Good morning, and thank you for the invitation to appear here today.
In my opening remarks, I would like to briefly outline for the Committee the latest economic and budgetary trends, before turning to recent important policy developments.Latest economic developments…
Turning firstly to the economic situation, where I think it is fair to say that the emerging data present a somewhat mixed picture. On the one hand, the exporting sectors continue to perform very well – overall exports increased by 7 per cent in annual terms in the first quarter, while monthly data relating to the second quarter suggest a similar pattern. The recovery in exports is increasingly broad-based, and I am particularly encouraged by the robust export performance of indigenous firms.
So the substantial improvements in both price and cost competitiveness that have taken place in recent years are now standing to us, and this is evident from the balance of payments which moved into surplus last year for the first time since 1999. Furthermore, the IDA has confirmed that the pipeline for inward investment is good.
On the other hand, domestic economic activity – in other words consumption and investment – remains weak. For instance, personal spending continues to decline as households maintain their savings at elevated levels. It is unfortunately the case that significant imbalances built-up during the boom will take some time to correct and, as such, it is unlikely that domestic demand will drive economic growth in the short-term. The growth that we are now beginning to see is export driven growth.
So we have contrasting fortunes between the buoyant exporting sectors of the economy and the domestic sectors. However, the general expectation is that the economy will expand this year for the first time since 2007. I note that this morning the ESRI projected that GDP would increase by 1.8 per cent this year. And while the Institute’s forecast is much stronger than most other available forecasts, the broad picture of an externally-driven recovery is consistent with my own view.
There are risks of course and in this regard, I would point out that the data-flow over the summer in many of our main export markets has disappointed and as a result short-term macro-economic projections for many regions are in the process of being revised downwards. The downgrading of the US sovereign debt rating has added to uncertainty, while the intensification of the euro-area debt crisis necessitated further ECB intervention in sovereign debt markets. So there is a lot of uncertainty, making economic forecasting more difficult, both in Ireland and elsewhere. But what is abundantly clear is that Ireland could not remain immune in the event that the global recovery was to stall. My own Department’s current forecast is for GDP to increase by 0.8 per cent driven by a strong contribution from the traded sector. A revised forecast will be published in the Pre-Budget Outlook in October.Public finances…
In relation to the public finances, the most recently published figures provide further evidence of stabilisation. At end-July, total tax revenue was 1.4 per cent above target, with three of the “big four” taxes recording surpluses. Allowing for timing factors, tax revenue is essentially on target at end-July.
On the other side of the equation, net voted expenditure is under control and being managed within the limits set out. So our target for the general government deficit this year – 10 per cent of GDP – remains on track. The end-August Exchequer Returns will be published tomorrow evening, and while the figures are still being finalised I understand that they will show a broad continuation of the overall position as of end-July.
For next year, the agreed target is for a deficit of 8.6 per cent of GDP and the Government is committed to implementing the necessary level of consolidation to ensure that target is achieved. The Comprehensive Review of Expenditure will be finalised over the coming weeks and the results of this process will inform the future path and composition of public spending. The next major step is the publication by the Government’s of the Pre-Budget Outlook which will set out a medium-term fiscal consolidation path for the period 2012-2015. I believe it is important that we provide as much clarity as possible regarding future consolidation in order to generate certainty and thereby enable households and firms to plan their spending and investment decisions.
I know that the previous Committee published a Report on the process of macroeconomic forecasts, models, fiscal oversight and the like. In your letter of invitation, attention was drawn to some of the key recommendations in this area. Since that Report has been published a lot has happened, and since coming to office this Government has taken a number of steps including the establishment of an Economic Management Council. Furthermore, on budgetary matters, an Independent Fiscal Advisory Council has been established as part of the process of reforming Ireland’s budgetary architecture. The function of the Council is to assess and comment on the Government’s budgetary plans and projections. Amongst other things, this will help ensure that an appropriate fiscal policy is pursued over the economic cycle.
No doubt these will be matters that the Committee will want to hear more about and I will be happy to discuss them further with Members this morning. For now I will just say that progress has been made on a number of fronts.Banking sector…
Turning now to banking sector issues, there has clearly been significant progress in stabilising the banking system over the past five months or so with some major milestones passed. I would like to give Members a flavour of the key developments, and I am of course happy to come back to elaborate on issues in the discussion later.
…(i) restructuring and renewal
In March 2011, following the completion of the prudential capital assessment review – the PCAR – and the prudential liquidity assessment review – the PLAR – by the Central Bank, I announced the Government’s proposals to comprehensively restructure the banking sector. This involves the creation of two domestic universal pillar banks that would be smaller and more focused on the needs of the Irish economy. As you know the two pillar banks are AIB, which was to be merged with EBS, and Bank of Ireland.
The legal merger of AIB and EBS was completed on 1 July 2011, as was the merger of Anglo and INBS. Considerable progress has also been made on the renewal of the boards at the banks. Restructuring is also continuing at ILP.
…(ii) bank recapitalisation
Another key goal of the Government’s programme has been to ensure that the banks are adequately capitalised to enable them to resume their core lending activities. The PCAR/PLAR processes identified a capital requirement of €24 billion, including a buffer of €5.3 billion.
While the Government committed to ensuring the banks would be fully capitalised up to that level, direct contributions were sought from subordinated debt holders, from the sale of assets and, where possible, by seeking private sector investors. At end-July some €7.6 billion was recognised from burden sharing and asset disposal exercises – completed and anticipated – as well as privately sourced equity capital. The State provided some €13.4 billion in capital, with a further €3billion of contingent capital notes. The commitment from the Irish State is lower than initially expected as a result of firstly, LME exercises with subordinated bondholders conducted since 31st March 2011 and secondly, private sector investment in Bank of Ireland. In the interests of brevity I do not propose to go into the details of these; instead I have circulated these details to Members separately.
Plans had been agreed with all the banks providing for the deleveraging - through amortization and sale - of approximately €70 billion of assets. Almost 80 per cent of the assets to be sold are located outside of Ireland. Each of the pillar banks has moved to establish core and non-core divisions and management teams for each business. Deleveraging committees with involvement of staff from the Department of Finance banking division have been set up in each of AIB/EBS, Bank of Ireland and IL&P to ensure delivery of the targets.
Progress has been made on the plans that were agreed with each bank and I have circulated some details also.
In terms of funding, the banks have been asked to focus on meeting specific Loan to Deposit Ratios over the PLAR horizon out to the end of 2013. Retail deposit levels have been stabilising over the past months with the rate of outflow falling. The banks themselves are organizing intensive marketing campaigns and creating focused treasury teams in order to try to rebuild the deposit levels.
While there has been a continuing reliance on ECB funding, the Committee should be aware of the positive developments that have been seen during a very turbulent period in the international capital markets.
At the time of the PLAR, we had anticipated that the banks would not be able to access the wholesale funding markets until the second half of 2013. Three
significant wholesale funding transactions have been completed by two banks and we are, once again, ahead of schedule.
…(v) credit provision
The Government is acutely conscious of the effect of SME credit on the overall economy and recognises that SMEs will need credit if they are to be the basis of the recovery of the Irish economy. There are a number of initiatives in train to assist SMEs in obtaining the credit they will require to take active part in the economic recovery.
The restructuring of the domestic banking sector creates capacity for the Pillar Banks to lend in excess of €30 billion over the next three years in SME and other important sectors. This is in excess of Central Bank estimates of the likely demand for SME and mortgage credit over this period. Both Pillar Banks are concentrating on the Irish economy and need to issue credit in order to make profits and rebuild their balance sheets.
The Government has imposed lending targets on the two domestic universal pillar banks for the three calendar years, 2011 to 2013. Both banks will be required to sanction lending of at least €3 billion this year, €3.5 billion next year and €4 billion in 2012. The two banks are also obliged to submit revised lending plans to the Department for how they will meet new targets.
The report of the Credit Review Office on the period to end March 2011 stated that the two banks had approved SME lending of €8 billion between them and that each had exceeded the target of €3 billion each in that year. I think that it is fair to say that both banks will find it challenging to meet the €3 billion target for 2011.
Both banks highlight the need for sufficient demand for credit from viable firms as an issue in their reaching the targets. My Department will commission an independent survey on demand for SME credit shortly and a meeting of the steering group to scope the exercise, consider the questions and initiate the survey was held last week.
I want to stress that we need demand for credit from viable businesses in order to get the banks to hit their lending targets. We have no intention of forcing banks to lend to businesses that are not capable of repaying funds advanced. Such an approach will only create further difficulties for the economy.Mortgage Arrears…
On the issue of mortgage arrears which has been the subject of considerable public debate in recent weeks, as the Committee may be aware, the Government’s Economic Management Council has tasked an Inter-Departmental Group to consider further necessary actions to alleviate the increasing problem of mortgage over-indebtedness and to report to it by the end of September.
The issue of mortgage indebtedness is complex and it is clear that there is no “magic bullet” or “one-size –fits-all” solution. While there has been many contributions to the debate including suggestions for the granting of extensive debt forgiveness, this simply is not a realistic option. Solutions must be found on a case-by-case basis through open and meaningful engagement between the distressed borrower and the lender. The planned reform of the bankruptcy and debt settlement arrangements are also key elements in any consideration of potential policy options.
I would like to stress that it is important that mortgage holders in difficulty, or who feel that they may face difficulty in the foreseeable future, discuss their situation with their lender at the earliest possible opportunity. It is true to say that the domestic banks have been capitalised to an extensive degree arising from the Central Bank’s PCAR exercise last March. Some of this capital is available to the banks to write off bad debts but the banks, of course, must be prudent in their actions and not fritter away their capital base through widespread unwarranted debt write offs.
Having said all that, the Government is acutely aware of the difficulties being faced by a growing number of mortgage holders. This awareness prompted the request by the EMC for further analysis of the recommendations of the Cooney Group but it is important to note that, as things currently stand, there are several important existing measures in place to support and protect mortgage holders in difficulty.
· The Central Bank’s Code of Conduct on Mortgage Arrears (CCMA), which amongst other things, provides for a moratorium on legal action against cooperating borrowers and also requires each mortgage lender to establish a Mortgage Arrears Resolution Process (MARP).
· The CCMA also obliges lenders to consider a range of forbearance options for mortgage holders in difficulty and this is being extensively utilised.
· Lenders representing about 70% of the market are implementing a deferred interest scheme recommended by the Cooney Group.
· The Mortgage Interest Supplement scheme currently supports around 18,500 households at a cost of some €77million in 2011 in meeting their mortgage interest payments.
· The Money Advice and Budgeting Service, (MABS), operating from 65 locations around the country, which is supported by the Department of Social Protection, provides free and independent services to borrowers in difficulty.
The Government will consider what necessary further action is warranted once the Inter-departmental Group has concluded its deliberations and reported to the EMC by the end of September as I referred to earlier.Programme compliance…
Turning to the joint EU / IMF Programme, it is clear that we are on track, with the various programme milestones being met to date. The final steps towards the conclusion of the third formal review are taking place at present, as the staff reports of the IMF and the European Commission are being considered by the IMF Executive Board, Eurogroup and ECOFIN tomorrow. The next review mission will be in mid-October with the subsequent staff reports being considered at executive level in November / December.
As Members will recall, euro area Heads of State and Government on 21 July agreed that Ireland, along with Greece and Portugal, would receive a reduction in the interest rate applying on its loans, and that the maturity of these loans would be extended. The precise application of the changes to the interest rate and loans is being discussed at present. It is hoped to have an agreed draft of the revised EFSF soon in order to complete parliamentary approval by end-September. Conclusion…
In conclusion, growth has returned to the Irish economy and the public finances remain on track. In the banking sector, key policy decisions have been made, and implementation is well advanced. We are complying with the terms and conditions of our external assistance programme. At a European level, design-flaws in the EFSF are being addressed, with a lowering of interest rates and lengthening of maturities.
Ireland’s standing in financial markets has improved, with sovereign debt yields indicating a clear decoupling from other programme countries in recent weeks. While still high, rates have fallen significantly from their peak and in recent days the yield on the benchmark 10-year bond has fallen below 9 per cent in the secondary market for the first time since February.
But we cannot – and will not – be complacent. We must build on this positive momentum and ensure that we continue to get ourselves back on track. Our deficit remains unsustainably high and economic recovery alone will not be sufficient to correct this; expenditure reductions and revenue increases will also be required in the forthcoming and future budgets. Moreover, downside risks on the external front have increased in recent weeks and such uncertainties add to the complexity of policy formation in this regard. So while considerable progress has been made, significant challenges remain.
I look forward to engaging with Members on these matters this morning.