Monday, August 7, 2017

What happened to Net National Income?

Back when we were hit in the face by the 26 per cent growth rate for 2015 we concluded the following:

The best we can do to strip out all of this madness is probably to look at net national income which excludes the provision for depreciation from all assets and accounts for net factor income from abroad.

Net National Income at Market Prices grew by 6.5 per cent in 2015 which is probably somewhere around where “the Irish economy” grew at in 2015 rather than the 26.3 per cent that “the economy in Ireland” grew by.

And that is probably still in and around where we think “the Irish economy” grew by in 2015 and maybe also for 2016.  But that is not the story that Net National Income is now giving.  Here are the nominal growth rates of Net National Income from NIE 2015 and NIE 2016:

Nat National Income Growth RatesReal growth rates are not available but it is the revisions we are interested in.  For 2015 we can see that the nominal growth of NNP has been revised up from 6.5 per cent to 10.8 per cent with a figure above ten per cent also reported for 2016.

Net National Income is GDP plus net factor income from abroad (negative in Ireland’s case) less the total economy provision for depreciation and an adjustment EU taxes and subsidies.  It differs from the new GNI* in that depreciation of all assets in taken out (rather than just for foreign-owned IP and aircraft for leasing) and no adjustment is made in NNI for the net foreign income of redomiciled PLCs. 

Still the extent to which these differences affect the growth of each may not be that large.  And that is what we see.  From 2012 to 2016 the average annual growth of nominal NNI in the table above was 7.5 per cent.  Over the same period the average growth of the new GNI* was 7.6 per cent.  There are some differences each year but they track each other pretty well.

So why was the nominal growth of NNI in 2015 revised up from 6.5 per cent to 10.8 per cent?

Looking at Table 1 of the NIE this is almost entirely due to the net trading profits of corporations.  Here are the NIE 2015 and NIE 2016 versions of Table 1.  The final column gives the “change in the change”.  Click to enlarge.

Table 1 NIE 2015 Changes

Lots of detail but the key is the change in the change in item 4 – the domestic trading profits of companies.  The 2015 increase in this has been revised up by €10.4 billion.  Further down the table it shows that net factor income from abroad in 2015 has gone from -€53.2 billion in NIE 2015 to -€56.0 billion in NIE 2017.  So we have a €10.4 billion additional increase in the before-tax profits earned in Ireland but less than €3 billion of additional net outflows.  This €7 billion probably added between three and four percentage points to the (nominal!) growth of GNI* in 2015.

The increase in net trading profits of companies seems to be made up of an increase in Gross Value Added and a reduction in the provision for depreciation though this is not certain.  The 2015 increase in the provision for depreciation for the entire economy has been revised down from €30.7 billion to €27.3 billion and though we have a breakdown of this by sector in NIE2016 a breakdown was not published with NIE2015 as Table 2 was entirely suppressed. [The CSO should be given credit for publishing lots of information – and additional breakdowns – that was either suppressed or not provided in NIE 2015].

Although the figures above show revisions for 2015 it seems similar earnings arose in 2016. Domestic trading profits of companies were down €0.5 billion but net factor outflows were €7.2 billion less.  Lots of moving parts but again it seems like the profits generated by Irish companies increased significantly in 2016.  The net foreign income of redomiciled PLCs was up €1 billion without which net factor outflows would have been down by more than €7 billion.

And we also seem to see something similar for 2014.  The domestic trading profits of companies in 2014 was revised up by €4 billion (from €52.3 billion in NIE 2015 to €56.7 billion in NIE 2016) but the level of net factor outflows was unchanged (-€29.7 billion in both NIEs).

Anyway the conclusion is much the same.  Some companies in Ireland are earning lots of extra profit and this isn’t being distributed or attributed to foreign owners or being consumed by depreciation.  Is there a systematic reason for this?  It is hard to tell.  We could try looking in the revisions but that suggests it is a combination of factors rather than down to a single factor. 

Here are the revisions between NIE 2015 and NIE 2016 of a number of key components in the national accounts (again all in nominal terms). Click to enlarge.

Revisions to NIE 2015 v 2016

The recent large revisions to the domestic trading profits of companies [item 4] can be seen at the top.  These revisions seem to be due to three factors:

  • downward revision to wages and salaries paid [item 9]
  • downward revision to the provision for depreciation [item 28]
  • upward revision to gross value added [item 51]

The first two of these will be largely GDP-neutral as they affect the composition rather than the level of GDP.  The latter will cause GDP to rise.

For 2015, there is a €14.8 billion upward revision to the trading profits of companies before tax. Of this around €1.3 billion can be attributed to a downward revision in wages and salaries and maybe something around €4 billion to a downward revision in depreciation (the provision for depreciation in the table above is a whole economy measure rather than just for companies). These could have arisen in any sector.

The remaining part of the revision is largely due to an upward revision to output.  For 2015, this seems to correspond to an upward revision of net exports of €5.5 billion but looking at Gross Value Added by sector we see that the revision is spread across a number of sectors.  There was an upward revision of around €2 billion to the GVA from industry, from distribution, transport, software and communications and from public administration and other services.  This spread does not point to anything systematic (in the revisions at any rate).

The €6.1 billion revision to GVA corresponds to the €6.2 billion revision to GDP.  Again all these are nominal.  Revisions to the deflators mean that the upward revisions to nominal GDP in 2015 did not feed through to increases in real GDP growth. In fact real GDP growth was revised down from the infamous 26.3 per cent rate to 25.6 per cent.

For 2014, we have a €4.4 billion upward revision to profits (and no revision to net factor income).  Again there is a downward revision to wages and salaries and also a downward revision to the provision for depreciation.  Around one-third of the revision to profits could be due to an upward revision in the GVA from the industry sector but in this instance it is not accompanied by an upward revision to net exports.

So what do we conclude? The nominal growth rates of net national income have been revised up and these upward revisions are largely the result of increased profits.  Why have profits being revised up? Seems to be a number of factors (lower COE, lower depreciation, higher output) all pulling in the same direction. 

Who is earning these profits? The much smaller changes to net factor income mean the profits are staying in the economy.  Part of this will be increased Corporation Tax payments staying in the economy but a large part of it is profits accruing to Irish companies.  Are domestic companies really doing as well as these figures would suggest? Maybe.

Thursday, August 3, 2017

Major revisions to the savings rate mean the household sector is a net borrower. Really?

While a lot of attention will undoubtedly by on the business sector in the Institutional Sector Accounts and links to the new GNI* developments in the household sector are also worth a sconce.  In this instance it is not about what is there but what is no longer there – a savings rate above ten per cent.

Here’s the current account of the household sector account and looking at the numbers shows almost everything as one would expect.  Aggregate earnings are up, aggregate wages are up, aggregate disposable income is up.  All in all the income flows paint a pretty positive picture of our recovering household sector.

Household Sector Current Account 2011-2016

There is little in the income flows that gives cause for concern.  In 2016, mixed income (labelled Gross Operating Surplus) grew 4.9 per cent while aggregate wages grew 5.1 per cent with a 6.5 per cent rise in wages paid by non-financial companies.  Work though property income and interest, taxes and social contributions, and transfers and we get to the 3.8 per cent rise in Gross Disposable Income which is not put at €94.4 billion for the year.  All as we would expect.

While the growth rates may be in line with expectations, and have not been significantly revised (chart here), the levels have been revised – and revised down.  This means that the gap between income and consumption has fallen and now the savings rate is much lower than previously indicated.  Much lower.

Savings Rates - Old and Revised

The revision begins from Q1 2010 and has become even more pronounced recently.  The last estimate published in April gave a household savings rate that was reassuringly above ten per cent.  In the revised figures published this week the average savings rate shown above has only been above ten percent for one quarter since 2010 and dipped as low as five per cent last year.  This is not so reassuring.

So what has changed?  The savings rate has changed because Gross Disposable Income has been revised down. For example, the 2016 figure has been revised down from €99.5 billion to €94.4 billion.  That is why five or six percentage points have been knocked off the savings rate.

Why has Gross Disposable Income been revised down? It is pretty easy to spot from the household sector current account we looked at when the last set of figures were published.  The whole post gave a very coherent view of what we think is happening in the household sector.  Such coherence is absent now.

Anyway, the big change is in the very first line – Gross Domestic Product.  The value added produced by the household sector has been significantly revised down.  In the April figures this was put at €29.5 billion for 2016; in the current figures it is €25.8 billion.  Gross Disposable Income for 2016 has been revised down by €5 billion and nearly €4 billion of this is explained by a downward revision in the value added produced by the household sector.  It is much the same for the other years.  It is not clear why this revision was applied.  Maybe a chunk of activity has been reclassified from the household/self employed sector to the non-financial corporate sector which may explain part of that mystery.

Anyway, we can see the implications of this reduction in the savings rate in the capital account.

Household Capital Account 2011 2016

The recent rise in household gross capital formation means that household investment expenditure is now greater than household savings so the household sector is a net borrower – and as shown by the last line has been since 2014.  Between current consumption and capital investment Irish household’s spending exceeds their gross disposable income. So much for deleveraging.

Here are the current and previous estimates of household net lending.

Household Net Lending

Is the current estimate a flashing red light that have been largely absent as the Irish economy continues its rapid recovery?  Not particularly.  But maybe with the trend we should look at it as amber.  The trend is down but it is still a long, long way from the heady days of 2006 and 2007 when the household sector was a net borrower to the tune of €20 billion a year – and that was just for consumption and investment in new capital goods, the borrowing for second-hand houses was on top of that.

The revisions to the data are very significant.  Previous is was estimated that between 2010 and 2016 the household sector was a net lender to the tune of €27.4 billion.  Working through the financial account we were able to see how these funds were used to increase household deposits and, most notably, reduce household debts.

Now it is estimated that over the same six years the household sector was a net lender of just €6.9 billion.  Again this €20 billion revision corresponds the changed estimates of value added produced by the household sector which has been revised down by €20 billion.

The issue is that during a period when the household sector is now estimated to have been a net lender of €7 billion household deposits increased by €10 billion and household debts were reduced by €50 billion.  How did we do this with so little funds available from income?

Can asset sales, debt writedowns or other revaluations explain it?  The apparent coherence shown using the figures from April is no more.  Later in the year the CSO will publish updated financial accounts that will be consistent with these non-financial accounts and we will see what story emerges from those. 

Wednesday, August 2, 2017

So what does GNI* tell us about the Irish NFC sector?

A fortnight ago the CSO started the process of publishing adjusted national accounts which are intended to give a better view of developments in the Irish economy as those produced using the internationally-agreed standards become even more distorted by the activities of MNCs operating here. 

The new measures published (as well as the publication of previously suppressed figures) is undoubtedly a step in the right direction but there was some disquiet that the adjusted measure of national income, GNI*, recorded nominal growth of 9.4 per cent in 2016.  With deflators close to zero this implies a real growth rate also around nine per cent which does seem a little high.

Today, we get some insight into that growth figure with the publication of the Institutional Sector Accounts consistent with the figures in the National Income and Expenditure Accounts.  Here is the sectoral breakdown of GNI* for each year since 2010.

GNI star by sector

The overall growth of GNI* of 9.4 per cent can be seen and we can now see the sectors this arose in.  The growth of GNI for the households and government sectors of five per cent seems about right while the financial sector records a small drop the sector itself makes up a small proportion of the total and can be volatile.  The standout figure is the 22.5 per cent increase in the adjusted GNI of the non-financial corporate sector.

The adjusted NFC measure accounts for the net income of redomiciled PLCs and the depreciation of foreign-owned aircraft for leasing and intangible assets.  The NFC sector is the only sector to which adjustments are made.  The recent growth in the adjusted GNI for the NFC sector is remarkable.  It was €18.4 billion in 2011 and rose to €55.2 billion last year – an increase of 200 per cent.  So let’s dig a little deeper in the NFC sector. 

Here is the current account of the NFC sector since 2011.

NFC Sector Accounts 2010-2016

Is it possible to see how the 200 per cent rise over the past five years in GNI* for NFCs has come about? Not especially.  But we can see what is not in the €55 billion figure for 2016.

Starting with the €188 billion figure of GDP, or Gross Value Added, of the NFC sector in Ireland we see that:

  • €51.3 billion went on the compensation of employees, an increase of seven per cent on 2015.
  • around €49 billion accrued to other sectors through dividends paid or retained earnings owed with most of this likely to foreign direct investors in the rest of the world sector.
  • we need to add €14 billion for dividends received and retained earnings owed to entities in the Irish NFC sector from the rest of the world
  • and subtract the €6.5 billion of interest paid (after the FISIM adjustment)
  • and subtract the €5.8 billion of net income (dividends and retained earnings) which accrued to redomiciled PLCs from the rest of the world
  • and finally subtract the €33.8 billion of gross value added consumed by the depreciation of aircraft for leasing and foreign-owned intangible assets.

So, the increase is not the net profits of foreign direct investors, the gross profits from the aircraft or intangible assets that foreign-owned companies have located here, the net income of redomiciled PLCs.  Back in April we wondered if the Irish business sector is doing better than we think and maybe it is but the GNI* figures suggest it is doing remarkably well.  Here is adjusted GNI for the NFC sector for the entire time series available:

Graph

Hmmm. Celtic Tiger how are ya?  The adjusted and unadjusted measures are shown here.  Between 1999 and 2006 GNI* for NFCs grew by 128 per cent (the unadjusted measure grew 144 per cent). Pretty impressive.  Between 2009 and 2016 the same measure grew by 308 per cent (with 444 per cent growth in the unadjusted measure). 

There is no doubt the steps taken by the CSO are getting us closer to what is happening in the Irish economy but do we really believe the Gross National Income of Irish business sector is more than twice what it was at the peak of the bubble? It could be that there is still something in GNI* (and also the current account) that means we haven’t quite yet reached our destination.

What could it be?  Impossible to say.  Is there an issue with the treatment of redomiciled PLCs?  The adjustment takes a Balance of Payments approach but what about the profits these companies earn in Ireland?  For most foreign-owned companies these would be recorded as a factor outflow in the Balance of Payments but for companies that are Irish-headquartered their Irish-source profits are not counted as a outflow unless they are actually paid out to foreign shareholders as a dividend.  It is hard to know if this is even a significant factor. 

What else could it be? Foreign profits of Irish MNCs?  Is there anything to indicate that they are doing remarkably well outside of Ireland?  Maybe it's profit shifting but that would have offsetting effects on GNI (domestic valued added down, foreign income up).  Any other suggestions?

It must be remembered that what we have so far is just the first step.  If we look at the CSO response to the report of the ESRG we note that they say:

  • The CSO proposes to include in the annual Institutional Sector Accounts (ISA) publication a breakdown of the non-financial corporations (NFC) sector into two broadly-defined, foreign and domestic, sub-sectors. The NFC sector accounts for 5 most of the multinational enterprises (MNEs) operating in Ireland. Initially, the breakdown will be between the companies covered by the CSO’s Large Cases Unit, i.e. the largest and most complex MNEs, and the remainder.
  • This initial work is scheduled for publication at the time of the annual sector accounts results in October 2017, following which the CSO will investigate extending this analysis to a quarterly basis.
  • The breakdown by Large Cases firms and the remainder in the sector accounts is an initial step; during 2018, we will develop the basis for the breakdown by ownership into MNE and other sectors and we will review other possibilities such as the feasibility of implementing this foreign / domestic split in other presentations of the national accounts data.
  • In addition, we will explore the data classifications proposed in the FitzGerald (2016) and Honohan (2016) papers.
  • The publication of Table 1 of the QNA in current prices is a longer term project; it is dependent upon the work already underway on the calculation of an output-based annual estimate of GDP to complement the existing income and expenditure measures. The schedule for this work extends into 2018.

If we had the NFC table above on a foreign firms (including redomiciled) / domestic firms basis it would really shine a light on what is going on. Hopefully.

Monday, July 31, 2017

The extra-ordinary volatility in GNP

Here are the quarterly growth rates of GNP from the latest CSO figures.

Quarterly GNP Growth Rates

The largest quarterly growth rate in the series is the 12 per cent recorded in Q4 2016.  And this is followed by the largest quarterly fall – the 7 per cent drop recorded in Q1 2017.  The series have always been volatile but this is on a different scale altogether.

What is going on?  It is hard to know.  MNCs are undoubtedly having an effect and it could be that some of these distortions (intangibles, inversions etc.) are being amplified by the seasonal adjustment applied to quarterly data.  Do they wash out if we look an annual growth rates? Not really.

Annual GNP Growth Rates

There is little that can be learned from these headline figures.  The CSO are working on producing modified measures, such as GNI*, on a quarterly basis which should be provide a better indication of what is going on.

Saturday, July 29, 2017

Ireland’s Positive and Improving Underlying Net International Investment Position

The last post looked at flows in the current account and concluded that this may be a good indication of what is happening to the current account balance once some of the distorting effects of MNCs are removed.

Adjusted Modified Current Account Annual over GNI star

This post looks at the stock position and as is frequently the case with Irish macro statistics the starting position is heavily distorted.   The CSO publish figures that remove the impact of IFSC activities but some MNC distortions remain.  You can go through the detail if you want but here is where we end up – a measure of Ireland’s underlying net international investment position.

Underlying Net International Investment Position

As can be seen this has been improving pretty much consistently since the current data series began in 2012.  The underlying NIIP became positive in 2014 and had since continued to become even more so.  The rest of the post shows how we get to this measure starting with the the overall net international investment position (NIIP) which is the balance of foreign financial assets and liabilities:

NIIP Total

The impact of the IFSC is excluded from all the figures.  The impact of the IFSC on the net outcomes is relatively small but does have a massive impact on the gross figures with huge levels of financial assets offset by a similar level of financial liabilities.

In Q1 2017 our NIIP was minus –€375 billion. Ouch.  Even before the event which caused the level shift in Q1 2015 it was around –€180 billion and was improving at a very moderate rate.  But we need to go under the hood to get any idea of what is going on.  The first thing to do is look at the gross totals that give rise to the net figure shown above.  Here are our total foreign financial assets and liabilities.

Total Foreign Assets and Liabilities

Whoa!  By Q1 2017 we had €1.4 trillion of foreign liabilities and €1.0 trillion of foreign financial assets.  And this is excluding the effect of the IFSC – include that and the figures are €5.0 trillion and €4.5 trillion.

Anyway, let’s just take the non-IFSC figures which on their own seem completely oversized for the Irish economy. So who has external liabilities of €1.4 trillion?

Foreign Liabilities

And there is our pollutant.  Around 90 per cent of the foreign liabilities are due to the non-financial corporate sector.  Do Irish companies have €1.2 trillion of external liabilities?  No, but companies resident in Ireland do.  It is pretty safe to assume that almost of the external liabilities of the NFC sector arise through foreign-owned MNCs. 

The NFC numbers don’t tell us anything about the underlying position of the Irish economy.  There will be information in figures for the other four sectors shown above but the scale of the chart means it is hard to see what is going on.

There may be many factors driving the increase in MNC-related foreign liabilities but one will be the onshoring of intangible assets to Ireland.  The Irish-resident entity that onshores the intangible does so with money borrowed from another (offshore) entity within the MNC structure.

And we see much the same when we look at the €1 trillion of foreign financial assets.

Foreign Assets

Here nearly 80 per cent is due to the NFC sector.  Do Irish companies have €800 billion of foreign financial assets.  Again, no, but companies resident in Ireland do.  In this instance we are looking at liabilities owed to Irish-resident entities within foreign-owned MNC structures.  It is possible that this is related to redomiciled or inverted companies.  Again, the underlying position of the other sectors is hard to identify given the scale of the graph.

If we just isolate the external debt liabilities and assets associated with direct investment we see the following (there will also be equity liabilities and assets associated with direct investment).

Direct Investment Debt

They have got there by different paths but both the gross external debt and external debt assets related to direct investment were about €500 billion in Q1 2017.  As we have pointed out before these huge increases in direct investment debt liabilities and assets have not been reflected in increases in interest flows related to direct investment debts.

Direct Investment Income on Debt

Anyway, that’s for another day.  What we want to do here is assess Ireland’s underlying net international investment position.  What the above shows is that to do this we need to remove the impact of the NFC sector which through the activities of MNCs is distorting the overall position.  This does remove the cross-border positions of genuine Irish companies but these are unlikely to change to general picture that emerges – though we can’t forget this.

So what is our Net IIP excluding NFCs?

Net International Investment Position

Ah, that’s better.  The navy line gives our underlying Net IIP excluding NFCs (and also the IFSC).  This has shown steady improvement since the start of 2012 when the current data series begins.  It has gone from –€90 billion in Q1 2012 to +€80 billion in Q1 2017.  We have gone from a net liability position to a net asset position – we have more external financial assets than we have external financial liabilities.

Net International Investment Position by Sector

Most of the improvement has been effected through the financial system.  In the early years of the crisis many of the external creditors of the banks were repaid with liquidity from the Central Bank which itself generated a negative Target2 balance.  While the banks had a relative small net position in 2012 the net position of the Central Bank, i.e the monetary authority, was –€91 billion at that time.  Since then the banks have reduced their reliance on central bank funding and the external position of the Central Bank has improved with that and stood at +€9 billion in Q1 2017.

Of the remaining sectors, financial intermediaries have a NIIP position of +€190 billion.  This, in large part, reflects the foreign financial assets of Irish-owned investment and pension funds.  The government sector has a negative position of –€129 billion representing the international nature of much of the borrowing it undertook in the crisis.  Add up all those and you get our underlying net international investment position of +€80 billion – which excludes the impact of NFCs (mainly MNCs).

So it seems the stocks as well as the flows in the Balance of Payments data is a positive indicator that continues to move in that direction.

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