Oireachtas Appearance on EU-IMF Interest Rates

I appeared today before the Oireachtas Committee on European Affairs to discuss the interest rates on the EU-IMF loans. I provided the committee with a briefing paper (available here) and a short presentation (available here). I will edit this post later to include the transcript of my opening statement and the questions and answer session when these materials are posted on the Oireachtas website.

There’s a lot of material in the briefing note and I’m not going to repeat it here. One point I would briefly point to, however, is that the note discusses how recent movements in market interest rates and the pricing of EFSM’s initial bond issue on January 5th (EU Commission press release here) meant that, by my estimates, the cost of funding from the EFSF and EFSM would be 40 basis points higher than had been estimated in the December note released by the NTMA.

These materials were prepared prior to today’s €5 billion bond auction the EFSF. Press stories have been very positive about how this bond auction went (e.g. here and here). However, the material I prepared discussed the pricing of the EFSM bond yield relative to swap rates. The January 5th bond was priced at mid-swaps +12 basis points while this bond mid-swaps +6 basis points, so the interest rate on today’s bond would not change my judgment on this issue by much.

Update: As promised here‘s the transcript of my appearance

31 replies on “Oireachtas Appearance on EU-IMF Interest Rates”

I would like to second Mr. Zhou’s vote of thanks. You have performed an excellent public service – particularly in the context of so much political – and comment forum – ranting about the extent to which the EU/IMF are hosing Ireland via the terms and conditions of this substantial sovereign support package.

But it would far, far better if this EA Cttee were empowered and resourced to invite those who argue the case for the potential to secure a significant amelioration of these terms and conditions to make their case, supported by relevant evidence – if this were possible, to contest the case you are making, to allow you to offer rebuttal and to deal with counter-rebuttal in return. The Cttee would then be in a position to form a view and make a decision and, then, to communicate it to the Dail which would have an opportunity to form a settled view on the matter and to provide direction and guidance to the Government.

This is how parliamentary democracy is supposed to work. You have done your bit – indeed, much more than a bit – but what will follow on from this is a catalogue of institutional and procedural inadaquacies. Should we be surprised, then, that the public interest is so ill-served in this polity?

This is probably more useful than being another economist running on the South East Dublin Independent ticket.

@ Karlos

excellent read.

However, for the short presentation link, I get some funky XML files on the zip download. How do i actually view the ppt presentation?

Yes this is very useful and contains the best explanation of how the EFSF works that I’ve seen.

The IMF did include a full schedule of disbursements, interest and principal repayments in their documentation (we’re all done in 2023 !!). No equivalent has been produced by the DoF/EU as far as I’m aware on the EFSM/EFSF portions – they should be required to do so. The DoF by nature seem to want to reveal as little as they can get away with. Perhaps the new MoF may impose some changes here and inform them that it is now the 2010s, and not the 1940s.

@Karl

Just to second the other comments about what is very clearly a publicly spirited labour. You deserve gratitude.

One question – shouldn’t the EFSM/EFSF rates be lower than 5.7% since there is zero currency risk involved. That is, our lenders obtain their funds in euros to lend to us so there is no insurance (hedging) premium to offset currency risk. Shouldn’t that mean a lower effective rate than the hedged IMF rate as with the IMF we need pay a currency hedging premium?

Hi Karl

from todays IT
“He pointed out that if a country was paying 6 per cent on its debt and had no deficit, it would have to grow by a nominal 6 per cent per year to achieve debt stabilisation.”

Now given that our growth projections are somewhere between -3 and +2.25 depending on who you listen too and that the cost of paying interest our debt is likely to be about 10 Billion excluding the off balance sheet stuff in 3 years I find the following comment a little confusing.

“A reduction of 100 basis points in this
margin and the EFSF’s margin would make little financial difference to other EU countries
but it would make a substantial difference to the outlook for fiscal sustainability for Ireland.”

I realise the point you were making in the latter comment was that 100 bases points for us is a lot more benificial to us than is painful to the other EU mamebers but I don’t see it as making a substantial difference in our sustainability.

In other words should you not have punted for at least 300 basis points or more (the Euro members should not be making a profit of 240 -292 they should be sharing a loss in order to help avoid large scale european default)

I mean if not are we not just discussing levels of insolvency (How dead is the Parrot?) whats the point?

The Powerpoint presentation had worked fine for me (and I suspect also for anyone who had the latest version which reads .pptx files.) However, in the interest of full access, I’ve replaced it with a PDF file. The table with the EFSF example is a bit granier but it can be read.

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@ Jagdip

its not a “hedging premium” as much as a cross currency interest rate translation ‘effect’ that you incur. “Cost” is the wrong word imo, ‘net effect’ of swapping risk from floating SDR to fixed EUR is more correct (not complaining Karl!! Just saying!)

@ Jagdip

I point out in the note that I don’t know how of the jump from the quoted IMF rates to the 5.7% in the NTMA note reflects currency hedging versus the cost of fixing the interest rate. However, I point out that it seems likely that the currency bit is a very small element: Swap rates tell us what the cost of swapping variable for fixed rates over 7 years will be and this would be most of the cost (http://www.swap-rates.com/EUROSwap.html)

In terms of the economics of this, everyone expects variable rates to go up over the next few years while exchange rate movements tend not to be very predictable. So one represents a bigger risk than than the other.

But I accept your point that, other things being equal, you’d expect a loan in euros to be cheaper than a loan in a basket of currencies that then needs to be hedged.

Just to be clear, though, we are not actually (to the best of my knowledge) engaging in such hedging or swap contracts.

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@ Eamonn

Sure, I’d be all in favour of eliminating the margin altogether, so perhaps the 100 basis point line was just more an illustration of the most that I thought might be achievable.

But don’t worry, the feasible set of what could be achieved is not defined by what an obscure Irish professor writes down in a briefing note.

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@ Karl

7yr USD/EUR basis swap (ie swap from $ Libor to Euribor) actually in our favour in this instance, by around 20bps (interbank). GBP/EURO basis risk something similar in our favour, and JPY to EUR negative to the tune of 34bps. So overall the pure currency basis risk is a net positive, but as you said, only marginally.

@ Karl

I wouldn’t be too sure of your lack of influence. Some TD might latch on to the line ‘sure a 1% reduction an we’ll be grand’ and pedal it enough to make it stick.

See where Dave McWilliams talk of ‘Cheapest bailout in the world’ got us.

@Karl W,

“..the feasible set of what could be achieved is not defined by what an obscure Irish professor writes down in a briefing note.”

Imo, your apparent modesty is unwarranted. Expert opinion of this nature – and the contesting of this opinion – is precisely what legislators require. It is up to them to decide whether or not to hold the government properly accountable. Commenting on government announcements, proposals and decisions is valid and useful, but providing analysis and advice to legislators trumps this comprehensively.

@ Karl

I wouldn’t be too sure of your lack of influence. Some TD might latch on to the line ’sure a 1% reduction an we’ll be grand’ and pedal it enough to make it stick.

See where Dave McWilliams talk of ‘Cheapest bailout in the world’ got us

Karl

“But don’t worry, the feasible set of what could be achieved is not defined by what an obscure Irish professor writes down in a briefing note.”

Maybe not but remember – talk is cheap – and Irish politics (and latterly economics) has no shortage of talk.

Actually working stuff out – properly – won’t get you much popularity right now but it is what should be happening far more than it is. It is remarkable that there is still almost no understanding of the “bailout” in terms of numbers certainly, and to some extent function, in the wider public – but they can’t wait to vote.

Good work and do avoid the temptations of turning into another of what a very distinguished fund manager used to descrie to me as “wind and piss merchants”.

Karl I get what you are saying and accept the point.

I guess I was just hoping that economists might start to ‘shoot for the stars’ in order to impress upon politicians the gravity of the predicament and the required level of radicalism in order to get out of this situation/hole/mess.

It’s a bad but probably not unpredictable state when only the far left and right wing independents are making the required level (and unbelievably similar) radical solutions.
However I appreciate the higher risks these strategies entail.

I feel like we are walking aimlessly over a cliff in the hope that Europe will provide a safety mat. When The ECB decides to allow the ICB to create its own debt, where the irish taxpayer rather than the european tax payer becomes the buck stopper I wonder whether any safety mat will be furnished.

What recommendations were made to the Committee? There don’t appear to be any in the slides.

“Nigeria is rated B+ by Standard and Poor’s, four levels below investment grade. Senegal, a similarly rated West African country, has $200 million of dollar bonds due in 2014 that yield 8.543 per cent, according to prices on Bloomberg.

Nigeria may get a lower yield at 6 to 6.5 per cent for 10-year notes, Stuart Culverhouse, chief economist at Exotix Ltd., a London-based brokerage, said in a phone interview, yesterday.”

http://allafrica.com/stories/201101180750.html

The summary states in the opening line

“The Irish government has negotiated with the EU and IMF that will provide €67.5 billion in contingency funding for the state over the period 2011-2013.”
I am focusing here on “funding the State”.

I have been attempting to get clarification on what funding the State is committed to in relation to the banks. Is the State via the Central bank committed to fund only the losses/capital requirements of the banks or is the State consequent to the guarantee committed to also borrow to fund bank liquidity which could in theory turn out to be in hundreds of billions if deposit flight continues.

My understanding is that the State is committed to fund bank losses and the ECB as lender of last resort committed to provide liquidity.

Could I prevail on somebody to clarify this issue?

@Celtic Pheonix
No malice intended.

@Joseph Ryan
Good question. Is the Irish Central Bank creating money or loading us with debt?

I believe that floating rates are the right way to go. If the rate rises, it is probably because of a pick-up in growth and/or inflation in the west. Ireland would benefit from both developments disproportionately, if it were to be so lucky. Ireland benefits from low rates if we remain in stasis; Ireland benefits far more from a pick-up in growth and/or inflation in the west, relative to the cost of paying a somewhat higher variable rate (and over a modest part of its debt to boot).
Loans to Greece were made under the IMF’s Emergency Financing Mechanism (3-year Stand-By Arrangement).
And as indicated in previous posts, I find the front loading of the support for Ireland quite surprising. That wasn’t addressed in these short but excellent reports of Karl’s. But would be worthy of interest.

@All
Has an official assessment of our solvency and/or the impact of the bailout interest rate on our solvency been published?

Thanks very much for your work on this, Karl. It’s truly amazing just how untransparent this stuff is.

You seem to be just about the only person trying to provide clarity.

I’m trying to work out your calcs on page 8 of the briefing note.

I’m struggling with the 10.86 million upfront margin. My rudimentary calc is 80 bn x 2.47% x 7 years = 13.83. Is there maybe a specific net present value adjustment figure I’m missing?

Also, the upfront negative carry implies a 16 basis point gap between AAA investments and the EFSF rate on the 20% buffer?

@ Alan G.

I worked out the upfront margin as an NPV of the payments discounting by 6.05%.

So it’s as follows

80*0.01*2.47(0.9395+0.9395^2+0.9395^3+0.9395^4+0.9395^5+0.9395^6+0.9395^7).

That’s about right on the negative carry.

These are just my guesses but they fit pretty well with information supplied to me by someone from the EFSF.

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