The Debt Factor

 

One week you're the darling of the Wall Street Journal, next you're an economic pariah. Where did it all go wrong for Ireland and what can we do to build favour with the hysteria-prone markets? asks MICHAEL CASEY

THE YIELD demanded by investors in Irish sovereign debt went above 6 per cent on 10-year bonds recently and the cost of insuring Irish debt is now second only to that of Portugal. By contrast, Germany, which is regarded as a safe haven for funds by the international markets, has to pay only about 2.5 per cent on 10-year bonds. This is a huge difference and may exaggerate Irish sovereign risk. Nevertheless, present ratings suggest if Ireland Inc were an individual borrower seeking a mortgage, it would have to queue up at the sub-prime window.

The real problem is, with such high interest rates to pay, our debt servicing costs will rise dramatically and absorb an increasing share of government revenue each year. A point could be reached where Government services would have to be slashed and/or taxation increased sharply, merely to service the debt.

How have we lost credibility so quickly? Senior politicians were recently accepting plaudits from Newsweekand the Wall Street Journalfor taking the hard decisions. The Minister for Finance cuts an impressive figure on the international circuit and is highly regarded. His legal background also reassures potential investors. What has gone wrong in recent weeks?

While the international markets often overreact, they usually get the direction right. When they started selling off Irish bank shares two years ago, official sources seemed genuinely surprised and vehemently denied the capital of the banks was in any way inadequate. We now know who was right on that occasion. Markets do not forget when officialdom makes such mistakes; all subsequent statements are taken with a grain of salt.

The money pit known as Anglo is obviously weighing on Ireland’s credit rating. It remains to be seen whether the recent decision to split up the bank will calm the markets. It may not do so, because of continuing uncertainty about the final amount of money to be spent on Anglo and how this will impact on the national debt/GDP ratio. This is a dilemma. Without a final figure the markets may well believe the Standard Poors estimate of €35 billion for Anglo alone. The authorities find it difficult to provide a final figure because they cannot predict the end of the slide in property prices. Nevertheless, the Government has promised certainty by October. Let us hope this will not prove to be a hostage to fortune.

Markets are also concerned about uncertainties relating to Nama, whether our zombie banks will start lending any time soon, the lack of an overall plan for the Irish economy, and the question of whether deflationary policies will prolong recession here.

Another source of uncertainty relates to the lingering Croke Park agreement and whether this may signal the beginning of “adjustment fatigue” on the part of Government, facing into a general election.

Another reason inhibiting borrowing by Ireland is the shortage of global funds in relation to the demand for them. The international scene is quite different to that in the 1980s, say, when the world was awash with petro-dollars and markets were forcing loans on developing countries without doing any sovereign risk analysis. Ireland had no difficulty borrowing back then; in fact, it was probably too easy to run up debt in those days.

The rating agencies are also trying desperately to restore their tattered reputations after their disastrous performances in the years leading up to the financial collapse. With the zeal of converts, the agencies are now marking countries down for venial sins. They ignore the fact that Ireland has never defaulted and that, in a worst-case scenario, we could call on the resources of the eurozone. (The rating agencies are not part of the solution; their role should be taken over by a responsible body like the IMF.)

The recent opinion polls have also played a part in Ireland’s high cost of debt. Rating agencies and markets put great store in political factors. The massive swing to Labour probably accounts for up to 100 basis points of the high yields we have to pay. This is the tyrannosaurus rex in the room. Someone should tell the markets the Labour party in Ireland is almost as rightwing as the other main parties. And if they coalesce with Fine Gael, the Government so formed will be well right of centre.

Whether we like rating agencies or the hysteria-prone markets, we have to live with them. Germany has put forward ideas for clipping their wings but unless the US takes a lead role, nothing much will happen. Markets are enormously powerful nowadays; the sheer weight of money makes them much more influential than the Federal Reserve System or even the US Government. One has the image of spoiled, excitable children equipped with fully loaded automatic weapons. They can cause enormous damage and they ignore regulation because the penalties involved are trivial in relation to their profits.

If the markets believe they were misled in the past they will react badly. To some extent, they were misled by Greece and Italy who, a decade ago, window-dressed their outstanding debt figures. Vengeance was swift and thorough, as evidenced by the deterioration in the credit rating for Greek bonds. I do not believe there is anything amiss in Ireland’s budgetary accounts, but we should be careful that everything is kosher. The last thing we need is statistical skeletons falling out of the closet.

It is salutary to review the tricks Greece got up to 10 years ago. Shortly after joining the eurozone, Greece borrowed heavily abroad but booked the loans as currency trades, thus avoiding the “debt” stigma. They did currency swaps (based on yen- and dollar-denominated outstanding debt) to create upfront cash payments and an increased stream of interest payments during the period of the swaps. The Greek government would, of course, have to make a huge balloon payment to their creditor, but not until the end of the period. In some cases the Greek government traded away airport fees, lottery receipts and road tolls for years to come. These future payments were not booked as liabilities, but rather as sales. Hence it looked as if Greece had not increased its outstanding debt at all and had not breached the EU guidelines on debt/GDP limits.

Who helped Greece with these shenanigans? Goldman Sachs who, incidentally, charged fees of $300 million. In 1996, JP Morgan helped Italy do something similar.

So, here we have Wall Street institutions helping governments window-dress their accounts, only to have other firms on Wall Street punish the same governments for taking such dubious advice. There is only one winner in this sort of game: Wall Street. It is “revolting in the extreme”, to quote an Irish Taxing Master in a recent case of over-billing. Not that the governments concerned were innocent; the technique used would greatly appeal to politicians the world over. They could hide the debt until a new government took over, at which point the balloon payments would blow up in the faces of a new administration. No doubt that was one reason the deal was put together by the Wall Street bankers who are accountable to no one, least of all taxpayers.

It is intriguing that the sleight of hand was not picked up by Eurostat, the statistical arm of the EU. That body had its own difficulties some years ago and may have temporarily lost its focus. There is apparently an internal investigation going on in the EU Commission. Eurostat claims it had drawn the relevant directorate’s attention to its suspicions, but that no action was taken. Like most bureaucratic investigations, this one may well run into the sand. It might be best if, in future, the IMF monitored accounting practices around the globe. That institution has considerable experience in the area, having sorted out war-related debts in various countries and having set up debt-monitoring systems in many less developed countries which do not have separate treasury management functions.

In Ireland, we have enough problems on our plate and do not need any taint of creative accounting. Some years back an attempt was made by the Department of Finance to reduce our national debt by deducting any amounts not yet spent. There was some merit in the idea but it was not consistent with international practice. The system of checks and balances proved adequate and the idea was dropped. It is interesting to note that one of the institutional improvements Greece has made is that the debt statistics section no longer reports to their Department of Finance.

It is to be hoped that in Ireland we still have a clean bill of health because, in the words of a former Taoiseach, “it’s the small things that trip you up”.


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