Colm McCarthy: Reward isn't the word, Wolfgang, it's restitution
It is dangerous for the State to shout about our bond market 'success' too loudly -- the Europeans might just believe it, writes Colm McCarthy
Ireland's prospects of regaining national solvency will be undermined unless a serious deal can be negotiated regarding bank-related debts, a substantial portion of which was unreasonably imposed by the European Central Bank (not by the troika) in the autumn of 2010. Of course the budget deficit also needs to be eliminated as quickly as possible.
There should be no premature celebration after a further sale of government bonds by the National Treasury Management Agency (NTMA) during the week. Selling bonds at unsustainable interest rates does not bring debt sustainability closer. The NTMA borrowed at just under six per cent. The funds are now on deposit at undisclosed, but much lower, interest rates. The immediate effect of borrowing at high rates, adding to cash balances, is to make the deficit worse, not better.
The justification offered by the NTMA is that Ireland faces heavy requirements to repay maturing debt early in 2014, after the EU/IMF programme ends, and borrowing now, even at high rates, provides some comfort in that regard. But the longer-term sustainability of the debt is quite unaffected by debt management manouevres. The inflation rate is likely to be about two per cent in the years ahead and the rate of economic growth has recently been about zero. Tax revenues are sluggish with low inflation and low growth, and cannot keep pace with mounting interest bills. Debt sustainability remains precarious without much lower interest rates or rapid economic growth.
It is widely expected that Greek debt will reach 170 per cent of national income within a few years, and that this figure will prove unsustainable. Markets expect that there will be a second Greek default. When Ireland's prospective peak debt burden is expressed relative to national income, it comes out at around 150 per cent, not far behind the figure seen as unsustainable for Greece.
The 120 per cent peak figure normally quoted relates to output (GDP), not national income. This matters because in Ireland national income, which corresponds to the base for taxation, is smaller than output, measured by GDP, since a substantial slice of Ireland's GDP is not part of national income at all. It corresponds to expatriated profits booked here by multinational corporations and not liable to significant tax impositions.
It would not be correct to say that debts at 150 per cent of national income are necessarily unsustainable: there have been (rare) historical examples of countries which managed to service debt at these levels. But those who are confident of sustainability are making a big bet on an early return to rapid growth, a sharp fall in interest rates, or both. The rates of interest paid by the NTMA in its recent borrowings are far higher than those charged, in the same currency, to Germany and other states deemed to be low-risk. The implication of the rates the NTMA chose to pay is that the lenders perceive a high risk of sovereign default by Ireland.
One of the reasons the NTMA was able to borrow at all is that the EU summit communique of June 29 last raised the prospect of some relief for Ireland from debts arising from the bank rescue. Every official action or statement which plays up the prospects for Irish debt sustainability weakens the incentive for EU partners to make serious concessions. Friday's Irish Times carried an interview with German Finance Minister Wolfgang Schauble, which illustrated the dangers of upbeat spin-doctoring coming out of Ireland. He downplayed the prospects for a debt-reduction deal in the following terms: "We cannot do anything that generates new uncertainty on the financial markets and lose trust, which Ireland is just on the point of winning back. We will have to avoid generating a headline like 'Aid programme for Ireland topped up' because then investors in California or Shanghai might not understand that this top-up is a reward for Ireland."
Taken at face value, Schauble's statement is simply absurd. Financial markets dealing with a distressed debtor will become less concerned if their debtor is relieved of some obligations, not more concerned. Schauble knows this perfectly well and so do the folks in California and Shanghai. But his phrase about Ireland winning back trust, and by implication not needing additional support, is part of
the price to be paid for trying to have it both ways. The Government cannot maintain that Ireland is unable to carry its debt burden without a better deal while simultaneously declaring success on re-entering the bond market. This is an open invitation to our European colleagues to dismiss requests for debt relief on the grounds that Ireland is doing fine without it.
The rescue deal for Ireland arranged with the EU and IMF in the autumn of 2010 did not include any condition relating to the repayment at 100 per cent of unsecured and unguaranteed bondholders in bust banks.
This additional debt was imposed on the Irish Exchequer by the European Central Bank, outside the terms of the financial programme and against the advice of the IMF, in circumstances which remain concealed. The legitimacy of this arbitrary action should be at the centre of the negotiations under way about debt relief for Ireland.
There will be debt relief anyway in whatever eurozone countries are unable to regain market access at affordable interest rates. They will default. In addition to a second default for Greece, market bond prices reflect high risks for Portugal, Spain and Italy, as well as Ireland. Until these countries can access sovereign credit in large quantities at interest rates of four per cent or so, the European sovereign debt crisis will lumber on. There remain serious doubts in the market about the commitment of European leaders to do what it takes.
Uniquely in the Irish case, there are grounds for believing that a portion of the sovereign debt arose through actions beyond its mandate by the ECB. The ECB does not enjoy explicit powers to dictate the terms on which bust banks are to be resolved. It appears, however, to have assumed such powers, under the presidency of Jean-Claude Trichet, before and during the negotiation which led to the November 2010 rescue.
The ECB has refused, as has the Irish Department of Finance, to release the text of a letter from Trichet to Ireland's Finance Minister, the late Brian Lenihan, dating from that period. As recounted by UCD economist Karl Whelan in his recent report on the matter for the European Parliament's Economic and Monetary Affairs Committee, an Irish journalist, Gavin Sheridan, requested the ECB to provide a copy of the letter.
The ECB declined to do so, as did the Department of Finance when requested by the Sunday Independent. The ECB's justifications for not releasing the letter includes the following: "The letter . . . is a strictly confidential communication between the ECB president and the Irish Minister of Finance and concerns measures addressing the extraordinarily severe and difficult situation of the Irish financial sector and their repercussions on the integrity of the euro area monetary policy and the stability of the Irish financial sector.
"The ECB must be in a position to convey pertinent and candid messages to European and national authorities in the manner judged to be the most effective to serve the public interest as regards the fulfilment of its mandate.
"If required and in the best interest of the public also effective informal and confidential communication must be possible and should not be undermined by the prospect of publicity."
The reluctance to release this letter doubtless reflects the sensitivity of the contents. It may not deal with the pay-off to unsecured bondholders at all -- the ECB was putting pressure on the Irish government to accept a bailout at the time and encountered some resistance. But the pay-out to bondholders occurred, and it is clear that this was at the insistence of the ECB.
Should the Irish Government seek judicial review of the legality of the ECB's behaviour at the European Court of Justice, as is provided for in the ECB statute, all of the relevant records should come into public view, including not just the undisclosed letter, but also emails and phone records from the period, covering any contacts between the ECB and European banks and creditor lobby groups. It would also be important to know whether any influence was brought to bear on the ECB by the finance ministries of Germany and France.
Wolfgang Schauble is not keen on a 'reward' for Ireland. Perhaps 'restitution' would sound more acceptable.