Ireland doesn’t matter.
That’s the message we got from the markets yesterday. Even as the country announced its huge new austerity budget, markets around the world rebounded.
It’s probably only to be expected. Markets are meant to be discounting mechanisms after all. What with strong economic data from Germany and some upbeat news on US joblessness, investors decided they’d had enough of the Irish story for now.
The problems will be back in the news again before too long. And markets are likely to get fresh fits of the jitters as other countries come under the spotlight.
But what I found most intriguing yesterday was some of the details in the Irish budget cuts, and what they can tell us about the boom years…
Ireland came out with a new budget yesterday. Everyone knew roughly what was going to be in it already, so there weren’t many surprises. Overall, the government plans to cut its budget by €15bn over the next four years. €10bn comes from spending cuts, while €5bn will be raised through higher taxes. This all comes on top of €15bn in cuts already made.
Let’s be clear here. Stock markets might have rebounded yesterday. But no one believes Ireland and the other peripheral countries are out of the hole. The yield on ten-year Irish government debt continued to rise – investors are clearly sceptical of the budget working. And Portugal – followed perhaps by Spain or Belgium – remains next in line for trouble.
We’ve more on the situation in the next issue of MoneyWeek magazine, out tomorrow (If you’re not already a subscriber, subscribe to MoneyWeek magazine).
Ireland’s cuts might not be harsh enough
But let’s get back to those cuts for a moment. That extra €15bn hacking sounds incredibly harsh. And there are serious doubts as to whether the government will be able to push it through. But when you look at the details, you start to wonder if perhaps it isn’t harsh enough.
Here’s a sample statistic for you. The minimum wage will be hacked back by 12%. This is more about boosting employment, than cutting the country’s debt directly. But something that I hadn’t fully appreciated is just how high the Irish minimum wage is. In Britain, the minimum wage for those over 21 is now £5.93 an hour. The Irish minimum wage is being cut to €7.65 an hour (from €8.65). That’s just under £6.50 an hour at the current exchange rate. And that’s after it’s been reduced.
Yes, that’s going to hurt after people have been used to getting paid at those levels. And I’m not making any specific comments about the merits of a minimum wage, or how high or low it should be in an ideal world.
But it does go to show – along with everything else, from property prices to politicians’ wages – just how out of control the boom in Ireland became. If the country wants to become competitive again, then in the absence of an exit from the euro (which cannot be ruled out), these cuts are very necessary.
What about Britain’s austerity measures?
And what of our own austerity measures on this side of the Irish Sea? One company offered an intriguing insight into the impact of ‘the cuts’ yesterday. Doorstep lender Provident Financial (LSE: PFG) came out with a solid trading update. Provident is a company we’ve tipped a few times over the years. It’s a proper sub-prime lender, not like the amateurs in the high street banks. The company knocks back a staggering 75% of requests for loans. That’s the sort of strict criteria you need to be able to profit from lending to a high-risk sector.
The company’s share price had suffered in recent weeks, partly due to fears that ‘the cuts’ would hurt its main customer base – people on low incomes. Indeed, quite a few high-profile hedge funds have been shorting it.
But yesterday’s results saw the stock surge by more than 8%. For one thing, business has picked up. Sales for the 12 weeks from the start of September were up 7% year-on-year. But the most reassuring point for the market was that Provident says the cuts to benefits aren’t going to hurt it especially. Chief executive Peter Crook said he expects the “direct impact of the Government’s spending review on the group’s customer base to be modest.”
For a start, less than half of its borrowers are “in receipt of non-universal benefits.” In other words, a good proportion of its customers have no particular dependence on the state. And the £500-odd weekly cap on benefits that households can receive will affect only 1% of its Home Credit customers.
As for public sector spending cuts, few of its customers work for the public sector – most earn money via casual or hourly paid work. Indeed, the government’s plan to increase the income tax threshold to £7,475 from April 2011 will be good news for “at least a third of Home Credit customers.” And of course, cuts to child benefit for the better off won’t impact on its customers at all.
Benefit cuts might actually have the desired effect
I’m not entirely sure what this says about the severity of ‘the cuts’ overall. The idea of capping household benefits at around the level of the average UK household wage never seemed especially brutal.
Part of the problem is that from the generally London-centric view of both high-profile politicians and the national papers, the average wage looks fairly low. So you get much handwringing over whether the state should or shouldn’t shell out to pay for people on low incomes to live in Kensington (we discussed the subject in the magazine a few weeks ago: The row over housing benefit). But for those living outside the M25, and certainly outside the South East, the cost of living – not to mention the average wage – is significantly lower.
Indeed, Provident’s update suggests that benefit reforms might genuinely hit those they are meant to target – people who are gaming the system, rather than those who are just getting by. In any event, despite the recent share price surge, Provident is trading on a current year dividend yield of more than 7%. Given its prospects, that looks pretty tasty to me.
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