Regaining Creditworthiness

Much of the pessimism about Ireland’s predicament has centred on the challenge of stabilising the debt to income ratio.   Undoubtedly this will be challenging, with good outcomes on nominal GDP growth and fiscal adjustment capacity required.    Of course, it has been made much more difficult by the massive bank losses the State has had to absorb.   But I think a focus on the stabilisation challenge misses a critical issue, which is regaining market access at a high if stable debt to GDP ratio (probably somewhere in the region of 120 percent of GDP).   

Martin Wolf’s column from last week provides a useful starting point for a diagnosis of the problem – an article that garnered all of one comment on the blog (from DOCM).   It draws on Paul de Grauwe’s insightful work on the susceptibility of countries in a monetary union to a debt crisis (see here), where a country without its own currency and central bank to act as lender of last resort is vulnerable to self fulfilling expectations that it will not be able to roll over its debts.   The EFSF/ESFM/ESM were put in place to help fill this LOLR gap, but have so far proven to be a poor substitute.   It is understandable that Germany and other likely net funders want to eventually reinstate market discipline, and so demand losses are borne by private creditors as part of any new bailout.   It is also understandable that they want to protect themselves from losses under the permanent bailout mechanism (the ESM) by demanding preferred creditor status.   But it is becoming increasingly evident that crisis-hit countries will find it extremely hard to regain market access with a half-hearted LOLR facility in place given any doubts that they will not be able to pass a debt sustainability test under the ESM. 

The official funders have to be willing to take on some additional risk if a mutually damaging combination of default and ongoing dependency is to be avoided.   One element is to clarify the way the debt sustainability test will be applied.   A current problem is that austerity measures weaken growth, thus making it harder to pass the test.   A useful amendment would be to assess growth in the debt sustainability calculation assuming a neutral fiscal stance.   Another useful amendment would be to set a ceiling on the size of any haircut, thereby limiting the uncertainty faced by potential new investors.   

As a quid pro quo for these amendments the government could offer to speed up the fiscal adjustment (along the lines recommended by the ESRI in its Spring QEC).   Of course, more fiscal adjustment is the last thing the economy needs as it struggles to pull out of recession.   Yet a quasi-permanent loss of creditworthiness and dependency on unreliable official support looks to be the bigger threat, as it saps confidence and undermines the perception of the economy’s stability.   Those resisting fiscal discipline must realise that the situation changed profoundly when Ireland’s creditworthiness disappeared in the second half of last year.   Some observers are putting forward the same fiscal policy prescriptions as they did when bond yields were around 5 percent.   They must see that the ground has fundamentally shifted.  

It is hard to see how further public sector pay cuts could not be part of any balanced additional adjustment.   A credible new regime for long-run fiscal discipline is also essential.  

The government should take the offensive in pointing out the incoherence of the current international support approach, while avoiding playing a self-defeating grievance card.   What is needed is a hard-headed look for a mutually advantageous set of policies that allow Ireland to shed its dependency.    The first step is a proper diagnosis of creditworthiness challenge. 

Business and Finance Article on Debt Sustainability

Here‘s an article I wrote for Business and Finance on the question of whether Ireland’s fiscal debt is sustainable.

One correction I’d add to the article is that I miscalculated the average interest rate on existing Irish debt and reported it in the article as about 3 percent. The correct figure, as calculated by the EU Commission, is 4.6%.

Government Revenues and Spending

One of the problems that plaugues discussion of the Irish public finances is there is a fairly widespread confusion over how much the government takes in as revenues and how much it spends.

Many people know that the figure for “tax revenues” has been about €30 billion in recent years, via press coverage of the monthly exchequer returns. (See here for the 2010 end of year exchequer returns showing €31.7 billion in tax revenue.) Many people also know that we have run deficits of close to €20 billion in recent years.

Together, these two facts have lead to the wide repetition of statements along the lines of “we are taking in €30 billion and spending €50 billion.” Often, a particular item of government expenditure, such as public sector pay or social welfare is then compared to the revenue take of €30 billion to illustrate the huge fraction of government revenues that it takes up.

It turns out however that a more accurate description of the Irish public finances has been the government has been taking in about €50 billion and spending about €70 billion. This pattern is hard to assess from looking at the Exchequer statements because, for example, they do not count the €11.4 billion in “social contributions” such as PRSI as taxes. Indeed, the whole definition of tax revenues is a bit arbitrary. I believe the USC is being counted as tax revenues, while various levies that it replaces were not.

The most useful description of the state of the Irish public finances is the materials provided to the European Commission, for example in Friday’s Stability Programme Update. Go to the second last page and you’ll see a useful breakdown of exactly how the General Government Deficit of €49.9 billon was determined. Take away the promissory note worth €30.8 billion and this deficit would have been €19.1 billion, determined by spending of €72.4 billion and revenues of €53.3 billion. (The last page contains a description of the relationship between the Exchequer Balance and the General Government Balance.)

Unfortunately, this simple and clear presentation of the public finances is not emphasised in the materials regularly released by the Department of Finance. Perhaps one of the reforms that the two new minsters in charge of spending and taxation could agree to would be to release regular clear presentations of the tax and spending figures underlying the general government deficit.

John Bruton: Time to turn our attention to the things we can change

John Bruton writes today on the downside of grievance and the upside of a positive surprise on the deficit-reduction effort: Irish Times article here.

Review Group on State Assets and Liabilities

The report of the Review Group on State Assets and Liabilities has been published here. While some of the key recommendations had been signalled over recent days in the media there is a lot of detail in the report. Apart from the recommendations on asset disposal there are lots of recommendations on the regulation and governance of state bodies.