7/2/20: Mapping Real Economic Debt 2019

A neat summary map of the real economic debt as a share of the national economies, via IIF, with my addition of Ireland's benchmark relative to its more accurate measure of the national income than GDP:

Yep, it is unflattering... albeit imperfect (there is some over-estimate here on the corporate debt side).

7/10/15: IMF's Latest Fiscal Data and That "Iceland v Ireland" Question

You know, there’s always fun to be had with the IMF’s Fiscal Monitor updates. If only because they throw some light onto yet to be published WEO updates. But this time around, I was given a mission. Someone few weeks ago on twitter suggested that I should revisit some comparatives between Iceland and Ireland. And so here we are, fresh Fiscal Monitor at hand, let’s crunch the numbers.

Take General Government Overall Balance as % of GDP. In 2014, Ireland (best pupil in the Euro class) had a deficit of 4%. This year, IMF forecasts a deficit of 2% (significantly outperforming our Troika allowance). Which is great news. Iceland (the ‘bad pupil in class’ judging by its desire to burn bondholders in the past) had deficit of 0.2% of GDP in 2014 and is forecast to post a surplus of 1.3% in 2015. Add two numbers together and you get 2 years cumulative deficit of ca 6% for Ireland and cumulative surplus of ca 1.1% for Iceland. Iceland will be posting its first full budgetary surplus in  2015 according to the IMF latest figures, Ireland will get there in… well, not any time before 2021 as IMF projects our best performance to be 0% deficit in 2018-2020. Who’s that pupil at the back row?..

Now, take General Government Primary Balance (so stripping out the pesky payments of interest on debt). Ireland had a deficit of 0.6% of GDP in 2014, moving onto a forecast surplus of 0.8%. So net over two years, roughly 0.2% primary surplus. Take Iceland now: 2014  primary surplus of 3.5% and 2015 projected primary surplus of 4%. Net over two years, roughly 7.5% surplus. Which is, sort of, kind of 37.5 times better than Ireland?.. But wait, Iceland reached its first primary surplus in 2013. Ireland will reach its first primary surplus in 2015. Best, you know, in the class… may be not quite in the school, but…

Onto Cyclically-adjusted Balance (government balance accounting for business cycles). Ireland to start with again: -2.5% of potential GDP deficit in 2014 and -1.4% of potential GDP deficit in 2015. Not bad. Poor Iceland: cyclically adjusted deficit of 0.1% in 2014 and projected surplus of 1% in 2015. Cumulative two years for Ireland: deficit of ca 3.9% of GDP, for Iceland: surplus of 0.9% of potential GDP.

Soldier on. Next up, Cyclically-adjusted Primary Balance. Ireland: 0.9% surplus in 2014 and 1.3% surplus in 2015. Iceland: 3.8% surplus in 2014 with projected surplus of 4.1% in 2015. Two years cumulative: Ireland’s surplus of ca 2.2% of potential GDP, Iceland’s surplus of 7.9% of potential GDP.

Both countries took on hefty debt beating in the crisis. Back in 2006, Gross Government Debt in Ireland was 23.6% of GDP and in Iceland it was 29.3% of GDP. Iceland was underperforming Ireland. In 2014 gross government debt in Ireland was 107.6% of GDP and in Iceland it was 82.5% of GDP. In 2015, as IMF projects, the figures will be 75.3% of GDP for Iceland and 100.6% for Ireland. Oh dear… but perhaps things are going to catch up for us in the medium term future? Ok, IMF projects Gross Government Debt out to 2020. This is, of course, no guarantee, but the best we can go by. In that somewhat not too distant future, Iceland’s Gross Government Debt is projected to be around 54.9% of GDP. Ireland’s - at 82.9% of GDP. Here’s a bit of farce: at the peak of debt crisis for both Ireland and Iceland - in 2012, our debt to GDP ratio was 27.5 percentage points higher than that of Iceland. Per IMF projections out to 2020, the difference will be… 28 percentage points.

Of course, nowadays it is fashionable to remind ourselves that despite having lots of debts we have some assets (AIB shares and stuff). IMF partially accounts for these by estimating Net Government Debt. So let’s take a look at that metric. Per IMF data, peak of net debt levels in Iceland and Ireland took place around 2012 (for Iceland) and 2013 (for Ireland). Back then Icelandic Net Government Debt was 25 percentage points lower than our Net Government Debt. This year, IMF projects, it will be 31.6 percentage points lower (50.8% of GDP for Iceland and 82.4% of GDP for Ireland). But may be we are on track to watch up with Iceland by 2020? Not really, per IMF forecasts, our Net Government Debt will be 29.6 percentage points higher then than Icelandic Net Debt.

So I’ll sum up for you the IMF latest data in 2 charts. Self-explanatory. In both charts, positive values showing Iceland outperforming Ireland in fiscal metrics. Enjoy:

While Ireland did deliver impressive adjustments on fiscal side post-crisis peak, it is simply incorrect to identify our adjustments as being consistent with achieving performance better than that found in Iceland over the same period.

28/9/15: Blow Outs in the Markets: Beware of Debt Financing

 This is an unedited version of my article in the Village Magazine from June 2015.

Three recent events, distinct as they may appear, point to a singular shared risk faced by the Irish economy, a risk that is only being addressed in our policy papers and in the mainstream media.

Firstly, over the course of May, European financial markets have posted surprising rises in Government and corporate bond yields amidst falling liquidity, widening spreads and increased volatility.

Secondly, both the IMF and the Irish Government have recognised a simple fact: once interest rates revert back to their 'normal' path, things will get testing for the Irish economy.

And thirdly, the Irish Government has quietly admitted that the fabled arrears solutions to our household debt crisis are not working.

Deep below the lazy gaze of Irish analysts, these risks are connected to the very same source: the massive debt overhang that sits on the back of our struggling economy.

Stability? Not So Fast.

Take the first set of news. The problem of spiking yields and blowing up trading platforms in the European bond markets was so pronounced in May, that the ECB had to rush in with a bold promise to accelerate its quantitative easing purchases of Government paper to avoid an even bigger squeeze during the summer. All in, between January and the end of May, euro area government bond yields rose by some 6 basis points, cost of non-financial corporate borrowings rose by around 9 basis points, and banks' bond yields were up 1 basis point. All in the environment of declining interbank rates (3-month Euribor is down 10 basis points) and massive buying up of bonds by the ECB.

In one recent survey completed by the Euromoney before May bond markets meltdown almost 9 out of 10 institutional investors expressed deep concerns over evaporating market liquidity (higher costs of trading and longer duration of trades execution) in the sovereign bond markets. In another survey, completed in late 1Q 2015 by Bank of America-Merill Lynch, 61% of large fund managers said that European and U.S. stocks and bonds are currently overvalued - the largest proportion since the survey began back in 2003.

In the U.S., current consensus expectation is for the Federal Reserve to start hiking rates in 3Q 2015. In Europe, the same is expected around Q3 2016. And recently, both estimates have been moving closer and close to today, despite mixed macroeconomic data coming from the economies on the ground. If the process of policy rates normalisation coincides with continued liquidity problems in the bonds markets, we can witness both evaporation of demand for new government debt issues and a simultaneous increase in the cost of funding for banks, companies and the Governments alike.

Cost of Credit

Which brings us to the second point - the role of interest rates in this economy.

In recent Stability Programme Update (SPU) filled with the EU Commission, the Department of Finance provided a handy exercise, estimating the impact of 1% rise in the ECB key rate. The estimates - done by the ESRI - show that in 2017, a rise in ECB rate to 1 percentage point from current 0.05% will likely cost this economy 2.1% of our GDP in 2017, rising to 2.4% in 2018 and 2019. By 2020, the effect can amount to the losses of around 2.5% of GDP.

This increase would bring ECB rates to just over 1/3rd of the historical pre-crisis period average - hardly a major 'normalisation' of the rates. Which means that such a hike will be just a start in a rather protracted road that is likely to see rates rising closer to 3-3.5 percentage points.

But here is a kicker, the ESRI exercise does not account fully for the realities on the ground.

In addition to the ECB rate itself, several other factors matter when we consider the impact of the interest rates normalisation on the real economy. Take for example cost of funds in the interbank markets. Average 12 months Euribor - prime rate at which highest-rated euro area banks borrow from each other - averaged 3.29% for the period of 2003-2007. Today the rate sits at 0.18%. Which means rates normalisation will squeeze banks profits line. If euro area, on average, were to hike their loans in line with ECB increases, while maintaining current 12 months average lending margins, the rate charged on corporate year and over loans in excess of EUR1 million will jump from the current 2.17% to 3.37%.

It turns out that due to our dysfunctional banking system, Irish retail rates carry a heftier premium than the euro area average rates, as illustrated in Chart 1 below. Which, of course, simply amplifies the impact of any change in the ECB base rate on Ireland’s economy.

The reason for this is the pesky issue of Irish banks profitability - a matter that is distinct from the euro area average banking sector performance due to massive non-performing loans burden and legacy of losses carried by our banking institutions. Per latest IMF assessment published in late April, Irish banking system is the second worst performing in the euro area after the Greek when it comes to existent levels of non-performing loans. In today's terms, this means that the average lending margin charged by the banks in excess of ECB policy rate is 3.4% for house purchase loans, 5.63% for loans to Irish companies under EUR1 million with a fix of one year and over, and 4.0% for loans to same companies in excess of EUR1 million. Which means that a hike in the ECB rate to 1% will imply a rise in interest rates charged by the banks ranging from 0.84% for households loans, to 0.92% for smaller corporate loans and to 1.22% for corporate loans in excess of EUR1 million.

Chart 2 below highlights what we can expect in terms of rates movements in response to the ECB hiking its base rate from the current 0.05% to 1%.

No one - not the ESRI, nor the Central Bank, nor any other state body - knows what effect such increases can have on mortgages arrears, but is pretty safe to say that households and companies currently experiencing difficulties repaying their loans will see these problems magnified. Ditto for households and companies that are servicing their debts, but are on the margin of slipping into arrears.

While the ESRI-led analysis does enlighten us about the effects of higher rates on tax revenues and state deficits, it does little in providing any certainty as to what happens with consumer demand (linked to credit), property investment and development (both critically dependent on the cost of funding), as well as the impact of higher rates on enterprise formation and survivorship rates.

In addition, higher rates across the euro area are likely to imply higher value of the euro relative to our major trading partners' currencies. Which is not going to help our exporters. Multinational companies trading through Ireland are relatively immune to this effect, as most of their trade is priced internally and stronger euro can be offset by accounting and other means. But for SMEs exporting overseas, every percentage point increase in the value of the euro spells lower sales and lower profits.

Debt Overhang: It Matters

Across the euro area states, there are multiple pathways through which higher rates can drain growth momentum in the economy.

But in Ireland's case, these pathways are almost all invariably adversely impacted by the debt overhang carried by the households and the corporate sectors. Current total debt, registered in Irish financial institutions as being extended to Irish households and resident enterprises stands at just over EUR263.7 billion. And that is before we take into the account our Government debt, as illustrated in Chart 3.

A 1 percentage point increase in retail rates can see some EUR2.64 billion worth of corporate and household incomes going to finance existent loans - an amount that is well in excess of EUR2.28 billion increase in personal consumption recorded in 2014 compared to 2013, or 24% of the total increase in Ireland's GNP over the same period. Add to that added Government debt costs which will rise, over the years, to some EUR1.5 billion annually.

What is not considered in the analysis is that at the same time, rising cost of credit is likely to depress the value of the household's collateral, as property prices are linked to credit markets conditions. Which means that during the rising interest rates cycle, banks may be facing an added risk of lower recovery from home sales.

The effect of this would be negligible, if things were relatively normal in Irish mortgages markets. But they hardly are.

At the end of Q4 2014, total number of mortgages in arrears stood at 145,949 accounts, amounting to the total debt of EUR29.8 billion or 18% of total lending for house purchases. 94,929 accounts amounting to EUR14.94 billion of additional debt were restructured and are not in arrears. Roughly three quarters of the restructured mortgages involve 'solutions' that are likely resulting in higher debt over the life time of the restructured mortgage than before the restructuring was applied. We cannot tell with any degree of accuracy as to how sensitive these restructured mortgages are to interest rates changes, but arrears cases will be much harder to resolve in the period of rising rates than the cases so far worked out through the system.

When, Not If…

You'd guess that the ESRI and Department of Finance would do some homework on all of the above factors. But you would be wrong. There is no case-specific risks analysis relating to interest rates changes performed. Perhaps one of the reasons why majority of analysts have been dismissing the specific risks of interest rates increases is down to the lack of data and models for such detailed stress-testing.

Another reason is the false sense of security.

Take the U.S. case. The U.S. economy is now in an advanced stages of mature recovery, based on the most recent survey of economic forecasters by the BlackRock Investment Institute. But the underlying weaknesses in growth remain, prompting repeated revisions of analysts' expectations as to the timing of the Federal Reserve rates hikes. Still, the Fed is now clearly signaling upcoming rate hike.

The Fed is pursuing a much broader mandate than the ECB - a mandate that includes the target of full employment. The twin mandate is harder to meet than the ECB's singular objective of inflation targeting.

While the European inflation is low, it is not as low as one imagines. Stripping energy - helped by the low oil prices - inflation in the Euro area was estimated to be at 0.7% in April 2015. Combined, prices of gas, heating oil and fuels for transport shaved 0.66 percentage points off headline inflation figure. Although 0.7% is still a far cry from 'close to but below 2%' target, for every 10% increase in energy prices, HICP metric watched by the ECB will rise approximately 1.06 percentage points. So far, in April 2015, energy prices are down 5.8% y/y - the shallowest rate of decline in 5 months. Month on month prices rose 0.1 percentage points.

Sooner or later, interest rates will have to rise.  In the U.S., explicit Fed policy is that such increases will take place after the real economy recovers sufficiently to withstand such a shock. In the euro area, there is no such policy in place, in the aggregate, across the entire common currency area, and in the case of specific weak economies, such as Ireland, in particular.

21/10/2014: Of Statistics: Ireland and ESA2010

Eurostat released a handy note showing revisions to euro area debt and deficit figures that arose as the result of conversion to ESA2010 methodology (yes, yes, that infamous inclusion of illicit trade and re-classification of R&D spending as investment, and much more).

You can read the full note here: http://epp.eurostat.ec.europa.eu/portal/page/portal/government_finance_statistics/documents/Revisions-gov-deficit-debt-2010-2013.pdf

And the effects are:

Government deficit revisions:

Click on chart to enlarge

One clear outlier in the entire EU28 is... Ireland. We had the largest, by far, downward revision in our deficit/GDP ratio of some 1.5 percentage points, pushing our deficit down from 7.2% of GDP (ESA95) to 5.7% of GDP (ESA2010) overnight. No austerity, just accounting.

We were similarly 'fortunate' on the debt calculations side:

Click on chart to enlarge

While revised actual debt levels rose, under new rules, the revised debt/GDP ratio fell due to GDP push up under the new rules. Lucky charms...

Per note, relating to deficit revisions: "Ireland (-3.1pp for 2010, -0.1pp for 2011, -0.1pp for 2012 and +1.0pp for 2013): the 2010 and 2011 deficits were  revised mainly for other reasons (than ESA 2010 introduction) and the 2012 and 2013 deficits mainly due to  introduction of ESA 2010. The deficit for 2010 was increased mainly due to reclassification of the capital injection  to AIB and the deficit for 2011 due to various reasons such as an adjustment to accrual calculation for PRSI,  health contribution and National Training Levy. The revisions in the deficit for 2012 and 2013 are mainly due to  the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central government. " 

Per note, relating to debt revisions: "Ireland (+12.2pp for 2011, +10.3pp for 2012 and +7.2pp for 2013): the revisions in the debt are mainly due to  introduction of ESA 2010: the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central  government as it became a government controlled financial defeasance structure in 2011."

So our actual debt rose. But our debt/GDP and deficit/GDP ratios fell:

Enron would be proud...

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.

4/9/2014: Repaying Ahead of Schedule: Ireland & IMF Loans

Last week Portugal's Expresso published a big article on Irish plans to repay earlier the IMF loans. The link is here: http://fesete.pt/portal/docs/pdf/Revista_Imprensa_30_e_31_Agosto_2014.pdf (pages 37-38)

My view on the subject in full:

1-      The Irish hurry is politically engineered or they understand that the present low sovereign bond yields mood can be a short-term window of opportunity in the Euro area?

In my view, Irish Government interest in refinancing IMF loan is driven by both political and economic considerations. On political front, following heavy defeats in the European and Local elections, the ruling coalition needs to deliver new savings in Exchequer spending to allow for a reduction in austerity pressures in Budget 2015 and more crucially support increased giveaways in the Budgets in 2016 and 2017. 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. 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. In addition, there is a very apparent need to refinance the IMF loans as the interest charges on these is out of line with the current funding costs for the Government. It is worth noting here that the Irish Government is far from being homogeneous on the incentives side. For example, from Minister for Finance, Michael Noonan's statements, it is pretty clear that the incentives to refinance the IMF loans are predominantly economic and financial. On the other hand, for majority of the Labour Party ministers and a small number of the Fine Gael Cabinet Ministers, the incentives are more political.


2-      The move is also a way of reducing the “official sector” debt in the overall sovereign debt composition (higher than 50 per cent)?

The issue of the 'official sector' debt as opposed to the total public debt is less pressing for the Irish state. Larger share of the official sector debt in total debt composition provides short-term support for bonds prices, as higher official sector debt holdings imply lower private sector debt holdings in the present. However, in the future, the expectation in the markets is that the official sector debt will be refinanced via private markets, thus higher share of official sector debt today is a net negative for the future debt exposures. The result is that higher official share of debt is supporting lower current yields, but rises future yields, making the maturity curve steeper, ceteris paribus. In the current environment, Irish government is not significantly exposed to shorter-term debt markets, but it is exposed to longer termed debt roll-over demands that are consistent with political cycle. Reducing official exposures, therefore, can be supportive of the longer-term view of the debt issuance by the state. However, the issue is marginal to Irish policymakers and certainly secondary to the political and economic benefits the early repayment of the IMF loans brings.


3-      This initiative is useful to upgrade the sovereign debt sustainability?

In the short run, if successful, the initiative will provide improvement in the sovereign cash flows, but will 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 will most likely lead to little material change in the Government debt dynamics. The issue of the greater longer term concern 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, there is likely to be a positive impact in terms of markets expectations on supply of Government bonds in the future and the direction of Irish fiscal reforms, both of which will support better risk assessments of the sovereign debt and Irish bonds. This is unlikely, however, due to the strong political momentum in favour of spending the new savings on reversing in part past savings achieved via public sector spending cuts and wages costs moderation. Such a move would likely be detrimental to Ireland's debt sustainability in the longer run. A third alternative is to deploy savings to reduce austerity pressures in the Budget 2015 across tax and spend areas. Tax reductions can be productive in stimulating sustainable growth and thus improving the fiscal position of the state in the longer run; spending cuts reductions will simply be consumed by remaining inefficiencies within the public sector.


4-      The Irish had some interesting political initiatives during the bail-out and post-bail-out period. First they change the annual promissory notes repayments into very long long debt (a kind of soft debt restructuring of 25 billion, 12 per cent of total public debt); then they decided for a “clean” exit opting out from the OMT constraints; and now they take the move to get out of IMF loans. In the framework of the Euro are peripheral countries this is an “innovation”?

The Irish government has taken a clearly distinct path from other euro area 'peripheral' states. However, this path is contingent on a number of relatively idiosyncratic features of the crisis in Ireland. Restructuring of the IBRC Promissory Notes was required due to political pressures of facing continued and clearly defined cost of the IBRC restructuring, but also by the significant pressures from the ECB to close off the ELA lines to IBRC, as well as Frankfurt's unhappiness with the structure of the Promissory Notes. In the end, this policy 'innovation' basically traded off short term savings for longer term costs and increased longer term uncertainty. It achieved substantial improvements in cash flow up front, but, depending on the schedule of bonds sales into the future, created little real savings over the life time of the loans. In the case of 'clean exit', Ireland benefited from the fact that a bulk of its deficits were incurred in extraordinary supports for the banks through 2011. In this sense, the Government had two years of relative stabilisation and decline in fiscal pressures before exiting the Troika programme. No other country in the euro 'periphery' had such deficit and debt dynamics. The move to refinance the IMF loans, however, is probably the first significant policy lead that Ireland deployed, as this move (if successful) will be paving the way for Spain, Portugal and Greece to follow in the future. Throughout the second stage of the euro area sovereign debt crisis (2012-present), the Irish Government deserves the credit for being recognised as being the one most actively seeking marginal improvements in the cash flow and rebalancing of debt costs and maturities within the euro area 'periphery'. But in part, this activism is also down to the fact that Ireland had a longer run in the debt crisis than any other 'peripheral' states and it deployed a plethora of various programmes, creating a policy map that is a patchwork of temporary and poorly structured programmes, like the IBRC Promissory Notes. Repairing these programmes offers Ireland a rather unique chance to get an uplift on some of its exposures.

21/6/2014: IMF 'Waived' Sustainability Requirement in Lending to Euro Area Countries

IMF paper, published yesterday now fully admits that the Fund has 'waived' its own core requirements for lending under the core programmes in euro area 'periphery'. More importantly, the criteria for lending that was violated by the Fund is… the requirement that "public debt be judged as sustainable with "high probability”" under new lending programme.

The paper is available here: http://www.imf.org/external/np/pp/eng/2014/052214a.pdf

Quoting from the IMF report: "In the sovereign debt crises of the 1980s, concerted financial support from the private sector was a standard feature of Fund-supported programs, most of which were within the normal access limits. By contrast, the spate of capital account crises that began in the mid 1990s occurred at a time when the creditor base had become much more diffuse, and the Fund’s strategy sought instead to entice a resumption of private flows through programs involving large-scale Fund and other official resources. While this strategy worked well in some circumstances, it failed to play its catalytic role in cases where, amongst other factors, the member's debt sustainability prospects were uncertain." 

Thus, the Fund clearly recognised that probabilistically, extended lending can only work where there is some confidence that the borrower debts post-lending by the IMF, are sustainable. In other words, the Fund agreed that there is the need for more extensive lending (in some cases), but that such lending should, by itself, not push beyond sustainability levels of debt. Were it to do so, the Fund would have required restructuring of the sovereign debt to reduce levels to within sustainability bounds.

This is how this 'bounded' lending beyond normal constraints was supposed to work: "In response to this varied experience, and to ensure effective use of its resources, the Fund concluded that decisions to grant access above normal limits should henceforth be guided by defined criteria. These were established in the 2002 Exceptional Access Policy, [EAP] which included a requirement that public debt be judged as sustainable with "high probability.” The framework applied initially only in capital account cases, but in 2009 became applicable to all exceptional access decisions."

Now, fast forward to the Fund entanglement in euro area debt/default politics: "When Greece requested exceptional access in May 2010, the policy would have required deep debt reduction to reach the high probability threshold for debt sustainability. Fearing that such an operation would be highly disruptive in the circumstances prevailing at the time, the Fund decided to create an exemption to the high probability requirement for cases where there was a high risk of international systemic spillovers—an exemption that has since been invoked repeatedly in programs for Greece, Portugal, and Ireland."

Elaborating on this, the paper states: "An important rigidity of the EAP came to the fore when Greece requested financial support in early 2010. When “significant uncertainties” surrounding the sustainability assessment prevented staff from affirming that debt was sustainable with high probability, the existing EAP framework would call for a debt reduction operation to deliver such high probability as a condition for the provision of exceptional access. In the case of Greece, where the high probability requirement was not met, however, there were fears that an upfront debt restructuring would have potentially systemic adverse consequences on the euro area. Given the inflexibility of the EAP, and the crisis at hand, the Fund decided to create an exemption to the requirement for achieving debt sustainability with a high probability when there was a “high risk of international systemic spillovers”. Since then, the systemic exemption has been invoked 34 times by end-May, 2014 in the three EA programs for Greece, Portugal, and Ireland."

Note that the systemic exemption has been invoked 34 times in just four years, in all cases in relation to euro 'periphery'. That is a lot of 'we can't confirm sustainability of debt levels post-programme, so we won't look there' invocations. More significantly, did anyone notice these invocations in IMF country reports that repeatedly assured us, since 2010 on, that things are sustainable in these countries?

Conclusion: the Fund now fully admits that its lending to Greece, Portugal and Ireland:

1) Required (under previous conditions) deep restructuring of sovereign debt; and

2) Was carried out in excess of the already stretched sustainability bounds.

The Fund loaded more debt onto these economies than could have been deemed sustainable even by its already stretched standards of 2002 EAP.

17/6/2013: On Debt of the Nations & Euro Crisis: 2 links

Update from the ZeroHedge on the Debt of the Nations: http://www.zerohedge.com/news/2013-06-04/debt-nations

Worth a read!

And while on the case of crises (for whatever you might read about Reinhart and Rogoff debate, debt overhang is a crisis) we have an excellent contribution by Dani Rodrik on solutions for the Euro area crisis: http://www.project-syndicate.org/commentary/saving-the-long-run-in-the-eurozone-by-dani-rodrik

Thought-provoking and comprehensive summary (albeit I do not necessarily agree with all of Rodrik's conclusions).

30/3/2013: Irish Debt Deleveraging 2012: Not much happening

Over the recent years we have been told ad nausea that all the economic suffering and pain inflicted upon us was about 'deleveraging' our debt overhang, 'paying down our debts', 'repairing balancesheet of the economy' and so on. Well, surely, that should mean reduction in our total economic debt levels, right?

Wrong! Our debt levels, vis-a-vis the rest of the world are up on the crisis trough and on pre-crisis peak (EUR580bn in 2007 to EUR651.2bn in 2012), and our net position (foreign assets less foreign liabilities) is down from EUR119.4bn deficit in 2007 to EUR153.7bn deficit in 2012:

 The above exclude IFSC.

Meanwhile, IFSC continues to grow in size, both in absolute and relative terms:

• Foreign assets up from EUR1,810bn in 2007 to EUR2,319bn in 2012
• Foreign liabilities up from EUR1,727bn in 2007 to EUR2,322bn in 2012
• Proportionally to our total foreign assets and liabilities the IFSC has grown from 79.7% in 2007 to 82.3% in 2012 on assets side and from 74.9% in 2007 to 78.1% in 2012 on liabilities side.

Back to non-IFSC balancesheet (as our policy makers and civil servants love treating ISFC as some sort of a pariah when it comes to counting its liabilities, and as some sort of a hero when it comes to referencing it in terms of employment, tax generation etc):

Chart above shows frightening trends in terms of our foreign liabilities as a share of GDP and GNP. Put simply, in 2007, non-IFSC foreign liabilities stood at a massive 357.5% of our GNP. Last year, they reached a n even more dizzying 488.1%.

You might be tempted to start shouting - as common with our officials and 'green jerseys' - that the above are gross figures and that indeed we have vast assets that are worth just so much... Setting aside the delirium of actually thinking someone can sell these 'assets' to their full accounting / book value etc, err... things are not looking too bright on the net investment position (assets less liabilities) side:

In 2007, Irish net investment position vis-a-vis the rest of the world was a deficit of 63.3% of GDP and 73.6% of GNP. In 2012 the net position was in deficit of 93.9% of GDP and 115.2% of GNP. Put differently, even were the Irish state to expropriate all corporate, financial and household assets held abroad and sell them at their book value, Ireland would still be in a deficit in excess of 115% of our real economy.

But back to that question about 'deleveraging' our debt overhang, 'paying down our debts', 'repairing balancesheet of the economy' and so on... the answer to that one is that Ireland continues to increase the levels of its indebtedness. The composition of the debt might be changing, but that, folks, is irrelevant from the point of view that all debts - government, banking, household, corporate, etc - will have to be repaid and/or serviced out of our real economic activity, aka you & me working...

23/3/2013: IMF 9th Review of Ireland's Programme

IMF Completed 9th Review with Ireland:

"Ireland’s strong policy implementation has continued and positive signs are emerging. Real GDP growth was 0.9 percent in 2012, and employment rose slightly over the year, although unemployment remains high at 14.2 percent. Further deepening its market access, Ireland issued €5 billion of 10 year bonds at 4.15 percent in March."

"The 2012 fiscal deficit of 7¾ percent of GDP was well within the 8.6 percent target. In 2013, the fiscal deficit is projected at 6¾ percent of GDP, moving toward the target of below 3 percent by 2015.  Public debt is expected to peak at 122½  percent of GDP this year and decline in later years provided growth picks up from the 1 percent rate projected in 2013."

"Financial sector reforms have continued to advance, but banks remain weighed down by nonperforming loans at about 25 percent of total loans." Per Mr. David Lipton, First Deputy Managing Director and Acting Chair:

"…problem loans remain high and accelerating their resolution is a key to economic recovery. The recent establishment of mortgage loan restructuring targets for banks is therefore welcome, and it will be supported by reforms announced by authorities that facilitate constructive engagement between banks and borrowers, promote the efficiency of repossession procedures as a last resort, provide banks with the right incentives through provisioning rules, and by sound implementation of the personal insolvency reform. Progress with resolution efforts for SME loans is also a priority.

“Building on the strong budget outturn for 2012, sound budget execution remains critical in 2013, including continued vigilance on health spending and a successful introduction of the property tax...

“Prospects for Ireland’s exit from official support have improved, yet continued strong policy implementation remains paramount given risks to medium-term growth and debt sustainability. Timely and forceful delivery on European pledges to improve program sustainability, especially by breaking the vicious circle between the banks and the Irish sovereign, would go a long way toward Ireland’s durable exit from drawing on official support.”

22/3/2013: Sunday Times, 17/03/2013

This is an unedited version of my Sunday Times article from March 17.


Economics is an art of contention. In so far as economics body of knowledge is concerned, the world is largely composed of an infinite number of things that are either uncertain, or open to interpretation. One of the very few near-certainties that economists do hold across the ideological and philosophical divisions is that an economy undergoing deleveraging of household debt is likely to experience a lengthy period of below-trend growth. The greater the debt pile to be deleveraged, the faster was the period of debt accumulation, the longer such a recession or stagnation will last.

Another near-certainty is that in a debt crisis, economy is unlikely to recover on foot of either monetary or fiscal stimuli. Monetary easing can help the deleveraging process if and only if low policy rates translate into cheaper mortgages on the ground. This requires a functioning banking system, in addition to monetary policy independence. Fiscal stimulus can only help to the extent to which it can temporarily stimulate growth, and even then the impact on more indebted households is unlikely to be any stronger than on less-indebted ones. Longer-term effects of a significant debt-financed fiscal stimulus in an economy already struggling with government and household debt, are more likely to be detrimental to the overall process of deleveraging. Higher debt today necessary to fund economic stimulus translates into higher burden of that debt in the future.

Meanwhile, deleveraging of the households in and by itself, even absent banking and other crises, is a process associated with dramatically reduced economic activity and growth.

Households struggling with a debt overhang are effectively removed from being active participants in the economy. Indebted households do not save, thus depleting their future pensions provisions and reducing overall levels of investment in the economy. Indebted households tend to cut back their consumption, both in terms of large-ticket durable goods and in terms of everyday items. They also reduce consumption of higher-quality higher-cost goods, adversely impacting domestic producers in higher-cost economies, like Ireland, favoring more competitively priced imports.

With banks beating on their doors, indebted households abstain from entrepreneurship and engage less actively in seeking improved employment opportunities. The latter means that indebted households, fearing even a short-term spell in unemployment, do not seek to better align their skills and talents, as well as future prospects for promotion with jobs offers. This, in turn, implies loss of productivity for the economy at large. The former means slower rate and more risk-averse entrepreneurship resulting in further reduction in future growth potential for the economy.

Last, but not least, household debt overhang results in increased rates of psychological and even psychiatric disorders, incidences of self-harm, suicide, stress and social dislocations. These effects have a direct and adverse impact on public services, the economy and the society at large.

In Irish context, the effects of household debt overhang (most acutely expressed in mortgages arrears) are likely to be significantly larger than in normal debt crises episodes and last longer.

Consider the sheer magnitude of the problem. In an average debt crisis, household debt arrears peak at around 7-10% of the total debt outstanding. Per latest data from the Central of Bank of Ireland, at the end of 2012, 143,851 private residential mortgages accounts and 37,995 buy-to-let accounts were in arrears. Total number of mortgages in arrears represented 19% of all mortgages outstanding.  Total balance of mortgages in arrears amounted to EUR35.4 billion, or 25% of the entire mortgages-related debt. Mortgages at risk of default or defaulted (defined as all currently in arrears, relating to properties with repossession orders and mortgages restructured during the crisis, but currently not in arrears) amounted to 238,663 accounts and EUR45.3 billion of the outstanding debt, or 25.3% and 31.9% of the respective totals.

Given expected losses from the above mortgages in the case of repossessions and/or insolvency, and inclusive of the interest costs due on this unproductive debt, over the next 3 years Irish economy is likely to face direct losses from this mortgages crisis to the tune of EUR20 billion. This will reduce our current level of gross fixed capital formation in the economy by 40 percent in every year through 2015.

In indirect costs, the crisis currently is impacting some 650,000-700,000 individuals living in the households with mortgages at risk, as well as countless others either in the negative equity or arrears on unsecured debt (credit cards, credit unions’ loans, utility bills etc).  Using basic cost of health insurance coverage, the relationship between health insurance spend in Ireland and cost of public healthcare, and assuming that annual cost of higher stress associated with debt overhang amount to just 10% of the total annual insurance costs, direct health costs alone from the debt crisis can add up to EUR400-500 million per annum. Factoring productivity losses due to stress, the total social, psychological and psychiatric costs of the mortgages arrears can run over a billion.

Costs of foregone entrepreneurship are even harder to quantify, but can be gauged from the overall decline in investment. In 2012 the shortfall in aggregate domestic investment activity compared to 1999-2003 annual average (taking the period before the rapid acceleration in property bubble) was running at ca EUR6.9-7.0 billion. This shortfall is roughly comparable to the above estimated annualized cost of servicing defaulting and at risk mortgages. Gross investment in Ireland is now running at a rate not seen since 1997.  Meanwhile, net expenditure by the local and central Government on current goods and services is running above 2005 levels, same as personal consumption of goods and services. This suggests that our current rates of domestic investment and associated entrepreneurship are down more significantly than personal and Government spending.

In some sectors, things are even worse.  Construction sector is clearly seeing no turnaround with new residential construction permits down 88% in 2012 on the peak, heading for historical low of estimated full-year 14,022 permits based on data through Q3 2012. Extending mortgage arrears crisis or deepening the households’ already significant debt overhang through the means of forcing them into repaying the unsustainable loans will only exacerbate the crisis in Irish construction sector and in all sectors of domestic economy.

In years to come, the mortgages crisis today is likely to cost Irish economy around 10% of our GNP.

And it is unlikely to ease significantly any time soon, since the above costs exclude the effects of likely acceleration in mortgages defaults in months and years to come due to the adverse policy and economic headwinds.

Firstly, ongoing fiscal consolidation is shifting more burden of paying for our State onto the shoulders of Irish households, including those subsumed by the debt crisis. This process is not going to end with Budget 2014.

Secondly, reform of the personal insolvency regime will add fuel to the fire by giving banks disproportional powers over the households in structuring long-term solutions to the mortgages distress. Changes to the Central Bank code of conduct for the banks in dealing with borrowers, along with the accelerated targets for restructuring non-performing mortgages announced this week are likely to push the banks to more aggressively deal with the borrowers. These factors will amplify the rate of mortgages arrears build up, driving more households into temporary relief measures. These measures will structured by the banks in absence of transparent and efficient consumer protection to suit banks’ objectives of extracting all resources out of households for as long as possible before forcing the households into bankruptcy in the end.

Finally, mortgages arrears will continue to rise on foot of weak economic growth and continued re-orientation of the Irish economy away from domestic activity toward MNCs. This headwind closes the loop from the household debt overhang to depressed domestic investment to higher unemployment and lower domestic growth to an even greater debt overhang.

In order to deal with the mortgages crisis, we need a prescriptive approach to long-term solutions based on principles of borrower protection, standardization and transparency.

All lenders operating in Ireland should be required to publish a full list of solutions offered to the distressed borrowers which complies with the minimum standards set out by the Central Bank and a borrowers’ protection watchdog, such as reformed and independent Mabs. The financial criteria and conditions that qualify borrowers for such solutions should be disclosed. The process of finalizing the details of solutions should involve borrowers supported by an adviser, fully resourced to deal with the lender and independent from the lender and the state.

Only by matching borrower and lender powers and resources in a transparent and strictly supervised manner can we achieve a resolution to this crisis. Until then, this economy will continue operating well below its potential rate of growth, condemning generations of Irish people to debt slavery. The status quo of the state granting ever increasing powers to the banks in dealing with mortgages arrears is not sustainable and is likely to lead to both economic misery, continued emigration, and in the long run to political and social discontent. Sixth year into the mortgages crisis of extremely acute nature, we can not afford another round of half-measures and fake solutions.

Box-out:

This week auction of Irish bonds put to some test the theory of yields divergence with the euro area periphery. Compared to Italian Government bonds auction carried out on the same day, Irish 10 year bonds were greeted by the markets with a cheer.  While supportive of the analysts’ consensus view that Ireland is decoupling from the peripheral states, such as Italy, Portugal and Spain, the results of the auction were at least in part driven by factors outside the Irish Government control. This was the first 10 year bond issuance for Ireland in 3 years and the issue came without much of the adverse newsflow surrounding the economy. Complete absence of 10 year bonds in the secondary market prior to the auction assured some of the demand. For Italy, this was the first auction following Fitch downgrade of the sovereign to Baa1 rating – fresh in the memory of the markets. Italian newsflow has also been disappointing recently with elections outcome unnerving the markets and with GDP figures (Italy has reported its 2012 full year growth almost a month ahead of Ireland, which is still to post results for Q4 2012).

Just how much of this week’s result for Ireland can be accounted for by the factors unrelated to the Government policies or real economic performance is impossible to determine. Nonetheless, Minister Noonan’s cheerful references to the auction as ‘extraordinary’ in nature sounds more like a political PR opportunism than of financial realism.