“the key objectives of policy must be to support domestic confidence and begin the process of restoring international confidence in our economy” – introduction to briefing notes given to Minister Noonan in March 2011
Will Irelandneed a second bailout? It will depend on domestic economic growth which in part depends on global economic growth, investor attitudes towards Europe and how interest rates charged by investors on any new bond issuances compare with rates from available bailout funds. With present official projections, it is hoped that by 2013 at latest, Ireland will be able to return to the sovereign bond market and obtain lending at interest rates which are comparable to those available from bailout funds, and thus not need a second bailout.
This week began with a “man with some slides”, the Citigroup chief economist Willem Buiter saying that Ireland should begin planning for the possibility of a second bailout; it’s worth repeating that – “Ireland should prepare for the possibility of needing a second bailout”. What domestic politicians and not a small number of media outlets heard was “we will probably/definitely need a second bailout”. Willem’s words ignited a wildfire of reporting and prompted political intervention, notably Minister for Finance, Michael Noonan saying the notion of Ireland needing second bailout was “ludicrous” and An Taoiseach Enda Kenny who was emphatic in replying to a question in London on Thursday when he “absolutely” ruled out a second bailout. And in Brussels, a spokesman for the European Commission described talk of a second bailout as “unhelpful”. I can’t help but recall the heavily redacted briefing notes given to Minister Noonan in March 2011 when he took up his new role – at the fore, the notes said “the key objectives of policy must be to support domestic confidence and begin the process of restoring international confidence in our economy”. Willem’s intervention is plainly an attack on that confidence in the eyes of our political leadership.
It should be said that Ireland will need to borrow money, regardless, beyond that available in the IMF/EU bailout. That is agreed by all, as our country will have a deficit at least until 2015 on current projections and we also have debt (sovereign bonds mostly) which will be maturing and we’ll need to repay the lenders. When we borrow from the bond market however, we don’t give the investors a say in how our country is governed. As we know, with a bailout on the other hand we have so-called conditionality, the IMF/EU call the shots in line with the bailout agreement. So the brouhaha during the week was not about whether Ireland needs to borrow more money – we already know we will – but about the source. And without meaning to insult anyone’s intelligence by stating the bleeding obvious, if we are unable to borrow from the bond market at rates comparable to those available from bailout sources, then we will tend to opt for a second bailout.
On Friday last the NTMA said it was planning to go back to non-bailout sources of funds in 2012 with a first phase a return to the Treasury Bill market – eg: 3 month duration – in mid year with a view to moving to longer term debt auctions late this year/early next year, subject to continued progress on the bailout programme and resolution of EuroZone crisis.Irelandis already borrowing small amounts with short durations but that is not done by auctions but by request. That’s what the NTMA said. What the media heard was “Irelandwill return to bond markets in 2012”. That’s not what the NTMA said, and it was careful to attach caveats.
Now we need funding for three main headings
(1) Day-to-day expenses of the State: we’re spending more on public sector and social welfare than we are taking in, in taxes. The resulting deficit needs to be funded from somewhere. We are working to get the deficit down and by 2015 to less than 3% of our GDP, which is seen as sustainable – that’s the official line. 2015 is four years away so who knows, but from this perspective, the absence of any growth stimulus as recommended by the ECB and many economists will make growth targets in 2013-2015 challenging.
(2) Bailing out the banks. A lot of this has already happened. But there is still nearly €3bn per annum for nearly 15 years that will need to be paid in cash for Anglo/INBS’s losses.
(3) To pay maturing debt. Even back in 2007,Irelandhad borrowings of about €40bn, and that has increased substantially since. These borrowings need to be repaid as they come due. So when we talk about a 10-year Irish bond, that is a bond issued to an investor for 10 years, we pay the investor interest on the bond each year and after 10 years, we redeem the bond, that is, we pay the investor the amount he originally gave us.
Of those three headings, (3) is pretty certain, (2) is based on stress testing in our banks and some say that the losses that might arise with mortgage defaults, loss-making tracker mortgages, legacy property lending which wasn’t transferred to NAMA may all mean that further bailout costs are incurred. (1) is probably the most uncertain, it depends on economic growth and the Government successfully bringing in measures to bring the deficit down. Based on current projectionsIrelandwill not need any more funding (or a second bailout) between now and the end of 2013. Could that change? Yes certainly, for example if our economy contracted 5% in 2012 and the deficit grew because of weak taxes and high social welfare payments, then yes we would need more funding before the end of 2013, but from this perspective that’s not considered likely.
But the big uncertainty is whether or not the interest rates demanded by lenders in bond markets will be low enough by the end of 2013, so that we are able to return to the bond markets. If interest rates remain elevated compared with rates available from bailout funds, the IMF and the European funds, then yes,Irelandwill need look at bailout options. That seems obvious, right? But this is what caused all the bother during the week.
It is certainly the case that Ireland’s notional cost of borrowing has declined considerably in the last six months, and at the close of business Friday, the notional interest rate on our bonds redeemable in 2020 was 7.84%, that compares with 14%-plus in July 2011 – however most of the decline happened last August in the wake of the EU summit in July which saw our bailout interest rates reduced. However it is still considerably higher than the 3.7% average interest rate which now applies to our bailout. On the other hand, funds from a bailout diminish our sovereignty and it may be preferable to obtain funding on the open market, even if rates are higher there. How much is the sovereignty premium worth? At least 300 basis points or 3% it seems in the case ofItaly which has in recent weeks been paying 7% for relatively small amounts of long term funding. Others suggest that anything above 6% is unsustainable. What are the chances of our funding costs falling from 7.84% to 7% or 6% in 2013?
Too early to say in an such a fast-changing environment; in the short term it looks unlikely as we lurch from one crisis to another in the EuroZone. We can certainly hope that rates demanded by the open market will come down to what is judged a sustainable level. And that is probably why Willem’s comments attracted such robust political responses – Minister Noonan and An Taoiseach have absorbed the advice given in their briefing notes in 2011, and by dismissing talk of a second bailout believe they are “instilling domestic confidence and restoring international confidence” whereas entertaining the notion of a second bailout is seen as doing the opposite – undermining confidence. But as France, like many others before, has found, no matter how much you attack the messenger/commentator, markets, ratings agencies and economies will tend to pursue their own paths.