Saturday, May 7, 2011

More on the Public Debt

Got up this morning to see that Morgan Kelly has another chilling article in The Irish Times.  It is required reading.  Prof. Kelly is willing to say things that other people are not.  On the whole issue of public debt sustainability, which we looked at recently, he is pretty clear.

Irish insolvency is now less a matter of economics than of arithmetic. If everything goes according to plan, as it always does, Ireland’s government debt will top €190 billion by 2014, with another €45 billion in Nama and €35 billion in bank recapitalisation, for a total of €270 billion, plus whatever losses the Irish Central Bank has made on its emergency lending. Subtracting off the likely value of the banks and Nama assets, Namawinelake (by far the best source on the Irish economy) reckons our final debt will be about €220 billion, and I think it will be closer to €250 billion, but these differences are immaterial: either way we are talking of a Government debt that is more than €120,000 per worker, or 60 per cent larger than GNP.

I tend to be with Namawinelake on this one.  I’d like to know how the €250 billion of debt is expected to materialise.  If this comes to pass (and Prof. Kelly has some previous on this) then the country will be insolvent.  There is no doubt about that.  However, in my view the total debt by 2014 will be closer to €200 billion.  This figure puts us on the border of insolvency but it is not one that makes default “inevitable”.

The €220 billion estimate from Namawinelake is from this comment in February and is reproduced here.  At least this provides some details to work from.

As regards government debt in 2014, for the time being I will go with the government’s own deficit projections (€43bn 2011-2014) though the balance of opinion seems to be that GDP growth will be less than official projections. I believe the Promissory notes will need be drawn down sooner rather than later and not in an even 10-years but frankly this is all tinkering around the edges. The real question is what will happen with ECB operations that see €100bn in our banks at present, how long can this emergency funding continue (it started in Sept 2008 in earnest) and will part of that end up on the national debt?

So general govt debt of €148bn in 2010 + €43bn deficit 2011-2014 + additional capital for banks (€35bn earmarked of which €25bn is described as a contingency) + debt redemption nil (rollover) + NAMA €45bn (€40bn bonds including pyt for sub-€20m exposures and €5bn development debt) + swapping of ECB/CBI ELA for national debt x,

So €271bn + x for ECB/CBI ELA swap for general government debt.

Obviously NAMA will have some value as will ELA and we start off with some funds in the NTMA/NPRF so the net will be less than that , but I would have said €220bn as a rough ballpark.

There is not a lot wrong with this analysis. Since February we have learned that developer loans of less than €20 million will not be transferred to NAMA.  Of course, this doesn’t eliminate the losses it just makes the potential NAMA losses a little smaller.  It makes the potential bank losses bigger by the same amount, but we now know that the banks will require €24 billion to cover these losses and become “over-capitalised” rather than the  full €35 billion of the contingency fund that was used in the debt estimate above.

This will bring the €220 billion debt estimate for 2014 down to below €210 billion and not too far from what we have forecast.  Of course, even that estimate is plagued with uncertainty as we have recently noted.

There are other issues related to the banking collapse that are not included.  These are the final outcome of the NAMA process, whether the shutdown of Anglo and INBS will require further injections of capital, and how to unwind the €140 billion of liquidity the banks have taken from the European and Irish Central Banks.  There is also the long-term hope that we will be able to sell off our stakes in the two ‘pillar’ banks to recoup some of the money swallowed by the bailout.  There is a great deal of uncertainty about all of these.

An extreme negative outcome an any of these could bring the debt level close to Prof. Kelly’s prediction of €250 billion.  It would be nice if he had told us which of these he expects to go south.  There are four items listed above and it might be easier to bet on one unspecified loser than try to find four winners but I’m willing with the following:

  • Namawinelake’s estimate that NAMA is currently nursing losses of around 11% on the loans it has obtained based on the site’s NWL Index.  The index “is about NAMA breaking even” and I’m not exactly sure how to translate this into a monetary loss, but NAMA has paid €30.5 billion for the loans it acquired.  This would indicate a loss of around €3.5 billion.
  • The Central Bank’s belief that Anglo and INBS will not require any additional capital from the State. If they do there are some senior bondholders left that have to be first in the burden-sharing line.
  • That the central bank liquidity can we wound down over time.  Should we be looking to end a situation that has our banks getting €80 billion from the ECB at the extraordinary low rate of 1.25% and a further €65 billion from the Central Bank of Ireland at around 3.00%, which itself is also from the ECB?  This is a huge implicit subsidy for the banks and, by association, us.
  • We can forget about selling the so-called “pillar” banks in the timeframe considered. We may be able to do so at some stage in the future but this does not enter into the medium-term sustainability analysis.

If all of these come to pass we can expect the 2014 debt level to be in the region around €205 billion.  If nominal GDP by 2014 got to €170 billion then the debt/GDP ratio would be around 120%.   The design of the Promissory Notes means that the amount of cash we will have had to borrow will be around €18 billion less, bringing the debt that we will actually have to pay interest on to around 108% of GDP and we would have to commit around 5% of GDP per annum to interest costs.  As I said here.

There remain some significant uncertainties that may force a restructuring regardless, but based on what we now know I think we can survive without a default/restructure. The decision may be made to take this option anyway and if the benefits of doing so exceed the costs then the view that the debt is “sustainable” is moot.


  1. "The design of the Promissory Notes means that the amount of cash we will have had to borrow will be around €18 billion less, bringing the debt that we will actually have to pay interest on to around 108% of GDP and we would have to commit around 5% of GDP per annum to interest costs."

    The promissory notes pay interest to the banks.

    Also the capacity of the government to raise revenue and the ability of consumers to spend is more closely aligned with GNP rather than GDP.
    So while the debt to GDP ratio looks close to borderline the debt to GNP looks unsustainable. Under the latest Growth and Stability Pact submitted by the government debt to GNP will peak at 142% of GNP in 2013

  2. Of course, you are right. We are liable for interest on the Promissory Notes. The design of them is such, though, that we don't actually pay the interest. Instead it is rolled up into the capital amount.

    In 2014 none of our tax revenue will go to meeting the interest on the Promissory Notes. We won't be paying it. We will be paying interest on the amount of money we have used to pay the Promissory Notes by then and the document indicates that this will be €0.65 billion for the year. The €1.6 billion interest due on the Promissory Notes will just be rolled up meaning they will be paid out over a longer timeframe.

    The gap between GNP and GDP is important but our ability to tax the incremental amount between them is not zero. The debt/GDP ratio is the internationally used standard for measuring public indebtedness. But Ireland just has to be different!

    Maybe a better measure would be the interest/tax revenue ratio. This gives a comparable measure of the burden of the debt. Unless there is an about-shift in our tax policy this is heading for 20% at an alarming rate. This is a huge burden to carry. Not impossible. But very very hard.

  3. @Seamus Coffey
    Not really that sure that the off-balance sheet trickery of the promissory notes helps that much in the medium, long or even the short term.

    Maybe it is just me, but after a number of years working in this area I think it is always best to look at what is actually happening rather than what they want you to think is happening.

    You are also making a massive assumption that the capital from the promissory notes will be needed in a linear manner over the next 10 years. In reality the timing of the actual capital requirements will be far less linear and much more front loaded than assumed in the DoF projections.

    "The gap between GNP and GDP is important but our ability to tax the incremental amount between them is not zero. The debt/GDP ratio is the internationally used standard for measuring public indebtedness. But Ireland just has to be different!"

    In this situation yes Ireland is different but not unique in having such a large gap between GNP and GDP. But it is a reality and shouldn't be ignored IMO.

    Yes, not non-zero but significantly lower than the average tax rate in the rest of the economy.

    Yes I think that is probably a better measure, so long as you include accrued and actual interest though.

    I haven't seen international comparative stats before so not sure if many countries have come back from the level we are heading but I would doubt it.

    I don't think it is an absolute certainty that Ireland will default I do however put the probability of default at more than 75%

  4. Limerick LeaderSaturday, May 07, 2011

    Seamus, Anglo and INBS currently has nearly €3 billion worth of guaranteed bonds with a further €3.7 in Senior Unsecured bonds. Whatever about the senior unsecured bonds burning guaranteed bondholders would mark a serious change of government policy, a policy change I can’t see the ECB being too happy about. Not the mention the associated market reaction. Financial Regulator said burning these bondholders was an open issue but given their senior status 50 cent in the Euro would still cost us over €3billion.

    In addition we are going to get a 1% interest rate reduction on our loans. I can’t stand all this political posturing going on in Dublin and Brussels, we were always going to get a reduction timed with Portugal’s entry to the fund. This saves us 3.375 billion up to 2014. Ok it is not going to solve our problems but surely some account should be taken of it. Morgan simply dismisses it.

  5. Limerick LeaderSaturday, May 07, 2011

    Sorry that 3.375 I was on about should be €1 billion.

  6. Hi Dreaded_Estate,

    I hadn't thought that the capital payments on the Promissory Notes could be nonlinear. I took the statement the "Promissory Notes will be paid in equal instalments over the next 10-15 years." from the DoF Note at face value. Change to that would have implications for my analysis which is based on this paragraph in the note.

    "The impact of the interest on the Promissory Notes on the General Government Balance is approximately €1¾ billion in both 2013 and 2014, and reducing in subsequent years. This equates to about 1% of GDP. However, it should be noted that this does not affect in any year the actual borrowing being carried out by the NTMA in order to pay the capital amounts due to the relevant financial institutions."

    If we have to make the capital payments earlier than the interest costs of the money we have to borrow to meet these payments will increase earlier. I had not factored that but can only take the DoF at their word!!!

    Like you I don't think default is an absolute certainty. It is very hard to put a probability on it as it will be a political as much as an economic decision. I think the probability of it becoming "inevitable" is somewhere around 20%. The probability of it actually happening is higher.

    Who is to say what will happen over the next few years. We cannot rule out an early election. Will the electorate get the option of choosing a party that offers a sovereign default as part of it's manifesto? That was not there this time but might be there in the future. This time it was a case of "better the devil you know".

  7. Seamus, Morgan said in his article that most of Irish government bonds are held by Irish banks and insurance companies. In one of your previous blog you said "The covered banks hold about one-eight of Irish government bonds".

    I had a gander through the maze that is the central bank website. According to CMBS report you referenced Irish banks hold €10.198 billion. According to the CB bulletin insurance corporations and pension funds hold €1.843 and if you include financial intermediaries and auxiliaries of €2.564 this brings the total €14.6 billion. This is about 16% of total Irish Government bonds of €90 billion.

    Is Morgan human after all or is something missing? 16% is hardly most!

  8. Hi Limerick Leader,

    We still don't know if Anglo and INBS will need more money. Alan Dukes has said that Anglo has enough to proceed with the wind down. The recent stress tests on the "viable" banks gave some details on the "zombie" banks in an appendix I (page 80 of the document.

    They indicated that Anglo was sufficiently capitalised but that INBS may have to make future provisions of up to €195 million. It states that the capital of the merged Anglo/INBS entity will have enough to absorb this.

    If they do need additional capital then hopefully the unguaranteed unsecured senior debt will take a hit. It has to!

    A 1% cut in the interest rate would be helpful. A €1 billion savings by 2014 is as much as we could hope for. €1 billion is a massive amount of money but in the greater scheme of this debt crisis it is nearly small beer. One billion euro! That's a lot of money.

    The BBC have reported that the rate cut is a done deal. Reports elsewhere have denied it. It would be welcome but not enough to make a difference one way or the other. I don' think it will bother Morgan Kelly too much!

  9. Hi Patrick,

    The statement "most Irish government bonds are held by Irish banks and insurance companies" by Prof. Kelly is wrong. I imagine this article was a while in the making so this is a substantial error to have slipped through.

    You go through the numbers fairly well. For a concise view see Table E2 of the Central Bank's Quarterly Updates. In the most recent version it is on page 159 of the pdf.

    This shows there were €90.1 billion of Irish government bonds in issue at the end of 2010. Of this €74.1 billion (or 82.2%) are held by "rest of the world" residents.

    Of the Irish resident holdings you just missed holdings by the government itself (€0.84 billion) and households (€0.25 billion).

    I thought it was significant enough that the covered banks held about one-eight of the government bonds. Prof. Kelly assumed this up to a whole different level - and is plainly wrong.

  10. It seems to me that there is a real need to make an analysis of net debt vs gross debt. Compared to other countries, the picture might well look much more positive when looking at the net debt position of Ireland rather than its gross debt. There is of course an issue that the assets that Ireland is accumulating are not easy to monetize. But they still have value.

  11. Anonymous,

    That is very true. As we have seen from some contributions to the debate it is possible to get virtually any debt figure you want if you start adding up all the liabilities you can find.

    At times the inclusion of some of these liabilities is very confusing. For example, why do we get excited about the €145 billion owed to the ECB and Irish Central Bank? What about the €300 billion of deposits that the banks owe? Surely we expect the banks to pay these deposits back at some stage as well. But they don't seem to count.

    As you say it is much easier to put a value on a liability rather than as asset. It is a problem we will continue to face and it simply boils down to differences of opinion.

    I think an important first step would be a growing realisation that a lot of these liabilities are partially offset by assets. There are plenty of people who want to take a one-eyed view of things.

  12. Seamus,

    Your comment on my article on Gurdgiev was very refreshing -- good to see some real economists that don't have an agenda working in Ireland today. (I posted a full response on the piece).

    Just to engage with the Kelly article, I wrote a piece on this today -- because while Kelly is a good journalist, I don't think he grasps some key aspects of marcoeconomics:


  13. Seamus, I had another read of Morgan’s article and I think it is a very mixed article to tell you the truth. Morgan deserves the utmost respect given his track record on predicting the property and banking collapse. There is some very interesting information on the political goings on re Honahan and Timothy Geithner who appear to be the new bogeymen. However, some of his figures are very much exaggerated. If he wants to exaggerate them fine but at least give us a reason for doing do. As you said before the figures are massive but that is no excuse to exaggerate them.

    We already discussed the Irish Bond composition error. I think there may be a couple of others. He notes that the IMF lent Ireland €30 billion worth of capital. I thought the IMF lent Ireland €22.5 billion. Where is this 30 coming from? Am I missing something? Maybe he meant Dollars, or for added confusion SDRs, who knows.

    He claims bank recapitalisation will cost €35 billion. The recent bank stress tests stated this figure to be €24 billion. By any standard these stress tests were stringent, even those dammed ratings agencies thought so. Where is the extra €11 billion coming from? Maybe he thinks the €24 billion will not be enough and is adding on a further €11 billion including further capital for Anglo. This is the most likely scenario but either way we don’t know because he never told us.

    He also says ECB and CB liquidity to Irish Banks is €160 billion. Where is this figure coming from? According to CMBS the liabilities of Irish Domestic Banks is €82.775 billion. The “other assets” column of the central bank’s balance sheet is €66.790 billion. There is no guarantee all of this column is for domestic Irish banks either. But let’s say a total of €150 billion although it is probably a few billion lower. Where is this extra €10 billion + coming from?

    He claims that Ireland will have a debt of €250 billion in 2014 and claims later at a stroke we can half our debt to €110 billion. I assume he is talking about the NAMA Winelake figure of €220 billion or else he has a few gremlins in his calculator. This raises the question why say €250 billion when a few paragraphs later he uses some other figure. So suppose it is €220 billion how does he come to the conclusion we can half this to €110 billion at a stroke. We cancel the promissory notes €36 billion (even though all of this wouldn’t be drawn down by 2014 anyway) reduce our exposure to ELA and possible losses in NAMA (which won’t be wound up for another decade).

    Maybe he will be right again but if he is going to trot out figures the least he could do is have them right with a bit more detail. It wouldn’t of killed him to dedicate a paragraph to show us exactly where he comes up with €250 billion and what exposure he thinks the taxpayer will have to ELA and NAMA, if any. All one can do from the article is make a guess.

  14. Hi Patrick,

    That is an excellent contribution and I thoroughly agree with all of it. I have some sympathy for journalists being sloppy with numbers but none for professional economists.

    You have picked a number of huge holes in the Kelly analysis. There is no doubt that the general diagnosis is correct - we are in a huge debt problem - but if we are going to implement the appropriate corrective measures then it is vital that the symptoms of the debt are correctly identified.

    To this end we should have been told how the €250 billion debt estimate comes about. All the "solutions" offered stem from that. It is not sufficient that we have to guess how this is expected to happen.

    It is an arithemtical impossibility that we can halve our debt by "walking away from the banks". As you point out the total debt figures are inconsistent but the suggestion is that we can save €110 billion of debt by cutting the banks loose. So far we have put €46 billion into them and have committed to another €20 billion. How can we save €110 billion so? We haven't even put in that much. Impossible.

    We could give the NAMA assets back to the banks. We will give them €30 billion worth of assets. They will give us €30 billion worth of bonds. The net debt effect is zero. We will have reduced our liabilities by €30 billion, but will only have done so by getting rid assets worth €30 billion (it may be a bit less).

    There is €28 billion of Promissory Notes outstanding and there will be about €3 billion of interest added to those between now and 2014. Here we can make a saving but it can be no more than €31 billion between now and 2014. In time it could be more but we are told it will be savings on the 2014 debt.

    Somehow a €31 billion saving is supposed to magic away €110 billion of debt. This is off the wall stuff.