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Play hard ball -- it's the only option

THE countdown for a new Taoiseach has begun. In about a month's time, we'll have a new government. Top of its to-do list should be trying to knock about €14bn off the interest bill on the IMF-EU bailout, and between €5bn and €29bn off our black hole of bank debt.

That would save taxpayers as much as €43bn -- but is it too much to hope for?

If our new leaders can't bludgeon a better interest rate out of the IMF and EU, Ireland will have to cough up almost €30bn in interest over the next seven-and-a-half years. That kind of bill will simply cripple our country -- and with interest rates expected to rise over the next few years, the bill could get even higher. Economic growth will be utterly banjaxed by the weight of repayments.

A new Government will have no choice but to play hard ball and renegotiate. Fine Gael's Michael Noonan looks nailed on for the Finance job, and this is what he should do.



Save €14bn

Under the current deal, the average interest rate on the €67.5bn loan is 5.8 per cent. That adds up to about €3.9bn in interest a year, according to Jim Stafford, partner at Friel Stafford Corporate Recovery. That bill could, of course, be lower if Ireland doesn't draw down the full €67.5bn loan -- but our economy would need to turn around pretty quickly for that to happen and the recent growth forecasts suggest that is not on the cards.

"We need to look at the possibility of renegotiating the interest rate on the IMF-EU loan," says Mr Stafford. "The 5.8 per cent rate is too high."

Mr Stafford says the new Government should aim to get the rate down to 3 per cent. "You have to go into negotiations and say everything is on the table -- even a default," says Mr Stafford. "A lot depends on the strength of the new Government."

If we could get the rate to 3 per cent, it would save us €1.9bn a year in interest, or €14.25bn over the seven-and-a-half years, says Mr Stafford.

The €67.5bn IMF-EU bailout is made up of three loans -- €22.5bn from the IMF; €22.5bn from the European Financial Stability Fund (one EU bailout fund) and shared loans from Britain, Sweden and Denmark; and €22.5bn from the European Financial Stability Mechanism (another EU bailout fund).

Some believe the interest rate agreed on the IMF's €22.5bn loan is untouchable.

"The interest rate on the IMF portion of the loan is tied to a fixed formula," says Donal Donovan, a former deputy director of the IMF who is an adjunct professor with UL.

"A bilateral negotiation between Ireland and the IMF about the interest rate on the loan is therefore not a possibility. The interest rates on the EU/ECB portions are also set by formulae. These formulae could be changed should there be an agreement among the EU and eurozone members."

If the interest rate on the €45bn borrowed from the EU bailout funds was reduced by 1 per cent, this would generate annual savings of about €225m between 2011 and 2013, according to Mr Donovan. "These savings would double from 2014 onwards before the loan starts to be repaid."

Hank Calenti, head of bank credit research at Societe Generale, believes it should be possible to renegotiate the interest rate on the deal.

"Historically, governments frequently renegotiate the terms of assistance they receive," says Mr Calenti, who worked on many debt renegotiations during the Latin American debt crisis in the 1980s when he was with the US Federal Reserve.

As well as the advantage of saving this country money each year, a lower interest rate would make it easier for Ireland to buy back some of its debt, says Dan McLaughlin, chief economist with BoI.

"If you're borrowing from the EU-IMF at a lower rate, it would make buying back other debt more attractive," he says. "Over time, the economy may improve and consumer sentiment may pick up. If this happens, the National Treasury Management Agency could go back to the markets and borrow money at lower rates."


The new government could also try to extend the term of the loan. Although this would push up our overall interest bill, it should make the annual interest repaymentsmore manageable.

The new Government could, however, have difficulty extending the term of the loan, says Mr Donovan.

"The repayment period of the IMF-EU loan is set," explains Mr Donovan. "More financing might be needed beyond this period, or we could have difficulty repaying the loan within that (seven-and-a-half year) timeframe. One approach then could be for the IMF-EU to provide a second, probably much smaller loan down the road to give breathing space while the first loan is being repaid. However, if a second loan were provided, it would take longer for us to reach the objective of reducing our exposure to the IMF-EU to zero."

Ireland simply can't afford to have €4bn a year going out of this country to pay interest on a loan.


Save €29bn

Another headache for the new Government is the billions of euro of bank debt in this country. The Government could save about €29bn if it imposed a 'bail-in' on bank bondholders. A 'bail-in' would essentially force bondholders to share the cost of propping up the Irish banks before taxpayers have to foot the bill.

"In our worst case scenario for bondholders, the Government would bail-in all unsecured senior, government guaranteed and subordinated debt," says Mr Calenti.

"In our best case scenario for bondholders, the Government would only bail-in subordinated debt. Let's assume writedowns of 90 per cent in junior subordinated debt, 80 per cent in senior subordinated debt (as occurred with Anglo) and 60 per cent in senior unsecured debt. With these assumptions in mind, we estimate potential 'savings' for the Government in the range of €5bn in the bondholders' best case scenario -- €29bn in their worst case scenario. The 'savings' could be materially higher or lower depending on how a bail-in is undertaken."

Mr Noonan or Ms Burton would, however, need to tread carefully with a bail-in as the Government itself -- as well as Irish workers -- could be exposed to the losses of bondholders.

"In Ireland's case, how large is the outstanding bondholder debt and to whom it is it owed?" asks Mr Donovan. "This is relevant since it appears the debt obligations of the Irish banks over the last few months may have been met, in part, through financing provided by the Irish Central Bank and the ECB."

Irish pension companies, with billions of euro worth of pensions held for Irish workers, could also take a hit.

There is about €15bn of senior debt in the Irish banks. "A good chunk of that debt is in BoI," says Donal O'Mahony, of Davy Stockbrokers. "The Government is a majority shareholder in BoI."

If the Government forced senior bondholders to take a hit, depositors in the Irish banks could find themselves in the firing line, he warns.

"If the Government went the extra mile and forced senior bondholders to take a hit, you can be sure senior bondholders would make a case that equity holders and depositors should also take a discount," says Mr O'Mahony.

If bondholders don't take a hit, the taxpayer will bear the brunt of the huge losses. With Mr Noonan recently hinting that he would try to renegotiate terms with senior bondholders, it seems some form of a haircut is on the cards.


Whether or not we will have a government radical enough to refuse to pay remains to be seen. But by all accounts, default would be disastrous.

"The consequences for one's international reputation are the worst imaginable," says Mr Donovan. "The banks here could very quickly run out of cash if we defaulted on the loan repayments," adds Mr Stafford. "If there's no more funding available, we could have Egypt on the streets."

Sunday Indo Business