My take on the transaction is in this Irish Times op-ed article.
Month: February 2013
Research seminar in contemporary Irish history, Centre for Contemporary Irish History, Trinity College Dublin. 13th February.
The seminar will take the form of a witness seminar focusing on contributions from Sean Cromien, former Secretary General of the Department of Finance. He will speak to the theme ‘The Department of Finance and its critics, 1956-1996’.
The seminar will take place at 4.00p.m. in the IIIS seminar room C6002, Level 6 Arts Building, Trinity College. All welcome.
Under the old Promissory Notes arrangement there were four interest rates involved:
- Promissory Note Interest Rate: 8.2% (from 2013)
- ELA Interest Rate: 2.50% (MRO + 1.75%)
- ECB Interest Rate: 0.75% (MRO)
- Government Borrowing Rate: 3.3% (under EU/IMF Programme)
As was eventually realised it is really only the latter two that matter. The repayments in the Promissory Notes converted very cheap debt at the ECB MRO rate to more expensive debt at the government borrowing rate. The problem was never the interest rate on this debt, the problem was that it needed to be paid down too quickly transforming it into higher-interest debt. Under the old arrangement the average duration for this was around seven years.
If we just focus on the Promissory Notes element of the arrangement (and ignore the transfer of IBRC assets to NAMA) the key interest rates in the new arrangement collapse to:
- Long-Term Government Bond Rates: c.3.5% (spread over Euribor)
- ECB Interest Rate: 0.75% (MRO)
Initially the interest rate on the new government bonds doesn’t really matter. The interest is paid to the Central Bank which repays it back to the Exchequer. The Central Bank pays the ECB MRO for the facility to hold the bonds.
Once the Central Bank sells the bonds the interest becomes payable to a third party and will no longer be returned the the state. This will start slowly with €0.5 billion of the bonds to be sold by the end of 2014. This will continue at a rate of €0.5 billion per year up to 2018, €1 billion a year from then until 2023 and €2 billion a year thereafter. Under the proposed schedule the Central Bank will have fully disposed of the bonds by 2032.
It is through this process that the cheap debt (based on the ECB MRO) will be transformed into more expensive debt (based on the rate on the new bonds). The difference now is that this process takes place at a much reduced speed over an extended period. The average holding period by the Central Bank is nearly 15 years.
In effect the period we have access to funding at the ECB rate has been extended by nearly eight years.
After the bonds have been fully disposed there is little difference between the Promissory Note arrangement and the Long-Term Bond arrangement. As stated this will happen in 2032.
The emphasis on what happens with the bond redemptions from 2038 to 2053 is somewhat misplaced. There was always going to be debt to service/roll-over during this period as a result of the Anglo catastrophe. As pointed out the real cost of this will likely have been significantly reduced but yesterday’s announcements make little real difference to this period.
The key gains are the short-term funding benefit with the cancellation of the Promissory Note repayments and the fact that the period for which cheap ECB funding is available has been extended from around 2022 out to 2032. The benefits are not related to the length of the bonds used (and nor does using long-term bonds generate an additional cost).
There is a lot of noise in the debate about the deal, much of it relating to how to place a value on future obligations.
One element in this is how to think about the value at maturity of the new long-term bonds. 25 billion euro of bonds will be placed at the central bank.
The interest costs of these bonds will vary with the euribor (plus a fixed spread).
However, the nominal value of the principal is fixed.
2013 GDP is about 168 billion euro, so 25 billion is 15 percent of 2013 GDP.
The average maturity of the bonds is 34/35 years.
If nominal GDP growth is 2% a year for the next 35 years (0% real + 2% inflation for example), 2048 GDP will be 336 billion, so the maturity value of the debt will be 7.4 percent of GDP.
If nominal GDP growth is 3% a year, 2048 GDP will be 473 billion, so the maturity value of the debt will be 5.3 percent of GDP.
If nominal GDP growth is 4% a year, 2048 GDP will be 663 billion, so the maturity value of the debt will be 3.8 percent of GDP.
The presentation file is here.
Update: supportive FT editorial here.
Some key points (from the ongoing press conference):
- Central Bank expected to hold the government bonds for a weighted average of 15 years – so the cheap ECB funding will not be extinguished very quickly. The gap between the interest rate it receives on the bonds and the cheap ECB funding will flow back to the government via the profits of the central bank.
- (Only if financial stability restored would the central bank sell the bonds on an accelerated schedule, beyond the minimum specified path. But if financial stability restored, sovereign bond yields would be lower, so selling the higher-interest bonds sensible.)
- There are liquidation costs in 2013, so no material difference in this year’s general fiscal balance
- In 2014-2015, the fiscal balance improves by 0.6 percent of GDP.