Yesterday’s EU summit leaves so many questions unanswered. Here are some of them…

“I think based on what we know so far, the package of measures agreed is good news for Ireland and should be welcomed. I think there are some important questions that do need to be clarified : the application of the interest rate cut, how much of the bailout facility will that relate to, the fund that was under examination today only represents about a quarter of the overall money that we are availing of, and secondly we need to know what the government has agreed on corporate tax harmonisation which could represent a real danger to this country’s economic interests”  Michael McGrath, Fianna Fail spokesperson on Public Expenditure & Financial Sector Reform, speaking on RTE News after the EU summit statement yesterday

I think Deputy McGrath summed up the general reaction to the statement yesterday evening inBrussels after the conclusion of the summit of EU leaders including our own taoiseach, Enda Kenny. Without any further press release from the Taoiseach or the NTMA or the Department of Finance, many questions remain:

(1) What is the new interest rate being charged on the bailout? The statement from the summit referred to “lending rates equivalent to those of the Balance of Payments facility (currently approx. 3.5%), close to, without going below, the EFSF funding cost” The EFSF website is not very helpful in explaining the “Balance of Payments” facility, in respect of  which, the website refers you to a broken weblink. Reporting from the summit suggests a rate of “3.5% to 4%” – but why not simply 3.5%?

(2) What part of the bailout does the new interest rate refer to? The IMF said the reduction didn’t affect its €22.5bn contribution to the Irish bailout. With respect to the EU contribution to the bailout, €17.7bn comes from the EFSF, €22.5bn from the EFSM and €5bn in bilateral loans (see here for the splits). The EFSF is the EuroZone fund, and the leaders of contributing countries were in attendance yesterday. The EFSM is the EU bailout fund and several leaders of contributing countries, eg the UK, were not present yesterday. Also there was no representation from the bilateral loan countries, the UK, Sweden and Denmark. So the conclusion on here is that the reduction only applies to the EFSF facility.

(3) Will the new interest rate apply to past as well as future drawdowns? The summit statement referred to “future EFSF loans” in respect of Greece but then said “the EFSF lending rates and maturities we agreed upon for Greece will be applied also for Portugaland Ireland”. The Taoiseach said at a news conference, reported by the Irish Times, “this [interest rate reduction] will apply not only to monies yet to be drawn down but also to future interest payments on existing loans and that’s an important consideration”

(4) What are the new maturities for the bailout loans? 15 years? 30 years? 40 years? And will the new maturities apply to loans already drawn down as well as new draw-downs?

(5) How is the six to eight hundred million saving, claimed and widely reported and not challenged, calculated? This was the quantum of annual saving claimed in Taoiseach Enda Kenny’s brief interview with RTE’s Tony Connelly in which he was asked “any idea in numerical terms what this will mean in terms of billions of euro saved because of this cut?” and answered “well, it’s of the order of 2% and my reckon (sic) without having all of the details which have yet to be worked out will be in the order of six to eight hundred million which is quite substantial”. If the new interest rate applies to the EFSF only then that is a maximum loan of €17.7bn and we are presently paying 5.9% so a 3.5% interest rate would result in a maximum annual saving of €424m. The Taoiseach says the new rate applies to previous draw downs but if that was not the case and only applied to the €14bn yet to be drawn down the maximum saving would be €336m. To get to the Taoiseach’s lower figure of €600m, we would need see a 2.4% saving on €25bn, which happens to be the total yet to be drawn down on both the EFSF and EFSM. To see a figure of €800m, there would need to be a 2.4% saving on €33.3bn which doesn’t represent the sum of any of the discrete elements of the sources.

(6) When will the terms of the EFSF be changed? This may be an administrative point but might assume more significance in the context of the next question.

(7) What does a constructive participation in “discussions on the Common Consolidated Corporate Tax Base draft directive (CCCTB) and in the structured discussions on tax policy issues in the framework of the Euro+ Pact framework” mean? For how long will Irelandneed “constructively participate”? Who will judge whether or not Irelandhas “constructively participated”? Using what criteria? What is the penalty if Irelandis not judged to have “constructively participated”? Will statements made  by Irelandnow, prejudging the outcome of the “constructive participation” violate the terms of the agreement? The Taoiseach was clear on RTE’s nine o’clock news last night (4:00 on) “we’ve actually achieved a substantial interest rate reduction, greater flexibility in terms of the fund, without conditions attached, and more flexibility in terms of the maturities” So “constructive participation” is not a “condition”. And lastly, why hasPortugal secured the new concessions without offering anything in return?

(8) On what basis will the EFSF buy back bonds? Will the bonds bought back be sovereign or bank or both? Will the EFSF have trigger purchase points eg ifIreland’s 10-year bond exceeds 10%?

But probably the most significant question is : why has Ireland not secured the same default deal as Greece? Okay, Greece’s debt:GDP is projected to reach 172% by the IMF and Greece has not implemented its Memorandum of Understanding and Greece’s economy continues to contract but Ireland is projected to have a debt:GDP of 118% with minimal growth this year (0.75% is the official current projection) and Ireland has implemented the Memorandum of Understanding. On what basis canIreland have been excluded from the default arrangements being put in place forGreece? Because our debt:GDP is “only” 118%? HasEurope thrown moral hazard out the window? Europe has said up to now thatGreece’s debt was sustainable ifGreece followed the programme. What has changed? It should be said that the Greek plan is still unclear as to what is meant by contribution from the private sector, and further details will no doubt emerge in due course.

“A Rubicon has been crossed in terms ofEurope” is how independent Irish politician Shane Ross described the conclusions yesterday. He was referring to the acceptance of default in the case ofGreecebut he predicted the Greek option would be open toIrelandand other indebted countries also. The source for that optimism is not at all clear.

With respect to the corporate tax issue, here’s why the commitment “to constructively” engage in discussion is of concern on here. And to illustrate the concern, consider another routine negotiation in Europe, the monthly setting of interest rates at the ECB. Patrick Honohan, governor of the Central Bank of Irelandis our representative on the 17-member governing council and representsIreland at the monthly meeting. The main ECB interest rate at present is 1.5%, having been subject of two increases of 0.25%-a-time in recent months.Ireland’s economy is presently so weak that it is generally agreed that the appropriate rate forIreland should be practically zero (or theoretically minus 5% according to Credit Suisse) whereas forGermany, the appropriate rate for that economy which is growing at 2-3% per annum with a looming inflationary issue, the appropriate ECB rate is 3-4%. Governor Honohan no doubt makesIreland’s case, but in the final vote, he needs to vote according to the needs of the 330m people in the EuroZone, not the 4.6m here. That’s the nature of Governor Honohan’s role in setting ECB interest rates and apparently the last two decisions to increase rates have been unanimous – there is no hidden conspiracy here : Governor Honohan has publicly said that in this one matter, setting ECB interest rates, he represents Europe not Ireland. And indeed, as ECB president, Jean-Claude Trichet repeatedly tells us, appropriate interest rates forEurope generally should be beneficial to all countries.

But that’s why the commitment given by Taoiseach Kenny yesterday is concerning. If he is presented with a position by his European partners which shows that adopting new corporate tax arrangements is better for Europe overall, perhaps because it stops companies diverting income generated in Europe outside the continent, then can Enda refuse to accept reforms even if they hurt Ireland’s national interests?

And regardless of the outcome of participation in discussions, Ireland’s tax environment has changed this week. From an implacable cornerstone of Irish industrial policy, corporate tax arrangements are now on the table for discussion, and that may have to be the case for some time, years perhaps, to come. Those considering investment in Europe today must place a higher probability of tax changes in Irelandthan a week ago. And that is in itself harmful. Prior to this, it was just unhelpful for France to raise the issue of our corporate tax rate, akin to the loaded question “do you still hit your wife”, it just sowed doubt in the future of our commitment to corporate tax arrangements. But that posturing could be dismissed with solemn commitments byIreland. We can’t give these anymore, or if we do, we are presumably prejudging “constructive participation”.

The position on here is there needs to be some clear communication on what was agreed yesterday. On the face of it, the interest rate reduction, considered in isolation is valuable, particularly if it applies to the EFSM and to past as well as future draw-downs. The extension of maturities is also valuable if it guarantees substantial funding at 3.5% for long periods – judged from a net present value perspective, that is good news for Ireland. The possibility of using EFSF funds to buy back bonds may also be helpful as it might deter stratospheric speculation in our bonds, but unless we get our bonds back down to sub-6% long term rates, then EFSF intervention in the market may only have a cosmetic effect. And not to be underestimated, yesterday’s conclusions have eased the crisis in Europe, at least for the time being which is also good for Ireland. These positives should be weighed against risk (perhaps just reputational risk) to our corporate tax arrangements and unequal treatment compared with Greecein seeing apparent debt write-down. Debt problems in Greece, Spain, Italyand arguably Irelandare not solved by yesterday’s announcements and we may be back here for Spainin weeks. And lest we forget, even if the annual saving from a lower interest rate is €800m, we are spending a multiple of that on bondholders in insolvent Irish banks. Earlier this week, it was revealed that we have spent €1,060m on unguaranteed, unsecured senior bondholders in just one zombie Irish bank, Anglo, so far this year. Yesterday’s interest rate concession is dwarfed by these ongoing payments.

UPDATE (1): 22nd July, 2011. It seems not to be online yet but I have the following statement from the UK Treasury confirming it will reduce the interest rate on its GBP 3.3bn bilateral loan to Ireland. No details as to the reduction but the loan agreement allows for a 2.29% margin which if the EFSF approach above is followed, will be eliminated.

“This morning I spoke to my Irish counterpart, Michael Noonan, and told him that we could cut our interest rate on our loan to them.

I’ve been arguing for some time that the interest rates charged for eurozone loans were too high. I’m pleased therefore they have now reduced those rates. That enables Britain to cut its rate on its loan to Ireland, while ensuring all of the benefit goes to Ireland and not to higher interest rates paid to euro area governments. We will still be more than covering the cost of our borrowing.

We stayed out of the Greek bailout as promised. But, for Britain, Ireland is a special case. Our loan will help them and is in our national interest”

UPDATE (2): 22nd July, 2011. And Minister Noonan has responded to the British move with his own statement, in which he opens “I welcome today’s announcement by the Chancellor that the UK proposes to reduce the interest rates on the loans to Ireland to a level slightly below the new European Financial Stability Fund (EFSF) interest rate. ” Currently 7 year sterling swaps are just below 3.5% so that makes sense.

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