Wednesday, July 19, 2017

So, what’s going on with the Current Account?

Last week the CSO provided the first insight into the new * variables that will hopefully address some of the distortions in the National Accounts that have been created by PLCs who have redomiciled to Ireland and offshore activities relating to assets owned by Irish-resident companies linked to aircraft leasing and intangible assets. 

While much of what was published was a useful step in the right direction a clearer view of what is happening in the Current Account of the Balance of Payments was not provided.  The problems with the official measure of the Current Account are evident below.

Balance of Payments Current Account Annual

After moving into deficit in the period from 2004 to 2007 the current account began to improve in 2008 but the improvement in 2009 and 2010 was much greater than the underlying performance of the economy would suggest.  The recent volatility is clear and this largely relates to the impact of the onshoring of intangible assets to Ireland.

To improve things we have been provided with a modified Current Account, termed CA*, that makes a number of important adjustments.  Per the CSO:

CA* is the current account balance (CA) adjusted for the depreciation of capital assets sometimes held outside Ireland owned by Irish resident foreign-owned firms, e.g. Intellectual Property (IP) and Aircraft Leasing, alongside the repatriated global income of companies that moved their headquarters to Ireland (e.g. redomiciled firms or corporate inversions).

The impact of the factors on the current account are shown in this table.

Globalisation Impacts on the Irish Current Account

The rise in the income accruing the redomiciled PLCs which drove the rapid improvement in the current account in 2009 and 2010 can be seen while the huge jump in the depreciation related to MNC owned intangible assets that caused in the recent volatility in the Current Account is also readily seen.

So what happens if we exclude the income of redomiciled PLCs, or equivalently consider them to flow out as a factor outflow to their foreign shareholders, and treat the depreciation on certain IP and aircraft assets as an outflow as this arises from gross profits that accrues to non-residents and is linked to assets that may have no direct link with the Irish economy?  Making these adjustments gives us this:

Modified Current Account Annual

Hmmm.  That’s not very good at all.  Yes, we do see some moderation of the improvement in 2009 and 2010 but recent figures do not make sense.  We would possibly have expected continued improvement in the Current Account for the last few years while the huge drop to a deficit of almost €30 billion in 2016 is not reflective of any underlying trend in the Irish economy.

So what are we missing?  Or maybe more accurately was remains in the modified Current Account that continues to distort the figures?  Adjusting for the depreciation of certain IP and aircraft assets is correct but no adjustment is made for their acquisition. 

Sometimes this assets are added to Ireland’s capital stock through a balance-sheet relocation (which has no impact on the current account) but other times the assets are acquired by an Irish-resident company and this transaction is recorded as an outflow in the balance of payments.  There is little doubt that the deficits shown in the modified measures for recent years are, in whole or in part, due to these acquisitions. 

Making an adjustment for the depreciation on these assets is appropriate for when these assets are here but we should also make an adjustment for how those assets get here if that has an impact on the Current Account.  So we need the net outright purchases in the balance of payments of the assets we are making a depreciation adjustment for.

We can get this from new Annex 4C of the Quarterly National Accounts.  This gives a modified Gross Fixed Capital Formation (in nominal terms) where the GFCF excluded from the modified measure are aircraft related to leasing and the onshoring of IP assets.  For some years the split between the two isn’t provided (as some quarters are suppressed) but we have their sum from the difference between the official and modified versions of GFCF.

Investment related to Aircraft Leasing and Purchase of Intellectual Property Assets

We should get a better picture of the current account if we make an adjustment for the fact that all of this investment in aircraft for leasing and the purchase of IP assets will have required them to be imported and therefore counted as an outflow in the Balance of Payments.  Now, there may be some differences in how these transactions are valued for National Accounts versus Balance of Payments purposes but any differences won’t materially change the result. 

So lets make an adjustment to the modified Current Account published by the CSO last week to take account of the purchase of aircraft for leasing and certain IP assets.

Adjusted Modified Current Account Annual

That seems much better.  We have the deterioration from 2004 to 2007 and a fairly steady improvement before return to a small surplus in 2014.  The figures since then seem questionable with a rapid move to a large surplus with this measure showing a surplus of €13 billion in 2016.  If this is true then we are in a very strong position but it does seem implausibly large.

Here is this approach applied above to getting an underlying Current Account as a percentage of GNI*.

Adjusted Modified Current Account Annual over GNI star

Are we running a current account surplus of seven per cent of national income?  It’s seems high.  A Current Account measure that seems to fit the underlying performance of the Irish economy up to 2014 but doesn’t thereafter isn’t of much use.  We want to know what is happening now.

The improvement in 2015 is likely partly due to €2.3 billion increase in Corporation Tax receipts seen that year, of which around 80 per cent was due to MNCs.  Corporation Tax did not grow to the same extent in 2016 so that cannot explain the continued improvement shown in this version of the Current Account.

There may be something happening within the income flow figures.  For example, the retained earnings of direct equity investment attributed to Irish residents increased by almost €3 billion in 2016 (from €10.9 billion to €13.8 billion) but as shown in the first table above the net foreign income of redomiciled PLCs only increased by €1 billion in 2016.  The impact of this €2 billion difference on the Current Account balance produced here is unclear. 

The 9.4 per cent nominal growth rate for GNI* also seems a bit high but it is probably not that far out of the ballpark.  It could be that there is another distortion on the income side that we need to be made aware of or it could be that our current external balance (along with our national income) really is improving at the rapid rate shown here but at least we’re only quibbling over a couple of percentage points of national income.  The figures published last week by the CSO allow us to get closer to what is really going on and it is a step to be welcomed.  More please.

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