8/12/2013: Exiting EFSF: Check.

So it's official - today we exited EFSF http://www.efsf.europa.eu/about/operations/ireland/index.htm

As I said on twitter: this is a big first step for Ireland. There are many more to be taken in the future, long future... from EFSF's perspective - we are not free until 2042...

What is worth noting in the above table is the extent to which the EFSF has already managed to restructure our debts - maturities extensions mean that the earliest repayment date - previously falling on 04/02/2015 now falls on 01/08/2029. That is a massive restructuring of debt, which, taken together with other changes, explains why we were able to avoid an outright default to-date.

Another thing to note: from my personal perspective, there is a sizeable chance, I and many of my friends (for some that chance is even greater), will not be here to toast the day when Ireland finally repays (or rather rolls over) the full EFSF debt. That's a 'generation lost'... right there... touch it... give it a hug... its us.

16/1/2012: Irish Bailout Redux - Sunday Times 15/01/2012

Several articles in the press yesterday on why Ireland will require / need a second 'bailout' - here's an excellent piece from Namawinelake and here's a piece from Colm McCarthy.

This is an unedited version of my Sunday Times (January 15, 2012) article on the same topic.

In May 2011, as Greece was sliding toward the second bailout, I conjectured that within 24 months, Ireland and Portugal will both require additional bailout packages as well. This week, my prediction has been echoed by the Chief Economist of the Citi, William Buiter.

According to Buiter, the costs of borrowing in the markets are currently prohibitive and the expiration of the €67.5 billion loans deal with the Torika, scheduled for 2014 will see Ireland once again unable to borrow to cover remaining deficits and refinancing maturing bonds. Ireland should secure additional funding as a back up, to avoid seeking it later “in a state of near panic”.

Buiter’s suggestion represents nothing more than a prudent planning-ahead exercise. In addition to Buiter’s original rationale for securing new lending, Ireland is facing significant fiscal and economic challenges that will make it nearly impossible for the State to finance its fiscal adjustment path through private borrowing in 2014-2016.

Speaking to the RTE, Buiter said that although Ireland’s situation was different from that of Greece, the economy remains under severe stress from banking sector bailouts. Addressing this stress should involve restructuring of the promissory notes issued by the state to IBRC, as the Government was hoping to do in recent months. But it also requires anchoring our longer-term fiscal adjustment path to predictable and stable sources of funding at a cost that can be carried by the weakened economy.

The Government will do well to listen to these early warnings to avoid repeating mistakes of their predecessors.

On November 18, 2011, Carlo Cottarelli, IMF Director of Fiscal Affairs Department gave a presentation in the London School of Economics, titled Challenges of Budgetary and Financial Crises in Europe. In it, Mr Cottarelli provided three important insights into the expected dynamics for debt and deficits that have material impact on Ireland.

Firstly, he showed that to achieve the ‘golden rule’ debt to GDP ratio of 60% of GDP by 2030, Ireland will be required to run extremely high primary surpluses in years to come. Only Greece and Japan will have to shoulder greater pain than us over the next 19 years to get public debt overhang down to a safety level.

Secondly, amongst all PIIGS, Ireland has the highest proportion of outstanding public debt held by non-residents (84%), implying the highest cost of restructuring such debt. The runner up is Greece with 65%. In general, bond yields are positively correlated with the proportion of debt held by non-residents.

Thirdly, Cottarelli presented a model estimating the relationship between the observed bond yields and the underlying macroeconomic and fiscal fundamentals that looked at 31 countries. This model can be recalibrated to see what yields on Irish debt can be consistent with market funding under IMF growth projections for Ireland. Using headline IMF forecasts from December 2011, 2014-2016 yields for Ireland are expected to range between 4.7% and 6.5%. Incorporating some downside risks to growth and other macroeconomic parameters, Irish yields can be expected to range between 5.3% and 7.0%.

Even in 5.5-6% average yields range, financing Irish bonds rollovers in the market in 2014-2016 will be prohibitively costly as at the above yields, Ireland's debt dynamics will no longer be consistent with the rates of decline in debt/GDP ratio planned for under the Troika agreement. This, in turn, means that the markets will be unlikely to provide financing in volumes, sufficient to cover debt rollovers. Thus, Ireland will either require new bridging loans from the Troika or will have to extract even greater primary surpluses out of the economy, diverting more funds to cover debt repayments and risking derailing any recovery we might see by then.

What Butier statement this week does not consider, however, are the potential downside risks to the Irish fiscal stability projections. These risks are material and can be broadly divided into external and internal.

Per external risks, the latest CMA Global Sovereign Risk Report for Q4 2011, released this week, shows Ireland as the 6^th riskiest country in the world with estimated probability of sovereign default of 46.4% and credit ratings of ccc+. Despite stable performance of our bonds in Q4 2011, CMA credit ratings for Ireland have deteriorated, compared to Q3 2011. And, our 5 year mid-point CDS spreads are now at around 747 bps – more than seven times ahead of Germany. This highlights the effect of a moderate slowdown in euro zone growth on our bonds performance.

Even absent the above risks, Irish debt dynamics can be significantly improved by significantly extending preferential interest rates obtained under the Troika agreement to cover post-2014 rollovers and adjustments. Based on IMF projections from December 2011, such a move can secure savings of some €9 billion or almost 5% of our forecast 2016 GDP in years 2014-2016 alone (see chart).

CHART

Chart source: IMF Country Report 11/356, December 2011 and author own calculations

Looking into the next 5 years, there is a risk of significant increase in inflationary pressures once the growth momentum returns to the Euro area. A rise in the bund rates can also take place due to deterioration in the German fiscal position or due to Germany assuming greater role in the risk-sharing arrangements within the euro area. Lastly, German and all other bonds yields can also rise when risk-on switch takes place in post-recessionary period, drawing significant amounts of liquidity out of the global bond markets. All of these will adversely impact German bunds, but also Irish bonds.

On the domestic front, we should be providing a precautionary cover for the risk of a more protracted slowdown in the Irish economy especially if accompanied by sticky unemployment. The risk of deterioration in Irish primary balances due to structural slowdown in the rate of growth in Irish exports (potentially due to strengthening of the euro in 2013-2016 period or significant adverse effect of the patent cliff on pharma exports) is another one worth considering well before it materializes. Lastly, there is the ever-growing risk that the markets will simply refuse to fund the vast rollovers of debt which is currently being increasingly warehoused outside the normal markets in the vaults of the Central Banks and on the books of the Troika.

Overall, Ireland should form a multi-pronged strategic approach to fiscal debt adjustment. Recognizing future risks, the Government should aggressively pursue the agenda of restructuring the promissory notes issued to the IBRC with an aim of driving down notes yield down to ECB repo rate and push for ECB acceptance of burden sharing imposition on IBRC bondholders to reduce the principal amount of the promissory notes. Pursuit of longer-term objective of forcing the ECB to accept a writedown on the banks debts accumulated through the Emergency Liquidity Assistance lines at the Central Bank of Ireland is another key policy target. Lastly, Ireland needs to secure significant lines of credit with the EU at preferential rates for post-2014 period with longer-term maturity than currently envisaged under the Troika deal.

Given the general conditions across the Eurozone today, the last priority should be pursued as early as possible. In other words, there’s no better time to do the right things than now.

Box-out:

The latest EU-wide statistics for Retail sales for November 2011 released this week present an interesting reading. Retail sector turnover index, taking into account adjustments for working days, shows Irish retail activity has contracted by 0.4% in November 2011 year on year. Overall activity is now down 5.2% on same period 2008, but is up 7.9% on 2005. For all the Irish retail sector woes, here’s an interesting comparative. Euro area retail sales turnover is now down 2.5% year on year and 1.6% on 2005. In terms of overall contraction in turnover, Ireland is ranked 15^th in EU27 in terms of the rate of contraction relative to November 2010 and November 2008 and 12^th in terms of contraction relative to 2005. Not exactly a catastrophic decline. Once set against significant losses in retail sector employment since 2008, these numbers suggest that to a large extent jobs losses in the sector were driven by lack of efficiencies in the sector at the peak of the Celtic Tiger, as well as by declines in revenues.

14/09/2011: Ireland & Portugal are allowed to restructure some of their sovereign debts

The EU Commission issued its proposals for altering terms and conditions of loans extended under the EFSM (and same is expected for EFSF). The details of release are here.

The move comes after July 21 EU summit agreement to alter these terms and took surprisingly long to deliver. This has nothing, I repeat - nothing - to do with the claimed efforts by the Irish Government to secure similar reductions over recent months. The reductions come on the foot of the EU-wide deal for Greece.

Per Commission statement: "The Commission proposes to align the EFSM loan terms and conditions to those of the long standing the Balance of Payment Facility. Both countries should pay lending rates equal to the funding costs of the EFSM, i.e. reducing the current margins of 292.5 bps for Ireland and of 215 bps for Portugal to zero. The reduction in margin will apply to all instalments, i.e. both to future and to already disbursed tranches."

Two critically important points here:

• The reductions, especially for Ireland, are significant in magnitude and will improve Ireland's cash flows and net small reduction in debt burden over time. However, much of these are already factored in recent debt and deficit projections.
• The reductions are retrospective, which is a very important point for Ireland.

Further per EU Commission statement: "...The maturity of individual future tranches to these countries will be extended from the current maximum of 15 years to up to 30 years. As a result the average maturity of the loans to these countries from EFSM would go up from the current 7.5 years to up to 12.5 years."

Two more important points follow from the above:

• Extended maturity in combination of lower coupon on borrowings imply significant cuts in NPV of our debt from EFSM, which, in turn, means that under current EU Commission proposal we will undergo a structured credit event (aka - an orderly default). When this course of action was advocated by myself and others calling for the Irish government to force EU hand on providing for structured default, we were treated as pariahs by the very same 'green jersey' establishment that now sings praise to the EU largess.
  
• Second point is that, as I have noted back in July, this restructuring implies longer term maturity period and can result in total net increase in our overall debt repayments, were we to delay implementation of austerity measures. The silver lining, folks, does have a huge cloud hanging over it.

Lastly: "...the new financial terms will bring benefits such as enhanced sustainability and improved liquidity outlooks. Moreover, indirect confidence effects through the enhanced credibility of programme implementation should result in improved borrowing conditions for the sovereign as well as the private sector."

In effect the above implies that absent such reductions and maturity extensions, Ireland and Portugal are unable to remain on a "sustainable" path and/or lack or experience a deficit of "credibility" whne it comes to their adjustment programmes. That, of course, is plainly visible to all involved.

So here we are, folks - we now had:

1. Bank defaulting on some of its liabilities - and cash machines kept on working
2. Government undergoing debt restructuring - and cash machines keep on working.

Not the end of the world, is it?

Economics 26/11/10: Contagion is spreading to Spain & Italy

Another day, another spike of contagion from Ireland's Sovereign bonds to other Eurozone countries:
Yesterday's closing bell marked another day in which markets have completely disagreed with the EU officials and Irish Government view of the reality of our and PIIGS' ability to weather out the current crisis.

Economics 22/11/10: November 12 - on the record re 'bailout'

This is an unedited version of my November 12 article in the Irish Examiner. Of course, since then the events have taken over the core premises of the article, but for archival purposes and also to posit the article into the context (at the time of print, the official position was 'we don't need a bailout'), I am posting this here.

Despite all the intensifying talk about the EU support, despite the growing number of assurances from the various officials and social partners that we can ‘grow out of our difficulties’, this week has clearly shown that Ireland is nearing the end game of the crisis. Tellingly, even the usual official policies cheerleaders, our stockbrokers, have by now one by one deserted the State-side of the arguments. As one analyst from IFSC put it earlier this week: ‘you know the game’s up when you can’t round up your own sales team to sell Irish bonds’.

The game is almost up. Were we to go into borrowing today, Irish debt will be more costly to finance than that of any other developed country, save Greece. On the assumption of a 70% recovery rate, the Irish 10 year Credit Default Swaps imply an 85% probability of Ireland defaulting sometime in the next 10 years. This, of course, is not the real probability, but an estimate. However, in comparison, even countries that availed over the last 3 years of IMF assistance, including Iceland, are enjoying much greater confidence of the markets.

We all know how we got into this predicament. Three years into the crisis, Irish Government continues to spend well beyond its means. Our current spending keeps rising. Tax revenue, despite significant tax hikes, is running below 2008 levels.

The markets know that the Irish Government has by now exhausted all means for extracting more cash out of this devastated economy. If, as expected, Minister Lenihan hikes taxes in the Budget 2011 again, he will be shifting more of our economic activity into the grey market where the taxman is a distant and powerless overlord.

Much anticipated Budget 2011 is unlikely to solve this problem. Cuts of €6 billion from the deficit this year will do very little to restore any credibility to the Government policy. As anyone with an ounce of common sense will know in the current conditions, the whole exercise will be equivalent to taking money out of one pocket – Government total spending – and putting it in the other – the banks, bondholders, social welfare and pay and pensions bill.

By avoiding soaking the bondholders from the start of this crisis, the Government has boxed itself into a proverbial corner. Instead of standing on a morally and economically high ground and soaking the bondholders early on in the crisis, as Iceland did, we have created a full-blown contagion from the banks to the sovereign. With liquidity evaporating from the shorter end of the banks funding market, this contagion is now a two-way street. Untangling this today, without going into a renegotiation of the sovereign bonds and/or guarantees, cannot constitute a credible policy position.

All of this comes before we even consider the real economy-side of the matters. With private investment on its knees, and companies, starved of trade and operational credits, operating outside the realm of normal corporate finance, can anyone really claim that we have a private sector capacity to escape a restructuring of the private or public or both debts?

Irish families are now so deep in debt and negative equity that consumption and household investment stalled, while deposits are vanishing to pay rising state and semi-state bills. Squeezed on both ends of their incomes – by falling earning and rising taxes and charges – these very households cannot be expected to provide more funding for our fiscal policy pyramid scheme.

But the final straw that broke the proverbial camel’s back is the belated realisation that the EU has no plan B for dealing with this crisis. In fact, it doesn’t even have a plan A. This was made absolutely clear by the vacuous nature of statements issued by the EU Commissioner Olli Rehn during and after his visit to Dublin this week.

The fundamental EU problem is that the much-lauded EFSF (European Financial Stabilization Facility) – the fund used to put Greece into a bond markets deep-freezer earlier this year – is not designed to address the problems we face. EFSF is designed to help cash strapped governments for a period of 3 years at ‘near market’ rates. Ireland is not cash-strapped. Nor are ‘near-market rates’ a sustainable lending option for us.

We are plain insolvent when one takes three to five years forward view. Our sovereign debt to GNP ratio is likely to exceed 140% by the end of 2015 and this is before we factor in the highly probable wave of mortgages defaults. Our household and corporate debts are more than double those of Greece. And we are staring at the abyss of rising interest rates and strong euro into the next 3-5 years.

EFSF is simply not fit for the purpose of rescuing Ireland.

At current yields, Ireland will need to grow its economy at some 6.5-7% on average annually for the next decade to counterbalance the mountain of debt we are carrying. At the ESFS rates – at ca 4.5%. Anyone expecting this to happen without radical and extremely painful structural reforms of the economy (not just budget cuts) should really go back to the basics of economics. With exception of exporting sectors our economy has slipped into a coma. Jolting it out of this state will require complete rethinking of our fiscal and economic policies.

As an optimist, I can tell you that this can be done. As a pragmatic observer of the current policy and economic environment, I have little hope that it can be done without restructuring our debts – either public or private or both – and issuing a new policies mandate for the political leadership.

Economics 29/9/10: IMF or EFSF hypotheticals

Hypothetical discussion of options for external assistance for Ireland in today's Irish Examiner - here, text link - here, associated publicity - here.