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.
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.
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.
