Growth and low interest rate will help reduce debt
IT is the most puzzling element of any bailout by the IMF and the EU. How can providing an indebted country like Ireland with even more debt solve its underlying problems?
Ireland already has a national debt of €90bn and it is rising fast. Within four years, even with a programme of cuts and tax hikes, Ireland's national debt will reach 114pc of everything the country produces. While other countries like Japan and Italy have higher debt levels, it is still a large debt for a small country and does not include NAMA, which is going to be taking on about €40bn of debt until it sells its assets.
Taking help from the EU and the IMF is not going to radically reduce these projections, but they will be offering loans at lower interest rates, delivering lower debt service costs.
IMF loans in particular come with rock-bottom interest rates, whereas the EU, which has to raise the money itself in the first place via the markets, charges 5pc through its European stabilisation fund.
The Government believes the debt should level off in 2014 after several budgets are used to cut the deficit back to just 3pc of GDP. Most analysts expect it to level out at about 110pc to 120pc of GDP, once again not including NAMA. Then the long road to repaying the money begins. For example, in 2014 the State is due to repay €10bn of borrowing, with €6bn due to be repaid in 2013.
The key for Ireland to repay the IMF/EU facility is growth.
Generate sufficient tax revenues and keep spending under control and eventually the deficit will come down and so will the annual budget deficit. Repaying the IMF/EU at a lower interest rate also helps.
However, the IMF/EU facility will include billions being made available to the banks.
It is this area where the ability to repay the debt gets murkier. If the money for the banks goes in as direct capital, the only way it can be repaid is via dividends to the Government or outright ownership. In the latter case, the Government would have to sell the banks back into the markets to generate at least some return.
If the IMF/EU gives money to the Government and it gets put into a fund for the banks, it will depend on whether the banks actually access the money.
For example, if the banks access the money they will presumably have to repay the Government via either a charge or shares. However, preference shares, which pay out a fixed coupon (or interest rate), are not favoured by the markets.
Ordinary shares make no payout to the Government and returning the money could only be done via the sale of the banks to most likely a foreign buyer.
If the banks draw down the money, ironically, the impact would be on the Exchequer, which would be taking on the loans on behalf of the banks.