This is an unedited version of my Sunday Times article from March 18, 2012.
At last, courtesy of the years of economic and
financial mess, Ireland is waking up to the problem of our debt overhang. For
those of us who have consistently argued about the unsustainability of our
fiscal and real economic debts predicament, this moment has been long coming. The
restructuring of some of the debts carried by the Government directly or
indirectly, on- or off-balancesheet is a matter of when, not if. Enter the
debate concerning the Promissory Notes.
Per international research, State debt in
excess of 90-95% of the real economic output is unsustainable. In real
economics, as opposed to fiscal projections, debt becomes unsustainable when it
exerts a long-term drag on future growth.
At the end of 2011, official Government debt
in Ireland has reached 107% of our GDP or 130% of GNP, according to NTMA. The
Irish economy is now operating in an environment of records-busting exports,
current account surpluses, and healthy FDI inflows, and yet there is no real growth
and unemployment remains sky-high. By comparatives, Irish economy is a
well-tuned, functional car stuck in the quicksand – engine revving, power train
working, wheels engaging, with no movement forward. This is a classic scenario of
a debt overhang crisis – the very same crisis that Belgium has been struggling
with since 1982, Italy – sicne 1988, Hungary – since 1991, and Japan – since
1995.
Something has to be done to deal with this
problem in Ireland no matter what our Government and the EU say in public.
Uniquely for a euro area country, Ireland’s
debt overhang did not arise solely from fiscal or structural economic shocks,
but was strongly driven by the country response to the financial crisis rooted
in a number of forces, including policy and regulatory errors by the EU and
ECB. Also, Ireland has undergone the most severe adjustments in its fiscal
position to-date compared to all other ‘peripheral’ economies, proving both our
capability and commitment to reforms.
Lastly, in contrast with all other countries,
Ireland’s economy is capable of getting back to sustainable levels of economic
activity. Irish economy needs a supporting push out of the quicksand of
banks-linked debt overhang to deliver on its sovereign debt commitments, and
become once again a net contributor to the sustainable fiscal system within the
euro area.
The IBRC Promissory Notes are a perfect focal
point for such a push for a number of reasons.
First, the magnitude of the Promissory Notes
allows for significant room to reduce Irish Government’s future liabilities,
combining €28.1 billion of debt, plus 17 billion in interest repayments. These represent
29% of our GDP. Eliminating this liability will restore Ireland back onto
sustainable fiscal and growth paths. Restructuring the Notes will not
constitute a sovereign default. Although their value is counted in Irish
Government debt, they are not traded in the markets. The Notes are, de facto,
Irish Government IOUs to the Central Bank of Ireland with IBRC acting as an
agent.
Second, Promissory Notes underwrite €28
billion of €42 billion IBRC debts to the ELA programme run by the Central Bank
of Ireland. ELA funds are not borrowed by the Central Bank from the Eurosystem
or the ECB, but are created by the Central Bank under its mandate. There is no
offsetting physical liability the Central Bank needs to cancel by receipt of payments
from the Government. The Notes also do not constitute Central Bank funding for
the Government as they finance stabilization of the Irish (and thus European)
banking system. Lastly, the ELA funding extended to the IBRC is already in the
financial system. Removing requirement on the Irish state to monetize the
Promissory Notes will not constitute an inflationary quantitative easing.
The Government is correct in focusing much of
its firepower on the IBRC’s Promissory Notes. Alas, efforts to-date suggest
that it is not setting its sights on the real solutions needed. This week,
Minister Noonan has identified the direction in which the talks are progressing:
restructuring the Promissory Notes repayment time schedule, plus possibly reducing
the interest rate attached to the notes via converting the notes into ESM debt.
The problem with this approach is that a
transfer of liabilities to ESM will convert Promissory Notes into a
super-senior Government debt. This is likely to have a negative effect on
Ireland’s ability to borrow funds from the markets in the future and make such
borrowing more expensive.
In addition, lowering interest rate on the
Promissory Notes carries two associated problems with it. The move can only
have an appreciable effect on Exchequer finances after 2014, when interest on
the notes ramps up to €1.8 billion from zero in 2012 and €500 million in 2013.
Delaying repayment of notes instead of
reducing the principal amount owed on them will not provide significant relief to
the Exchequer in the future and will make the period over which the debt overhang
occurs even longer than 20 years envisioned under the current Notes structure.
This will pose serious risks. History of business cycles suggests that between
now and 2025 when Notes repayments will fall significantly, we are likely to
face at least two ‘normal’ or cyclical recessions. During these recessions,
Notes repayments will coincide with rising deficit pressures and national income
contractions that will exacerbate the Promissory Notes already adverse impact
on Irish economy. Extending the period of notes repayments risks compounding
more recessionary cycles in the future.
Furthermore, delaying notes repayments can
risk increasing the overall future demand for debt issuance by the state.
Currently, Ireland is facing two debt-refinancing cliffs during the life of the
Promissory Notes: €45.6 billion refinancing over 2013-2016 and €62.4 billion over
2017-2020. If Notes repayments are delayed, their financing will stretch
further into post-2020 period, just when the subsequent roll-overs of
Government bonds will be coming due.
In more simple terms, current proposals for
Promissory Notes restructuring are equivalent to making quicksand pit
shallower, but much wider.
Ireland needs and deserves a direct
restructuring of the ELA. The most optimal outcome of such a restructuring
would be de facto cancellation of ELA requirement for repayment of
IBRC-borrowed €42 billion. Once again, such a move would have zero inflationary
impact on the economy as on the net no new money will be created in the euro
system over and above the amounts already present.
There remains, however, one sticky point.
Allowing Ireland to restructure its ELA can, in theory, lead to other Central
Banks following the suit. This problem of moral hazard can be easily mitigated
by ECB by ring-fencing Irish ELA restructuring solely for the purpose of
winding down IBRC. Making ELA writedown conditional on shutting down Anglo and
INBS, plus potentially Permanent tsb will disincentives other countries from
using their own ELAs to rescue solvent banks. Irish restructuring can be
further isolated by tying ELA writedown to progress already achieved by Ireland
in tackling fiscal deficits and restructuring its banking sector. Put simply,
with such a proviso in place, no other Euro area country would want to dip into
its National Central Bank vaults if the associated cost of doing this will
amount to over 50% of its GDP.
Ireland’s crisis is unique in its nature and
its resolution provided a buffer to cushion the credit crisis blow to the
entire euro area banking sector. Ireland both deserves and needs a breakthrough
on the debts assumed by taxpayers in relation to the insolvent IBRC. Even more
importantly from Europe’s point of view, the ECB needs a positive example of a
country emerging from the deep crisis within the euro system. Ireland is the
only candidate for success it has.
Source: NTMA and author own calculations.
Note: In computing second round of rollovers, only Government bonds are included and taken at 95% of the principal amount. All other debts are excluded.
Box-out:
In the wake of last week’s Quarterly National Household
Survey release, the Government was quick to point to the improvement in the
number of employed on a seasonally adjusted basis as the evidence the
employment policies success. Overall numbers in employment rose in Q4 2011 by
10,000 or 0.56% compared to Q3 2011, once seasonal adjustments were made.
Furthermore, per seasonally adjusted data, full-time employment was up 8,700 –
accounting for 87% of this jobs creation. Alas, this is not the entire picture of
the job market health. Year on year, seasonally adjusted employment was down
17,800 or 0.97%. More ominously, unadjusted employment was up just 2,300 in Q4
2011 compared to Q3 2011 – an addition of statistically insignificant 0.1%.
Interestingly, full-time unadjusted employment figure fell by 700 jobs (-0.1%),
while part-time employment rose 3,000 (+0.7%). At the same time, number of
part-time workers who are underemployed has jumped 5,800 in a quarter and
28,100 year on year. Two reasons can help explain the above disparities. First,
Government training programmes have been aggressively taking people out of
unemployment counts, increasing employment numbers. In the case of Job Bridge,
for example, these are unpaid ‘internships’ with questionable rate of post-internship
transition to work so far. Second, since Q1 2011,
CSO has used a new model for seasonal adjustments, which may or may not have an
effect on seasonally adjusted headline numbers. Lastly, seasonal adjustments
can increase, not reduce quarterly data volatility at the times when trends
change. Particularly, with flattening out of the employment figures after years
of steep declines, seasonal adjustments can introduce a temporary bias into
subsequent data. In short, making conclusions about the actual changes requires
more careful reading of the numbers than a simplistic headline figure
referencing. With all annual indicators pointing to a shallow decrease in
employment, the Government would be best served to have some patience and see
how subsequent quarters numbers play out before jumping to conclusions on the
success of its policies.
