Monday 23 October 2017

Dan White: Playing hardball on bond yields the only way out of crisis

We'll be stuck in a debt trap until we can manage a budget surplus and that's when the game will change

Dan White

Dan White

Minister for Finance Michael Noonan hailed the market response to last week's sale by the National Treasury Management Agency of €5bn of 10-year Irish government bonds as "extraordinary".

Unfortunately the yield we are paying on those bonds, 4.15 per cent, means that Ireland is still stuck in an unsustainable debt trap.

The latest sale of 10-year benchmark Irish bonds shows just how far we have come from the dog days of summer 2011 when yields, the implied interest rate, soared above 14 per cent. It also marked the first time that Ireland had been able to sell a new issue of 10-year bonds since before the 2010 EU/IMF bailout.

Indeed so strong was demand for these new bonds that the NTMA, which had originally hoped to sell €3bn worth, ended up selling €5bn with investors submitting offers for up to €12bn.

Unfortunately the yield demanded by investors on these new bonds, 4.15 per cent, was still a massive premium over what Germany pays on its 10-year bonds, currently about 1.48 per cent. Without this 267 basis point (2.67 per cent) spread there is no way that investors could have been persuaded to purchase the new bonds last week.

The Government and the NTMA clearly hope that last week's bond sale will allow Ireland to exit the bailout on schedule at the end of this year. However, even if we do it is clear that Ireland will remain under adult supervision for the foreseeable future.

Look at the numbers. According to the Department of Finance's own forecasts, Irish government debt will have climbed to €203.5bn by the end of this year. This will be the equivalent of 121 per cent of GDP, which the Department of Finance estimates will be €167.7bn in 2013.

Hang on a minute. When it comes to measuring the value of Irish economic output, GDP – which includes repatriated multinational profits – is vanity while GNP, which excludes them, is sanity.

For this year the Department of Finance is predicting that Irish GNP will be €133.9bn, 20 per cent smaller than our GDP. What this means is that, far from the 121 per cent being predicted by the department, our year-end debt as a percentage of our economic output will in fact be 152 per cent if GNP rather than GDP is the preferred benchmark.

Therefore Ireland's fiscal crisis is much more serious than most of us realise and fixing it will take far longer.

On the basis of a debt/GNP ratio in excess of 150 per cent and the 4.15 per cent yield we had to pay to get last week's bond issue away, Ireland would have to pay the equivalent of 6.3 per cent of its total economic output every year just to pay the interest on the national debt if it were to rely exclusively on market funding. In fact this is quite close to the €8.1bn (6 per cent of GNP) which the Department of Finance has pencilled in for debt service costs this year.

On top of this we will, even if we meet the targets set for us by the Troika, still have a budget deficit of 2.9 per cent of GDP (3.6 per cent of GNP) as late as 2015, with the Department of Finance forecasting budget deficits of 7.5 per cent of GDP (9.4 per cent of GNP) and 5.1 per cent of GDP (6.4 per cent of GNP) for 2013 and 2014 respectively.

You don't have to be a mathematical genius to work out where this is heading. Even when we meet the Troika's Holy Grail of a 3 per cent budget deficit we will still need to find the equivalent of 10 per cent of GNP, about €14bn, every year just to pay the interest on our existing borrowings and fund new borrowing. By comparison the Department of Finance is forecasting annual nominal GNP growth (real economic growth plus inflation) in the 2.5 per cent to 4 per cent range between 2013 and 2015.

In practice what we would be doing is raising fresh loans just to pay the interest on our previous borrowings. This would leave us stuck on a fiscal treadmill with no apparent means of escape.

There may, however, be one glimmer of hope. Although both the Government and the NTMA have been very quiet on the subject, the key objective for this country must be to achieve at least a primary budget balance – the 3 per cent of GDP budget deficit is merely eyewash for the Troika. Translated into plain English this means balancing the national books before interest costs.

The good news is we are closer to this than is generally recognised. The Department of Finance is forecasting a €3.4bn (about 2.4 per cent of GNP) primary budget deficit this year followed by a €757m surplus next year and a €4.7bn surplus (3.25 per cent of GNP) in 2015.

That's when the game changes.

There is no way that we can sustain an interest burden equivalent of 6 per cent of GNP. Until Irish bond yields fall closer to German levels we will remain stuck in a debt trap with no means of escape.

Michael Noonan or his successor must use the opportunity presented by this emerging primary budget surplus to push down the yields which we pay on our borrowings.

They shouldn't be squeamish in using the leverage this will give them to improve our situation. Economic recovery depends on reducing this burden to much more manageable levels.

Irish Independent

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