Anglo “deal” means more debt and austerity
The announcement of a deal on the legacy debt of Anglo Irish has been greeted with almost universal acclaim by politicians, academics, business leaders and the media. This has created the impression that a real breakthrough has been achieved that will result in a lifting of the debt burden and an easing of austerity. The problem is that an examination of the deal shows such hopes to be unfounded.
Even to describe the measures announced by the Irish government as a deal is dubious as they have yet to receive the endorsement of the EU and ECB. At the time of writing the ECB has merely noted what has been proposed and said that it will make a final judgement sometime over the coming year. Given that Germany’s representative on the ECB has already expressed concerns an endorsement is by no means certain. But if we assume that ECB support is forthcoming then that raises a number of questions. Firstly, what is the nature of this new deal? Secondly, will it work? And thirdly, what will it mean for the Irish people?
The nature of the deal
The proposed deal on the Anglo debt has two basic elements. The first is the conversion of the debt into a sovereign bond, and the second is the extension of debt repayments over a much longer period. Under the previous arrangement the Irish Central Bank provided the nationalised Anglo and its successor, the Irish Bank Resolution Corporation, with emergency lending assistance (ELA) to enable it to payout out creditors. The Government created collateral for these loans from the Central Bank through the creation of “promissory notes” that were scheduled to pay out annually over a ten-year period. These notes came with a high interest rate of around 8 per cent. However, given that these payments were between two arms of the state, and that the Central Bank returned any money it made on the transaction to the Exchequer, the high interest rate was negated. The interest on the Anglo bailout was effectively the ECB’s main re-financing rate, which is currently just 0.75 percent. In terms of the overall cost the Irish government would have been paying out not much more than the principal of €32bn, which equated to annual payments of €3.5bn over a ten year period. Of course, while on the face of it this was an internal mechanism, it could not have operated without the ECB. Ireland is part of the Eurozone and the Irish Central Bank is an arm of the ECB - the loans to fund the repayment of Anglo’s creditors could not have been created without its approval. It is because this resolution of the Anglo debt is dependent upon an institution external to Ireland that it can be described as a bailout, not just of a bank but also a state.
The proposed new deal on Anglo cuts this process short. The Irish Bank Resolution Corporation (IBRC) is liquidated and the promissory notes are converted into long-term sovereign bonds. The total outstanding debt related to Anglo will still be paid but over a much longer period. This translates into annual payments of €1bn over a period of almost 40 years up until 2053. Once again the Irish Central Bank plays a key role – it is committed to holding a substantial proportion of the freshly issued sovereign bonds for a sustained period. Like the previous arrangement the transactions that take place between Government and Central Bank will effectively keep interest payments at the ECB’s main re-financing rate. The deal will also result in the expansion of NAMA with some of the liquidated bank’s assets going into the state owned property company. The symbolic distinction between state and bank debt will end with the legacy debts of Anglo being absorbed into general sovereign debt.
Will it work?
It is claimed that this deal will reduce the debt burden upon the state, ease austerity and create more favourable conditions for economic recovery. This in turn will enable the Government to exit the bailout and return to financial markets.
However, there are a number of reasons to doubt such a successful scenario. The most obvious one is that the debt associated with Anglo has not been reduced. The Irish government is still committed to paying this debt in full – a debt write down has never been on the agenda and Irish politicians have never sought to raise it. Instead they argue that extension of the payment period is affectively a write down of the debt with reduced annual payments and inflation eroding its value. The figure of a reduction of €20bn has been bandied around but this only applies to the 10 year period that the promissory notes deal was scheduled to run. It ignores the €30bn of payments that will be made over the additional thirty years the new deal is scheduled to run. While inflation will reduce the value of those payments the difference between the overall cost of the promissory notes and the sovereign bonds is likely to be marginal. It is also the case that the Anglo debt only constitutes around a third of the total bailout package and that the terms related to the balance remain untouched.
The success of the new deal is also dependent on factors that are external to its own structure. An assumption underpinning the deal is that Irish economy will return to strong growth in the near future thereby reducing the relative size of the debt burden and improving the state of public finances. However, all the evidence points to a very weak recovery and a lower long-term growth rate. For example, the IMF predicts that the Irish economy will grow by 1 per cent this year while the NERI forecasts growth of just 0.6 per cent for 2012 and a similar rate in the two following years. This means a smaller economy with a higher debt ratio generating lower tax revenues that expected.
One of the factors limiting growth is the ongoing contraction of manufacturing in Ireland. The only sector of the economy that can increase productivity and create real value is too small to sustain a recovery. This is in contrast to the bloated financial sector that continues to lay claim on huge economic resources. Moreover, the crisis within the financial sector is ongoing and a new shock, likely to be triggered by defaults on household debt, will require further injections of capital into Irish banks. All of this will make it more difficult for the Irish state to meet the terms of the revised bailout.
There are also factors external to Ireland going against the bailout deal. The first one of these is the deterioration of the broader European economy. The EU continues to be the main market for Irish goods and services and if it is depressed will have a negative impact on growth. The second is the bubble building in the European bond market. Currently it has never been cheaper for states to borrow money but when this bubble bursts the yields on bonds will rise dramatically. This will have severe consequences for Ireland’s attempts to return to the financial markets and to service its existing debt.
The biggest failing of the Anglo deal is that it fails to put the Irish state in a position where it can finance itself without relying on one of the branches of the Troika. So while Ireland may formally exit the bailout programme and return to the financial markets it will only do so with the support of the ECB.
The mechanism for this will be OMT (outright monetary transactions) program. It came into existence last September when Spanish and Italian bonds were coming under serve pressure. Fearing that one or both on them would have to go into the formal bailout process the ECB initiated a programme of bond purchases. This lowered the interest rate on the debt of these states and allowed them to continue financing themselves. Of course this is a bailout even if it is not formally recognised as such. It raises the prospect of Ireland exiting one bailout mechanism and immediately entering another
What will it mean for the Irish people?
The new deal on Anglo debt offers no relief to the Irish people. There is no indication that the revised terms will ease austerity. The Central Bank governor Patrick Hanohan made this explicit when he declared that it would not have “any sort of budgetary consequences.” Irrespective of any deal on the Anglo debt the Irish Government is locked into the Fiscal Stability Compact that commits it to bringing the public deficit to below 3 percent of GDP by 2015. On current growth projections, meeting this target requires €5.1 billion of additional fiscal adjustments in 2014 and 2015. So there is no relief in the short term, and given the weakness of both the Irish and European economies, there is none in the medium to long term either. This leaves the prospect of unending bailouts and austerity.