Business and Finance Article on Debt Sustainability

Here‘s an article I wrote for Business and Finance on the question of whether Ireland’s fiscal debt is sustainable.

One correction I’d add to the article is that I miscalculated the average interest rate on existing Irish debt and reported it in the article as about 3 percent. The correct figure, as calculated by the EU Commission, is 4.6%.

17 replies on “Business and Finance Article on Debt Sustainability”

If, however, Ireland falls short of the targets set in the current adjustment programme and the debt outlook looks worse in 2013, then this will raise the question of whether private sector debt should be restructured.

From the context it’s fairly clear that “private sector debt” means debt owed to the private sector, but I suspect you’ll confuse some readers. As a creditor, I’ll be relieved if maturities are extended while coupon payments are maintained at the existing level. Judging by market prices I’m not alone in expecting something worse.

Does B&F insist that every paragraph consist of just one sentence?

Yeah, the 4.6% interest rate on existing debt, correction above, makes the situation a hell of a lot worse. Clearly lack of growth, global downturn, dangers of a deflationary spiral, broken domestic economy, further austerity, make restructuring an urgent necessity, before fiscal position spirals out of control.

The figures are a snapshot though and don’t take into account the effects of austerity cuts the DoF is being secretive about that will come into effect in coming budgets. Both the ESRI and the DoF are silent on these matters.

It appears to me what is on the cards is, a smaller domestic economy and banking sector; a smaller public service. Savings will be achieved by driving people out of Ireland through forced emigration thus reducing the need for a larger public service. Growth if achieved will not come from GNP but from GDP fed by large multinationals with small employment levels.

As Hal said to Dave in 2001, “Everything is going extremely well” 🙂 Default beckons!

“Gerard Lyons, chief economist at Standard Chartered bank, said pressure had been mounting from Berlin. “I think the Germans have been playing hard ball for a few weeks now. If Greece does go I don’t think they will be the only one.”

Spiegel Online said the meeting was being held under strict secrecy and that both the German finance minister, Wolfgang Schäuble, and his deputy, Jörg Asmussen, were attending.

It quoted from what it said was an internal German finance ministry paper that Schäuble was taking with him to Luxembourg, which warned that a Greek exit “would lead to a significant depreciation of the domestic currency versus the euro” and increase Greece’s debt levels to 200% of GDP.

“The government has raised the possibility of leaving the eurozone and reintroducing its own currency,” the report said.”

“The European Commission’s projections are for Ireland’s debt-GDP ratio to peak at 120% in 2013 and slowly decline thereafter. ”

This is based on the General Government Debt (GGD) measure of national indebtedness. By 2013 we will have paid over €9 billion of the Promissory Notes. There will still be some €22 billion outstanding that are included in the GGD but we won’t have actually had to borrow that money, and hence won’t have to pay interest on it. There will also be another €10 billion of interest on the Promissory Notes that will be added incrementally to the GGD over the next decade or so.

This €22 billion of debt that won’t actually have been borrowed would knock about 14 percentage points off the effective debt/GDP ratio bringing it down to around 106%. This will reduce the amount of debt interest will be incurring. The EU’s projections of an interest cost of 6% of GDP by 2013 also include the interest on the outstanding Promissory Notes which we will not be paying at the time.

Of course, it is correct to include the Promissory Notes when measuring our public indebtedness, but if looking at how much interest we have to pay in 2013 the full amount should not be included because of the way these Promissory Notes are constructed. It will matter by 2025 when we have the estimated total of €43 billion paid over on them.

The GGD also do not allow for the €22 billion of cash we have sitting in various accounts but that is only a temporary state and we’ll find a way to burn through that between now and the end of 2013.

Focusing on the Promissory Notes might seem like picking around the edges of the details when we have a huge debt problem, but given that we are on the border of sustainability such things can tip the balance one way or the other.

There remain some significant uncertainties that may force a restructuring regardless but based on what we now know I think we can survive without a default/restructure. The decision may be made to take this option anyway and if the benefits of doing so exceed the costs then the view that the debt is “sustainable” is moot.

@ Seamus

“There will still be some €22 billion outstanding that are included in the GGD but we won’t have actually had to borrow that money”

I’m not sure I see your point.

Suppose that instead of issuing the promissory notes, we had issued a sequence of zero-coupon bonds, each worth €3.1 billion on maturity, with one of them maturing in 2011, another maturing in 2012 and so on. In that case, would you say that we didn’t really borrow that money?

I agree that the actual “cash equivalent” interest payments on the notes differ from how the GGD records them — we’ll be paying the interest later than the GGD will record — but I don’t see how changes any analysis of sustainability by much.

@ Seamus Coffey,

Have you some more detail on that.

I’d like to see how the €9 bn has been calculated or the rationale for not having to borrow the “€22 billion outstanding that are included in the GGD but we won’t have actually had to borrow that money, and hence won’t have to pay interest on it”

@Colm Brazel
The entire promissory note was added to the GGD last year (the year before?). There’s an interest holiday on it until the end of 2012.

Thereafter, interest is rolled up so instead of being 10 yearly payments of 3 billion (starting in 2011), it becomes 14 I think.

The point is that the promissory notes do not ‘cost’ interest each year, even though they are in the GGD, so you can’t just multiply GGD by an average interest cost to get the annual interest bill.

Of course, we should be amortising the known upcoming cost, but hey, as a leading business editor tells us, governments don’t pay back debt…

@ Karl

Of course if we had issued zero coupon bonds we would have borrowed the money. Hence these would also be included in the GGD. The issue for sustainability is the amount of interest that has to be paid on the debt.

Issuing zero coupon bonds would not be unsustainable – until, of course, you have to borrow elsewhere at positive rates to pay them off. I think the same distinction holds for the Promissory Notes.

If the Promissory Notes were constructed so that the first payment did not occur until 2021 we would not be including them in an analysis of debt sustainability for 2013. Naturally they would form a part of the total liability of the State, but they would have no real effect in 2013. Their impact would be felt in the future. In this hypothetical case they would only generate a burden once payments began in 2021.

Back to reality and we know that the payments on the Promissory Notes began in 2011, but by 2013 only three payments will have been made. We will have had to find €9 billion to meet these commitments. At that stage, what the final bill for the Promissory Notes will be is just a number. It could be 0, 32 billion or 3.2 trillion. Whether the debt is sustainable in 2013 does not really depend on what the final bill for the Promissory Notes will be. We won’t have had to actually borrow any of the money to pay the remaining Promissory Notes (and interest) by then.

The Promissory Notes are a debt and over time they must be paid. The distinction I am trying to make is between the amount of the debt and the money used to pay that debt. For the foreseeable future this will be borrowed money and this is the money I think that matters for sustainability.

There’s a great sequence in this video that reminds me of the current situation with the Troika

They keep asking us what’s wrong with us
We keep saying back
what’s wrong with you
What’s wrong with you
is what’s wrong with us

@ Seamus\Hogan

I agree figuring out average interest rates is made tricky by the funny accounting treatment of the promissory notes.

On the question of sustainability in 2013, I don’t think we can wave away concerns about debt that matures a number of years off in the future. Take a look at Figure 40 in the Commission document. We have some very large amounts of maturing debt in a number of years time and the promissory notes (perhaps best thought of as a sequence of bonds of different maturity) effectively add to this.

If investors worry about long-term sustainability, then maybe they will lend short-term but then if there’s a lot of short-term debt then the situation is always on a knife-edge. While the timing of repayments does matter, the total quantity of debt also matters. Ultimately, if there’s too much debt, then private sector borrowers may just decide to pass on us.

“Here is where this situation resembles a pyramid or a Ponzi scheme. Some of the original bondholders are being paid with the official loans that also finance the remaining primary deficits. When it turns out that countries cannot meet the austerity and structural conditions imposed on them, and therefore cannot return to the voluntary market, these loans will eventually be rolled over and enhanced by eurozone members and international organisations. This is Greece, not Chad: does anyone imagine the IMF will stop disbursing loans if performance criteria are not met? Moreover, this “public sector Ponzi scheme” is more flexible than a private one. In a private scheme, the pyramid collapses when you cannot find enough new investors willing to hand over their money so old investors can be paid. But in a public scheme such as this, the Ponzi scheme could, in theory, go on for ever. As long as it is financed with public money, the peripheral countries’ debt could continue to grow without a hypothetical limit.

But could it, really? The constraint is not financial, but political. We are starting to observe public opposition to financing this Ponzi scheme in its current form, but it could still have quite a way to go. It is apparent that, if not forced sooner by politics, the inevitable default will only be allowed to take place when the vast part of the European distressed debt is transferred from the private to the official sector. As in a pyramid scheme, it will be the last holder of the “asset” that takes the full loss. In this case, it will be the taxpayer that foots the bill, rather than the original bondholders that made the wrong investment decisions”

The writer was governor of Argentina’s central bank and director of the Centre for Central Banking Studies at the Bank of England

@ Karl,

The Promissory Notes are a bit of headwrecker and you are right that the final bill does indeed matter. Given the severity of the crisis we are in, it is not helpful that there is such uncertainty about the debts that we have already generated, nevermind the unknowns that might be coming down the track. The B&F piece will be useful for those trying to get a handle on all this.

Que sera sera! Or, don’t cry for me Argentina!

This debate is rather beside the point. The real issue is whether or not Ireland chooses to take the steps to make the debt sustainable. There is not a shadow of a doubt that this is possible.

The “term-sheet” of the ESM on the issue of sustainability is of an incredible wooliness. It refers to a “sustainability analysis” but does not stipulate who should carry it out. If debt is considered unsustainable “the beneficiary Member State will be required to engage in active negotiations in good faith with its creditors”. Required by whom?

The underlying logic is that no state will be allowed to default but without this threat, what pressure can there be on creditors to negotiate?

The approach is a mess and we will have to see the treaty language before any firm judgement can be made.

The markets know this and with what is now a monotonous regularity, Friday after Friday, there is a spate of well-placed media articles designed to stir the cauldron, make investors nervous over the weekend and make money for a lot of people. What is of interest this weekend is that the rumour starts with Der Spiegel. This, no doubt, emanates from a strong political strand in the CDU represented by no less a person than the current German Minister for Finance who opined early in the crisis that Greece should not just volunteer to leave the euro area but be thrown out.

The meeting of creditor countries in Luxembourg, if it is actually taking place, should be an interesting one. Germany will finally, in my opinion, have to face up to the fact that there is no such thing as a free lunch. If the country wishes to continue to enjoy the benefits of the internal market and the enormous saving in transaction cost that the euro represents for German exporters, it will have to contribute hard cash to re-balancing the economies of Europe, a disequilibrium to which German domestic policies have largely contributed, not least the failure to apply free movement of labour from the outset of enlargement and various other distorting measures to maintain the competitiveness of the export sector at the expense of other sectors of the economy.

@seamus, karl

I think that just focusing on annual interest payments is too simplistic to allow you to estimate private investors’ assessment of debt sustainability. Its just a first iteration.

The second might be as Karl suggests, the repayment and coupon profile, but in the end it is about confidence. I wouldn’t buy a bond that sneaked repayment just prior to a spike in cash flow demands because that known spike would start a debate about sustainability and if the consensus view was likely to be that it was not, then at that moment the bond I had bought would become subject to possible restructuring.

Was that a tumble-weed I just saw roll across this thread.

In my view this is a far more useful contribution to the debt sustainability debate than the one that has just passed 330 comments but the mob has spoken.

I find the article to be sensible, sober and reassuring. Now if I could rid myself of the niggling doubts about the competence of our gov’t and its unwillingness to rein in the deficit. If the Europeans at all levels are convinced that we are serious about bringing things under control this will allow the politicians and the ECB/IMF to provide us with the degree of leniency that we desperately need.

It all boils down to political economy and the fact that nations do not have friends, they have interests.

Economic actors are animals that sometimes cannot be caged.

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