as low as 188.7% in 2002 is now at 382.3%. Household debt:disposable income remains considerably above the Eurozone average.

However. the level of government debt is the elephant in the room ... and the government’s predictions in this area leave me very uneasy. Here’s why.

Gross Government debt: actual 1991-2018, forecast to 2024

National debt four times higher than in 2007

The amount of money owed by the State is almost four times as high as it was in 2007. Quantitative Easing plus the improved credit rating of the State allows the government to borrow at negative interest rates for up to 5 years, at 0.20% for 10 years and 1.15% for 30 years.

These low rates allow the State/NTMA to both reduce the interest bill (the debt that is being repaid in 2019-2022 was mostly borrowed at the start of this decade at rates between 4.0% and 5.5%) but also to “reprofile” the debt repayment. Many governments e.g. the US don’t repay their debt: they simply refinance or re-borrow new funds to repay maturing debt.

Reprofiling is most useful to avoid a lot of debt maturing at the same time (the risk being that financial markets are not conducive to raising debt at that time). This is referred to as concentration risk. The second benefit of reprofiling is to push out the repayment dates. This is the one that is more tempting …and scary. It merely pushes out the debt repayment date making it someone else’s (some other government’s?) problem.

The cost of servicing government debt (despite the absolute level of debt increasing) has fallen from €7.7bn in 2013 to a forecast €5.3bn in 2019 thereby contributing to a material % reduction in the Budget deficit over the period. But this is not due to actions taken by the government. It’s the effect of QE. To put this in layman’s terms, it’s like owing the banks €100,000 in 2007 and €400,000 today but because interest rates have fallen from 5% to 1%, the annual interest bill is lower. Most households would start using the lower interest bill to start repaying the loan. But the government is using the cost saving to spend on other expenditure, leaving the massively higher debt untouched for the most part.

Now let’s look to the forecasts included in the 2019 Budget.

The government has revenues (taxes) and spends it on services (health, education, welfare).

The PAYE take has increased from circa €15bn in 2012 to €21.4bn in 2018. As the number of people at work has increased by 20.6% between 2012 and 2018 (from 1.89m to 2.28m) this is not surprising. (Source: CSO). However, the 2019 Budget forecast projects growth in income tax from €21.4bn in 2018 to €28.8bn in 2023 which is a 34% increase in the ANNUAL income tax take. The number of people employed over the same period increases by 10%. Mathematically, it means either higher tax rates (unlikely) or higher incomes … which means no slowdown is anticipated. The same trend for VAT: jumping from €14.0bn in 2018 to €18.4bn in 2023. In fact, they project annual tax revenue to increase from €69.0bn in 2018 to €84.1bn in 2023.

What happens the €15bn increase in annual taxes? €12bn will be spent on day-to-day expenditure while capital expenditure (schools, roads, hospitals, broadband) will increase from €5.9bn to €9.4bn. The cost of servicing the national debt (the interest bill) will actually decrease by almost €1bn per annum over the period.

The net effect of that forecast significant improvement in tax revenues will be to move from an annual net deficit of (€2.7bn) to an annual net surplus of €0.6bn over the next five years.

No household should be run like this.

To put that in plain English, if we hit those optimistic figures by 2023 (representing over a decade of strong economic growth), we will just about then be able to start repaying the massive debt owed.

Or in layman’s terms, it is equivalent to the person whose debt has grown from €100,000 to €400,000 over the recession enjoying increased income of 3%-4% every year for 10 years, but spending all that increased revenue (and borrowing a little more) until 2023 when he/she decides that maybe they will be in a position to start repaying the €400,000. No household would be run like that. But that’s where the government finances are broadly forecast to behave over the next five years.

Threats from global competition and possible EU challenge on corporate tax rate

On top of all of the above, there is a very similar theme rearing its ugly head: The top 10 companies accounted for 45% (or €4.7bn) of the Corporation Tax (CT) take in 2018 up from 40% the previous year and an average rate of 23.8% for the period 2008-2012 (Source: Revenue). 100 companies pay almost 75% of the total CT bill with foreign-owned companies paying 77% of the total.

They are also significant employers that pay well, giving momentum to the PAYE figures. We have a heavy dependence on US companies, especially in the tech/social media space. We did this with manufacturing 25-30 years ago but eventually lost these jobs to low-cost economies. We did this with housing in the noughties which was arguably worse as such taxes were one-off receipts. The risk in this space today is not only to low-tax jurisdictions globally but the possible challenge to our tax rates from within the EU.

Spending more than we earn

In summary we are continuing to spend more than we earn (after capital expenditure) even though we have experienced significant income growth. We are forecasting this to continue despite a backdrop of Brexit, international trade wars, possible asset price bubbles due to QE, etc. We have a different type of concentration risk, but we know how such risk have played out in the past. We are still borrowing at the top of an economic cycle but at the bottom of an interest rate cycle meaning interest rate cuts won’t be available to assist people like they did in 2008.

All of this points to the need for prudent investment management, sound evaluation of investment opportunities and the establishment of solid, robust borrowing arrangements. They should be at the top of your agenda in any case. But good times induce complacency. The advice is to avoid complacency with your personal and business assets …. just in case the government doesn’t take the same view.

John Finn is Managing Director of Treasury Solutions and Founder of The Treasury Hub providing banking and financing risk management advisory services to a range of Irish of international firms.

More in this section

IE logo
Devices


UNLIMITED ACCESS TO THE IRISH EXAMINER FOR TEAMS AND ORGANISATIONS
FIND OUT MORE

The Business Hub
Newsletter

News and analysis on business, money and jobs from Munster and beyond by our expert team of business writers.

Sign up
Puzzles logo
IE-logo

Puzzles hub

Visit our brain gym where you will find simple and cryptic crosswords, sudoku puzzles and much more. Updated at midnight every day. PS ... We would love to hear your feedback on the section right HERE.

Lunchtime
News Wrap

A lunchtime summary of content highlights on the Irish Examiner website. Delivered at 1pm each day.

Sign up
Revoiced
Newsletter

Some of the best bits from irishexaminer.com direct to your inbox every Monday.

Sign up