Helping construction industry to recover makes economic sense

 

OPINION: Nama will sort out the banks but where is the help the construction sector needs desperately?

BEFORE WE condemn any sector of our economy to a period of insignificance, it is worthwhile understanding the contribution this sector has made and its capability of contributing to our future. A case must now be made for the construction industry being restructured so it achieves an optimum size compatible with the needs and ambitions of our country.

The optimum size for the industry suggested by the Construction Industry Federation (CIF) suggests an output of €18 billion. The construction industry was a key driver of economic growth over the decade to 2007.

By the end of 2007, the industry had reached a value of €38.5 billion, 24 per cent of GNP, and employed about 400,000 people (direct employment plus 40 per cent indirect employment). This was equivalent to 19 per cent of total employment.

The CIF recognised that an industry of this size in response to a concentrated period of unprecedented economic and demographic growth had become unsustainable. A very sharp adjustment is now under way. A further decline beyond 2009, which is now inevitable based on current statistics, is essentially eroding the economy’s long-term productive capacity. The latest data for construction output in 2008 suggests that the volume of output declined by about 25 per cent and current indications are that the industry this year will contract by about 40 per cent, implying an output level of 17.6 billion.

On current projections of construction activity, and in the absence of a major stimulus package to reinvigorate the industry, the size of the construction industry will shrink to about €12.3 billion by 2010 – some 33 per cent below its long-term optimum and 68 per cent below the peak three years earlier.

By 2011 output will have shrunk to below €10 billion, meaning the industry will be operating at almost half of its optimum level. This decline has serious consequences, as are already evident for tax receipts, direct and indirect construction employment and wider economic activity. The result will be a deeper and longer depression which will delay any recovery.

From an employment perspective, the deterioration in the industry will continue to exert a major drag on the economy with employment estimates for 2010 and 2011 suggesting that total employment in the industry will fall back towards 126,00 by the end of 2011, bringing employment in construction back to 1994 levels.

Based on the medium-term growth needs of the economy, construction output should be at least €18 billion for a number of years, equivalent to 12 per cent of 2008 GNP. If we don’t have this as our goal, Ireland will continue to fall behind the rest of the EU in our accumulated capital stock.

In terms of residential construction output, this year will be less than 20,000 units, while next year will see less than 10,000 new homes constructed with practically no multi-unit developments being built. This effectively means the house building industry is at a standstill, even though the ESRI recently acknowledged that Ireland requires 40,000 new homes per annum.

From the outset, the Government made it clear what the objectives of Nama were: cleansing the balance sheets of the banks, infusing liquidity into these entities and in turn rejuvenating the economy. Most of us believe that if the Bill goes through as is, or in some amended form, the first two objectives will be achieved but the third, rejuvenating the economy, therein lies the problem.

How can the public be sure that when the bank’s balance sheets are cleansed and a large injection of liquidity has occurred, that the banks will put the national interest ahead of the perceived best interest of the shareholders?

When Nama has completed the process of issuing bonds in exchange for portfolios of loans from the banks, which will be done progressively over possibly two years, the question is, “will the banks invest some of this liquidity into the corporate and consumer sectors in Ireland”?

Having received the liquidity, the banks will be obliged to protect and preserve their balance sheets in a way they failed to do over past years as there will be an obligation on them to do so, with strong oversight by the regulators. The new capital adequacy requirements are stringent and the new capital ratios will be followed keenly by the marketplace That may leave little room for new lending.

If we examine the option of lending funds to the banks’ customer base, we need to determine which sectors are in most need of liquidity and which of these in normal circumstances would the banks view as good risks. In identifying sectors that have genuine growth potential, it is equally important that the banks don’t over-lend into a particular area, causing yet another sectoral credit bubble. Areas associated with exports are clearly in the sights of the lending institutions, but what really is their capital needs at this time, as many of these are cash rich.

Consequently, the problem for the banks as they examine the risk profile of their customer base is that the riskier credits will require more liquidity than others. Caution and discipline are essential in lending, but there is no substitute for good judgment on difficult but potentially profitable projects.

The credit process and credit executives have been tested over the past 10 years and the case for rejection will always be easier.

Working capital is what is required in all sectors but the security available is likely to have been diluted over the past three years. With €77 billion taken off the balance sheets at a discount of €23 billion, leaving an injection of some €54 billion to go into the banks, we must ask ourselves into what sector would anyone put more than €1 billion.

The single biggest sector that requires investment is construction and property. This sector is on its knees and is parched for liquidity. It is the sector we all blame for the poor state we are in today. Having experienced the massive downside of the excessive losses associated with this sector, we must ask ourselves can the economy recover to an acceptable level within a specified time frame (four to five years) without reinvesting in construction and property. The construction industry is reported to have lost 150,000 jobs over the past two years and the likelihood of recovery in this sector without investment is remote.

We struggle between restitution and retribution. It is natural to feel that we have all been let down by every level of authority in place from the birth of this financial crisis. Regulators, auditors, bankers, developers, Government, brokers, the list goes on.

The outcry from the public is clear: “We entrusted you with the responsibility and accountability for the financial system and you have let us down. Worse still, you are trying to bail out the principal perpetrators.”

However, leaving the construction industry underfunded must be the equivalent of shooting ourselves in the foot. This sector needs to be managed from a funding and investment perspective in a disciplined manner.

By ring-fencing those potentially good assets and providing the owners with an opportunity to complete or begin and finish projects in partnerships with Nama and the banks, we have a chance of rekindling the property market and the economy.

If the major developers walk away and leave a mass of unfinished projects, the consequences for the country are unimaginable.

For progress to be made it is imperative that Nama, the banks and the developers sit down together and determine a way forward that is in the best interests of the country.

Michael Soden, former chief executive of Bank of Ireland, is an independent financial consultant and commentator

The Irish Times Logo
Commenting on The Irish Times has changed. To comment you must now be an Irish Times subscriber.
SUBSCRIBE
GO BACK
Error Image
The account details entered are not currently associated with an Irish Times subscription. Please subscribe to sign in to comment.
Comment Sign In

Forgot password?
The Irish Times Logo
Thank you
You should receive instructions for resetting your password. When you have reset your password, you can Sign In.
The Irish Times Logo
Please choose a screen name. This name will appear beside any comments you post. Your screen name should follow the standards set out in our community standards.
Screen Name Selection

Hello

Please choose a screen name. This name will appear beside any comments you post. Your screen name should follow the standards set out in our community standards.

The Irish Times Logo
Commenting on The Irish Times has changed. To comment you must now be an Irish Times subscriber.
SUBSCRIBE
Forgot Password
Please enter your email address so we can send you a link to reset your password.

Sign In

Your Comments
We reserve the right to remove any content at any time from this Community, including without limitation if it violates the Community Standards. We ask that you report content that you in good faith believe violates the above rules by clicking the Flag link next to the offending comment or by filling out this form. New comments are only accepted for 3 days from the date of publication.