Opening Remarks By Joe McNeill, and Michael Connolly, to Joint Committee on Finance, Public Expenditure and Reform 07 March 2012 Speech Thank you Chairman and members of the Committee, for inviting us to address you on the issue of non-financial corporate (NFC) debt. Today’s is a joint presentation by the Central Bank and the Central Statistics Office (CSO) and both institutions will make short opening statements. We are accompanied today by Mr. Martin O’Brien and Mr. Fergal McCann, economists in the Statistics and Financial Stability Divisions of the Bank, respectively. Our focus today is on the NFC sector, which, with the household sector is the key driver of activity in the real economy. The presentation will be split in two parts – in the first part, the CSO will look at overall structure, composition and liabilities of the NFC sector, including multinational enterprises operating in Ireland. In the second part, the Bank will focus on borrowing by the NFC sector from banks in Ireland. 1. Overview of NFCs in Ireland - CSO The Non-Financial Corporations Institutional Sector contains the largest grouping of companies in the economy. This classification includes all company sizes from extremely large Multinational Corporations (MNCs) located in Ireland down to small retail operations. The activities covered fall under the broad headings of Industry, Construction, Distribution and Services, excluding Financial Services. Charts 2 – 6 give background information on the number of enterprises, employment, turnover and value added for this sector. This Institutional Sector covers 194,000 enterprises and the majority of these entities are either termed micro – having less than ten employees or small i.e. less than fifty employees. The total employment of the sector is 1.2 million persons engaged. The turnover of the sector amounts to €314 billion and Gross Value Added is €84 billion for the sector. Chart 7 presents an analysis of debt by Institutional Sector across a number of countries shown as a percentage of Gross Domestic Product (GDP). The chart demonstrates the levels of debt for each institutional sector relative to annual GDP at current prices. These same measures form the building blocks for the Scoreboard for the Surveillance of Macro Economic Imbalances, and the related set of legal instruments – the so-called six pack. One measure is particularly relevant to this presentation; private-sector debt has a threshold of 160 per cent of GDP. This represents a combination of the debt of Households, Financial and Non-Financial Corporations. Clearly Ireland has breached this threshold, however while the level of household debt is well understood following the boom years, corporate debt needs more examination. Today we are concerned with the Non-Financial element of this corporate debt which stands at almost twice the level of GDP. Chart 8 gives a broader analysis of balance sheet data by Institutional Sector. The net figures for the sectors in the domestic economy i.e. Households, Government, Non-Financial and Financial Corporates, add up to the total for the Rest of the World. The rest of the world figure is equivalent to the Net International Investment Position – another of the scoreboard measures. For Ireland the measure is approximately 100 per cent of GDP. However, the crucial point of the slide is that the focus on debt is a partial analysis and overlooks other liabilities of the various sectors including shares(equity). It is also clear that in general these assets are matched by liabilities. Chart 9 demonstrates that the majority of these liabilities are international and relate to International Financial Services activities at IFSC. Chart 10 presents the trend in overall Non-Financial sector debt. It is important to note that this debt includes borrowing of Multinational Enterprises, Aircraft Leasing Companies, Holding Companies and Domestic Small and Medium Size enterprises (SMEs). It also illustrates aspects of the two speed economy where borrowing for the International corporates continues to increase, while GDP and the activities of domestic firms are essentially flatlining. Chart 11 matches the debt liabilities with the debt assets of the Non-Financial Sector. This part of the presentation concludes with slide 12 showing the source of the debt accumulated by this sector. An important element of this debt is the borrowing by multinational enterprises from related Treasury operations that operate in the IFSC. 2. NFC borrowing from banks in Ireland – Central Bank The Central Bank collects a number of data series on NFC debt from banks operating in Ireland and I propose to give a brief overview of these today. As I mentioned in my previous appearance on the 8th February, the data compiled by the Bank are compiled according to the international statistical framework, standards and methodologies. The data presented in the charts are based on our monetary statistics and represent NFC borrowing from the banking sector i.e. all banks licenced to operate in the Republic of Ireland. It can be argued that this is one way of getting behind the indigenous versus MNC aspects of overall NFC debt in Ireland, as credit from the resident banking system is likely to be a more significant source of financing for indigenous firms than for MNCs. A number of charts have been circulated to Committee members to illustrate developments in lending by banks to the NFC sector over recent years. The most recent data shows that the outstanding amount of Irish NFC credit on the balance sheet of banks in the Republic of Ireland was €87.7 billion at end-January 2012, almost entirely related to loans, as opposed to holdings of NFC debt and equity securities. This is down from a peak of €171.3 billion in August 2008 (Chart 1). Members should keep in mind that this drop in on-balance sheet amounts of credit to NFCs is not equivalent to the underlying change in the amount of credit advanced by banks to the sector, as the impact of transfers to NAMA and related valuation issues explain the vast majority of this change. Adjusting for these effects shows the underlying drop from peak for Irish NFC credit advanced by banks in Ireland is 6.2 per cent. Annual rates of growth for NFC loans in Ireland peaked at 37.1 per cent in July 2006, and have been falling steadily from that point. Conversely euro area trends were much more subdued with annual rates of growth peaking at 14.9 per cent, then falling to minus 2.4 per cent in early 2010 before turning positive in the latter part of 2010. It is interesting to note the contrasting trends in loans of different maturities between Ireland and the euro area. Longer maturity loans of over five years maturity in Ireland grew much more rapidly before the crisis and fell particularly sharply afterwards, with year-on-year contraction of 13.4 per cent in February 2010. This decline has moderated in recent quarters, and is now broadly unchanged over the year ending January 2012. Euro area developments were much more subdued, and while rates of growth have slowed, they have always remained in positive territory. Growth rates for shorter loans up to one year have a much different pattern for Ireland, and have generally been above euro-area levels, with year-on-year changes remaining positive. Euro-area loans in this category fell sharply following the crisis before recovering in late 2010 and early 2011. This shows that short-term funding has increased in importance for Irish NFCs. This would indicate that Irish NFCs may be more reliant on short-term borrowing (including overdrafts) for working capital purposes, with longer- term borrowing, which is usually associated with investment spending remaining weak. As well as looking at changes in the volume of lending to NFCs, it is important to look at the cost of servicing this debt. Chart 3 shows retail interest rates on lending to NFCs in total and across the various maturity categories. On all counts, interest rates in Ireland were higher in years prior to the crisis but fell below the euro area following the crisis before converging in 2011. Most recent data show that NFC loan rates in Ireland have decreased more than those in the euro area as a whole over the last few months, particularly for shorter-term loans. Looking behind the aggregate NFC credit figures, it is possible to distinguish the lending activity to the different sectors of economic activity (i.e. agriculture, manufacturing, construction, etc.), and this can be seen in Chart 4. To do this, we have to refer to lending by banks to all private-sector non-financial enterprises, as opposed to corporates. The enterprise definition is broader and includes lending to sole-traders, etc., but there is of course a very high degree of overlap. As is well known, the expansion of credit was mostly related to activities in the property-related sectors of construction and real estate. Credit to these sectors at their peak in June 2009 accounted for 66 per cent of total credit to non-financial enterprises, and even now still account for just under 60 per cent of outstanding credit. The Bank has recently started collecting new data on SME lending as highlighted in Chart 5. Looking at SMEs in particular may provide further clarity on the debt situation of indigenous firms, which we know from CSO data, are more likely to be SMEs than foreign firms. As well as tracking net flows (i.e. draw-downs less repayments of principal) the Bank also asks for actual new lending drawn down each quarter – this represents lending which was not on the balance sheet in the previous quarter, excluding any renegotiations of existing debt. It is noticeable in Q3 2011 that construction still accounts for the largest amount of actual new lending, followed by agriculture and other, including some service-type activities – see Chart 6. Nonetheless, there is negative year-on-year growth across all the sectors listed, as repayments of debt outstrip new lending. In order to get an understanding of the cost of servicing bank lending by SMEs we can turn to the retail interest rate statistics again. Data on interest rates for SME loans in particular are not collated, but proxies based on the interest rates prevailing on new business loans by size of the loan have been analysed in the past. These data are shown in the last page of our handout. In contrast to the aggregate NFC lending interest rate data it can be seen that interest rates on loans of smaller value are typically higher in Ireland than in the euro area as a whole. This is in line with recent research on SMEs carried out by Central Bank economists.