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EU Interest Rate Calculations

Well thanks Silvio! If it weren’t for the comical actions of Signor Berlusconi, I doubt if we would have obtained yesterday’s long-hoped-for interest rate cut on our EU loans. Certainly, the cut isn’t in any way related to the negotiating skills of the government – who were last seen essentially waving a white flag on this issue.

On the substance of the deal, like Namawinelake, I’m frustrated at the lack of useful detail about the new interest rate and potential changes in loan maturities.

An annual saving of €800 million is being widely cited but I have my doubts if the correct amount has actually been calculated. My guess is that the final savings could be a bit larger, perhaps as much as €1.2 billion annually.

The first open question relates to which funds the cut is being applied to and the second relates to the size of the cut in the interest rate itself. The statement merely says

The EFSF lending rates and maturities we agreed upon for Greece will be applied also for Portugal and Ireland.

However, Ireland is only borrowing €17.7 billion from EFSF and no reasonable multiple of this number delivers annual savings of about €800 million. It seems most likely that the reasonable assumption is being made that the interest rate will also be cut on Ireland’s €22.5 billion of loans from the EFSM, though as this is an EU vehicle, last night’s meeting could not announce such a cut.

If we applied a cut of “about two percent” to the “about €40 billion” of EFSF and EFSM loans, then my fuzzy math calculations come up with “about €800 million”. So that’s the likely source of the figure.

However, it seems likely to me that the terms of Ireland’s €4.8 billion in promised bilateral loans from the UK, Denmark and Sweden will be renegotiated, so a more accurate fuzzy math would apply “about two percent” to exactly €45 billion to arrive at “about €900 million”.

Then there’s the question of the size of the interest rate cut. The Irish media have clung firmly to the notion that the average interest rate on our loans was about 5.8 percent, despite plenty of evidence that the cost of the EU component was going to be higher than had been projected last November.

As I reported here a few weeks ago, by my calculations (spreadsheet here), the average interest rate on Ireland’s EU loan was going to be 6.21 percent. The Eurozone statement promises an interest rate

equivalent to those of the Balance of Payments facility (currently approx. 3.5%), close to, without going below, the EFSF funding cost.

That could imply a cut of 2.7 percent, which if applied to the full €45 billion would give “about €1.2 billion”. That may be right or wrong since we don’t have much information yet. But I suspect that once things are worked out, the savings will be greater than the €800 million being quoted.

Update: Sean O’Rourke just put my calculations to Michael Noon on the RTE News at One. The Minister conceded that it was likely that the interest rate cuts would be extended to the bilateral loans and that this would get the savings up to €900 million.

When a higher figure of €1.2 billion was put to him, the Minister noted that this might have included the likely reduction in future IMF rates (something I’ve written about before but wasn’t including here.)  The difference here comes from my comparison of the “about 3.5 percent” with my calculated current average EU rate of 6.2%.

With the average margin over cost of funds currently running at about 300 basis points, it still seems to me that a reduction of this margin to get the interest rate “close to” the funding cost sounds like a reduction closer to three percent than two percent. But I could be wrong.

Economics and Psychology One-Day Conference

The fourth one day conference on Economics and Psychology will be held in the UCD Geary Institute on November 25th. The purpose of these sessions is to develop the link between Economics, Psychology and cognate disciplines in Ireland. A special theme of this year’s event will be the implications of behavioural economics for public policy. Abstracts (200-500 words) should be submitted before August 31st to Liam.Delaney@ucd.ie. Selected papers will feature in a special issue of the ESR policy section. Those wishing to have their paper considered should submit a draft before the November 25th session. Final drafts will be submitted for external peer review in January 2012.

Sunday Night Open Thread

This is a bit of an experiment following on from discussions with various commenters about open threads. There’s no set topic, discuss what you think is important for the Irish economy, I’ll close the thread tomorrow evening.

But, to make it more interesting, why don’t we agree to put in a link in each comment for further reading, with a blurb for why others should read this particular piece? I find link roundups very useful. It’s got to be one (roughly) Irish economics-themed link per post though, or the software will just think it’s spam and queue it for me to look at.

I’ll start.

NamaWineLake gets right into details about the repayment of our bondholders. The sheer detail involved in constructing this post merits a careful reading.

Comments open, no particular theme, share (and discuss) links you like. Let’s see how this goes.

Oh, and ZOMBIE MARX! Because, well, just because.

Central Bank Appoints Deputy Governor

The Central Bank of Ireland has appointed Stefan Gerlach to the position of Deputy Governor. The press release is here. Stefan will bring to the job an exceptional set of qualifications in the areas of macroeconomics and monetary policy. For those interested in finding out more about Stefan’s qualifications, his personal web page is here and his RePEc page is here.

Fasten Your Seat-Belts….

In yesterday’s Sunday Independent, noting that Italian and Spanish ten-year yields had closed Friday at just under 5.30 and 5.70 respectively, I wrote:

‘The sole priority for the Eurozone should be to prevent the spread of bond market contagion to Spain and Italy, launching a new financial crisis on a scale beyond the rescue capability of the EU and IMF. If the crisis affecting Greece, Ireland and Portugal can be confined to those three countries there is a reasonable chance that Spain and Italy will retain access to the markets. If the contagion-spreaders in control of European policy continue the shambolic performance of recent months…… Spain and Italy will be swamped and the costs of resolving the Greek, Irish and Portugese problems will begin to look like a bargain. The Spanish Treasury managed to sell some three- and five-year bonds during the week….. But at some stage solvent-for-now issuers such as Spain must face the music in the ten-year market or their outstanding debt bunches shorter and shorter. If the Spanish ten-year interest rate edges much above 6%, the game will probably be up.’

Spanish ten-year yields breached 6% this morning, with Italian yields approaching 5.7%. EU Finance ministers are meeting this evening and might ponder this comment from Reuters:

‘Gary Jenkins, head of fixed income at Evolution Securities, said that while Italy is still a long way from the tipping point in terms of bond yields — markets have focused on yields of 7 percent as unsustainable — recent experience shows how quickly things can get out of control. Greece, Ireland and Portugal spent an average 43 consecutive days trading over 5.50 percent before they went north of 6.00 percent on a consistent basis, Jenkins said. That fell to an average of 24 consecutive days before rising above 6.50 percent, and just 15 days before the 7.00 percent level was breached on a consistent basis.’

In a low-growth economy like Italy and with an inflation target of 2% I am not confident that the ‘tipping-point’ is as high as 7%. But not to worry, the EU Commission is on the case, this from RTE:

The EU has called for a ban on rating agency decisions on countries under internationally-approved rescue packages. Speaking in Brussels, Internal Markets Commissioner Michel Barnier also said that governments should be fully informed before being downgraded by ratings agencies.

So the agencies would have to quit rating Greece, Ireland and Portugal, but could fire ahead rating Italy and Spain. Jose Manuel Barroso, the EU Commission president, also targeted the agencies last week, alleging market manipulation no less, and anti-European bias. The problem, in the estimation of these two EU luminaries, has been caused by the ratings agencies. With no Plan B apparently, the failure of Plan A needs to be assigned somewhere, and US ratings agencies will do fine. 

What precisely is the proposal of the EU Commission to deal with the contingency that Spain and Italy are forced to exit the bond market over the next few months? 

Meanwhile the Italian authorities have banned short selling of bank stocks, which older readers will recall was the source of the problems at Anglo.

Both Spain and Italy need to tap the markets on a continuing basis. The yields they now face at ten years are about the level that persuaded Ireland to take a holiday from the market last September. Their yield curves are also beginning to flatten ominously, with shorter rates rising more quickly than mediums.   

The bank stress tests Mark II are due on Friday. This could be a long week.