Ireland sets out record austerity budget

* Lenihan urges passage, says cuts are "demanding" 

* First in series of budget votes passes 

* Opposition says budget one of "puppet" government 

* Election expected in first quarter of 2011 

* IMF to meet Friday to approve Ireland bailout funds (Adds IMF comment) 

By Padraic Halpin and Carmel Crimmins 

DUBLIN, Dec 7 (Reuters) - The Irish government detailed the toughest budget on record on Tuesday, targeting 6 billion euros in spending cuts and tax hikes, and warning passage was crucial to avert a deeper crisis and free up EU and IMF rescue funds. 

In a speech to parliament, Irish Finance Minister Brian Lenihan sketched out austerity measures for 2011 including cuts to child benefit and public sector pensions, but stuck with growth forecasts that some economists -- and even the European Commission -- believe are too optimistic. 

Ireland's parliament passed the first in a series of votes on the budget on Tuesday evening, suggesting that enough of the budget is likely to pass to release bailout funds. The budget's success had looked in doubt when independent politicians, on whom the government depends for support, said they might vote against it. 

But the steps to pass the budget seemed to satisfy the IMF, which scheduled a board meeting for Friday to consider a 22.5 billion euro loan for Ireland, part of a bigger 85 billion euro joint EU/IMF rescue package. 

IMF Managing Director Dominique Strauss-Kahn is set to return to Washington from Europe to chair the meeting. 

"We welcome approval of the 2011 budget by the Irish parliament," an IMF spokesman said. "This is a clear sign of Ireland's strong commitment to tackle its problems and harness the impressive growth potential of this open and dynamic economy." 

The risk premiums investors demand to hold Irish 10-year bonds instead of German benchmarks fell on Tuesday to their lowest levels in a month, in anticipation that the budget would be approved. 

A burst property bubble has transformed Ireland from one of Europe's brightest economic stars to a country that has been forced to seek a bailout from the IMF and the EU to cover its borrowing costs and shore up its banks. 

"PUPPET GOVERNMENT" 

The bailout, the second in the euro zone after Greece was rescued in May, has stirred outrage in the humbled former "Celtic Tiger." Opposition parties slammed the government for mismanaging the economy and sacrificing Irish sovereignty. 

"This budget is the budget of a puppet government who are doing what they have been told to do by the IMF, the EU Commission and the European Central Bank," said Michael Noonan, finance spokesman for the center-right Fine Gael party and a possible future finance minister. 

Once all the resolutions underpinning the budget have passed early next year, Prime Minister Brian Cowen -- the most unpopular leader in recent Irish history -- has promised to call an election he is widely expected to lose. 

That means a new government, most likely a coalition of Fine Gael and centre-left Labour, will have to oversee the budget cuts. 

Both opposition parties have said they will renegotiate the terms of the bailout package agreed late last month, although in practice they will have little room for maneuver, having agreed to the broad targets of the rescue plan. For details, see 

Noonan said a new government may also have to bring forward the 2012 budget if targets for next year were not being met. 

HURTING THE PEOPLE 

The 2011 budget is the toughest in a four-year austerity plan that aims to save 15 billion euros -- nearly 10 percent of annual economic output -- and get the worst deficit in the region back within EU limits by 2014. 

Cowen will push through some four billion euros in spending cuts next year, with social welfare benefits, public pensions and capital projects all set for the chop. 

"I'm afraid for the future, I'm afraid for the country and everyone around me," said Maeve, 62, a retired lecturer who broke into tears when talking about economic hardship at the Moore Street market in central Dublin. 

Tax adjustments will make up another two billion euros with roughly half of the additional revenues coming from lowering income tax bands and tax credit changes, allowing the government to target the 45 percent of workers, on lower incomes, who did not previously pay income tax. 

All property-based tax relief is due to be eliminated by 2014, drawing a line under controversial policies that helped fuel the property bubble and prompted accusations of a cosy relationship between the government and real estate tycoons. 

Tax breaks, low interest rates and loose lending policies fueled a development binge that saw housing estates, shopping centers and hotels spring up across the country. Now many stand idle or half-built. 

At the height of the boom property prices in Dublin rivaled those in Manhattan and Moscow, and thousands of Irish were millionaires on paper. The surge in personal wealth created a champagne lifestyle where helicopters were a favored mode of transport and many ordinary citizens splurged on second homes. 

EXTREMELY OPTIMISTIC 

Some economists have warned that the budget measures risk tipping Ireland into a prolonged downturn that would make its debt targets even harder to achieve. 

"Ireland will not be a pretty place in 2011," said Jim Power, chief economist at financial services firm Friends First. 

But Lenihan retained his view that gross domestic product (GDP) would expand by 1.7 percent next year, nearly double the European Commission's forecast of 0.9 percent. The government is forecasting growth of 3.2 percent in 2012, 3.0 percent in 2013 and 2.8 percent in 2014. 

Danny McCoy, head of the Irish Business and Employers Confederation said he saw little in the budget to help job creation or restore economic competitiveness. ($1=0.7541 Euro)  

reuters.com

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Ireland: Bail-Out With A Boomerang

Submitted by Alex Gloy, CIO of Lighthouse Investment Management

Ireland: Bail-out with a Boomerang

European government bond spreads have widened dramatically with the second country going bankrupt: Ireland.

10 year Irish government bond yield. Source: Bloomberg.com

An example of low indebtedness as recently as 2007 (25% debt-to-GDP ratio compared to 65% for Germany)  – the country has descended into financial chaos within 3 years. And, contrary to Greece, Ireland has not overspent, nor falsified government statistics.

This year alone, saving its banks from collapse will cost Ireland 32% of GDP.

But the EU/IMF rescue package saddles the country with another EUR 85bn of debt – more than 50% of GDP (remember, Maastricht criterion was 60%). The ratio would look even worse if you used the gross national product (GNP) instead (EUR 139bn vs. GDP 170bn for 2009[2]). A lot of global firms have shell companies in Ireland, where – due to the low corporate tax rate of 12.5% – profits are being booked. Royalties are charged towards holding companies in higher-tax countries to  avoid paying higher taxes. These tax shells are run by few employees and do not add much to the industrial output or tax base of the country. Hence GNP would be a better measure of economic strength.

It seems Ireland tried to resist a bail-out, but was forced to accept (Irish banks are hanging on by a thread of EU 130bn of loans from the ECB).

But wait a minute – non-Irish banks make up EUR 35bn of this amount[3].  And didn’t some foreign banks (among them German Depfa, which was bought by Hypo Real Estate which in turn had to be rescued by the German government and has so far cost more than EUR 100bn) move their headquarters to Dublin to escape stricter regulation at home? And now the EU/IMF forces the Irish tax payer to bear the cost of bailing out those banks?

The government is doing its citizens a disservice by accepting a bail-out. The “National Recovery Plan 2011-2014″ intends to save EUR 15bn (“front-loaded” 6-5-4bn for the years 2011-13) by cutting expenses (10bn) and raising taxes (5bn) in order to reduce the budget deficit to less than 3% by 2014.

The budget plan sees GDP increasing by 1.75%, 3.25%, 3% and 2.75% in the years 2011-14.

Can anybody explain to me how an economy, which was shrinking by 11% (GNP) last year, that will be saddled with austerity (demand-reducing) measures of another 10% of GNP is supposed to grow? Not only have government tax revenues declined by 33% since 2007[4] but also will increased interest burden (because of the bail-out loans) eat up 20% of revenues by 2014 (up from 8% in 2009)[5].

The sanity of the authors of this “recovery plan” has to be questioned.

Everything happens for a reason. Probably the Irish tried first avoiding a bail-out. Then, as it became unavoidable, putting “fantasy” numbers in the budget just to get over with it and to be able to sell it to the people as a “recovery” story. The plan could have been to take some EU/IMF money (paid out in tranches) and then default (or hope for a miracle).  Or, more elegantly, let the banks go bust (like Iceland) and avoid bearing the costs for bailing them out.

The guys from the IMF/EU are no amateurs. Seeing through this possibility they mischievously demanded the Irish contribute EUR 17.5bn of money from the National Pension Reserve Fund and from the country’s own cash reserves. Perversely, Ireland is rescuing itself with its own money. Hence, should the government dare to default, those pensioners will feel the cold as their money goes up in smoke.

I have rarely come across anything so blatantly opposed to the interests of the people. Comments by readers of Irish newspapers reflect the outrage, but a protest after the bail-out announcement counted only 50,000 participants.

One last chance to escape from this draconian bail-out is the government vote on December 7. The government could fall apart, individual members could defect – anything is possible. If the plan passes -  good luck and all my sympathies to you, Irish people.

The bond market has already reached its verdict: Ireland will eventually default. The 10-year government bond yield (9.35%) is now higher than before the bail-out announcement (roughly in the 8-9% range).

Why would the EU and IMF subordinate a country to such an endeavor guaranteed to fail?

Some point towards the 12.5% corporate tax rate being a thorn in other governments’ sides. Some point towards EUR 139bn owed to German banks, among them apparently some Landesbanken (WestLB is said to stagger after Bayerische Landesbank recently walked away from a merger).

The message seems to be that one country’s people has to pay because another county’s people doesn’t want to pay for its banks’ mistakes.

When, according to credit default swap prices[6], Greece and Ireland have, despite bail-outs, the second and third highest default probability (55% and 40%) on earth, something has to – and will – give. We are talking about bankruptcies of entire countries. And, as outlined in earlier letters, the cohesion of the Euro zone. Which leads us to the next topic: how complacent must equity investors be not to see the imminent risks in Europe? Are they waiting for the German Constitutional Court to possibly veto any bail-out (as demanded by the “no bail-out clause”) in February 2011?

The only solution for a last-minute attempt to save the Euro would be to abolish individual sovereign debt issuance and to replace by a supra-national issuer. Of course, Germany’s credit rating would suffer, and its government bonds would tumble significantly. And even such a move would not solve one of the main problems: divergence in unit labor costs within the Euro zone over the last decade.

Half-hearted solutions could be a split into a “North-Euro” and “South-Euro” as proposed by Hans-Olaf Henkel[7]. But even that would lead to a run on banks within the weaker currency zone.
footnote:

[2] Quarterly National Accounts, CSO Irish Central Statistics Office, March 25, 2010, page 1

[3] “Sharp rise in Irish banks’ ECB borrowings” in: RTE News, October 29, 2010

[4] “The National Recovery Plan 2011-2014″ by the Irish Government, page 10

[5] “The National Recovery Plan 2011-2014″ by the Irish Government, page 8

[6] “Highest default probabilities” by: CMA, November 30, 2010

[7] “Wirtschaftsexperte Henkel fordert “Euro-Nord” und “Euro-Sued”, dpa-AFX November 26, 2010

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Structured products stage a comeback

Not everyone is so upbeat, but private bankers agree equity products which provide a partial hedge against a market crash have become popular, because most agree that stock markets are currently delicately balanced.
Private bankers say marketing conditions are good because investors view equities as cheap but lack the confidence to buy more following a dull performance of their portfolios over the last year.

They are also concerned by problems in the eurozone, triggered by the Irish bailout. But they draw encouragement from the way stocks have continued to grind higher following renewed US quantitative easing.
Fears of inflation are undermining bond sales and, according to SG, there is even evidence of individual stocks performing in line with fundamental prospects, as opposed to the market's ebb and flow.

Mark Dickson, operations director at Blue Sky Asset Management, a structured products adviser, says investors are increasingly adding structured products to their equity portfolios.

Structured products were knocked for six when Lehman went bust, undermining their performance guaranties. But the bank sector recovery, outside Ireland, and the rise in stocks to levels last seen a fortnight before Lehman's collapse have restored faith in them.

Nicolas Cagi-Nicolau, SG's head of structured products solutions, says his bank has sold structured products worth €8bn, against €6.4bn last year. SG has not sold as much as €8bn since 2007, prior to Jérôme Kerviel's unauthorised trades which cost it €4.9bn.
David Poole (pictured), managing director at Citi Private Bank, said: "We are seeing strong interest in products with downside protection for people who want to preserve their wealth and take a measured risk. They are typically prepared to take a one to three-year view."
Mark Rushton, director of BNP Paribas Wealth Management, is not so upbeat. He pointed out that products offering a hard guarantee to investors did not provide attractive terms at present. He said: "With little in the way of interest rates to use and volatility still buoyant, traditional fully capital-protected structures offer little value."
He said sales of structured products in the UK were relatively restrained. But he agreed there was an international appetite for certain products. He said: "Those which offer more limited, or soft, protection can offer satisfactory potential returns."
Bankers' products offering complete capital protection – or hard guarantees – are out of favour because the yield on cash is insufficient to buy enough put and call options to generate a satisfactory return. A fall in stock market volatility, prior to Ireland's formal bailout and North Korea's attacks, has also diminished returns from baskets of puts and calls.
Blue Sky's Dickson said investors could get a better hard return by leaving deposits with a bank rated below AA: "But someone wanting a hard guarantee would not tend to be interested in this."
SG's Cagi-Nicolau added that investors in hard guaranteed structured products would also be at risk if interest rates went up. But he is upbeat on client interest centred on those offering a softer, partial guarantee, known as barrier, or auto-callable products.
There are many varieties. They typically guarantee the capital invested as long as the value of its investments does not halve in value.
Annual coupons are also paid, assuming the investments do not fall by more than a set amount, although investors sacrifice stock market gains beyond the coupon rate.
One typical product in the UK is the six-year Morgan Stanley FTSE100 defensive bonus note, which offers a 6.25% coupon, as long as markets do not tank by more than 65% by maturity, plus a capital guarantee which stays intact, as long as the index does not halve over the six years.
In equities, SG has been structuring products around indices for some time. However, Cagi-Nicolau said SG had found evidence to suggest that stocks are starting to perform independently of indices, rather then seeing a correlation in performance.
He said: "This trend started to appear in September, and we see no evidence of it breaking down. We are now exploring ways of putting together baskets of stocks to create a new variety of product."
He confirmed structured products investing in emerging market currencies had been popular, along with one based on the price of gold. He stressed that SG had set out to achieve transparency and structure which would not leave clients marooned in particular products.
However, there is no shortage of advisers warning investors to look at the small print before they sign up.
Yogesh Dewan, a former Goldman Sachs private banker, set up boutique Hassium Asset Management to advise clients on the best way to approach such investments.
Dewan said: "Investors would be wise to question the motives behind being sold a structured product."
He added: "The client supposedly gets exposure to equity (or other financial) markets without risking their capital. In return, the bank gets the upfront fee, often up to 3%, and in some cases an additional annual management fee.
"Unfortunately for the client, due to the low cash yields, current participation levels are low and performance caps can prevent an investor from accessing significant upside potential. The downside is protected but only if there is no knock-out, the product is held to maturity and the issuer remains in business."
Dewan said: "Banks need to be more transparent about the excessive costs associated with structured products as well as the broader risks."
http://www.efinancialnews.com

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