Extending the EU loans: Some costs?

There have been reports that the Troika is considering extending the repayment schedule of Ireland’s EU loans.  It is reported that this “could see the country paying back EU loans over an average of 30 years instead of the current 15 years”.  Of course, the report finishes with an emailed statement from a European Commission spokesman who says “'this is simply not true".  However, that is simply in line with the official response to this crisis which holds the view that nothing can happen until it happens.

The repayment of Ireland’s EU/IMF loans is due to begin in 2015 and they actually have an average duration of 7.5 years rather than the reported 15.  Extending the terms of the loans would have medium-term funding benefits for Ireland.  Also, if the loans were extended at lower interest rates than Ireland could access elsewhere there would be lower interest payments for the government. 

This are undoubted benefits if this was to arise but there may also be some costs to extending the terms of the loans.  One potential source of such costs is the draft of the ‘Two-Pack’ regulations currently being negotiated between the Commission and Parliament at EU level.  Here is article 11 on "’Post Programme Surveillance” from Com 2011/819, the first part of the Two-Pack.

Article 11
Post-programme surveillance

1. A Member State shall be under post-programme surveillance as long as a minimum of 75% of the financial assistance received from one or several other Member State(s), the EFSM, the EFSF or the ESM has not been repaid. The Council, acting on a qualified majority on a proposal from the Commission, may extend the duration of the post programme surveillance.

2. Article 3(3) shall apply. On a request from the Commission, the Member State shall also provide the information mentioned in Article 7(3) of Regulation (EU) No XXX on common provisions for monitoring and assessing draft budgetary plans and ensuring the correction of excessive deficit of the Member States in the euro area.

3. The Commission shall conduct, in liaison with the ECB, regular review missions in the Member State under post programme surveillance to assess its economic, fiscal and financial situation. It shall communicate every semester its findings to the EFC or to any subcommittee the latter may designate for that purpose and assess notably whether corrective measures are needed.

4. The Council, acting by qualified majority on a proposal from the Commission, may recommend to the Member State under post programme surveillance to adopt corrective measures.

Under these proposals Ireland will be under ‘post-programme surveillance’ until at least 75% of the EU loans have been repaid.  This surveillance will require EU/ECB review missions each semester (currently set as a calendar year) and, if deemed necessary, the Council may recommend that we adopt some ‘corrective measures’.   Extending the terms of the EU loans will extend the period we will be subject to Article 11 of this regulation (if it comes into force).

Paragraph two says that “Article 3(3) shall apply”.  Here is article 3(3), which deals with a country’s banking system and its response to any macroeconomic imbalances:

3. On a request from the Commission, the Member State under enhanced surveillance shall:

(a) communicate to the Commission,the ECB and the European Banking Authority (EBA) at the requested frequency disaggregated information on the financial situation of the financial institutions which are under the surveillance of its national supervisors;
(b) carry out, under the supervision of the European Banking Authority, stress test exercises or sensitivity analyses as necessary to assess the resilience of the banking sector to various macroeconomic and financial shocks, as specified by the Commission and the ECB, and share the detailed results with them;
(c) be subject to regular assessments of its supervisory capacities over the banking sector in the framework of specific peer review carried out by the EBA;
(d) communicate any information needed for the monitoring of macro-imbalances established by Regulation No XXX of the European Parliament and of the Council on the prevention and correction of macroeconomic imbalances.

The regulation cited in part (d) is Regulation 1176/2011 which came into force as part of the Six-Pack last year as is one of the two regulations that established the Macroeconomic Imbalance Procedure.

Article 11(2) on post-programme surveillance also mentions another regulation.  This is article 7(3) of the other half of the Two-Pack and is currently Com 2011/821.  Article 7 deals with the closer monitoring for member states in the Excessive Deficit Procedure, and paragraph 3 of this says:

Member State shall report regularly to the Commission and to the Economic and Financial Committee or any sub-committee it will designate for that purpose, for the general government and its sub-sectors, the in-year budgetary execution, the budgetary impact of discretionary measures taken on both the expenditure and the revenue side, targets for the government expenditure and revenues, as well as information on the measures adopted and the nature of those envisaged to achieve the targets. The report shall be made public.

The Commission shall specify the content of the report referred to in this paragraph.

This means that even if Ireland is not in the Excessive Deficit Procedure (deficit > 3% of GDP or debt > 60% of GDP with excess not declining by “1/20th” per annum) we could still be asked to produce a report as if we were in the EDP.  For countries that actually are in the EDP this report was formalised into the “budgetary and economic partnership programme” in Article 5 of the Fiscal Compact.  This programme requires the endorsement of the Council and the Commission but countries under ‘post-programme surveillance’ may be requested to submit a similar report.

An extension of the repayment schedule for the €45 billion of EU loans Ireland will receive as part of the current programme may bring some benefits.  However, a dearth of one-armed economists means there may also be some costs that need to be considered.

UPDATE: Some details of the actual repayment schedules for the EU, IMF and bilateral loans agreed as part of the current €67.5 billion programme can be seen in this recent PQ answer from Michael Noonan [HT: Kevin] and this answer has some useful tables on the details of the EFSM and EFSF loans drawn down by Ireland.

Presentation on EU Economic Policy

Here are the slides from a presentation I gave at a workshop on ‘Surviving the Economic and Financial Crisis’ held recently in UCC.

Six-Pack, Two-Pack and the Fiscal Compact

Will a ‘Yes’ Vote Cost €6 billion?

The cost of a ‘Yes’ vote as a result extra austerity that will be forced on us if the Treaty on Stability, Cooperation and Governance has been a main plank of the ‘No’ campaign.  Some of these claims are made on the basis of the application of the debt brake rule but they are little more than scaremongering.

The last week or so have seem the claims move to faux outrage to the impact of the structural deficit rule.  As per the Treaty, this will require Ireland to move to a structural deficit of no more than 0.5% of GDP over a timeframe to be agreed with the European Council.

The largest party of the ‘No’ campaign regularly claim:

“The Governments campaign is based on fear and evasion. They are asking us to sign up to new rules and regulations that will cost every single voter but refuse to tell us how much. They are asking us to write a blank cheque knowing that the cost will be at least €6 billion.

To ensure that this is quoted accurately you can see more here, here, here and here:

“The Government has a responsibility to explain to people the cost of a Yes vote. If the Treaty is passed we will have to reach a structural deficit of 0.5% after we exit the current Troika austerity programme in 2015.
“According to the Department of Finance’s own Spring Forecast published last week the structural deficit in 2015 will be 3.5%. The gap between this figure and the new 0.5% rule is equivalent to approximately €6 billion.

The figures come from the Stability Programme Update released a few weeks ago.  The projections of the structural budget balance are on the last page which has a table which shows that using the methodology applied by the European Commission it is projected that there will be a structural deficit of 3.5% of GDP in 2015.  Just a few pages earlier it can be seen that the projected nominal GDP for 2015 is €178,850 million.
It can be seen that the 3 percentage point gap is equivalent to €5,365.5 million.  There must be some imprudent application of the rounding rule being used to bring this to the €6 billion figure used above.

At this remove it is impossible to know what the structural deficit will be in 2015 (will we ever know?) and suggesting that there is a €5.4 billion gap to be filled may be an accurate representation of the situation.  This is not what is being claimed though and there is repeated reference to “€6 billion of cuts” but the claim that this is based on the upcoming referendum are very wide of the mark.  We cannot just vote away the necessity to reduce the budget deficit.

The structural deficit can be reduced through a combination of three factors:

• economic growth
• structural improvements in labour and capital
• fiscal consolidation

No allowance is being made for the first two to assist in reaching the target.  Of course, the important point is that this target is not new and will be unaffected by the outcome of the referendum.  As we have pointed out before there has been a EU regulation (equivalent to national law) that governments run a balanced budget since 1997 and that this was restated using the structural deficit in 2005.

In December 2005 the Department of Finance decided that Ireland would set itself a Medium Term Budget Objective (MTO) in terms of the structural deficit that would be “close to balance”, that is 0% of GDP.
The Stability Programme Update released with Budget 2010 in December 2009 contains the following useful section on page 32:

Review of Ireland’s medium-term budgetary framework and proposed reforms
In considering improvements, it is important to note the procedures already in place. Ireland’s budgetary process is already conditioned by various rules and requirements:

Under the Stability and Growth Pact,

• There are ceilings of 3 per cent of GDP for the general government deficit and 60 per cent of GDP for gross government debt.
• Medium-term budgetary objectives for the structural balance of the public finances.

Under the Excessive Deficit Procedure,

• The Irish authorities have made commitments aimed at reducing the general government deficit below 3 per cent of GDP by 2014 – with implicit strictures on taxation and expenditure.
• The EU’s fiscal surveillance process calls for improvements in national fiscal governance arrangements capable of improving the sustainability of public finances.
• There is an obligation to make annual improvements of 0.5 per cent of GDP towards structural balance after the excessive deficit has been corrected.

This was published two and a half years ago and clearly states that Ireland has the “obligation” to move to a “structural balance” after we exit the EDP (which was subsequently extended to 2015).  This is actually more stringent than the –0.5% of GDP limit placed on the structural deficit in the Fiscal Compact.

In the April 2011 Stability Programme Update (which is still seven months before the Fiscal Compact came into being) the Department of Finance announced a revised Medium Term Budget Objective on page 39:

In October 2007, the ECOFIN Council agreed that long-term fiscal  sustainability, notably the future impact of ageing, should be better taken into account when Member States are determining their medium-term budgetary objectives (MTOs). The subsequent EU Commission document “Modalities for the implementation of the new MTOs” set out the methodology for doing so. In the Irish case, the findings suggest an MTO of -½ per cent of GDP, which allows for 33 per cent of the likely cost of ageing to be covered.

In April 2011, without any recourse to a treaty, the Department of Finance announced that we were changing our MTO to –0.5% of GDP.  We were obliged to achieve what is set out in the Fiscal Compact long before this campaign begun.  How come it took until the announcement of a referendum to generate such interest in something the Department of Finance have been discussing and committing us to for six and a half years?

This was re-emphasised on page 31 in the most recent Stability Programme Update a few weeks ago:

As discussed in last year’s SPU, Ireland’s ‘medium-term budgetary objective’ (MTO) currently stands at -0.5% of GDP. This objective was set well in advance of the Inter-Governmental Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the ‘Stability Treaty’). Ireland is making progress towards the achievement of its MTO, with further progress to be made in the post-2015 period on a phased basis, in accordance with a timeline to be agreed.

The “timeline to be agreed” will be in line with the Code of Conduct of the Stability and Growth Pact as revised by Council Regulation 1055/2005 and the application of this will not be changed by the referendum result.  The regulation states that:

The Council, when assessing the adjustment path toward the medium-term budgetary objective, shall examine if the Member State concerned pursues the annual improvement of its cyclically-adjusted balance, net of one-off and other temporary measures, required to meet its medium-term budgetary objective, with 0,5 % of GDP as a benchmark. The Council shall take into account whether a higher adjustment effort is made in economic good times, whereas the effort may be more limited in economic bad times.

This means we could have up to six years to move from a structural deficit of 3.5% of GDP to under the 0.5% of GDP limit.  As we are a high-debt country we will probably be asked to achieve that more quickly but even four years would give plenty of opportunity for economic growth and structural improvement to contribute to the effort.

The fiscal rules in the Treaty are not “new” and we cannot avoid them by voting ‘No’ in the referendum.  There maybe reasons for rejecting this Treaty but a claim that it will cost €6 billion in extra cuts and taxes has very little going for it.  In fact, you could say that compared to what were committed to in December 2009, the Treaty will actually save us something.

The General Government Debt

At the end of 2007, the gross general government debt was €47.2 billion.  The recent Eurostat debt and deficit release showed that this has increased to €169.3 billion at the end of 2011.  That is an increase of an incredible €122 billion in just four years.  We can use the previous post on the general government accounts to see how that has come about.

There we saw that from 2008 to 2011 Ireland ran underlying primary deficits summing to €48.5 billion.  Interest expenditure over the four years was €15.4 billion.  At the same time temporary or once-off measures totalled €41.4 billion, with bank-bailout payments making up the bulk of this.

These three items sum to €105.3 billion.  To get to the full €122 billion increase we must account for some stock/flow adjustments.  In the main this is an increase in borrowings to build up a cash buffer.  Details from the NTMA show that balances of €17.8 billion “were held
in Departmental Funds + other Accounts, including the Exchequer A/c.” at the end of 2011.  At the end of 2007 these cash balances were just €4.4 billion.

Here is a summary table of the changes in the debt since 2007.

The largest single item is the €48.5 billion of primary deficits run since 2008.  This is the excess of government expenditure on public sector pay, social welfare, services and investment over government revenue. 

The next largest item is the €47.2 billion of debt we carried into the crisis in 2007.  This debt is largely the residual of the last great crisis in the public finances from the 1980s.  Data from the NTMA show that in 1994 (commonly taken as the start of Celtic Tiger Mark 1) the general government debt was €41.7 billion.  It hardly changed over the next 13 years.

Temporary and once-off measures account for €41.4 billion of the increase in the general government debt.  The vast majority of this is the bank payments and of that the bulk is the €30.85 billion of Promissory Notes used to recapitalisation Anglo, INBS and to a lesser extent EBS in 2010.  Once-off measures (though they seem to be happening a lot) account for 34% of the increase in the debt over the past four years and 25% of the stock of debt at the end of 2011.

There is a big drop them to the final two items.  Over the four years interest expenditure was €15.4 billion.  In 2007, interest expenditure was €1.8 billion so if the 2007 debt and interest rates had been maintained interest would still have consumed €7.2 billion over the four years.  The extra debt added about €8.2 billion of additional interest costs over the four years and the bulk of that is due to the primary deficits rather than the once-off measures.  From the last post we saw that social transfers-in-cash totalled €96.7 billion over the four years.

The final item is the stock/flow adjustment that is mainly an increase in borrowing by the NTMA in 2008 and 2009 to build up cash balances.  The NTMA borrowed far more than was needed to fund the deficits and a cash buffer was built up that has been maintained as part of the EU/IMF programme.  The general government debt is a gross measure so no allowance is made for assets even though this cash could be used almost immediately to reduce the debt by that amount.

The composition of the general government debt was provided in this recent PQ to Michael Noonan.

The General Government Accounts

There are a number of measures of government revenue and expenditure.  The Exchequer Accounts tend to get a lot of attention as they are released on a monthly basis but they only give a partial picture of the government sector.  The general government accounts give a far better overview of the impact of the government sector on the economy. 

These are not produced on a regular basis but the requirements of the Stability and Growth Pact means a useful table is included in the Stability Programme Updates which are now published each April.  The general government accounts are not perfect but they are far more useful than the Exchequer Accounts.

The general government sector includes central government, local government and the Social Insurance Fund.  It does not include semi-state companies, state-owned banks or NAMA.

The ‘underlying’ general government balance, which is the overall balance net of temporary measures, is the benchmark used in the Excessive Deficit Procedure and it is this that must be reduced to under 3% of GDP by 2015.  The following table gives the overall and underlying general government balances from 2006 to 2012, and by subtracting interest expenditure from the latter the underlying primary balance.

As a result of the effect of the bank-bailout payments, which form the bulk of the temporary measures that occurred between 2009 and 2011, it is difficult to determine what direction the public finances are going.  The underlying deficit peaked at 12.2% of GDP in 2009, fell in the next two years and is projected to continue falling in 2012.

The primary deficit measures the excess over revenue that the government is spending on providing goods, services and transfers to Irish people.  The underlying primary deficit also peaked in 2009 and when it hit 10.2% of GDP.  Since then it has declined and it is expected to be 4.5% of GDP in 2012.

The improvement in the primary balance is greater because of the impact of our increased interest expenditure on the underlying balance.  Interest expenditure was 4.1% of GDP in 2012.  More than one-quarter of this was carried into the crisis and in excess of a half of it was due to the underlying deficits that ballooned in 2008 and 2009.  Interest on the bank bailout forms a very small part of the 2012 interest expenditure.

The trend is clear.  Since 2009,  both the underlying balance and the underlying primary balance have been declining, though both still remain excessively high.

The following table gives the euro-equivalent of the GDP proportions in the above table.

The underlying balance has improved from €19.6 billion in 2009 to €13.7 billion in 2012.  By applying the temporary measures (the largest of which are the bank-bailout payments) to total expenditure we can get a crude measure of ‘underlying expenditure.

The excess money we are spending on ourselves as measured by the underlying primary balance has fallen from €16.4 billion to 2009 to a projected €7.2 billion this year.  In 2007 the general government ran a surplus of almost €2 billion.  Of the deterioration of more than €18 billion that occurred over the following two years, one-third was due to the an increase in expenditure and two-thirds was due to a drop in revenue. 

It can also be seen that interest expenditure is projected to be €6.5 billion this year and that it was almost €2 billion in the run-up to the crisis.  Finally, we will look at the breakdown of revenue and expenditure provided in the general government accounts.  Click to enlarge.

The reason for the drop in revenue can be easily noted in the main revenue columns of ‘taxes on production and imports’ and ‘current taxes on income and wealth’.  After bottoming out in 2010 revenue has risen slightly in the past two years.

In the expenditure table the figures for compensation of employees and intermediate consumption were not provided separately until 2010.  Since then the combined figures have been €27.7bn, €26.5bn, and €26.6bn.  Cash transfers peaked at €25 billion in 2009 and are expected to be €24 billion this year. 

The named column that shows the largest reduction is gross fixed capital formation or investment.  Investment from the general government sector (central and local government) was almost €10 billion in 2008 but this has been cut to just €4 billion for 2012.  It is the cuts in capital expenditure that have brought expenditure down.

Current expenditure has remained largely unchanged over the past five years.  It is up about €1.5 billion since 2008 but the composition of the total has changed.  There has been an increase of around €4.5 billion in interest expenditure since 2008 which has been partially offset by a €3 billion reduction in primary current expenditure.

Looking at the gross expenditure figures can be slightly misleading and there are some important reasons why they should not be considered in isolation.  One such caveat is the Public Sector Pension Levy which raises around €1 billion a year.  When this was introduced government gross expenditure was unchanged and the impact of the “pay cut” was seen as an increase in revenue.

Even taking into account this it is still the clear that only a relatively small portion of the improvement in the public finances has taken place via current expenditure/revenue which is by far the largest area of expense.  A greater amount of ‘improvement’ has come from the huge reductions in capital expenditure.  In 2012, out of primary expenditure of €64 billion, just €4 billion or 6% will be on capital investment.  Around 94% of expenditure will be current.

Cork Independent 17/05/12

A short article I wrote on the Treaty on Stability, Coordination and Governance for The Cork Independent can be read here.

Bond Yields

After three months with barely a budge the Irish government 9-year bond yield as calculated by Bloomberg jumped back over 7% in the last few days.

The yield did rise as high as 7.7% earlier but is now back to around the 7.4% level it began the day at.  There have be no domestic changes to explain the move in recent days and the driver is uncertainty in Greece.  On this day last year the equivalent yield was 11.2%.