Credit data show weak activity and heightened Government risk, writes EUNAN KING

DATA RELEASED yesterday showing the breakdown of lending by sector up to December 2008 illustrate the depth of the economic slowdown. Credit extended, apart from the financial sector, grew by only 5 per cent in December compared to a year earlier.

In the previous two years growth averaged 23 per cent per annum. However, these December versus December comparisons mask the fact that reasonable growth in the first part of the year was replaced by sharp slowdown as the year progressed.

Between Q3 and Q4 lending to sectors outside the financial sector, fell by €3 billion or 1 per cent. Real estate and construction accounted for over €2 billion of this while personal lending declined by over €0.5 billion in the quarter.

The slowdown was spread across a wide range of sectors. The only sectors recording an increase in credit were the electricity, gas and water sector and health and social work activities. However, within the personal sector it is notable that mortgages for principal dwellings increased by over €1 billion while buy-to-let mortgages declined by more than three quarters of a billion in the quarter. The Table shows the amount of credit extended to the main borrowing sectors and the change on a year earlier.

Mortgage credit accounted for 43 per cent of total lending and the real estate and construction sectors accounted for a further 34 per cent. While mortgage credit grew by almost 6 per cent from December 2007, this was the slowest pace in 22 years. Mortgage lending in Q4 compared to Q3 rose by a mere €355m. Lending to real estate and construction rose by less than 6 per cent year-on-on-year. Of the total mortgage credit extended of €148 billion, €34 billion was for buy-to-let properties. This represented a 50 per cent increase since end 2005, but the bulk of this growth took place in the 12 months to the end of 2006.

Since the end of 2005 house prices have declined by less than 10 per cent, according to the Permanent TSB/ESRI house price index. In some areas prices have fallen much more sharply.

Lenders on average were advancing less than 70 per cent of the value on buy-to-let properties in 2006 and 2007. The owners of such properties would not be in negative equity position until prices are down by more than 30 per cent.

Mortgage repayments have been made more affordable as interest rates have been cut. The percentage of disposable income absorbed by mortgage repayments, for a married couple, is estimated to fall to its lowest level since 1997. It is estimated to be about 17 per cent of income this year compared to a peak of 27 per cent at the end of 2006.

However, affordability on its own is no guarantee that the market will pick up soon. There is a large overhang of unsold property, though some of this may be impossible to sell because of its location. Uncertainty about employment prospects and a general caution about new spending provide an added constraint. Nevertheless affordabililty is a support to the market, particularly where the mortgage repayment cost is now at or below that of renting,

The bulk of the bad debt problem in the Irish lending institutions would appear to be concentrated in the €112 billion in loans to construction companies and real estate companies. Of these loans, Anglo Irish Bank would have accounted for more than €30bn.

The Anglo loan book is now a Government risk and the bulk of the remainder of loans to this sector are held by AIB and Bank of Ireland. The bond market would appear to be pricing in a high chance that these loans too will end up as a Government risk, through these banks being nationalised or bailed out.

The cost of borrowing for the Irish Government is now 2.6 per cent above Germany. Greece is the only country in a worse position at 2.7 per cent above. The average for the countries with weak credit ratings, namely Portugal, Italy and Greece, is only 1.6 per cent.

This bad debt problem is now compounding the already wide fiscal deficit. The increase in the cost of borrowing for Ireland signals the urgency with which the Government needs to act. The Government needs to give clear evidence that the public sector is not being asked to bear more than the private sector is shouldering.