Friday 20 September 2019

We're not out of the debt woods yet

A release from the IMF's IOU book won't mean we can loosen our belts, says Colm McCarthy

The Irish summer should now be in low gear with August designated the silly season and early September devoted to the conclusion of the hurling championship. Attention then normally turns to ritual pre-budget submissions from uncountable legions of interest groups, ministerial grandstanding and fevered media speculation culminating in a well-leaked and spin-doctored budget in early December.

In compliance with a new EU-mandated timetable, the 2014 budget is due in mid-October this year, eight weeks earlier than usual. So the pre-budget speculation season, including the political grandstanding, has been brought forward.

The process of emerging from the Twin Bubbles in bank credit and public expenditure commenced a full five years ago in July 2008 with a modest (at least in retrospect) package of expenditure reductions. To listen to some of the recent discussion you could be excused for believing differently but there is at least another five years to go in getting the financial position of the Irish economy back into some kind of balance.

The exclusive focus of numerous recent contributions on the scale of October's fiscal adjustment lacks context, to be kind. This will be a long haul and arguments about how much austerity should be embraced in October are missing the point by a mile. The budget should be seen as another staging post along a long road which will stretch to 2020 and beyond.

Ireland is scheduled to exit the emergency EU/IMF financing programme from January next. During the three-year period 2011 to 2013, the Government will have borrowed over €60bn from the official lenders, mainly the European institutions and the IMF but also through some bilateral government-to-government loans from the United Kingdom and others.

Resorting to these official lenders became unavoidable in the autumn of 2010. The state lost the ability to borrow in the markets under the weight of budget deficits and the enormous costs of bailing out the creditors of bust banks.

For the last three years the state has been spared the consequences of losing market access because these official lenders were willing to step into the gap. Had they not, the state would have faced default on both bank and sovereign debt. There would have been an immediate closing of the budget gap, including far harsher austerity measures than those we have endured.

From January onwards, the Government will be required to recruit willing market lenders, at affordable interest rates, to fund the on-going budget deficits and the repayment of historical borrowings as they fall due. The State's debt may never literally have to be repaid but it does have to be re-financed on a continuing basis, which means a knife-edge existence for the Irish Exchequer until such time as budget surpluses permit the actual retirement of debt and the return of non-crisis credit ratings.

At the end of 2013, the Government's gross debt will exceed 150 per cent of the national income. When the government's substantial cash holdings and some other financial assets are taken into account, the net debt will still be more than 120 per cent of national income.

It is bizarre that continued borrowing, which will add to this debt mountain, is routinely described as austerity. The IMF is on the record to the effect that Ireland's debts will not prove sustainable unless there is early and sustained growth at a reasonable rate. Since this resumption of growth is not guaranteed, it follows that many more years of tight budgetary policy, plus some good luck, are required before it becomes prudent to think about a more relaxed budgetary stance. It is an illusion to presume that graduation, in January next, from the EU/IMF rescue programme signals the end of the financial emergency.

The discipline required by the official lenders will be replaced by the discipline of volunteer lenders in the international financial markets, easily spooked by signs of consolidation fatigue and political irresolution in over-indebted countries.

As if the Government's debt burden was not enough to worry prospective lenders, the State has further off-balance-sheet liabilities both for guaranteed bank borrowings and for the borrowings of NAMA, the agency which bought the dud commercial property loans from the banks. It also has massive unfunded pension liabilities for State employees and the worrying prospect of further bank rescue costs if mortgage loan recoveries go badly.

So the Irish Exchequer will not have regained its fiscal freedom of action next January just because reliance on the EU/IMF financing has come to an end. Only when the debt ratio has been reduced substantially, after a period of surplus budgets and sustained economic growth, will the government have regained some freedom of action in fiscal policy.

This could take a decade even if things go well. If things go badly, it may not be feasible to exit from reliance on official lenders for the foreseeable future, and there may have to be a successor rescue programme with further conditional emergency finance, or default. The scale of market borrowing required over the next decade is shown in the table above.

The total to be borrowed over the next decade averages €13bn per annum, even if the so-called austerity regime is adhered to. It could be a little less given the likelihood of some further loan maturity extensions. If the government borrows for short periods, as inevitably it will to some extent, part of the borrowing will have to be renewed.

In 2013 the government has been adding to the outstanding debt at the rate of around €1bn per month. Government revenue is still, after tax increases and expenditure cuts, running way behind government spending and the State is continuing to over-spend on a grand scale.

From January next, if exit from EU/IMF oversight happens, market lenders will expect evidence of a commitment to bring new borrowing to an early halt. The enormous amounts to be borrowed in future years will be forthcoming provided two conditions are met. The first is that the economy begins to show some serious signs of recovery. The second is that the political class begins to show some understanding of the nature of the constraints with which they are now confronted.

The IMF, the Economic and Social Research Institute, the Fiscal Council, the Central Bank and numerous independent commentators have been urging the government to stick with its plans and get the deficit down as quickly as possible. The contrary view, that an early relaxation can somehow be justified, is supported by trade unions, the employers' body, IBEC and numerous politicians.

An ingredient in these calls for budgetary policy relaxation is the decision by the NTMA, the government's borrowing agency, to sell large quantities of new government bonds and to place the cash on deposit at much lower interest rates. There will be €22bn of this pre-funding at the end of 2013. This appears to be creating the impression that the cash is there to be spent. On the contrary, it adds to the gross debt and inflates the deficit by several hundred million per annum.

There may well be a compelling case for a looser budget policy at European level. But for heavily-indebted countries such as Ireland, any premature loosening on a go-it-alone basis will make little difference to aggregate demand, courts rejection in the markets, default and a longer spell in receivership as wards of the official lenders.

Sunday Independent

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