Seamus Coffey: Welfare and public service sectors will be the keys in a tough and daunting 2012
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IRELAND is heading for a general government debt of around €200bn by 2014. One-quarter of this is as a result of bailing out the banks. One-half is due to the need to borrowing beginning in 2008 to fund government expenditure on social welfare, public sector pay and other goods and services, while we brought the final quarter of this debt with us into the crisis. This debt was largely the overhang from the last fiscal crisis in the 1980s. The debt was never repaid but its significance was reduced by growth and inflation.
This is a huge debt level but one that is on the border of sustainability. It is likely that a debt of €200bn can be carried from 2014 but it will be difficult. Just like the debt from the 1980s we have little ambition to actually pay this off. The aim is to service the debt by paying the interest and hope that, in time, growth and inflation will reduce the burden of doing so.
At the start of 2011 it seemed that even this was a goal that was unattainable. At that time there were some forecasts that the debt would reach €250bn by 2014 and even the IMF were forecasting a debt of around €225bn by 2014. The interest costs on this level of debt could not be managed by the State. The debt would not be brought under control as we would have to borrow continually just to meet the interest payments so the level of debt would rise inexorably.
It is now clear that Ireland will not have to service a debt of €250bn by 2014. There are a number of reasons for this. The worst-case scenario of the cost of the bank bailout was €85 billion and this was built into the earlier forecasts. This has since turned out to be €62bn with €45bn of that borrowed.
The interest rate on Ireland’s EU loans was significantly reduced last July resulting in annual savings of around €1bn. It was also revealed that the Department of Finance had made a double-counting faux pas and that €3.7bn of the debt never even existed in the first place.
€200bn is still a colossal amount of debt and the ability to carry it will depend on the required growth and inflation rates materialises. There is also the possibility that we may be able to offload our stakes in the functioning nationalised banks and use the receipts to reduce the debt burden.
Some of the “off-balance sheet” items remain a concern. The debts of the National Asset Management Agency and the Irish Bank Resolution Corporation are essentially debts of the State. While this is true these bodies do not put any burden on the State to meet their interest expenses or debt repayments.
It is possible that the IBRC will be moved onto the State’s balance sheet in 2012 but that will not make our predicament any worse. We are already liable for the losses accrued by the profligate actions of Sean Fitzpatrick and Michael Fingleton.
NAMA has purchased €70bn of loans which will allow it to cover much of the €30bn of debt the agency created. The IBRC has already been provided with €35bn of funds to meet its liabilities and there is little indication that it will need more.
Even if these bodies do need additional support a figure of around €20bn would be hugely on the pessimistic side. Again it is not the size of the debt that matters but the interest burden it creates.
At 5pc interest such a shortfall would cost the State €1bn a year. This is a large sum but it is not one that will be definitive in determining whether Ireland is forced into a default. We may choose to default on some of our debts but a hard or forced default is not the inevitable outcome that some commentators are suggesting.
There has been a lot of attention on the Promissory Notes given to Anglo and Irish Nationwide. There may be some benefits from a lower interest rate or lengthened term on these notes but as the interest is paid by the Exchequer to the IBRC who in turn pay it to the Central Bank there is no real saving as these are all State-owned entities.
There only way a real saving is possible on the Promissory Notes is if the capital amount to be repaid on them is reduced and there is little sign of that occurring.
Ireland is heading for a general government debt of around €200bn in 2014. The annual interest cost of this is likely to be around €10bn and this is the figure that will decide if we default or not. This will be around 6pc of GDP. The interest will in the 1980s peaked at almost 9pc of GDP but we are not facing into the growth and potential offered by the 1990s.
There are those who believe the path out of the crisis is by “burning the bondholders”. This is based on the mistaken belief that we can save the full amount not repaid to these creditors. If €1bn of bank bonds are not repaid the State does not save €1bn as it does not have this money to repay the bondholders in the first place. The State saves the €50m annual interest bill that would have arisen as a result of borrowing the money to repay the bondholders.
A unilateral full default on all the bonds remaining in the covered banks would struggle to realise gains of close to the €45bn we have borrowed to put into the banks. Even if this could be achieved the saving to the State would be around €2bn per annum.
We would still have €8bn of interest costs not related to the bank bailout and would need funds the cover the remaining primary deficit. Saving €2bn per annum may sound attractive but it would come at a cost of immediately cutting the deficit by €12bn per annum.
There is no doubt that the current approach to getting out of the debt and deficit crisis is slow and painful. It is also true that there will be many who will shout loud about many opportunities that are being missed such as “burn the bondholders” and “tax the wealth”.
There is no doubt that these approaches do offer benefits but the claims generally completely overstate these benefits and ignore the costs that come with such actions.
There is still a long way to go and bringing down the deficit remains a priority. The government needs to restore stability by addressing the key elements of the public finances. These are social welfare payments and public sector pay on the expenditure side, and income taxes and the collapse of capital and wealth taxes on the revenue side. If the necessary steps are taken we can bring the deficit under control and put our debt on a sustainable footing. Ireland will not default.
Seamus Coffey is a lecturer in economics at UCC and a blogger at http://economic-incentives.blogspot.com
