At least we're not Iceland

Michael Burke: Over on Irish Economy, Kevin O'Rourke has criticised the Finance Minister for arguing that not allowing a default of bank debt had been a positive - the example given where that had happened being Iceland.

The are two aspects to this strange official boast.

The first is to do with the banking policy, where Iceland could not prevent its banks from bankruptcy and default. It is a simple matter of fact that as a result Iceland does not now have an additional millstone of bank debt tied around the neck of all future taxpayers. However, the country itself was bankrupted and required funds from the IMF and Nordic neighbours. I know of no-one who believes that this State is currently insolvent. The Finance Minister seems to believe that it would have been- had fewer liabilities accrued to the State with no bank bail-out and their default. The example cited is usually Lehmans, but this is incorrect. Lehman's balance sheet was a multiple of the entire Irish banking system combined, and its trading interrelationships vastly greater. Even so, when it went under, it took other financial institutions with it, but no sovereign borrower. The Iceland/Lehman example does not stand up.

However, many observers suggest that the 'final' bill for the bank bailout here is up to €50bn. This may be an underestimate. The stress test on the portfolio of loans applied was 70%, and it is taxpayer's capital which is filling the breach. But NAMA is already applying losses to loans it is purchasing of 67%. So this doesnt' look like a very stressful test.

If further cuts are in the pipeline, the economy will not revive significantly and the loan losses may continue to mount. This is a situation worse than Iceland, created by policy.

The other aspect of the boast is an economic one, which has more exercised the contributors over at IE. On a national accounts seasonally adjusted basis Iceland’s GDP indeed peaked in Q3 2007 and has fallen by a cumulative 16.3%, in line with the OECD data cited, and compared to a 13.4% decline here.

But there is a strange tendency in economic debate to treat Ireland as if it is an economy sui generis. So, it is insisted that, as GDP data is distorted by MNC transfer pricing, GNP should be the real reference for the economy. Agreed. But other countries have an external sector too. Ireland’s GNP should properly be compared to Iceland’s GNP. This contracted in Q2 by 7.7% q-o-q and by 7.8% y-o-y. A link to the actual data can be found via this quirky piece. This shows that the latest decline is driven by an extraordinary run-down in inventories, which reduced GDP by 5% in the quarter.

In current prices, not s.adj., Icelandic GNP fell by 11.8% from its peak, compared to a 26.3% fall in Irish GNP (or 17% in real terms). This nominal measure is crucial regarding taxation revenues, since, unfortunately taxes are paid in current, not 2008, Euros. It is from current taxes that existing debt interest payments as well as principal repayments must be made. But on either measure, the Irish position is much worse.

The new Icelandic government has increased taxes, so that revenues are 9.4% higher in the year to August, compared to 2009. Tax revenues fell here by 19% in 2009 and are down 9% in the year to August.

So the Minister is right. Ireland is not Iceland. It’s much worse.