Debt and Interest

There has been a lot of focus on the level of debt in Ireland.  The household sector is suffering from a debt overhang as a result of the excesses of the previous decade, the government sector has seen its debt level soar as it tried to cover the losses in the banking sector and continues to run huge deficits, while the level of debt in the non-financial corporate sector appears enormous but seems to require a closer examination.

Using the CSO’s Institutional Sector Accounts it is possible to come with charts like the following (starting from when the dataset begins).

The lines in the chart represent the non-consolidated sum of the liabilities of each sector under three headings.

  • AF2: Currency and Deposits
  • AF3: Securities other than Equity
  • AF4: Loans

The government is the only sector to have liabilities in all three categories as it had retail debt, government bonds and outstanding loans (mainly Promissory Notes) summing to €141 billion at the end of 2010.  The corporate sector has both loan and outstanding debt securities, though loans make up 97% of the €347 billion total.  The household sector has €185 billion of loans outstanding and is the only sector showing a declining level of debt.

The total of these is €673 billion which is equivalent to 430% of GDP or 526% of GNP.  There has been much speculation about where these aggregates are headed over the next few years and whether a default of debt in any or all the sectors is imminent.  A debt level in excess of 500% of GNP does suggest that only one conclusion can be drawn.

However, before declaring that the debt is “unsustainable” and can never be carried it is worthwhile to consider the actual burden that this level of debt is creating rather than simply focussing on the size of the debt.

Again we can turn to the CSO and this time to the Non-Financial Accounts and the interest expense in the Primary Allocation of Interest Account (item D41). 

Two of the lines here appear to make sense.  Household interest expenditure rises with interest rates and debt accumulation and peaks in 2008 at €8.1 billion and then falls as interest rates fell and debt was repaid and was €4.2 billion in 2010.  The interest expenditure of the government begins to rise from 2008 due to well-known reasons and was €4.9 billion in 2010.

The pattern on interest expenditure by non-financial corporations does not present itself to such a straightforward analysis.  This peaked in 2008 at €7 billion but in 2010 had fallen to just €712 million.

At 2.3% of the liabilities from the first chart, the interest for households appears low but the figure for non-financial corporations is startling given that we have just seen that they had €347 billion of potential liabilities requiring interest payments.  Surely firms paid more than €712 million of interest in 2010?

One thing to note is that these accounts are non-consolidated so there could be intra-company loans in the total.  Secondly, firms did make substantial payments in 2010 as distributed income of corporations (€18.0 billion) and as reinvested earnings on direct foreign investment (€14.6 billion).

The interest expense of government is set to increase over the coming years but lower interest rates and continued repayment will reduce the figure for households.  The total for businesses remains an anomaly.

In total in 2010, the three sectors allocated €9.8 billion to interest.  This is equal to 6.3% of GDP or 7.7% of GNP.  Under neither measure does this look like an impossibly large burden but perhaps the discussion will unearth a deeper understanding of these figures.

19 thoughts on “Debt and Interest”

  1. Without wishing to divert from the central theme of debt sustainability, the liability of €347 billion, however arrived at, is disconcerting. I do hope the CSO might enlighten us.
    Is it possible that this may include the ECB €150 billion to the banks?

    But even deducting this figure one hopes that there has not been corporate manipulation of the location of liabilities, particularly in the banking sector, on foot of the bank guarantee.

  2. @ DE

    I think on the government debt side 2014 is flagged as the bumper year for interest repayments.
    This is due to certain payment holidays we gave ourselves etc.

    @ all
    I was watching the Bailout programme on Monday
    Ajay Chopra was saying that
    Under the terms of the bailout agreement Ireland was supposed to be repaying the capital of that loan over 12 payments every 6 months starting in 2014 so that the whole bailout amount is repaid by 2020.
    This would amount to about 6billion per year.
    I presume that we are assuming or have been told that that is not now going to be expected?
    I guess the fact that it could not be paid will see to that.

  3. @ Eamonn

    the IMF part is structured repayment starting in 2014, so about 3bn per year from that, but the EFSF/EFSM stuff is bullet, one big payment at maturity per issue, so that will be chunky amounts but not starting until 2016 or so, and going out to 2022 as-is, and some of this may end up being 15-30 years in tenor. Assume we are back in the markets by then.

  4. @ Seamus Coffey

    Guessing wildly in an effort to pullk the thread back to the key question:

    T”he pattern on interest expenditure by non-financial corporations does not present itself to such a straightforward analysis. This peaked in 2008 at €7 billion but in 2010 had fallen to just €712 million.

    “At 2.3% of the liabilities from the first chart, the interest for households appears low but the figure for non-financial corporations is startling given that we have just seen that they had €347 billion of potential liabilities requiring interest payments. Surely firms paid more than €712 million of interest in 2010?”

    Actually before I guess wildly – do this firms include the famous MNCs? If so, could this be something to do with their own accounting procedures?

  5. One potential benefit from the current eurozone crisis is that the interest payments from households are likely to continue to fall in 2012 as mortgage rates fall in line with ECB base rates.

    Incidentally, the ESRI has issued its Autumn report this morning.

    http://www.esri.ie/UserFiles/publications/QEC2011Aut_ES.pdf

    It is now forecasting a decline in GNP next year driven of 0.3% by a 1.5% reduction in consumer spending.

    In its Spring report, the ESRI forecast 2% GNP growth in 2012 incorporating a 2% increase in consumer spending. Since then, in my opinion, the outlook for the Irish consumer has not changed to such a dramatic extent. The budget austerity measures to be implemented are broadly in line with expectations 6 months ago and unemployment is relatively flat since then. The mortgage situation continues to decline, but that would presumably have been a base case scenario in any forecasts in Spring 2012.

    Despite this big change in the ESRI’s opinion on the outlook for the Irish consumer and economy generally in 2012, the Spring report actually forecasts a higher general government deficit in both absolute terms and relative to GDP then the much more bearish report issed today. I do not see how that adds up. The analysis given in the report is brief and a little glib in my opinion. For instance this statement should be fleshed out more:

    ‘For 2012 the targets are also likely to be realised, in spite
    of the deteriorating international situation.’

    Will the government really hit its deficit target in 2012 if we re-enter recession?

    I hope in future the ESRI will consider adding more detailed explanations of its forecasts and some more commentary on why its latest report deviates from recent previous editions.

  6. @ Joseph,

    The category “Firms” as used here is non-financial corporations so banking liabilities are recorded elsewhere.

    @ Gavin,

    Yes, MNCs are included in the category of non-financial firms and their activities will have a huge influence on the figures. According to the CSO just ten companies accounted for one-third of total exports in 2009. That is nearly €50 billion flowing through ten firms.

    @ Dreaded Estate,

    It’s hard to know. The MTFS has government interest expenditure peaking at 7.5% of GNP in 2014 (6.2% of GNP excluding the Promissory Notes).

    With interest rates set to go lower and remain there it is likely that the household sector interest burden will continue to fall slowly and based on the numbers here this will be around 3% of GNP (which as I said above seems low).

    Without understanding the reason for the decline from 2008 it is impossible to know where the interest burden on non-financial corporations will go.

    If it was similar to the amount paid by households (as it was up to 2008) then it could be that interest would peak at somwhere between 12% and 14% of GNP.

  7. Very interesting Seamus. The structure may be fine as long as interest rates stay on the floor. A couple of ifs in there and fingers crossed.

    During the cat era so many people were given mortgages way beyond 3 times salary “because interest rates are low and you can afford more”. And that comes through in the numbers. But now there is no such thing as risk free and bond yields are rising and it is clear that cheap money was mispriced. So where do that leave Ireland ?

  8. The interest expenditure graph for government debt is relevant but how relevant is it for household and business debt?

    Government debt can, hopefully, be rolled over. However, households and businesses also have to pay back the capital. This makes the sustainability of the debt more questionable.

    Without questioning the growth rates, the bailout programme sees Irish government debt as a percentage of GDP peaking at levels similar to Italy. As a proportion of GNP it will be far higher. On top of this, household debt and business debt is far higher in Ireland than it is in Italy. The current plan will see Ireland re-enter the markets with a debt overhang worse than Italy? I don’t think this is realistic.

  9. Well – does anyone know of a country that has successfully ‘shouldered’ a banking bust of 45-55% of GD(N)P and prospered?

  10. @ Carson
    Do you not think that a 2% increase in VAT as well as other tax increases which would curb new vehicle sales announced recently would be enough to reduce growth by this amount?

    Retail sales for October were also down 3.8% YoY

  11. @ Seafoid

    “During the cat era so many people were given mortgages way beyond 3 times salary “because interest rates are low and you can afford more”. And that comes through in the numbers. But now there is no such thing as risk free and bond yields are rising and it is clear that cheap money was mispriced. So where do that leave Ireland ?”

    Same place as most of the rest of the western world.
    I think that your analysis that money was underpriced is correct however with the level of Debt in Europe Japan and the US anything other than extremely low interest rates would likely lead to the system collapse due to mass debt defaults.
    The term vicious cycle comes to mind.

  12. @ Eamonn Moran

    I think the VAT increase will certainly impact on consumer spending next year. However, when the ESRI published its report it knew that a budgetary adjustment of about €3.6bn would be needed in 2012 with somewhere between 33% and 50% of that coming from tax and the majority of that coming from increased indirect taxes.

    The ESRI report makes a lot of headlines each quarter when it is published and I think it has done a poor job this year in the quality of the analysis it has presented. In this report, the forecast is for consumer spending and GNP growth to fall well below the government’s target but that the deficit will not. I would like to see some of the thinking behind that assessment.

  13. @ Carson

    I agree, if you read the summery it just says they think they should be still able to reach the targets without saying why.
    Send Joe Durken a tweet when he is on Vincent Browne next. 🙂

  14. 1. Does this study include an assumption that interest rates charged to businesses have declined as ECB/Euribor have declined??

    If so that is a bad assumption as our banks have been charging higher interest on the basis that they were paying higher interest (no update on that lately).

    2. Do these figures explain why the Goverment pays lip service to commercial rents reform, personal insolvency reform and proper bank resolution legislation but does little about it?

    If so then the Govt is making a mistake as history, and the IMF, tells us that one does better if one faces up to insolvency as soon as possible.

  15. @ Eamonn Moran

    “however with the level of Debt in Europe Japan and the US anything other than extremely low interest rates would likely lead to the system collapse due to mass debt defaults.”

    Probably. Which could mean 10 or more years of Japan style stagnation over the next decade . Lex mentioned it at the weekend.

  16. That €347 bn looks high. Not sure if they’re the same thing, but have a look at Table A.14 “Credit Advanced to Irish Resident Private Sector Enterprises” here: http://www.centralbank.ie/polstats/stats/cmab/Pages/BusinessCredit.aspx

    As of June 2011 it lists:

    Total: €212 bn
    Tot ex Financial Intermediation: €99 bn
    Tot ex Financial Intermediation & Property Related Sectors: €44 bn

    If €99 bn is used, the GNP ratio drops to around 350% & the €712m looks less outlandish. Another point worth noting is that our net government debt will peak at around 102% of GDP once cash on government balanced sheet is considered.

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