The idea of borrowing money at negative interest rates is hard to get your head around. Yet Ireland again sold longer term debt this week at a negative rate, with the National Treasury Management Agency raising ¤5.5 billion at an interest rate of minus 0.257 per cent for a term of over 10 years. What does this mean for the State's finances as we wrestle with the cost of the pandemic and face other longer-term bills in areas like housing, health, the environment and pensions? Here are seven questions.
1. How does it work when a State borrows at a negative interest rate?
The State has issued debt with a face value of €5.5 billion at a slight premium. To be exact, it will take in €5.654 billion, which it will receive from the investors on January 12th. In mid-October 2031, the NTMA will repay these investors at the face or par value, paying them €5.5 billion. The difference - just under €154.5 million – reflects the negative interest rate being accepted by the investors. They are getting back a little less than they lent.
2. Why would investors do this?
There is a mountain of cash in world markets looking for a home, partly due to the massive monetary expansion by world central banks first after the financial crash and then in response to the pandemic. Interest rates were already on the floor before the pandemic hit – and now billions more cash is being pumped into the system. This has cut options for investors, with Bloomberg estimating that not far off 30 per cent of all investment grade debt – more than $1 trillion in cash terms - is now trading at negative interest rates.
So the choice for investors is to stay safe and lose a small amount of money via bond investments, or to opt for riskier assets like equities or very high risk debt. A lot of money has gone into equities, and most big investors want to hedge their bets, so there is a rush of money into bonds too. Ireland is seen as a safe bet due to the budget management of recent years and strong growth before the pandemic, and our 10-year debt is now trading in line with or below other mainstream EU borrowers like France.
3. But it still seems weird to invest at a loss?
It does. And it is. But in markets this is called the TINA trade - there is no alternative for a lot of big funds than to buy debt as negative rates . Banks charge them to hold money – because the ECB in turn charges the banks to hold their cash.
Some of the shorter term buyers of Irish debt will be betting that the price of the bonds will go even higher and hope to sell it off at a profit. Other longer-term investors, such as big insurance and pensions funds, will be matching future liabilities with what what they see as a rock solid asset. In some cases, currencies can be an issue – investors by buying Irish debt also have an exposure to the euro.
4. What is the role of the ECB?
The ECB does not buy debt directly from euro zone governments. But it is now committed to buying significant amounts, and it does so in the market from other investors. It already holds some €50 billion of Irish debt from its pandemic programme and earlier quantitative easing measures, and is likely to buy roughly another €15 billion this year.
This presence of the ECB as a ready buyer in the market – committed to buying an amount around two thirds of what Ireland plans to raise this year – is a huge reassurance for investors, effectively underwriting them for a period and possibly giving some a chance to cash out at a profit. The pandemic programme is set to continue at least until the end of this year, and central bank support will likely remain a key factor for some years to come, albeit the ECB will eventually try to pull back. How and when it does this is a vital issue.
5. So do we just carry on borrowing?
For now, yes, certainly in terms of paying the pandemic costs. The key constraint is not now the cost of debt servicing. It is what the debt might cost to refinance when it reaches maturity. Or whether a high borrowing and debt level might lead to a sharp rise in borrowing costs at some stage for Ireland if ECB support starts to be withdrawn and markets start to assess which countries are most exposed. Hence, the Government has stated that it wants to be in the middle of the pack in terms of debt and deficit levels – in other words, not out of line with other EU countries.
In terms of traditional metrics, like the ratio of debt to GDP, we remain in line or below many other EU countries, but the impact of multinational accounting on our GDP means this measure is not ideal. Looking at general government debt as a percentage of annual government revenue (229 per cent versus EU average of 181 per cent), or interest payments as a percentage of revenue (5 per cent versus an EU average of 3.5 per cent), shows debt levels here are already at the higher end.
That said, the transformation in the repayment burden of our debt due to lower interest rates has been extraordinary. We have raised a massive amount of new debt over the last five years, partly to refinance the borrowings from the Troika during the crisis and other maturing debt. The NTMA has issued €92.6 billion in medium and long-term debt since 2015, at an average interest rate of 0.83 per cent. As a result the average interest rate on all our debt has fallen from over 5 per cent at the time of the last crisis to less than 2 per cent now.
6. So what happens for rest of this year?
The NTMA has said it will raise €16 billion to €20 billion this year to fund the State's borrowing needs. There are no significant redemptions of outstanding debt this year, but given the favourable borrowing conditions, the NTMA will likely take the opportunity to raise close to its higher-end target, and keep its cash pile high. There is speculation in the market that it will continue to redeem floating rate bonds issued to refinance the bail-out of Anglo Irish Bank and Irish Nationwide. Some €7.5 billion of these are still held by the Central Bank of Ireland. They don't mature until after 2050 though Ireland has been under pressure fro m the ECB to sell them down as quickly as possible.
7. What about the longer term?
There is a strong message from all the major interational bodies – the Europen Commission, ECB, OECD, IMF and so on – for states to spend to combat the economic impact of the pandemic. This means central bank support will continue for some time yet, and will not be withdrawn in a hurry. EU debt and deficit rules are suspended, though in what shape they may return is up for debate. So Ireland, like other countries, has an opportunity to keep borrowing for now – and due to lower interest costs, to carry a larger debt level in the longer term.
The constraint now is not repayments – it is the uncertainty about what rate we will be able to refinance at in 8- 10 years time and beyond, when the loans being issued now need to be rolled over. Note that US long-term rates have risen over 1 per cent this week – the markets are starting to look to the possibility of some uptick in inflation. We may be able to borrow at relatively low interest rates in historic terms for some years to come – but borrowing at negative rates is due to the ECB and their support will gradually be withdrawn.
So we can’t just keep borrowing €20 billion every year – though there will be an argument about whether we need to move a balanced budget, or remain in a smaller deficit position in the next few years.
The Government will set out a strategy in a medium term plan in April. Given the commitment entered into over the past year – including some which are longer term and not directly related to the pandemic – this will be challenging. The bottom line is that we will go forward with a higher debt level, perhaps rising from just over €200 billion before the pandemic, to €240 billion or so afterwads. Higher debt is likely to be sustainable provided the economic growth rate exceeds interst rates – a key factor in debt dynamics.
But looking at longer-term spending commitments – in areas like health, housing, the environment and so on – new revenues will be needed. Some of these will be provided when the economy starts growing again, but new taxes and charges are likely too if Ireland wants to sustain a permanetly higher spending level.
