Repaying the Debt?

A lot of attention recently has been given to the fiscal rules that formed the basis of the recent EU treaty (inter-governmental agreement?).  One that has attracted significant attention is the Debt Brake or “One-Twentieth Rule”.  The balanced budget rule allowed a structural deficit is no more than 0.5% of GDP is probably more important but some of the commentary on the Debt Brake is worth considering.

On last night’s Primetime, Miriam O’Callaghan introduced a question to Kieran O’Donnell by saying:

“People are talking about €6 billion needed to take out on an annual basis”

On the previous night’s Vincent Browne, Stephen Donnelly said:

“To pay down €100 billion in five years you’ve got to pay down €5 billion a year, that’s what the treaty says.”

I have read the treaty and I don’t know where this is coming from.  The opening report on Primetime suggested that if our debt peaks at 118% of GDP in 2013 we would then have 20 years to reduce the debt and that we would have to “dramatically pay down this debt”.  The prospect of repaying debt is not an attractive one given the current state of the Irish economy.  However, it is not a prospect we are are not likely to face.

Ireland is currently in an Excessive Deficit Procedure which is largely about getting the annual fiscal deficit below 3% of GDP.  For 2012, we are targeting a deficit of 8.6% of GDP, and the current plan is to get that down to 2.9% of GDP by 2015.  As long as a country is in the EDP it is that annual deficit rather than the total debt that is key metric. 

And then once the country gets the deficit below 3% of GDP it enters a three-year transition period before the debt rule becomes effective.  This was explained in this Council Regulation:

"For a Member State that is subject to an excessive deficit procedure on 8 November 2011 and for a period of three years from the correction of the excessive deficit, the requirement under the debt criterion shall be considered fulfilled if the Member State concerned makes sufficient progress towards compliance as assessed in the opinion adopted by the Council on its stability or convergence programme. "

The implications for each country are more clearly detailed in this press release.  The last line confirms that Ireland will not be subject to the "numerical debt reduction benchmark", the one-twentieth rule, until 2018.  This is likely to be the earliest.  The three-year transition period does not begin until the excessive deficit has been corrected.  In this three-year period a country has to show is “sufficient progress towards compliance”, which is rather woolly.

It is also important to note that the “one-twentieth” rule does mean the debt has to reach the 60% of GDP target in 20 years.  It specifies that about one-twentieth of the gap between the current debt level and the 60% of GDP target must be closed each year.

Under the rule a country with a debt of 120% of GDP has 20 years to get the debt down to 70% of GDP, with the one-twentieth improvement getting so small that it can take another 20 years to bring the debt down to the 60% of GDP level.

The required reductions in the debt ratio appear large at first but do moderate significantly as the debt converges on the 60% level.  This is not a linear projection that will require €x billion to repaid each year.

Given our deficit problems, the focus until 2015 and beyond will be on bringing down the deficit rather than repaying debt.  There is no requirement to repay debt and bringing down the deficit will stabilise and, in time, reduce the debt ratio.

So what happens in 2018?  Will we have to start “taking out” money from then?  Debt projections out to 2018 are unlikely to be very reliable.  In its last published review the IMF projected a General Government Debt of 111% of GDP in 2016.  With the planned reduction in the deficit that could be down to 105% of GDP in 2018.  No one can be sure.

If the debt brake is applied for a country with a debt of 105% of GDP they would have to reduce the debt ratio to 101% of GDP the following year. [Technically they only have to budget to achieve the required debt reduction rather than actually achieve it.]

A country with a balanced budget would achieve that with a real growth rate of 2% and an inflation rate of 2%.  There would be no necessity to make any debt repayments.

In fact, once the debt ratio gets below 90% of GDP, a country with 2% inflation and growth rates would be able to run (small) deficits and still meet the debt reduction requirements.  The debt brake does not eliminate the potential to borrow additional money but it does substantially limit the rate at which this money can be borrowed.

From an Irish perspective (and the perspective off all other countries) the balanced budget rule  is far more significant.  This requires a structural deficit of no more than 0.5% of GDP (1.0% of GDP for countries with a debt of below 60% of GDP).  If by 2018 Ireland has a structural deficit of less than 0.5% of GDP it is likely that we would satisfy the conditions of the “one-twentieth” debt brake rule without the need for any additional measures.

If the budget has been brought into balance by 2018 (a big if but we have the luxury here of just having to assume it) it is likely that growth and inflation would do most of the heavy lifting for the debt ratio reduction.  With a balanced budget an inflation rate of 2% and a growth rate of 2% would be enough to bring the debt ratio down from 105% of GDP to 101% of GDP and all the way down to the 60% target.  We would not have to make any debt repayments but could choose to do so.

As stated above it is the balanced budget rule which will potentially have a greater effect .  The conditions and effect of the debt brake are fairly objective and clear.  There is no consensus on how a structural deficit should be measured so the precise implications of the balanced budget rule cannot be objectively assessed.  The 3% limit on the overall budget deficit remains.

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All yields now under 7%

Here is a snapshot from yesterday Daily Outstanding Bonds Report from the NTMA.

At there closing prices in trades put through the Irish Stock Exchange yesterday all Irish government bonds were yielding less than 7%.

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Debt in Ireland in 2011

A previous post showed the increase in private sector loans from 2003 until its peak at the end of 2008.  This showed that the level of private sector loans to Irish residents from banks in Ireland was around €350 billion in December 2008. 

Since then consumer loans from the banks have fallen to about €20 billion.  Residential mortgages have increased to €114 billion while buy-to-let mortgages have fallen to €33 billion offsetting the increase.  Loans to the business sector excluding the property sector have fallen to €40 billion.    Here is a summary table which updates the table from the earlier post.

As a result of the NAMA transfers and the exit of Bank of Scotland (Ireland) from the market it is hard to tell what has happened to the €112 billion that had had been lent to the property sector by the end of 2008. 

In the Central Bank data loans to the construction sector have fallen from €9 billion to 2008 to €3 billion now while loans for land and development activities have fallen from €103 billion to €56 billion.   Most of this fall is as a result if transfers to NAMA rather than repayments.

The “transactions” data provided by the Central Bank which accounts for the NAMA transfers and bank exits rather then the “volume” data which doesn’t.  This shows about a €5 billion drop in construction loans and no change in land and development loans because of transaction (draw downs and repayments) over the past three years. 

We don’t know what has happened to the loans that went to NAMA or what has happened to the loans in Bank of Scotland (Ireland) that are now being handled and wound-down by Certus.  We will just assume that there has been a €5 billion drop in property sector loans over the past three years based on the drop in construction loans.

Summing these changes means bank loans into the Irish economy are down to around €315 billion.  By adding in credit union loans and loans from other sources it is likely we would get up to €330 billion, give or take.  This is the total extent of private sector loans in the Irish economy.

With 2011 GDP likely to around €156 billion and GNP around €128 billion the loan to national income ratios will be around 210% for GDP and 260% for GNP.

At the end of 2011 the General Government Debt was around €166 billion.  Around €46 billion of this is to cover losses the covered banks made on the above loans.  Most of these losses were in land and development loans but the losses will by no means be confined to that category.  In our €330 million private sector total we have counted these non-performing loans but it is money from the government that will pay them (though only for losses in the covered banks).

The extra debt from the government sector is around €120 billion, about one-third of which is the debt the government brought into the crisis in 2007 and two-thirds the debt the government has accumulated by running huge deficits since 2008.  This €120 billion of government debt onto the earlier €330 billion of private sector loans gives a total of €450 billion of debt in Ireland. 

If we want to sure to be sure that this is the total amount of debt in Ireland we can make an allowance for some other loans such as those sourced from outside Ireland.  All in, it is likely that the sum of household, business and government debt accumulated by Irish residents is something under €500 billion.

At €500 billion it would put the debt ratios at 320% of GDP or 390% of GNP.  This is an excessive level of debt.  The next post will consider how this can be brought under 300% of national income though a reduction to well below that will be necessary to return to “safe” levels of debt.

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Who “went mad borrowing”?

The following quote has generated a lot of response in the past week:

“What happened in our country was that people simply went mad borrowing.  The extent of personal credit, personal wealth created on credit was done between people and banks - a system that spawned greed to a point where it just went out of control completely with a spectacular crash.  The country borrowed over €60 billion at excessive rates and the IMF eventually came in with the Troika."

It is of course the answer Taoiseach Enda Kenny gave at a panel session at the World Economic Formum in Davos last week when he was asked “what went wrong in Ireland?”.  I’m not sure what the last sentence is referring to but here we’ll focus in the extent to which “people simply went mad borrowing”.

Here is a graph of loans to Irish residents from January 2003 to January 2009.  The data can be extended to December 2011 but the actual fall in loans is exaggerated in this data because of the impact bank exits and NAMA have on the Central Bank’s banking statistics.  In January 2009 this factors were not at play and this is widely accepted to be around the time when total loans peaked in Ireland.  It can be seen that the rate of increase began to ease in late 2007 and had plateaued by the middle of 2008.

The blue line represents total loans to Irish residents.  This increased from €110 billion in January 2003 to €350 billion by December 2008.  A rise of 220% in just six years.  Total loans went from being around 90% of GDP in 2003 to nearly 200% of GDP in 2008.  This would satisfy any criteria for going  “mad”.  The red and green lines represent total loans to Irish residents excluding two categories.

The red line excludes loans to businesses in the construction sector and for real estate, land and development activities.  The green line further excludes loans to households for buy-to-let mortgages.  The green line is thus total loans to Irish residents excluding loans for investment and speculation in the property sector.

Excluding these loans, loans to Irish residents rose from €83 billion in January 2003 to €195 billion by the end of 2008.  This is still a rapid rise but is an increase of 135% rather than the 220% increase seen for all loans.

As a percentage of GDP loans outside of investment in the property sector rose from 66% of GDP in 2003 to 108% of GDP in 2008.  This is a large increase but not catastrophic.

Loans for investment and speculation in the property sector rose from €27 billion at the start of 2003 to €150 billion at the end of 2008.  There was an increase from 25% of GDP in 2003 to 83% of GDP in 2008.

There is no doubt that borrowings by Irish people increased dramatically from 2003 to 2008 but a lot of the increase was concentrated in the construction, property and development sectors.

Loans to Irish businesses outside of the property-related sectors was €29 billion at the start of 2003 and reached €60 billion by the end of 2008.  This rise from 20% of GDP in 2003 to 33% of GDP in 2008 has not put us in the position we are in now.

Excluding buy-to-let investment mortgages loans to households rose from €52 billion to €140 billion.  Residential mortgages increased from €40 billion to €110 billion and other consumer borrowings rose from €13 billion to €30 billion.

With property-related loans perceived as being the source of our ills it is worth noting that household residential mortgages rose by €70 billion while investment and speculative loans in the property sector rose by more than €130 million.  Both increases are excessive but it must be realised that one is almost twice as large as the other and also that the increase in mortgage debt was spread over hundreds of thousands households rather than being concentrated like the property loans.

Here is a summary table and an annotated version of the graph used above is here.

The stand-out figures are the 350% increase in buy-to-let mortgages and the 490% increase in loans to the construction and property sectors.

[Note: The data here are taken from the Central Bank’s Money, Credit and Banking Statistics.  This includes data from all banks operating in Ireland.  For the period in question this excluded the credit union sector which was added to the data in 2009.  Total loans in the credit union sector have not exceeded €8 billion so their inclusion would do little to alter the conclusions.  The data also exclude loans that may have been obtained from banks outside of Ireland but it is not clear now prevalent this was in the household and business sectors.]

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Croke Park Presentation

Here is a screencapture video of a presentation I gave at a conference that was held in Croke Park last Friday.  The presentation looked at investment in the Irish national accounts data and the breakdown between current and capital expenditure in the government accounts.

The conference was a Dublin Economic Workshop meetings held in collaboration with the UCD Geary Institute and UL.  Liam Delaney, Colm Harmon and Stephen Kinsella were the organisers.  The full programme can be seen here while audio podcasts and copies of the slides used in all of the presentations can be accessed here.

There is a thread on www.irisheconomy.ie that looks at some of the issues raised in the talk here and the site also has threads open on some of the other sessions held that day.

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