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Archive for November 25th, 2010

Buried away on page 34 of the Four Year Plan (the so-called “National Recovery Plan”) published yesterday was a commitment which should freeze the hearts of those whose livelihoods depend on a recovery in the commercial property sector. As part of the government’s drive to return competitiveness to certain parts of the economy, it has identified rent costs in both the private and public sector as a drag on competitiveness and has developed some specific action points to address the perceived imbalances:

(1) The proposals of the Working Group on Transparency in Commercial Rent Reviews will be implemented.
(2) The Office of Public Works will lead a coordinated effort to reduce office rents by up to 15% and review the efficiency of property arrangements across the public sector.

Although we are some two months away from the publication of the Q4 commercial price indices for the State, it was striking that although both the SCS/IPD and JLL indices showed modest capital declines in Q3, 2010 (2.6% and 1.1%), both recorded nearly 5% quarterly declines in rents (that’s close to 20% annualized) in a country that before last March 2010 had rental agreements with upward-only rent reviews, whose terms continue in effect even though new leases won’t have them. These rental trends are also a cause for deep concern for any recovery in the commercial sector because those 7-9% advertised yields quickly become 4.2-5.4% yields after a couple of years of 20% rent declines even if capital prices remain constant.

Yesterday DTZ identified Ireland as yet again the outlier facing problems, with the publication of its periodical Debt Funding Gap report. It defines the debt funding gap as “the difference between the existing debt balance as it matures over time and the debt available to replace it.” In other words those investors who bought Irish commercial property with short term lending will face difficulty when they need roll over their loans. And as we saw in the recent Paddy McKillen case, it is not unusual for Irish investors to use short term funding as a key tool for managing the financing of their property assets.

And today, the Independent reports that the IMF is putting pressure on NAMA to start disposing of property. DTZ said yesterday that it expected NAMA to start “orderly disposals in 2011”. I’m not sure that those responsible for making disposal decisions have grasped the fact that we are slowly but surely losing decision-making discretion in this area, and despite the rational and meritorious decisions to a framework strategy which foresees different recovery in different markets and disposes of assets accordingly, it seems that pressure will be brought to dispose in a more generalized way. The IMF is now just repeating its advice in the last routine country mission in June 2010 but I think there will be far more urgency and precision in their entreaties today. Of course one of NAMA’s board members, Steven Seelig, is a former Mission Chief at the IMF and indeed had some previous IMF involvement with Ireland – he may become a key bridge between the needs of NAMA and the IMF now.

So the prospect of increased supply from NAMA, declining rents and the scarcity of funding all point towards a continuing decline in prices which are now some 60% off peak. Though quality buildings in prime locations may suffer less, the scale of the challenges facing the sector are such that no project is immune – there are rumours that the sale of the Liffey Valley Shopping Centre may have stalled. How many more transactions face being placed on ice until there is greater visibility on prices in the sector?

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They could have called it the “Enda Kenny has no willy plan” or the “Bertie Ahern – unappreciated in his own lifetime plan” but they didn’t. They called it the “National Recovery Plan” and that’s what most media seemed self-compelled to call it yesterday and although it was being referred to as the more neutral “Four Year Plan” late last night, it seems that today we’re back to the more subjective moniker.

The Plan of course is our blueprint for getting our nation’s revenues back in equilibrium with its costs. During the boom years up to 2007, the nation’s coffers were bulging with tax receipts from the domestic construction boom, and its trickle down effect into practically all sections of the economy. And whilst the State did create a rainy day fund – the National Pension Reserve Fund (value today €25bn though some €11bn of that is earmarked for/invested in AIB/BoI) – the approach was, as articulated by our former Finance Minister Charlie McCreevy, “if we have it, we’ll spend it” and indeed we did – social welfare, state pensions, public sector headcount and salaries, capital programmes, reductions in tax – funding these rose in line with income. Sadly the construction and property bubble burst cataclysmically and suddenly and so we’re left with an imbalance – some 12% of GDP this year and the Plan published yesterday maps out how we will get back to 3% by the end of 2014. It’s a major adjustment but it really just contains the bread-and-butter tools to adjust the levers of financing the day-to-day running of the State.

Calling it the “National Recovery Plan” was the first indication of partiality but that could be forgiven. References to “a small increase in GDP” in 2010 might seem trivial but in the government’s minds this marked a “turning of the corner” and “stabilisation”. It may well be that GDP does increase slightly in 2010 though the most recent ESRI forecast in October 2010 and a Reuters poll of economists a couple of weeks ago both put GDP in 2010 in negative territory (my own forecast is that the government will be right on this one). It was an unfortunate co-incidence that S&P downgraded the country’s credit rating yesterday and gave their own forecast for GDP in the next four years – “”nominal GDP would be “close to flat” over the next two years” and growing 2% in 2013. The anchor to the Plan is that we will see an average of 2.75% growth in GDP in the next four years – without such growth we’ll still have an estimated deficit:GDP of 7% in 2014. That is probably the shakiest assumption in the plan itself.

The measures outlined in the Plan can be debated. The usual advice for fiscal adjustments is that they be timely, efficient and fair. I noticed that many measures are being pushed out to 2012 and beyond (VAT, property tax, water charges) and I think the government is going to face a challenge in coming up with a €6bn adjustment in the 2011 Budget which will be debated in two weeks time in the Dail. There is a ruthless efficiency in levying a round €100 flat-rate tax on property and reducing the minimum wage by round €1 (not strictly part of the fiscal adjustment but an element of the plan as regards competitiveness) but efficiency was less evident in reductions in public sector wage costs – if the recent unfocussed €400m redundancy/early retirement scheme in the HSE is anything to go by, then we should be concerned at how further reductions in the cost of the public sector will be handled. “Fairness” is a tricky topic, though imposing the same property tax in 2012 on a €100,000 terrace in Tallaght as a €20m house on Shrewsbury Road doesn’t seem very fair though there is an indication that the tax will eventually become more progressive. Increases to VAT disproportionately affect the less well-off. Whilst it is clear that lowering the threshold at which tax becomes payable on wages from €18,300 to €15,300 will increase the tax burden at the lower level it wasn’t clear how salaries at higher levels would contribute on a progressive basis.

Overall, the four year plan didn’t strike me as particularly innovative. In terms of optics we’re likely to keep our Taoiseach as one of the Top 5 best paid heads of state in the world which doesn’t seem fair even if it’s a relatively tiny cost in the overall scheme of things and the impression given was that fundamental non-marginal reform of the public sector was to be avoided. Some changes flagged had the ring of being rushed about them – why a €1 change to the minimum wage, why a €100 property tax. Quangos seem to have escaped scrutiny and there was no reference to privatizations (energy, transport, port and airport authorities). The competitiveness section seemed to lack detail on the comparisons used and I think some businesses will be skeptical at the conclusion that we are competitive in the cost of energy and communications.

However, the glaring omission from the four year plan was the ongoing cost of the banking crisis which frankly has the potential to render practically meaningless and farcical any debate about this fiscal adjustment because the exposures and landmines in the banking sector may be multiples of €15bn. Minister Lenihan yesterday seemed specific in saying the four year plan accounted for the situation in the banks as at the end of September 2010 – remember the Big Bang announcements intended to give certainty and finality to the cost of our bailouts. But has the outlook changed since September 30th? It seems, from recent days, that AIB and BoI are to receive additional capital – the Financial Regulator said that this will be to “overcapitalize” the banks, others say that unprovisioned future losses could be another €20bn+ and will that additional €5.3bn flagged in the worst case scenario be needed for Anglo and EBS? How will the withdrawal of ECB emergency liquidity assistance affect our finances? How will the exceptional measures by our own Central Bank be reined in? In the four year plan interest on the national debt is put at €8.4bn in 2014 – but calculations on here yesterday put the interest estimate from €7bn (5% of €140bn) to €32bn (9% of €350bn) with a more central scenario (and arguably more realistic one) of €15bn (6% of €250bn). The difference essentially comes down to the banks.

So we have a four year plan for running the country – arguably it’s not great but it’s adequate in itself. The plan will be debated in the Dail (though not voted upon) and can apparently be changed by an incoming government in agreement with our rescuers in the EFSF/IMF. But without a four year plan for the banks, we’re essentially arguing over necessary minutiae but ignoring the potentially far bigger picture.

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