Sunday Business Post 13th of September - What is the real burden of the national debt? PDF Print E-mail

Sunday Business Post, September 13, 2009 -

 

In our view media commentary dealing with the national debt burden (on our grandchildren) has served only to confuse the ordinary citizen. The simplest way to think about the debt burden is to highlight the annual cash interest payments which must be paid by the state to cover the cost of the national debt.

 

All of us are paying interest on our bank overdrafts. We understand that burden. In 2008 the state paid €2.144 billion interest, and interestingly enough, the figure has been around €2billion annually over the last 20 years.

 

We have been considering the present data about the potential national debt increases as a result of the upcoming budget deficits, and any effect which Nama might have on the level of the debt and the annual interest cost of debt servicing. In general terms, it is unusual for national debt ever to be totally repaid. It is in the nature of permanent capital, mainly used to finance infrastructure, and available to the exchequer for which annual interest is paid.

 

Governments issue bonds carrying an interest rate with a repayment date spread. For example, take 4.5 per cent treasury stock 2015/2018. The government has the option of redeeming the debt between 2015 and 2018.The redemption normally takes the form of the issue of replacement bonds, depending on the requirement at the time.

 

Between 1999 and 2007, Ireland enjoyed budget surpluses on its current account but the requirement for infrastructural expenditure created overall deficits which were funded by national and/or international borrowing.

 

There is normally no problem for a country like Ireland in raising these funds as, up until recently, we enjoyed a high credit rating. Recent events have had adverse effects on our credit rating, so we are now paying higher interest rates. In spite of recent problems, the NTMA has been able to raise the necessary funds to deal with the current deficits.

 

Since 1975, the percentage of national debt interest to the total tax take has varied from peak of 30 per cent in 1985 to a low of 4.3 per cent in 2007. When related to GNP, the percentage peaked at 11.1 per cent - also in 1985 - with a low of 1.3 per cent in 2007.

 

Using available data we have attempted a projection of numbers for expenditure, for interest on debt, capital costs, taxation revenue and GDP.

 

We have kept in mind a strategy of maintaining an interest to tax revenue at between 10 and 20 per cent; all aiming at getting the deficit to GDP down towards the EU 3 per cent by 2014.

 

In this analysis the debt interest as a percentage of revenue stays around 13 per cent from 2011 to 2014. This compares well with 1985, at 32p er cent, and also with the 20 per cent figure for 1976 which preceded the manifesto year.

 

The national debt to GDP ratio was around 120 per cent in 1990, and 24 per cent in 2002. It grows to around 80 per cent in 2014.This is tolerable when we consider earlier figures like 120 per cent, and when we remember that the national debt is a rolling process - with old loans being replaced by new ones.

 

We have not heard from any commentator what the interest costs of national debt might be now or in the future, just words about the ‘‘debt burden’’ without quantification.

 

We cannot blame the ordinary citizen for interpreting the debate to mean that the taxpayer will be paying multi-billions of euro due to the Nama process.

 

The big figures for debt interest in our calculation are due almost totally to the deficits arising from the recent public sector benchmarking, trade union-driven income increases paid to one and all over the last decade and the growth in public service employment.

 

The burden is not due to Nama because of the fact that it, as designed, is not expected to add to debt interest cost. It is inevitable that An Bord Snip Nua should bite into the expenditure levels.

 

Say, on the basis that Nama pays, for example, €60 billion in bonds to the banks for the banks’ developer debt and, at the end of the day, collects €50 billion of principal plus interest.

 

Over time Nama will collect principal and interest from these debts and will use the principal amounts to redeem bonds each year. If Nama receives more interest from the loans than is paid on the bonds, it will have a contribution to its operating costs and/or make a profit. If debt repayments are not kept up to date and/or default, there will be insufficient repayments of principal to redeem all of the bonds.

 

The interest problem may be handled inpart by the expected interest differentials between the interest received on the loans and the interest paid on the bonds. If there are shortfalls in principal repayments which cannot be covered by the interest differential when all the collectible loans are repaid, there will be unredeemed bonds in Nama’s balance sheet.

 

As there will be no income to service these bonds, they will have to be repaid by the government and taken into the national debt.

 

On the basis of unredeemed bonds of, say, €10 billion, this would involve an increase in the national debt of that amount and an annual interest charge of, say, €500 million per annum, or 5 per cent.

 

Such interest shortfall should be covered by an annual levy on the banks. On the basis of the banks’ profits returning to around €5 billion per year over the next five years, such a levy would be reasonable.

 

On this basis the only cost of Nama to the public purse would be some additional national debt with the interest on it being paid by the banks.

 

In our second article in The Sunday business Post on June 21, we suggested a formula whereby the bank would participate in any surpluses on assets taken over by Nama. As the loans are cleared, the bank(s) would participate in any amounts received by Nama over and above the original valuation.

 

A similar suggestion was in the recent IMF report. We are sure that such an arrangement could be structured and operated, and would avoid any criticism that Nama was paying over the odds for the assets.

 

It would have a further advantage. Nama will be relying on the co-operation and goodwill of the banks in the management of the loans taken over.

 

If the banks are going to benefit from the loans being finalised successfully, they will be more likely to contribute their best efforts. If they have nothing extra to gain, why should they bother?

 

The gap between current market value and long-term economic value will be bridged through a two-stage payment, which has merit. It has been speculated that Nama will issue two classes of bonds.

 

Nama could readily issue negotiable bonds to cover the market value of the loans acquired, as well as deferred bonds which would not be negotiable or carry any interest until some future date, when the collateral was sold at a price higher than the original market value. We would welcome comments as to how such deferred bonds would be treated in the banks’ balance sheets and how they might be valued.

 

It is possible that, as ‘deferred’ assets, they would not be included in the various tiers of capital. Comment from the Institute of Chartered Accountants would be helpful.

 

Finally, it would be helpful if the 40-plus economists would show us where we might be wrong in our analysis of the debt interest. Our first article on the Nama project appeared in The Sunday Business Post as far back as April.

 

Now that commentators have accepted that Nama would not be borrowing to pay cash for the bank assets, maybe we could have a more rational and less ideological debate.

 

Professor Noel Mulcahy is a former executive vice president of the University of Limerick