After waiting for what had felt like an interminable period we finally got some more meat on the bones of the proposed European Union/International Monetary Fund/European Central Bank bail out for Ireland. There was obviously pressure to get a deal agreed before markets opened in Asia for the start of the week. However this leaves me with two main thoughts. Firstly the deal has the feel of something of a patchwork quilt and this is not impressive considering that Ireland’s problems have been known for a while, why was a plan not ready? Secondly the panic over timing has very little to do with Ireland. As she had funding into the middle of next year and could if necessary in extremis have drawn on her National Reserve Pension Fund (NPRF) to extend this period of not having to borrow, I am left with the conclusion that the timetable was forced by fear of contagion. This fear of contagion covers the Iberian peninsula for now with both Portugal and Spain at risk. To my mind the construction of this deal is almost as much a deal to try to save them as it is for Ireland.
The Statement from the Irish Government
The State’s contribution to the €85 billion facility will be €17½ billion, which will come from the National Pension Reserve Fund (NPRF) and other domestic cash resources. This means that the extent of the external assistance will be reduced to €67½ billion.
The facility will include up to €35 billion to support the banking system; €10 billion for the immediate recapitalisation and the remaining €25 billion will be provided on a contingency basis. Up to €50 billion to cover the financing of the State. The funds in the facility will be drawn down as necessary, although the amount will depend on the capital requirements of the financial system and NTMA bond issuances during the programme period.
The purpose of the external financial support is to return our economy to sustainable growth and to ensure that we have a properly functioning healthy banking system.
The external support will be broken down as follows: €22½ billion from the European Financial Stability Mechanism (EFSM); €22½ billion from the International Monetary Fund (IMF); and €22½ billion from the European Financial Stability Fund (EFSF) and bilateral loans. The bilateral loans will be subject to the same conditionality as provided by the programme.
Fiscal Policy and Structural Reform
The Ecofin has acknowledged the EU Commission’s analysis that a further year may be required to achieve the 3% deficit target……The Council has today extended the time frame by 1 year to 2015.
If drawn down in total today, the combined annual average interest rate would be of the order of 5.8% per annum. The rate will vary according to the timing of the drawdown and market conditions.
The Programme endorses the Irish Government’s budgetary adjustment Plan of €15 billion over the next four years, and the commitment for a substantial €6 billion frontloading of this plan in 2011. The details of the Programme closely reflects the key objectives set out in the National Recovery Plan published last week. The adjustment will be made up of €10 billion in expenditure savings and €5 billion in taxes.
As part of the Programme, Ireland will discontinue its financial assistance to the Loan Facility to Greece. This commitment would have amounted to approximately €1 billion up to the period to mid-2013.
The agreement starts with something which is really quite extraordinary and that is the claim that it is an “€85 billion facility” and the implication that Ireland will be receiving funds of this amount. Er no, as she is taking some 17.5 billion Euro’s from a combination of her National Pension Reserve Fund and her cash reserve. Accordingly the actual size of the bail out loans is 67.5 billion Euros rather than the 85 billion claimed.
Number Crunching: the interest-rate is not as implied and maybe much higher
There is an interesting claim about the interest rate too as it says that it would be 5.8% if all the funds were drawn down today. So let us do some number crunching.
85 billion Euros at 5.8% would cost Ireland some 4.9 billion Euros per year.
The 22.5 billion from the IMF can be borrowed for 3 years at 3.12% so this costs 0.7 billion Euros per year.
The 17.5 billion from the NPRF/cash reserve you could argue costs nothing but let us use 4.5% as an estimate of what it cost so 0.79 billion Euros per year.
So the remaining funds from the bilateral loans/EFSM/EFSF cost 4. 9 billion less 1.49 billion or 3.41 billion Euros per year. As they are 45 billion in total then the interest rate on them is approximately 7.5%. This is not what it has been badged at.
Here is the relevant section from the IMF website.
At the current SDR interest rate, the average lending interest rate at the peak level of access under the arrangement (2,320 percent of quota) would be 3.12 percent during the first three years, and just under 4 percent after three years.
1. If there was any real doubt that this is a bail out of Ireland’s banking system rather than her economy then the fact that ten billion Euros will go into her banking system immediately settles the matter.
2. Of the 35 billion Euros for the banks some 12.5 billion Euros is to come from the NPRF. The NPRF has a value of around 24.5 billion Euros but it has already invested around 7 billion Euros in Irish bank preference shares. So if the funds are drawn down it will only be left with 5 billion Euros. As it was only a few days ago it was supposed to be getting the ability to buy Irish government bonds then this is a very substantial U-turn! If any potential Irish pensioners are reading this you have my sympathies as by the time this is over there may not be much left of your fund. After all if you put this another way it is hard to avoid the view that money is being transferred from (future) pensioners to bankers….
3. Senior bondholders in Irish banks have been left unaffected which returns me to point 1 again.
4. Irish banks are being told by the European Central Bank that they will have to wean themselves off of the extraordinary amount of liquidity it has been supplying them. This has totalled some 130 billion Euros recently which is equivalent approximately to Ireland’s Gross National Product. The logical consequence of this is that interest rates in Ireland for mortgages and deposits are likely to rise in order to attract replacement funds.
5. The Irish banks will be forced to raise their core capital ratio to 12% which is the reason for the ten billion Euro capital injection,although rather curiously the Central Bank of Ireland estimates the cost at 8 billion Euros.
When I have considered what might help Ireland in her hour of need I was thinking of a bail out larger than this and at a lower interest rate. As I thought the bailout strategy had weaknesses already then it appears that this one now has very little chance of success. It may buy some time. Of course the bailout strategy has never appeared to include any form of debt restructuring and this looks ever more vital in any return to solvency for Ireland.
As to the Euro zone well it is weaker too. As time goes by more and more minds will start to wonder why in a bail out of a small country like Ireland funds needed to be deployed both from Irish domestic resources and from countries outside the Euro zone such as the UK,Denmark and Sweden.There are two possible reasons for this the first is that even the Euro zone has little faith in the shock and awe bail out mechanisms it has previously boasted about. The other is that it is keeping as much powder dry as it can for possible bail outs on the Iberian peninsula and beyond.
The sums here are simply not enough. Should Ireland’s property market continue to weaken then her banks will be hit by losses in this area too. So the danger is that she will need another one. However the foreign loans of 67.5 billion Euros represent some 15,000 Euros per head as it is. When we hit 2013 with a national debt to GDP ratio of 118% or a national debt to GNP ratio of 145% the numbers increasingly make Ireland look insolvent and a restructuring to be a vital component of any true rescue plan as this just “kicks the can down the road”.
The Irish may also be wondering why after contributing around 20% of their own bailout they have ending up paying an average interest rate more than 0.5% higher than the one applied to Greece.