Anousha Sakoui has written a very interesting Analysis article in today’s FT on the experiences of some top European officials during various Emerging Market debt crises during the last 30 years: you can read it here.
Category: Bailout
Here is a link to the article by Gary O’Callaghan that Colm McCarthy referred to in a previous post but for which there was a problem with the link.
A reader has written to me about an important item missing from my briefing paper on the IMF-EU loans. I noted in the report that the amount of money that Ireland can borrow at cheap rates is three times our IMF quota and that this quota was about to increase. However, I did not mention that a much larger increase in Ireland’s quota is likely to occur over the next year or so.
On November 5th, the IMF concluded its 14th General Review of Quotas with the Executive Board recommending that the Fund’s Board of Governors adopt the proposed quotas. The proposals include a doubling of the total amount of quotas and review of each county’s share of the total. Ireland’s share is proposed to increase further from 0.528% to 0.724%). This means that Ireland’s IMF quota will increase to around SDR 3.45 billion, which at current exchange rates would translate to a quota for almost €4 billion.
If implemented, these proposals would allow Ireland to borrow almost €12 billion at IMF’s low interest rate (currently 1.38%) with the remaining €10.5 billion at the higher rate (3.38% for the first three years, 4.38% thereafter). Over a seven and a half year period, this would translate into a loan that had an average margin over the variable SDR base rate of 228 basis points, down from the 326 basis point margin associated with the IMF lending terms that prevailed at the time the bailout deal was increased.
To come into effect, the proposals must be approved by 85% of the IMF’s voting share and 113 member countries. It’s unclear how long this will take but it may take a year or so.
I think this adjustment of the IMF lending terms is an important point to keep in mind when considering the lending terms on the EU loans. The EU lending authorities have been keen to point out that, once compared in the appropriate fashion, their loans can be viewed as having equivalent cost to the loan that the IMF offered the Irish government in November. This is true. However, when compared against the terms that the IMF is going to offer Ireland in the near future, the European loans are a good deal more expensive.
It is obviously true that a lower interest rate on the EU loans to Ireland would help debt sustainability. As written by Karl and highlighted in the FT today:
The overall cost of funding from the EU sources appears likely to be over 6% per year. If this is the rate that the Irish state will be paying in coming years, the national debt will grow by 6% each year even if the state is running a zero primary deficit (the headline deficit minus interest payments.) This would require a 6% growth rate in nominal GDP to stabilise our debt-GDP ratio even when we are not running a primary deficit. In other words, an interest rate of 6% will make debt stabilisation far more difficult in the coming years than an interest rate that doesn’t carry a large profit or risk margin.
This is an important point to make and is a standard way to illustrate the impact of the interest rate on debt sustainability.
However, for the 2011-2015 period, it is important to appreciate that the impact of a lower interest rate on this source of funds would be limited:
- There is a lot of Irish government debt outstanding, much of it funded at substantially lower interest rates. There is about €81 billion outstanding, maturing at various dates between 2011 and 2025 (see the interest rates and maturity dates at the NTMA website).
- Also, there is short-term debt outstanding and John Fitzgerald has pointed out that the NTMA could do more short-term debt financing under the ‘umbrella’ of the EU/IMF deal
- A substantial amount of the new borrowing needs of the Irish sovereign will be met by drawing down cash balances and the assets of the NPRF
Putting these factors together means that the projected average interest rate on Irish sovereign debt over 2011-2015 will be 3.9%, 4.0%, 5.3%, 5.3%, 5.4% (according to the IMF’s December 2010 Ireland report) so that the near-term impact of shifts in the marginal cost of funds from the EU will be limited. (Still nice to have a lower rate, however!)
In addition, Karl’s illustrative example focuses on a zero primary deficit. The IMF projections are that Ireland will run primary surpluses of 1.2% in 2014 and 1.5% in 2015 – of course, this assumes that the fiscal plan is implemented and that nominal output growth meets the IMF’s projections. A different way to express the same point is that, for a given path for nominal GDP growth, the higher the average interest rate, the higher the primary surplus that will be required to stabilise or reduce the debt/GDP ratio.
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