EFSF Charging 7%?

During the discussion of the bailout on Prime Time tonight, the prospect was raised (and not denied by Minister Batt O’Keefe) of the EFSF charging 7% to Ireland for its loans.

It may be worth taking at look at the calculations that I did on this issue a few weeks ago. I worked out the formula for the interest rate at the time as

Effective Interest Rate = 1.2*(3-year swap rate + Margin + Annualised Cost of Once-Off Service Fee)

which worked out at the time as

Effective Interest Rate = 1.2*(1.57 + 3.0 + .167) = 1.2*4.737 = 5.68.

The three-year swap rate is now 1.9%, which would give

Effective Interest Rate = 1.2*(1.9 + 3.0 + .167) = 1.2*4.737 = 6.08.

The government’s most recent projections show the debt-GDP ratio peaking at 106%. This is prior to the admission that large amounts of additional money will be borrowed to recapitalise the banking sector. Piling on an interest rate of even 6.1% onto the likely debt levels would greatly reduce the prospect of Ireland avoiding sovereign default. An interest rate of 7% would be grossly unacceptable.

Put simply, if these reports are true, the government needs to refuse any deal based on such a high interest rate. Indeed, unless the government feel compelled to play their role in a morality play in which Ireland is used as cautionary tale, they should refuse any deal featuring a rate higher than the 5% rate that Greece obtained.

Update: As commenter Tull points out, while we’re drawing down the money over three years, the relevant maturity for the interest rate would be length of time before we have to pay it back.  Plug in seven years, for example, and we’d get

Effective Interest Rate = 1.2*(2.67 + 3.0 + .5/7) = 1.2*4.737 = 6.88.

Honohan Gives His Views

His latest speech is here.

IMF: Structural Reforms in Ireland

The IMF has just released a new Staff Position Note Lifting Euro Area Growth: Priorities for Structural Reforms and Governance

[One of the co-authors is Ajai Chopra]

Its recommendations for Ireland are:

1. In relation to the labour market:

  • Introduce gradual decrease of benefits over time of unemployment spell and stricter job search requirements
  • Provide more resources to the unemployment agencies (FÁS) to provide efficient job search assistance to the growing number of unemployed
  • Review the level of minimum wage to make it consistent with the general fall in wages

2. In relation to improving competitiveness:

  • Reform planning and licensing systems in net work industries, so as to increase competition in sheltered services sectors
  • Focus public resources on high-priority projects in the knowledge-based economy

Bondholders and Restructuring

The completely nebulous nature of last night’s annoucements in relation to bank restructuring means we are no wiser today than yesterday about what is actually going to happen with our banks. However, the following statement from Michael Noonan (not a man given to reckless speculation, I would venture) is worth discussing:

Fine Gael finance spokesman Michael Noonan said there may be conflict between European officials and the International Monetary Fund the restructuring of Ireland’s banks.

Mr Noonan said the IMF may favour more burden sharing with bank bond holders than European officials as a condition of aiding Ireland.

As is this article by John McManus.

Irish Government Statement on Application for Financial Aid from EU and IMF

The statement is available here.