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JOINT COMMITTEE ON EUROPEAN AFFAIRS díospóireacht -
Tuesday, 25 Jan 2011

EU/IMF Loans: Discussion with Professor Karl Whelan

We are discussing the European Financial Stability Facility and the European Financial Stability Mechanism, about which Professor Karl Whelan from the school of economics in University College Dublin will give a presentation.

We arranged a meeting in Frankfurt with Jean Claude Trichet that was scheduled for Monday 31 January. Unfortunately, due to events in the interim, we must forego that meeting but I am sure in the future the benefits of this discussion will be clear.

Apologies have been received from Deputies Howlin and O'Rourke and Senators Quinn and Prendergast.

I welcome Professor Whelan. We will listen to his presentation and then there will be a short time for questions and answers. Today's meeting will be shorter than usual but due to the importance of this issue, and the benefit the discussion will have in the future, we will proceed.

Professor Karl Whelan

I have circulated a briefing note on this issue that goes through the technical considerations related to interest rates on the IMF and EU loans. There are many technical issues relating to these loans and it will not be possible to describe them in full in a ten minute presentation. I will give an overview in a short presentation but I will occasionally refer to calculations that are discussed in the briefing paper.

The overall package of funding associated with the EU-IMF package has frequently been described as an €85 billion package but €17.5 billion comes from Irish State funds. The package of external funding is €67.5 billion. That is being offered from four different sources: €22.5 billion comes from the International Monetary Fund, €22.5 billion from the European Financial Stability Mechanism, which is associated with the EU, a further €17.7 billion from the European Financial Stability Facility and €4.8 billion in bilateral loans from Britain, Sweden and Denmark. I will discuss the first three of these. It was requested that I discuss the European loans but it is important to compare the European loans with the IMF loans. There has been a great deal of comparison in the media and that is a useful starting point.

The IMF loan is a variable interest rate loan, and the State will have to pay interest at a rate dependent on short-term money market rates in financial markets. The funds will be loaned to Ireland in the form of SDRs, special drawing rights. That means we will not get the €22.5 billion in euros, we will get it in a mix of euro, dollars, sterling and yen that will translate to €22.5 billion depending on the exchange rates at the time.

This loan is an example of what the IMF refers to as an extended fund facility, a standard IMF programme, and the terms and conditions associated with the programme are standard across all countries. The principal features of the interest rate on the loans are that loans up to 300% of a country's IMF quota carry very low interest rates. Often we read that the IMF lends to countries at extremely low interest rates that help them with their financial difficulties. That is true up to a point but when they borrow larger amounts, surcharges are added on. The surcharge will increase in proportion to the length of time the money is borrowed for. It increases from two percentage points to three percentage points after three years.

Ireland's loan is very large relative to the IMF's standard lending practices, even though it only accounts for a third of the external funding for our loan; it is 23 times our current quota. The quota is calculated based on an economy's GDP and other features of its economy. Most of the money, therefore, that Ireland is borrowing from the IMF will carry these large surcharges. What is the interest rate on the IMF loan to be? We do not know because it depends on variable interest rates. The calculations we have seen tend to be based on current market interest rates. Based on those rates, we can calculate that the average interest rate during the first three years will be 3.1% and after the first three years, almost 4%.

Those figures are based on Ireland's current quota. In fact, there is an extra complication; Ireland's quota is about to be revised upwards by about 50%. That will allow us to borrow some more of the money at a lower interest rate, which drops the average cost by about 20 basis points.

In general, the approach the Government is taking to the funds being borrowed is to pay them back over a relatively long period. A benchmark of seven and a half years has been used for the European and IMF loans. By my calculation, with variable interest rates, if it is paid back over seven and a half years, the loan will cost Ireland 317 basis points, 3.17%, more than the variable interest rates used as the basis for the formula. We should bear that figure in mind when looking at the European loans.

The IMF loans carry two different types of risk. The first risk is the interest rate risk; because the interest rates are variable, they could go up. It is likely the interest rates in the formula for the IMF lending rate will increase. Policy rates from the ECB, the Bank of England and the Federal Reserve are at historically low levels and we expect they will increase in the coming years. The second risk is currency risk. The Irish Government gets its tax revenue in euros, and if the euro depreciates in the coming years, we must still pay the IMF back in SDRs, meaning we must pay back dollars, yen and sterling. If the euro depreciates that would effectively increase the cost of the IMF loan. European loans have neither of these elements to them. They are fixed interest rate loans and they are denominated in euro. To provide a more direct comparison, the NTMA has done calculations that basically indicate what would happen if one swapped the stream of IMF loan payments with variable rates in euro or in SDRs for something that carried a fixed rate and was denominated in euro. They calculate that would be about 5.7%. It should be emphasised that this kind of swap is not actually taking place, the NTMA is not entering into an enormous hedging contract or an interest rate swap contract. This is purely for illustrative purposes but that is what the 5.7% rate is.

Moving on to the European loans, there is the mechanism and the facility. The facility is extremely complicated in structure and I will not be able to do it justice in this short presentation but I can take further questions on it. The mechanism is extremely simple compared with either the facility or the IMF loans. The mechanism is essentially a way that the EU can go into financial markets and borrow based on the financial backing provided by the resources from the EU budget. It was agreed last May that the maximum amount that the EU could do for this was €60 billion, so clearly on its own the mechanism was not going to provide enough funding to solve the EU sovereign debt crisis. It was clear that a larger fund than this would be necessary. Ireland is being offered €22.5 billion from the mechanism so that it is clear the facility must provide a lot more of future funding.

The operation of the mechanism is pretty simple. The EU goes to financial markets and borrows money at fixed rates at certain maturities and it takes all that money and lends it directly to Ireland. However, in the meantime, the EU adds on 292.5 basis points, it is very precise. In other words it is adding on almost 3% to its cost of borrowing. What will that cost us? The NTMA estimated in December that these loans would have an average interest rate of approximately 5.7%, thereby on a like by like basis, being equivalent to the IMF loans. I looked into this last week. Based on recent developments in market interest rates, and also the fact that the mechanism issued a bond on 5 January - and we know what the terms of that bond were - my assessment is the actual rate that the mechanism will be lending to Ireland is something more like 6.1%.

The facility has a very complicated structure. Rather than go into precisely what the complicated structure is - that may be a good point for questions - I will try to explain the reason for this complicated structure. The mechanism linked directly to the EU budget is clearly not large enough to credibly say that you can stand by and help Ireland, Portugal, Spain with their budgetary problems, so a much larger facility was required. Ideally one wants this facility to be something that was shared across all eurozone countries and that is indeed what the facility is. The problem is that not all eurozone countries are good credits. It was unclear that international investors would want to lend money to something that is essentially a weighted average of eurozone creditors or if they did, the cost of that funding would be quite expensive because of the participation of weaker creditors. These transactions are only taking place when international markets decide that the country applying to the programme is not a good bet for paying back loans. To get a low interest rate in the market, these EU facilities have to convince the market not to worry about the credit quality of the donor country, that is the country that is getting the money. Instead they need to say that European Union countries are standing behind this and the markets know for that reason they will get their money back.

The way the facilities have been constructed is to reassure people that the average financial strength is essentially the same as the AAA rated members of the eurozone. Roughly 80% of the financial backing for this facility comes from AAA rated members and the facilities operate as though one only needs to worry about the credit worthiness of those member states. What that means is that when they borrow €100 million in the market, they do not lend out all of that €100 million, but keep some back for cash to assure investors that there is a pile of cash sitting there already ready to pay interest payments and so on. Furthermore, of the money earmarked for a particular country, much of it is kept back to increase the cash buffer and so much of the interest cost that Ireland will pay takes the form of an immediate deduction of a lot of the money that we are borrowing.

I will show a slide of what a stylised loan from the facility would look like in terms of cash flows and I will come back to it later. These additional features to try to make the facility more attractive to investors add about 35 basis points to the cost of the facility's funds relative to the costs of the mechanism's funds. Therefore, since I calculated that I think the mechanism's interest rate will be approximately 6.1%, I think at this point the cost of the facility would be approximately 6.45%. Again, it will depend on the rate at which the facility is able to raise funds in the market. They have not done so yet, but I understand they are planning to do so this week.

There is a detailed discussion on the content of this slide in the briefing paper. Essentially it is a set of numbers describing that when the EU goes into the market as the EFSF and borrows €100 million, it only earmarks €80 million as being a loan to Ireland and then it immediately deducts a load of that money so that Ireland never sees it. In this example, Ireland only gets €67.5 million. We make interest payments for a number of years but at the end of the day, we still need to pay back the full €80 million. One can then calculate how this arrangement would have worked relative to a regular loan of €67.5 million from the bank and make interest payments back. In this example, when we put it all together, there is a simple average interest rate of 6.05%. This is an illustration of what is meant when people say that the interest rate would be about 6%. As I have said, I have calculated the figures and I think it would be slightly higher.

I will finish up on these two points. Comparing the EU and the IMF loans, it is important to emphasise that although it may appear that the IMF loans carry a lower rate than the corresponding EU loans, once they are compared on a like-by-like basis, it is fair to say that the overall costs of funding over a long period would be likely to be similar. It is true that right now and over the next year or two, the cost of funding from the IMF is lower than the cost of funding from the EU and we have locked in at fixed rates this relatively high cost from the EU. However, the cost to the IMF is more of a process that we expect to increase in the future. That is an important difference. When thinking about what it would cost a country to borrow at variable rates compared with fixed rates, one can think of all three of these programmes as being programmes that tack on a margin of 3% to the corresponding cost of borrowing. The last question but probably the most important question, is whether there is room for getting a lower rate by negotiating on any component of these loans. In relation to the IMF loan, I would say, absolutely not. This is a standard programme and one can go on the IMF's website and find out the terms and conditions and what an extended fund facility looks like.

Will Professor Whelan repeat that loudly?

Professor Karl Whelan

In regard to the IMF component of the loan, there is simply no way that one can renegotiate that component of the loan. However, in respect of the EU components of the loans, to my mind the situation is quite different.

Will Professor Whelan say that loudly as well?

Professor Karl Whelan

The EU procedures for the facility and the mechanism are not something for which our long-standing programmes would set out terms and conditions that apply to every country in the world. These two facilities currently have one client, Ireland. In a sense we are the test case or guinea pig for establishing what this type of lending should be. If somebody believes that because a statement has been put out by the facility or the EU Commission stating that the rates will be at a certain level, and believes that means they are set in stone, I note that has not been the case. The EFSF released a statement last summer describing how the loans would work which stated that the margins would be 300 basis points for the first three years and 400 basis points afterwards. The actual overall average margin is of the order of 247 basis points. It was referring to the part without the extra costs relating to the credit enhancements. Even though I do not recall a press statement about this, the margin already has been negotiated downwards, relative to what we thought it would be last summer.

In turn our EU partners that are lending this money can make the point that they are lending us this money at lower rates than we would get in financial markets. There are limits to how far one should push this comparison. On the one hand, that is the case. That is why we are where we are. At 6% it is important to emphasise that the ability to stabilise the budget deficit at average interest rates of 6% starts to become extremely difficult. The standard way to think about this is to stabilise the debt to GDP ratio. Even if Ireland had a zero primary deficit, our debt would still grow at 6% per year, just from the interest payments. To stabilise the debt to GDP ratio, with a zero primary deficit, we would need nominal GDP to grow at 6%. If one thinks we will be an average European country in the future and have average levels of European inflation, then one would pick a figure such as 2% which is the ECB's target. That would require 4% real growth to stabilise the debt to GDP ratio, even if we were running no primary deficit. That gives an indication of why economists think interest rates at the level of 6% make it difficult to stabilise the debt.

Ultimately the EU packages must be viewed as related to a political goal of European solidarity, that the EU does not want Ireland to default on its debt, it does not want its debt to become a destabilising influence on the rest of Europe. The interest rates on the loan should be judged from that political solidarity viewpoint. I would emphasise there is still room to negotiate to get a lower rate on the European loans and there is some indication from European politicians that this view is held in certain other quarters.

That presentation was a little longer than expected.

No problem. It was very useful information. I will call Deputy Brendan Howlin, Senator Paschal Donohoe and Deputy Seán Power in that order.

I thank Professor Whelan for his helpful insight into issues with which members of the committee and Members of the House have been trying to grapple. People speak very dogmatically about things that are not dogma. If we approach it on the basis of what we can do to lessen the burden on Ireland and what approaches politically and economically need to be taken to do that, we could work towards some type of focus.

Along with other colleagues, I met with both the IMF team and the European Commission team on a couple of occasions when they were in Dublin. Obviously I was not directly involved in the negotiations but perhaps Professor Whelan would gives us a few of the international comparators.

One of the issues that seemed to loom large with our European colleagues was that of moral hazard. If one reads the speeches of its founding fathers such as Schuman who talked of European solidarity and the need to avoid political or economic hegemony of the large member states, the principle that seemed to underpin the EU was the need for a generous spirit. It was the complete opposite of the post First World War view which was to punish the aftermath of German aggression. It strikes me that we are back to post First World War principles of punishing moral hazard or delinquency as opposed to constructing an economic package that is sustainable for an integrated economy in Europe. I am interested in Professor Whelan's view on that principle from an economic perspective and whether there is any economic argument for saying that if one had it cheaper, they would all abandon the bond market for cheap money.

Professor Whelan projects the interest rates are slightly higher than the NTMA projected rate. Can the State afford the interest rates on the projected growth rate which changed in our discussions? In our first discussion with the European Commission, the projected growth rate for next year was 1.5%, subsequently it halved. From an economic perspective can we have a horizon that makes economic stability sustainable with that level of debt?

My third question is on the balance of IMF and Commission loans. Most of us who are passionately in favour of the European ideals found it a huge frustration that the deal, and even the attitude that we experience in our direct dialogue with the representative of the IMF, seemed to be more supportive than that of the Commission. Is there any economic merit in looking at a rebalancing of the IMF portion of the loan or is that set in stone?

I thank Professor Whelan for his presentation. To respond to the points made by Deputy Howlin, I think we are dealing with a flawed plan. However, it is not animated by the kind of spirit that draws the Treaty of Versailles. That is a point I want to emphasise. The political solidarity that we are looking for here is greater. It has been demonstrated up to this point that we need more political solidarity but the solidarity that exists is still many notches ahead of what Europe experienced between the First World War and the Second World War.

It is a great-----

It is important when one makes such a point that if somebody feels differently they respond to it. One of the reasons we are dealing with such inflamed views is because the environment within which the discussion is taking place is very tense and very emotional. There is a marked difference between the tone that underpins this issue and that which the German nation found after the First World War. That is an analogy I want to clarify.

In terms of this package, Mr. Willem Buiter, chief economist of Citigroup, recently described the operation of this financial stability mechanism as being "an invitation to sovereign debt default". Is that an assessment Professor Whelan would share and, if so, why? In regard to seeking a lower interest rate, regardless of the politics of whether we want one or not, the reason one is needed is the economic analogy Professor Whelan ended up with. The simple rule of thumb I call to mind in this regard is that if a country's predicted growth rate is higher than the rate of interest it is paying on the markets for its borrowing, it will probably be able to move forward in a sustainable manner. On the other hand, if the rate of interest is higher than the rate of growth, then that country is in serious difficulty. Professor Whelan alluded to a similar point. Ireland does not have a hope of achieving growth rates of 5.7% to 6.2% in the next two to three years. What is a plausible way forward for our country in a situation where growth rates are improving beyond where they have been but not anywhere near the levels to which we or anyone else might aspire?

I join colleagues in thanking Professor Whelan for his presentation. There is not much point in dwelling on the IMF aspect of the bailout for now. In regard to the European Union funding, Professor Whelan suggested that we are comparable to a guinea pig. One might assume that the country which is first up for treatment could expect preferential treatment. It is strange that little more than two months after the agreement was reached, Professor Whelan is in a position to say to us that we have paid too high a price and that it can be renegotiated. Why is that so obvious to Professor Whelan today but was not obvious to those who participated in the negotiations? To what degree was the interest rate negotiated or did negotiations take place at all? Was it a proposal that was presented or were any meaningful negotiations attached to what went on?

Looking to the future, and 2015 being an important year, what does Professor Whelan predict the national debt and our annual repayments might be at that stage? Can the country afford them?

I apologise for my late arrival. I thank Professor Whelan for taking the time to produce this extremely comprehensive report which is of great benefit to the committee in its work. On 1 December 2010 the National Treasury Management Agency, NTMA, issued a technical note on European Union-IMF programme borrowing costs, divided into three categories. First was the IMF, which it put at 5.7%. I am not so interested in that figure but I note what Professor Whelan said in that regard. Second, the European Financial Stability Mechanism, EFSM, was put at 5.7% and, third, the European Financial Stability Facility, EFSF, was put at 6.05%. Does Professor Whelan regard that technical note as having been accurate at the time or was it not, in his view, as accurate as it could have been? Is it the case that some of the charges or interest are rolled up and are payable in the beginning such that the net effective interest rate on the total borrowing is greater than the stated interest rate?

Was Ireland's borrowing quota raised on the grounds of necessity or on the grounds of economic factors, indicators and so on? Professor Whelan mentioned interest rate increases, something that has been referred to throughout Europe in recent times. It is not a reassuring signal to this country in its present situation. The reason given for such a change is to address the inflationary tendencies in other member states. Are there not other ways of treating inflation such as credit controls and similar measures? We were told for the last ten years or more that interest rates were the only way in which countries could control their economies. I do not accept that and am of the view that there are other means that have a less dramatic impact.

On euro depreciation, it is my view that it can be beneficial to our economy. The technique to be deployed in this regard relates to the degree to which it can benefit us in terms of better exploiting that part of the economy that is likely to flourish even in the current difficult situation. I ask Professor Whelan to comment on these points.

Professor Karl Whelan

I propose to take the questions in reverse order, beginning with those of the Chairman. Deputy Howlin and Senator Donohoe raised big picture points relating to moral hazard and the politics of the issue whereas the latter questions were more technical and can be ticked off more quickly.

The process by which Ireland's quota was raised was completely unrelated to the crisis or the funding package. There is a regular review of quotas with several aspects determining the outcome. It is essentially related to how much money the IMF expects it would have to lend to a country were it to get into trouble. Therefore, in the case of a country with a large GDP, for example, there would be a larger amount in question. The IMF also considers other factors such as how open to trade a country is, which might mean it is more likely to have a balance of payments crisis. I do not know the technical details of the upward revision in Ireland's quota, but I suspect it is largely due to increases in GDP since the last quota review. It may look as though the IMF negotiated a rate with us and then somehow gave us a lesser rate-----

How often do these reviews take place?

Professor Karl Whelan

I am not sure. I understand it is a complicated process which does not take place very often.

That requires legislation.

Professor Karl Whelan

It happens once every number of years. As I said, it is unrelated to our current difficulties. Regarding what we might expect to see in respect of interest rates, that might be a good question for the committee to raise in any prospective discussion with Mr. Trichet. Most eurozone countries will see quite contractionary fiscal policy for several years. It may indeed be that we will not see a large take-off in inflation, and this could limit interest rate increases. However, I suspect that the view of the European Central Bank's governing council is not so much that it is concerned about runaway inflation but more that the current level of interest rates is considered abnormally low and that raising rates by 200 or 300 basis points would effectively be a return to normal. I fear there is a problem for us in that the type of international growth conditions on which we will rely to deliver the growth envisaged in the Government's projections may result in an interest rate tightening from the ECB which will raise the cost of funding in this programme and have other negative effects.

There is no doubt that euro depreciation is a good thing for Ireland's export sector. As with all these issues, however, there are multiple effects when any change like that happens. One relatively limited side effect of a euro depreciation would be a rise in the effective cost of the money from the IMF.

Deputy Mulcahy asked about the NTMA technical note that was released in December. I have no reason to believe there was anything in that note that was technically incorrect at the time it was written. Mr. Mark Merrigan of the National Treasury Management Agency, NTMA, was helpful to me in preparing this note.

The NTMA does not issue technical notes on this every week. Two things have happened since that note was published. First, the market interest rates, on which the calculations are based, have gone up. In particular, the seven-eight year swap rates have increased by approximately 20 basis points or 0.2% since December largely, I believe, in response to noises emanating from the ECB that it will tighten and increase rates faster than people expected. Second, the mechanism launched a bond issue on 5 January. A Commission document released around the same time as the document upon which the NTMA calculations were based made clear relative to market interest rates at what it believed the mechanism would raise money. My interpretation of the bond issue on 5 January - I may provide these calculations to the NTMA in respect of which if I am incorrect I will communicate with the committee and provide clarification - is that the interest rate on it was higher relative to market interest rates than had been assumed in the calculations released by the NTMA.

In terms of the manner in which the ESF works, I do not believe the EU has done a good job in explaining how this facility works. It has released various legal and summary documents in regard to how the facility works, which could lead multiple sensible people, on examination of them, to come up with completely different conclusions.

Professor Whelan is starting to feel normal.

Professor Karl Whelan

I have put together a note on how cash flows in a typical loan work, which people are free to take home and study or entertain their family and friends with it. The note is partly based on information supplied to me by the European Financial Stability Facility, which to be fair, was quick in responding. I requested a clear description of the cash flows and how they work and was provided with information in this regard from the ESF. These are my calculations based on information supplied to me by staff from the ESF.

In respect of a loan of, for example, €80 million provided to us by the ESF over seven years, this means the ESF would borrow €100 million on the market from which it would withhold €20 million as a cash reserve and then invest it in high quality triple A securities. One might think at that point that we get a loan of €80 million but that is not the case. The ESF immediately deducts the margin element of the interest rate up-front and keeps it. There is also a service fee based on drawing down the whole sum in addition to the profit margin, which, interestingly, based on the calculations provided to me by the ESF, applies to the €100 million. I do know why. Also, there is an element that we need to cover. This relates to the fact that the 20%, in this example €20 million, that the ESF has taken and invested in high quality liquid assets is not yielding as much as the ESF is paying out to its bond holders. In this example I have used 2.88% because that is what the ESF expects its borrowing rate to be. Because the interest payments supplied each year by Ireland will not cover all of the sum and the cash investments that the ESF has used its €20 million for will also not fully cover it, it then falls back to the Irish Government to provide the cash to ensure the interest rate is fully covered. We are covering the shortfall because the money withheld is invested in a low yielding asset. This, in ESF terminology, is called the adjustment for what is termed negative carry. That too is deducted leaving, in this example, a loan disbursement of €67.5 million.

There is a great deal of room, within all these cash flows going up and down, to manipulate the stated interest rate in such a way as to make it bigger than it looks. I completely agree that could have been done. To my knowledge, and in this example that is not done, namely, the ESF and NTMA have not twisted the statistics in any way. If Ireland was loaned €67.5 million and had to pay back all these payments, namely, the €2.3 million per year in interest payments and the full €80 million, how would this compare with a regular loan? In this example, we borrow €67.5 million and end up repaying €96 million. The €6.05 million which falls out of this does so on the basis that we are repaying 42% more than we are getting. That is over seven years.

Is Professor Whelan saying that the net effective interest rate is as indicated in the technical note?

Professor Karl Whelan

Yes.

Despite that €20 million is withheld and that the charges are loaded up-front as provided for in the technical note?

Professor Karl Whelan

Yes. All of that is included. The only adjustment I would make to that calculation is that the mechanism's borrowing rate would also apply to the facility. Since the December NTMA note was released there have been developments

In regard to the example of €100 million, why do we need to invest €20 million elsewhere? If that sum when invested makes money, as it is likely to do, why then is it not used to offset the real interest we are paying?

Professor Karl Whelan

On the Senator's second question, if the ESF goes out of the market and borrows €100 million at an interest rate of 2.5%, it needs to pay out €2.5 million per year on the €100 million. If it keeps any of the money and invests it in lower yielding assets, then as far as it is concerned it is losing money. We will have to cover that element of cost. On the more interesting question of why it withholds €20 million, this effectively means that only €80 million of the €100 million is really at risk. It turns out only 80% of the financial support provided by various governments comes from Triple A rated countries. This enabled the facility to go into the markets and say, "We're as good as AAA. While we have some countries backing it that are not AAA, we are as good as AAA." What this means - this point has been made quite a lot in The Financial Times and various other newspapers - is that while on the face of it the facility looks like a €440 million facility, it is, in terms of the amount of loans it could actually disburse, quite a bit less. We now know from the Irish example that the ESF only disburses two-thirds of the money it raises. This leaves the facility at approximately €300 million, some of which has now gone to Ireland. There are questions around whether the facility is big enough to bail out Portugal and Spain. That is the basic answer in regard to why the ESF withholds the extra cash. The withholding of €33 million in cash allows the ESF to honour the interest payments throughout the period of the loan, without having to go back to the French or German Government if the Irish fail to repay or the non-AAA people pull out. That is how that works.

Deputy Power asked a question that is a bit beyond my pay grade. He asked why, if I think we could negotiate a lower rate, the Government did not do so on the night. I do not know and I suspect it may be many years before anybody knows, if ever. However, it seems clear that the rate was negotiated. It was not as simple as the Europeans turning up with a legal document from last summer which described how the EFSF loan facility works and telling the Government to take it or leave it. The margin in the loan we negotiated is lower than that set out in the EFSF documentation made publicly available last summer. My briefing note provides a link to the frequently asked questions, FAQ, document released last summer, which describes how the facility operates. The new FAQ section on the EFSF website has in Orwellian fashion removed the previous wording. Thanks to the wonder of Google, however, the old FAQ document is still in the website. One can find a discussion from last summer on how the margins were to operate for the programme. They are now operating differently.

In that sense, it is not the case that a line has been drawn in the sand in terms of a long-standing programme with fixed rules, which is how the IMF can be described. Furthermore, the IMF programmes apply to many countries and we would put a special case by arguing for extended fund facilities which are different to that of every other country in the world. At present, the EFSF and the EFSM are only dealing with Ireland. Nobody else is getting a loan deal. That could put us in a position to change the terms.

Concern has been expressed by financial markets about debt sustainability at these interest rates. The value of Irish Government bonds on financial markets did not increase subsequent to the deal. Financial markets to not believe the prospect of Irish insolvency decreased with the deal. They continue to suspect that there is a high possibility that the sovereign will default on the basis of funding at 6%. We can ask ourselves whether that is where we want to be or if a better funding rate would improve our position.

Since the deal was negotiated, there is a better understanding among our European partners and politicians of the risks of potential default in Ireland. Ms Sharon Bowles, MEP, the chair of the Committee on Economic and Monetary Affairs, has suggested that the €10.86 billion kept as a margin might not have to be repaid. This is a compromise proposal in the sense that a risk premium is being kept but if the loan turned out to be a safe investment and everybody makes money, we would not have to pay it back. It appears the political discussion has expanded since the deal was announced.

In regard to where I think the debt-GDP ratio is going, the IMF has released a superb document which reviews the Irish economy over the life of the programme. It projects that debt-GDP ratio will reach 125% by 2015. That is based on the assumption that all €35 billion of funds earmarked for the next phase of the bank bailout will be spent, in other words, that we will take on an additional €17.5 billion in debt. We do not yet know whether we will have to do this. If all that debt is repaid at a rate of 6% and we end up on EFSF funding as a standard for several years, my maths is good enough to calculate that 7.5% of GDP would go out the door in interest payments. It is difficult to predict whether that would be sustainable. There is not a long history of sovereign default in modern western European countries but debt burdens of that level have resulted in sovereign defaults around the world.

Deputy Howlin and Senator Donohoe asked about moral hazard and the big picture question of whether they want to help us. The Europeans view the terms and conditions of these programmes as being similar to those of the IMF. In the calculations I have presented one could argue that the terms and conditions are not so different from those of the IMF in that they provide longer term financing instead of short-term variable rate financing. They are denominated in euro as opposed to special drawing rights. The Europeans would say that is perfectly reasonable. We have a debt issuance agency that over the years has raised debts over the longer term at fixed rates and in euro rather than over the short term. We have demonstrated that is the way we want our debt to work.

We have a slight problem as we must suspend for a vote.

Professor Karl Whelan

I am happy to conclude.

May I put a question to Professor Whelan?

Of course.

Perhaps Professor Whelan can respond to my questions first.

Professor Karl Whelan

Like many emergency facilities, the programme is structured so that is not the first port of call. An emergency funding programme of this kind in nearly every instance would be designed with disincentives. The problem is that it is difficult to be consistent over time when the disincentives potentially increase the probability of default to such high levels. That is the position of the European sovereign debt crisis at present. There is a great deal of inconsistency. For instance we are adopting policy proposals that say we have to allow for orderly defaults on sovereign debt in the future so that there is bond market discipline for Governments, but not yet. That is not consistent. When we get to 2013 or 2014 and we tell bond investors that they are on moral hazard watch and if there is a default they will lose out, they will not want to play ball. In 2014, the incentive will probably be to permit default on past debts. The moral hazard question is one of several in which there is a lack of consistency in terms of how we treat this issue over time, but it will have to be resolved one way or another.

I apologise for my late arrival. I was delayed at another meeting. From our point of view, the risk of failure increases the longer we have high unemployment and a lack of growth. It is in the interest of the whole of Europe as well as those who are lending us money that we get out of this situation. This brings me to the European approach to this type of situation.

We will suspend the meeting for the duration of the vote before returning to Deputy Barrett's question.

Sitting suspended at 3.10 p.m. and resumed at 3.20 p.m.

I thank Professor Whelan. As Professor Whelan will be well aware, the risk of failure for us gets greater with high unemployment and lack of growth, and with the rates we are being charged. I have been thinking of proposals that we should put to Europe, not alone for this emergency in which we now find ourselves but for the future. I would appreciate Professor Whelan's view on this.

It strikes me that if the European Union - it is called a "Union" - is to operate in any sound sensible way and develop so that we can use each other's economies to mutual benefit, grow employment and all the rest, we must sort out this question of borrowing money and at what rate. We are a small country. As Professor Whelan will be well aware, in business, the bigger one is, the stronger one is when it comes to, first, borrowing money, and second, the rate at which one borrows it. Within the European Union it is extraordinary that ratings agencies that no one knows anything about can dictate the rate of interest we are likely to pay because of recommendations they make about our economy and other European economies. If we can set up the European Central Bank, an independent body, can we not set up a European ratings agency that would be totally independent and made up of professionals whose sole task would be to rate each member state?

If we had three divisions, Ireland would be in the third division but our target would be to get into division 1. While we are in division 3, however, if we borrow money, we must pay a higher rate than those in division 1. Should it not be possible for Europe as a whole to borrow the money on behalf of the member states? In doing so, those countries in division 1 would not be carrying a burden for us in division 3 because we would have to pay a higher rate of interest. Suppose the money is borrowed for all member states at 2%, we might have to pay 3% but that would leave room for Germany to borrow at 2% or even lower. The purpose would be that we would be able to borrow without being exposed to ratings agencies. There would be certainty about borrowing while we act as a union while recognising some of us have the incentive to get into division 1. It is in our interests to get our house in order because we would be able to borrow at a lower rate. The certainty of being able to borrow at a reasonable rate offers a way forward. It is the sort of thinking I would like to see. Am I missing something? Is that a flawed way of thinking?

I agree with Deputy Barrett's comments on independent ratings agencies. Tragically, the financial markets as a whole have been a lot more accurate about the outlook for the Irish economy than we give them credit for.

How can an economy stabilise itself if the growth rate is so much slower than the rate of interest? Is there any way out of this dilemma that does not involve multilateral debt restructuring? Growth and debt are on either side of the equation and the growth side has huge problems in getting above the rate of interest. Is the debt side still open to political choice? I stress that I am talking about multilateral action, not unilateral action.

Professor Karl Whelan

In regard to Deputy Barrett's proposal about centralised European borrowing that is then lent to different countries, that has been discussed over the years, with much of it emanating from financial markets. Many bond market participants have outlined that they would like to have a European bond and a single European bond market instead of French bonds, German bonds, Irish bonds and so on. That has emerged as one way to get out of this crisis and deal with the problems for weaker sovereigns that are in trouble. Technically it could be done but then we would have to move on to the politics of such a move.

That is where the ratings agency would come in.

Professor Karl Whelan

The ratings agencies do not-----

Our own ratings agency.

Professor Karl Whelan

The ratings agencies have done a poor job at various times over the years but they tended to do a poor job of saying bonds were safe when they turned out not to be. If anything, it could be argued that during the sovereign debt crisis, they have tended to lag the judgment of financial markets. Bond yields showed what the market was thinking about Greece, Ireland or Portugal. A couple of months later, Moody's and Standard and Poors would validate those judgments. The ratings agencies have been at the scene of many crimes in recent years but they are not key.

I am sorry, perhaps I am not making myself clear. I am aware there has been discussion of a European bond but I am trying to get at the point where there would be an independent ratings agency equivalent to the ECB. Its only job would be to rate each member state. It would be an internal EU matter, but the EU would be the borrower. That would satisfy the fears of other member states that they would carry us, as a result of our involvement in the system, which might lead to a higher rate of interest. I do not want them to carry us while we are in division 3.

Professor Karl Whelan

I favour centralised, government-sponsored ratings agencies and this could be done through the Bank of International Settlements in Basel. I would worry, however, that a specific European agency that carried out ratings and that decided what country was in what division would become the sort of dysfunctional political football we often see. If logic dictated that France be relegated to division 2, one suspects there would be pressure to ensure it would not be. I am inclined to use outside information.

Most observers would reckon that Germany would only get involved in European bonds if it had far closer control of what countries like Ireland did with the money once it was lent to them. It is great to be in favour of getting cheap money backed by the wider European project but the reality of high frequency, close European control of what Ireland does with its money might be less attractive. As things stand, the politics are such that Germany is not interested in this idea, even if it was allowed to attach conditions. That could change and it is being discussed in Germany at political level. It could happen but only with substantial strings attached that would have implications for Irish democracy and sovereignty.

Professor Whelan expressed anxieties about the national debt reaching 125% of GDP, which would be a significant worry. It hit 130% in the 1980s and we were paying 33% of our net income in interest. We are nowhere near that now, and that is before the trend changes. I am not suggesting things are easy but we have been in a worse position and achieved much better results a couple of years later by taking decisions that were unpalatable at the time.

Professor Karl Whelan

On the issue of debt stabilisation, I am not coming down one way or the other. There are different probable outcomes. Yes, we have been here before, but on the other hand the type of economic growth that emerged from the late 1980s onwards is unlikely to be replicated and the four year plan does not anticipate that kind of growth re-emerging. There is a sense that we got out of gaol in the late 1980s with an outcome that is unlikely to be repeated.

On a more general point, debt sustainability is not as simple as the magic of a debt to GDP ratio. It depends on a whole range of factors in terms of how creditors view a person's credit worthiness and ability to deal with things. In terms of the question that Senator Donohoe put, it is pretty clear that in the long term if we had to sustain 6% and we were borrowing year after year from European facilities at those kinds of rates, it would be difficult to sustain a debt to GDP ratio. What we must hope for is that if the debt to GDP ratio stabilises and starts to turn around one can borrow from the market and do so at cheaper rates than 6%. In a sense, part of the damage of the high interest rate is that over the next couple of years it makes it harder to turn that corner and see clear progress in the right direction, at which point one is more likely to see market confidence restored.

I do not want to overstate how a reduction of 50 basis points off the loan rate, given that this is only a fraction of our borrowing, will make a difference over the next couple of years. I still think it is worth making it an issue and putting our case out there in the European forum. There is a great deal of change at present, in terms of the European sovereign and financial situation generally. There may be opportunities to get this element of the package adjusted.

I thank Professor Whelan for his input to this very interesting discussion. There is no question but that he is correct when he says we live in changing times and that there will be further changes, some may be for the better and I hope none is for the worse.

In regard to the general issue, we need a major diplomatic initiative by this country throughout the eurozone and the European Union in general to explain our position to our colleagues in other parliaments, economists and academics. Unfortunately, we cannot do that work, but it is of major importance that we explain our position to our colleagues, whatever position we come from. I find it difficult to talk to parliamentary colleagues throughout the European Union who do not seem to have all the information necessary to come to a decision on our position. Similarly, we do not understand their position and that is a serious deficit in the exchange of information and the dialogue that needs to take place between parliamentarians, economists, academics and educationalists of the various member states.

I thank Professor Whelan for a very interesting paper and with his permission, when we publish the committee's report we will attribute his contribution in the normal way. Debate on this issue is likely to continue and we look forward to meeting Professor Whelan again. We all recognise the importance of making the correct decisions now as opposed to trying to correct things in four or five years time when things could be more difficult.

The joint committee went into private session at 3.35 p.m. and adjourned at 3.40 p.m. until 11.30 a.m. on Thursday, 27 January 2011.
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