11 February 2013

Karl Whelan: Ireland's promissory note deal

Writing on his Forbes blog, Whelan discusses the new arrangement, as well as some of the objections to the deal that have been raised in Ireland. He concludes with a discussion of some of the legal issues considered by the ECB when approving the deal.

Anglo Irish Bank is no more.  Its successor, the Irish Bank Resolution Corporation is being liquidated. Unfortunately, its legacy of debt piled on the Irish public’s shoulders is not dead. Still, last Thursday’s announcement, which saw the infamous promissory notes replaced with a series of very long-term bonds, is a useful step in reducing the burden associated with the IBRC. Credit is due, in particular, to the Central Bank of Ireland Governor, Patrick Honohan, who oversaw new arrangements being put in place that secured the approval of the ECB Governing Council...

There are a number of ways to think about the benefits of the new arrangements.

• With the public debt ratio now over 122 per cent and investors potentially concerned about the prospects of sovereign debt restructuring taking place if the debt ratio cannot be stabilised, the dramatic reduction in financing requirements over the next decade is helpful. It reduces the chances of a sovereign default triggered by inability to meet payment demands to the private sector.

• More generally, delaying payments off into the future allows them to be dealt with at a time when inflation and economic growth have reduced the burden they impose. For example, the final two principal payments of a combined €10 billion will occur in 2051 and 2053. If made today, these payments would account for 6.25 per cent of Irish GDP. However, if nominal GDP grows at 4 per cent per annum over the next 40 years, these payments would be closer to 1 per cent of the GDP at the time of the payment, making it far easier to simply roll this debt over.

• One way to calculate the reduced burden due to delaying payments is to calculate the net present value (NPV) of the stream of payments. The spreadsheet [see full artiacle] uses a 6 per cent per annum discount rate and calculates the NPV of the promissory note payments as 19.5 billion and the NPV of payments under the new bonds as €12.8 billion. This represents a 34.4 per cent reduction in the NPV. While clearly some way short of a full write-off, last week’s deal still represents a clear improvement on the promissory notes.

Objections to the Deal

Some of the reaction to the deal in Ireland has been negative. Some have criticised the new arrangements because they don’t involve a full write-off of the IBRC’s debt. However, the European Treaty’s outlawing of “monetary financing” makes it clear that loans from central banks to state-owned banks can’t simply be written off and there was never any chance whatsoever that such a write-off could have emerged from negotiations with the ECB. Those with moral objections to the nature of this debt should consider whether the Irish authorities should have rejected a deal that reduced the burden of the debt because of the absence of an unattainable deal.

A second objection has been the idea that the deal simply “kicks the can down the road” or (more emotionally) “forces our children and grandchildren to pay off huge debts”. Well public debt rarely ever gets paid off. Instead it is rolled over as long as financial markets believe governments have the capacity to honour their debts. Unless economic growth and inflation come to an end (in which case the Irish people will have a lot more than IBRC debt to worry about) future generations of Irish taxpayers should be able to roll over these debts (though before Ireland’s children all grow up and have children of their own, the country will face the challenge of selling large quantities of the new bonds next decade without generating losses).

Full article

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