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Debt’s dominion

By Sinead Pentony.

Is Ireland’s level of debt sustainable? The Troika drew attention to our high public debt in their final review of Ireland’s bailout programme. The first few weeks of 2014 have seen good news on Ireland’s cost of borrowing on the bond markets and the decision by Moody’s ratings agency, after all the others,  to upgrade our grading to ‘investment grade’. We also have modest, but consistent improvement across a number of key economic indicators including GDP, employment growth and unemployment, giving us reason to hope that the worst may be over.  

These recent developments are leading some to think that the crisis is fading. On closer inspection, the improvements in the bond markets are not necessarily due to an improvement in the fundamentals of the Irish and Eurozone economies, and have probably been influenced by the ECB’s decision to introduce an Outright Monetary Transactions (OMT) programme in 2012. Mario Draghi’s “whatever it takes”, did the trick; investors believe the ECB could and would counter rising spread by buying up debt.

So where does that leave us with the current levels of debt and more importantly, the sustainability of that debt? Chart 1 illustrates the scale of the debt we are carrying (117% of GDP in 2012) compared to other European countries (EU average, 85% of GDP in 2012). The IMF projects that our debt will have peaked in 2013 at 124% of GDP and decline to 112% by 2018.

Many commentators make the case for using GNP as an economic indicator as it more accurately reflects Ireland’s economy and the large multi-national sector. Calculating our debt levels using this indicator brings our debt-to-GNP ratio up to 145% in 2012; and using this measure in Chart 1, our debt levels are the second highest in the EU and much closer to Greece’s.  Using existing GNP forecasts, our level of debt will be in the region of 150% of GNP for the next 3 years.    

It is important to remember that we put €64 billion into the banks, approximately €42 billion of which was borrowed. Our current (public) debt is €205 billion, which means that over 20% of our public debt is a result of the bank bailout, where private bank losses were transferred to the taxpayer. These figures don’t include NAMA loans of just over €30 billion. It is not clear if NAMA will break even, make a profit or a loss in the future. However, the exchequer will be liable for any shortfalls in the future.

The re-engineering of the IBRC (Anglo) promissory notes in February 2013 improved Ireland’s underlying general government balance by just under €1 billion, but it’s important to remember that this deal included no capital write-down but focussed instead on reducing the interest rate and extending the period of repayments from 7-8 years, to 30-40 years.

Adding in private (household and corporate) debt provides a more complete picture of the true scale of the debt burden on the Irish economy. Private household debt remains very high, at almost 200% of disposable income which is just over 100% of GDP (€172 billion). Debt associated with corporate/business sector is measured through ‘non-financial corporation debts’, which are estimated to be 195% of GDP (€318 billion). While a large portion of debt is associated with multinationals and the financial services industry, it also includes SME debts. The total debt in the Irish economy is estimated at €695 billion, which is almost 420% of GDP.   

This level of (public and private) debt in the Irish economy is one of the main reasons why growth is struggling to take root. Chart 2 illustrates how quickly our debt could rise even further if growth forecasts don’t materialise and the current nascent recovery experiences a ‘growth-shock’. For example, a temporary reduction in growth by two percentage points would result in our debt jumping to over 130% of GDP.

Households and businesses are rightly focusing on paying down debt, which is limiting spending in the domestic economy and investment in businesses. There is also evidence of households and businesses that are in a position to borrow, not being able to access credit, which is compounding the lack of demand in the domestic economy, and further dampening growth.    

Meanwhile, an ever increasing proportion of our taxes are going towards servicing the public debt at the expense of investment in infrastructure and public services such as health and education. The cost of servicing the national debt increased from €2.1 billion in 2008 to €8.1 billion in 2013 – that’s a four-fold increase in debt repayments within five years.

To put the scale of the debt burden in context, the total budget for the Department of Education is €8.8 billion. It would cost just over €3 billion to introduce a universal system of early-years education and childcare; and it would cost less than €500 million to introduce free GP care for all, abolish prescription charges for medical card holders and expand community and long-term care.

The evidence suggests that growth is likely to be adversely affected by high debt ratios, and continuing fiscal consolidation will undermine growth in the absence of offsetting policy stimulus. Ireland’s future potential for growth in output and employment is currently constrained by the fact that we have the lowest level of investment as a proportion of GDP in the European Union. Investment in social, human and physical capital is a key component of medium-term economic growth which is a key ingredient for making debt sustainable.

The economy itself is not generating enough income to bring down debt levels without compromising investment in human and physical capital and public services. Action is required on a number of fronts to make the level of debt more sustainable and to create a virtuous cycle of growth:

At EU level, definitive action is required to break the link between banking and sovereign debt (including legacy banking debt) and measures should be put in place to write-down and/or restructure legacy banking debts;

The Anglo-Irish debt should be expunged completely;

A programme of writing down and/or restructuring household debt, including SME debt  should be introduced.  This would constitute a significant stimulus;

Fiscal consolidation measures should be eased and future adjustments achieved primarily through taxation measures on assets and wealth;

Investment in human and physical capital needs to be front-loaded and fast tracked to counteract the effects of fiscal consolidation and maximise the growth potential in the economy. •

[Feb 2014]