I have a letter in the FT today responding to Martin Wolf’s article yesterday: you can read it here.
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.
In Billy Wilder’s classic movie “One, Two, Three” James Cagney plays a hard-charging marketing executive coaching his clueless son-in-law on the correct answers to give during an important job interview. The son-in-law is told to describe the current international situation as “serious, but not hopeless,” but during the job interview he mangles this and describes it as “hopeless, but not serious.” The interviewer is impressed with his originality and insight. The same mangled answer might apply to the current Irish economic situation: hopeless, but not serious. The corner has been turned. The Irish economy will now experience a slow, steady recovery as the IMF-guided programme unwinds the deep structural flaws that developed in the Irish economy during the credit-fueled bubble of 2002-2007.
His latest speech is here.
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.