More on the Interest Rate Question

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.