16/615: Expresso on Ireland's Repayment of IMF Loans

My comment on Ireland's early repayment of IMF loans for Portugal's Expresso, 13/06/2015 ECONOMIA page 11

12/2/15: IMF's Latest Ukraine 'Package'... It's Political

As expected, the IMF announced a revised package of loans for Ukraine today. Below is the statement with some comments.

Top line conclusions:

1. IMF Extended Fund Facility Arrangement gives Ukraine more breathing space (three years at a shorter end of debt repayments) and avoids significant repayments due this year under the old arrangement.
2. Nonetheless, the new package is still too short in its maturity - Ukraine will need closer to a decade to rebuild the East and own economy, and to implement reforms, while allowing reforms to take hold and start delivering on growth. 
3. IMF funding comes with expectations of European funding and will probably (at this time it is uncertain as no details have been released yet) imply Fund participation to 2/3 of the total package.
4. Ukraine needs not more loans, but a Marshall Plan with loans:grants ratio of 1:1 or close and total package volume of USD60 billion and duration of at least 10 years. In ignoring the grim realities of Ukrainian economy, the IMF has once again gone for a political compromise instead of a real solution.

IMF statement (select quotes):

"February 12, 2015: Nikolay Gueorguiev, Mission Chief for Ukraine, issued the following statement today in Kyiv: “The mission has reached a staff-level agreement with the authorities on an economic reform program, which can be supported by a four-year Extended Fund Facility, in the amount of SDR 12.35 billion (about $17.5 billion, €15.5 billion), as well as, by considerable additional resources from the international community. The staff level agreement is subject to approval by IMF Management and the Executive Board. Consideration by the Executive Board is expected in the next few weeks, following the authorities’ implementation of decisive front-loaded actions to achieve program goals."

So the total package extended to Ukraine is now in the region of USD40 billion. This might be enough, if the hostilities in the East end in the next month or so, and assuming post-hostilities ending, Ukraine regains the regions as a part of at least some Federal structure. Barring that, if the regions gain significant autonomy from Kiev, it is hard to see how the Ukrainian economy can sustain a loss of ca 15-20 percent of its GDP and still fund the debt it will be carrying.

“The policies under the new arrangement, developed by the Ukrainian authorities jointly with Fund staff, are designed to address the many challenges confronting the Ukrainian economy. Economic activity contracted by around 7-7½ percent in GDP in 2014, weighed down by the conflict in Eastern Ukraine, which  has taken a significant toll on the industrial base and exports, undermined confidence and ignited pressures on the financial system. The economic reform program focuses on immediate macroeconomic stabilization as well as broad and deep structural reforms to provide the basis for strong and sustainable economic growth over the medium term."

It is worth noting that in October 2014 WEO, IMF estimated 2014 GDP decline of 6.5% and forecast growth of 1% in 2015, followed by 4% in 2016 and 2017. At an upper reach of the latest estimate, the Ukrainian economy was shrinking at an annual rate of 1.5 percent in Q4 2014. Which is quite surprising as prior to that it was falling by 2.0-2.2 percent per quarter. Meanwhile, EBRD and others are forecasting for Ukrainian economy to shrink 5% in 2015 (a swing of difference of 6 percentage points compared to the IMF dreaming).

Ukraine's “…2015 budget initiates an expenditure-led adjustment to strengthen public finances within the availability of resources. This required bold, but necessary, measures, including keeping nominal wages and pensions fixed. The budget is supported by revenue reforms, including increasing the progressivity of the personal income tax and streamlining the tax system. The authorities are committed to medium term reforms of the civil service and the important health and education sectors, aiming to improve quality and efficiency, as well as widening the tax base and improving customs and tax administration. Fiscal consolidation would continue over the coming years which together with the debt operation envisaged by the authorities will strengthen debt sustainability."

All of this sounds benign, until you think about the impact of these reforms on Ukrainian power base (oligarchs), and foreign investment (sensitive to taxation regime). In addition, behind the 'widening of the tax base' rests a push to increase effective tax burden on general population. Now, consider this: inflation is running at close to 13% pa, hrivna is devaluing, taxes are rising (both in terms of enforcement and rates and breadth of applications), while nominal wages are fixed. And that in a country with GDP per capita (adjusting for PPP) at $8,240.4 in international dollar terms (for cross-referencing, comparable figure is $24,764.4 in Russia). So how soon will there be social unrest boiling up?

Again from the IMF release: “The authorities are firmly committed to deep and decisive measures to reform the critical energy sector. They have developed a comprehensive strategy aiming to foster energy efficiency and independence, increase domestic gas production, and restructure Naftogaz. As part of this strategy, and to rehabilitate Naftogaz while eliminating its drain on the budget, the authorities have decided to implement frontloaded gas and heating price adjustments aiming to reach full cost recovery by April 2017, while protecting the poor through revamping social protection schemes and allocating sufficient budgetary resources. At the same time, efforts are under way to improve Naftogaz’s corporate governance, as well as the framework for payment compliance and recovery of receivables."

What the above means is that cost of energy to middle classes and above will rise and it will rise dramatically. Note two things in the above: one part of this increase will come from eliminating energy subsidies these classes currently receive.  But another shock will come from "eliminating [Naftogaz] drain on the budget" which means that supports for low income earners and the poor in the form of subsidies will have to be loaded onto the rest of the population if Naftogaz were to be a cost-recovery vehicle.

“Monetary policy will be geared toward returning inflation to single digits in 2016 within a flexible exchange rate regime. To strengthen confidence in banks and improve their ability to intermediate credit and support economic activity, the authorities are moving ahead with a multi-pronged strategy to rehabilitate the banking system. The regulatory and supervisory framework will be upgraded, including through measures to address above the limit loans to related-parties; banks’ balance sheets will be strengthened, where needed, following a prudential review of banks; and measures will be undertaken to enhance banks’ asset recovery and resolution of bad loans."

Banking reforms are desperately needed in the Ukraine, as banks are running non-performing loans to the tune of 20 percent and that is before any losses taken on Eastern Ukrainian operations and before we take out foreign lenders who face lower NPLs due to more selective lending to larger enterprises and foreign companies. But driving inflation down to single digits by 2016? Any one can pass the IMF folks a reality pill? Driving inflation down to these levels will require a massive deflation of demand and money supply. Which will cut across bot the above reforms in taxation and wages moderation, and across the banks reforms too.

“Structural reforms will aim at improving business climate, attracting investment and enhancing Ukraine’s growth potential. To this end, the authorities are advancing efforts toward deregulation and judicial reform and implementation of the anti-corruption measures.  They will also proceed with state-owned enterprise reforms, to minimize fiscal risks and improve corporate governance structures and de-monopolization."

All is fine. Except we have no idea what any of it really means. Still, major risk to Ukraine on this front is what will it do replace lost Russian (and other CIS) investments and remittances?


In short, so far, we have very little to go on the IMF latest package fundamentals, but plenty indications that Ukraine is in for some serious, serious social and economic pain in years to come. This pain is necessary. But what is highly questionable is whether this pain is feasible over the 4 year horizon of the new programme. Should Ukraine get some real help: a Marshall Plan with, say at least 50:50 grants to loans ratio and a package worth around USD60 billion over 10 years instead of 4 year loans that only shore up redemptions of other debts?

9/9/2014: An IMF Loans Deal Can Be a Win-Win for EU and Ireland

Earlier today I was covering the topic of Ireland seeking an early repayment of the IMF loans on the CNBC (@CNBCWEX) http://video.cnbc.com/gallery/?video=3000309131. Here is a quick note summarising my views on the topic.

DEAL: The Irish Government is hoping to refinance the IMF portion of the Troika debt to achieve annual savings of some EUR375 million due to lower bond yields enjoyed by Ireland today compared to the IMF interest charges. The Government is looking to pay down EUR15 billion of the EUR22.5 billion total the country owes to the IMF.

IMF loans come with 4.99% interest rate against 1.80% marketable yield on Irish Government 10 year bonds. Back in July, Irish Finance Minister, Michael Noonan said he aims to refinance the first EUR5 billion of IMF loans before end of December, with the same tranche going for refinancing in the first half of 2015 and a final EUR5 billion in 2016.

Since then, following the ECB’s latest rate cut last week, Irish Government yields hit negative territory and yields on 10 year paper are currently trading at yields of under 1.7%.

The Government also has EUR20.6 billion in cash reserves that can be used to fund IMF loans buy-out. And the fiscal performance in 8 months through August 2014 has been surprisingly strong, even stripping out one-off payments.

INCENTIVES: The Irish Government interest in refinancing IMF loans is driven by both political and economic considerations.

On political front, the Coalition Government suffered heavy defeats in the European and Local elections earlier this year. So the Government needs to deliver new savings in Exchequer spending to allow for a reduction in austerity pressures in Budget 2015. Savings of few hundred millions of euros will help. And an ability to claim that the IMF loans have been repaid, even if only by borrowing elsewhere to fund these repayments, can go well with the media and the voters tired of the Troika. Optics and reality are coincident in the case of refinancing IMF borrowings, creating a powerful incentive to deliver.

Additional consideration is provided by the Government failure to secure a deal on legacy banks’ debts (see below), which de facto aligns Irish Government political interests with those of the EU.

On economic incentives side, the Government clearly is forwarding borrowing and re-profiling its bonds/debt maturity timings to minimise short-term pain of forthcoming repayments and to safeguard against the potential future increases in the rates and yields. Especially since the latest Exchequer figures are pointing to Ireland significantly outperforming the Troika targets for 2014-2015 and the economy is showing signs of recovery.

All-in, this is a smart move for the Irish Government and a win-win for the economy, the EU and the governing Coalition.

SUPPORT:  In August, the Economic and Monetary Affairs Commissioner Jyrki Katainen said that in his view, Irish plan to pay down IMF portion of the Troika loans ahead of schedule makes sense.

The EU Commissioner statement came on foot of the letter by the IMF mission head to Ireland, Craig Beaumont in which he said that the Fund will not impose early repayment penalty on Ireland, were the Government to refinance its debt.

Last week, Mario Draghi cautiously commented on the deal. When asked about his position on it, Draghi said that the ECB “took note” of the proposal and will monitor “very, very closely what is being done with the sale of assets so that monetary financing concerns are being properly and significantly addressed.” In other words, Draghi explicitly linked the IMF refinancing deal with the IBRC-legacy bonds held by the Central Bank of Ireland. The ECB has always signalled that it is interested in seeing Irish Government disposing of these bonds at an accelerated schedule. The accelerated disposal of the bonds means that the Irish Government sells these bonds in the markets to private holders and the coupon payments on these bonds become payable not to the Central Bank (which can recycle payments back to the Exchequer) but to private bondholders. On the other hand, however, the value of these bonds is now likely to be over par, implying that disposing of them today can generate capital gains for the Exchequer. At any rate, Mr Draghi’s statements does signal the ECB willingness to deal on the prospect for refinancing of the IMF loans.

Regardless of Mr Draghi’s comments, we had more statements in support of the deal so far in the last few days with unnamed EU Commission sources indicating further EU support.

As the decision remains with the Euro area governments on whether such a repayment will trigger automatic repayment of other multilateral loans, these are more important than Mr. Draghi’s position. As long as the ECB does not actively object to the deal, Minister Noonan is likely to secure an agreement without triggering automatic repayment of the remaining loans.

The reason for this is simple. In June 2012, the EU promised to review sustainability of Irish public debt in light of potential retroactive recapitalisation of the Irish banks. However, with subsequent developments, it became painfully clear that the Euro states had no intention of providing any significant support for Ireland. In order to back out of the proverbial corner, the EU will look favourably on any debt restructuring or refinancing deal the Irish authorities can design that does not imply retrospective recapitalisations.

Letting Ireland have a EUR375 million annual breathing space is a cheap solution to the EU's dilemma of issuing promises, without any intention of following through on them. 

REALITY: The truth, however, remains simple. EU and ECB insistence in 2008-2011 on paying in full on Irish banks debts has derailed Irish economy and is costing this country in terms of lower economic growth, high unemployment, high burden of taxation and dysfunctional banking system saddled with legacy debts. EUR375 million savings - welcome as they might be - is a proverbial plaster applied to a gaping wound left on Irish public finances by the crisis.

IMPACT: In the short run, refinancing IMF loans will provide improvement in the sovereign cash flow, but can cause the rebalancing of some private portfolios of Irish government debt.

In the longer run, the direct effect of a successful refinancing of the IMF loans can lead to a small, but a positive change in the Government debt dynamics. The definitive point here is what the Irish Government is likely to do with any savings achieved through the debt restructuring.

If the funds were to be used to fund earlier closing off of other official loans or closing off the remaining (and still large) deficit gap, there is likely to be a positive impact in terms of markets expectations and this will support better risk assessment of the sovereign debt dynamics. However, this is unlikely, due to the strong political momentum in favour of spending the new savings on reversing, in part, public sector spending cuts and state wages moderation. The problem is that in this case, interest costs reductions achieved under the deal will simply be consumed by remaining inefficiencies within the public sector. Such a move would likely be detrimental to Ireland's debt sustainability in the longer run.

It is worth noting that in 8 months through August, the Government took in EUR971 million more in tax revenues (UER700 million if one-off measures are netted out) than it planned in the Budget 2014, so some tax rebate is overdue, given the hefty burden of taxes-linked austerity on Irish economy. But the state is still borrowing EUR800 million per month to fund its spending. And we spent around EUR5.5 billion so far this year on funding interest payments on the debt.

Economics 17/08/2009: Global Recession is Over - IMF

Per IMF's Chief Economist, Oliver Blanchard, the global recession is now over and a recovery has begun. "The turnaround will not be simple," Blanchard wrote, as "The crisis has left deep scars, which will affect both supply and demand for many years to come." Blanchard expects growth start occurring in 'most countries', but at low rates - not enough to shift unemployment off its highs.More importantly, Blanchard argues that potential global output may have been permanently reduced and that any growth to take place in the short run will still remain highly dependent on government stimulus and accommodating monetary policies. Sustaining growth "will require delicate rebalancing acts, both within and across countries," he said

Now, of course for Ireland, this is not much of a welcome news. Our fiscal stimulus is perverse NAMA sucking cash out households' pockets, plus the widely anticipated and media-supported tax hikes in the next Budget. Our monetary easing is there solely to help the banks, who in turn are now raising mortgage rates.

Per Blanchard, US consumption (ca 70% of the US GDP) and most of global demand will be very slow to return to pre-crisis levels. These long-term declines are driven primarily by wealth effects due to the fall-offs in personal wealth on the back of housing and stock markets collapses. Blanchard, who devoted much of his academic career to the models of nominal and real rigidities remarked that he perceives the crisis legacy as having made Americans more aware of the unlikely events that can yield catastrophic consequences. This is known in the literature as "tail risks". The likely result of this will be a permanently higher rate of savings in the US and elsewhere around the world, leading to lower consumption, but cheaper financial capital.

Interestingly, Blanchard apparently ignored the issue of increased risk aversion that might also accompany the fear of 'tail risks'. If this does materialise, higher risk aversion can shift the burden of financing the latest crisis off the fiscal authorities (through lower yields on bonds) onto the shoulders of already strained corporates (with higher required returns to equity financing). The resultant knock-on effect will be to double the adverse risk of lower consumption by the households, reducing potential rate of growth globally.

Global rebalancing to address this new reality will require, in Blanchard's view :

• "Both higher Chinese import demand and a higher (yuan) will increase U.S. net exports";
• Higher domestic consumption growth in China (effectively replacing the US as the main consumption growth player in global economy);
• Lower current account surpluses in China; and so on

Thus Blanchard's view has not really change that much since the beginning of the crisis and even further back. Even in the late 1990s the IMF kept sounding alarms about the Sino-US imbalances.

Another long-term challenge is decoupling the real economy off its dependence on state spending. This will be painful, as current stimuli around the world spell higher taxation in the future and thus lower future growth. "In nearly all countries, the costs of the crisis have added to the fiscal burden, and higher taxation is inevitable," Blanchard said. "All this means that we may not go back to the old growth path, that potential output may be lower than it was before the crisis," he added.

What's there to say about our country, then - a cost in tens of billions and no stimulus in return... aka NAMA.

What if? - When the IMF knocks on neighbours' doors

In light of the IMF rescue packages for Latvia, Iceland and Hungary, it is worth looking at the conditions imposed under these loan contracts. While Ireland has not requested IMF assistance, yet, as probability of such a request rises (due to the deepening mismatch between Exchequer receipts and outlays), what austerity measures can the Irish Government count on should our rescue be structured along the lines similar to the above three states?

In answering this question (table below), I use the following comparatives:
(1) Current and forecast GDP and GDP per capita levels and growth rates;
(2) 2008 and 2009 budget deficits; and
(3) Relative extent of committed liabilities under various national rescue plans.

The estimates are presented under two scenarios for Ireland:

• 'Benign' scenario implying IMF/external funding of 10% of the 2008 GDP which will cover ca 30% of committed state liabilities for 2009; and
• 'Average' scenario consistent with 25% of GDP borrowing covering ca 75% of liabilities).

A third scenario - consistent with relative liabilities in line with those in Iceland would imply an improbable, but not an impossible demand for external funding of up to 58% of GDP. To err on the conservative side, I omit this scenario in the current post.

Finally, it is worth noting that I do not 'price-in'

• the effect of deeper economic contraction in Ireland than in some of the reference countries;
  
• the effects of higher public spending as a share of the domestic economy in this country relative to the reference countries; and
• factors relating to inflation differentials and currency adjustments (note that all countries in receipt of IMF loans have had significant currency devaluations, while Ireland had a significant currency appreciation).

Thus, these estimates should be viewed as lower bounds.


To date, the only sign of any 'austerity' measures coming from the Department of Finance is a vague rumor that Brian Cowen is looking for a 5% wage bill cut in the public sector. Whether or not this figure is gross of the wage increases granted in the latest Partnership agreement is a moot point, given the austerity measures of 15-20% estimated above.