Ireland’s national debt at the end of next year is expected to be almost €240 billion, according to the latest forecasts in the budget, following two years of heavy borrowing to combat the pandemic. And there will be more to come beyond 2021 – even if it is on a lesser scale. But in direct contrast to the last crisis , we can borrow at extraordinary low interest rates. So is the bulging debt now a danger to the economy? Or are low interest rates giving us a free pass to keep on borrowing – and spending?
1. The key trends
Ireland’s national debt jumped after the last crisis – partly due to the banking crisis but also the massive gap which emerged between spending and borrowing. In cash terms it has stabilised since then, gradually falling as a percentage of GDP as recovery took hold after 2014.
Now debt is on the rise again and some €40 billion will be added this year and next . The debt to GDP ratio, the traditional measure of the debt burden, was 57.4 per cent last year, and is due to rise to 62.6 per cent this year and 66.6 per cent next year.
However, Ireland’s GDP figures are famously inflated by multinational accounting. The debt as a percentage of a new measure of the size of the economy developed by the Central Statistics Office to factor out multinational distortions – GNI* – is due to rise from 95.6 per cent last year to just under 115 per cent in 2021. IMF figures estimate that internationally, the average debt to GDP ratio is now heading for 100 per cent. Its not a perfect comparison, but our debt is now high enough by international standards.
But low interest rates are helping – a lot. ECB interest rates have remained on the floor since the last crisis and as outstanding Irish debt matured, the National Treasury Management Agency has been able to replace it at much lower rates. So the average interest rate on the all the debt Ireland holds has fallen from 5 per cent when the last crisis hit to 2.2 per cent last year.
As large amounts are now borrowed at rock bottom rate – 10-year borrowings were raised recently at a negative interest rate – the average interest rate is expected to fall below 2 per cent this year and drop to 1.6 per cent next year. The average interest rate cost of €22.7 billion raised by the NTMA so far this year has been just 0.2 per cent.
The bottom line is that despite the massive rise in debt, the burden of servicing it – paying the interest bill – continues to fall. It will drop from 6 per cent of total tax revenues in 2018 to 4 per cent next year. As a percentage of GDP,the cost will fall from 1.3 per cent of GDP last year to 1 per cent next year. Even in cash terms, despite the soaring debt level, the cost of servicing the debt will actually fall from €4.7 billion this year to just under €4 billion next year.
2. Why is it different this time?
Ireland’s debt shot higher during the last crisis and the indebted balance sheets of banks, households and the property sector all added to our woes. This time household balance sheets are in much better order – in fact savings have soared and led to excess deposits in the banking system. But a vital factor in the market now in the presence of the ECB, which has added a special pandemic programme to the existing high level of supports it has in the markets.
This has increased existing ECB supports for the market which had already been a key factor in keeping borrowing costs low. Under the pandemic programme alone, the ECB is typically buying around €1.6 billion in Irish bonds each month. It bought €2 billion in September. The ECB buys bonds from other investors rather than directly from governments – but in effect it is “printing money” to fight off the impact of the pandemic. The monthly amount it buys is not far off what the NTMA needs to raise – so this is hugely significantly in holding down the cost of borrowing not only for Ireland but across the euro zone.
The ECB has said that this programme will continue buying at current levels until the worst of the pandemic is over, and at least until next June. After that, up to the end of 2022, it will maintain its net holdings and reinvest and proceeds. There is tension at the ECB about the scale of the support and a decision will have to be made about what happens after next June. But even if the additional buying is wound down, it does look likely the ECB will remain in deep in the markets for the next couple of years. Borrowing costs may not remain as low as they are now, but the should remain low by historical standards.
3. The short-term outlook
The State has significant cash moving into 2021. The budget documents estimate cash reserves will be €12 billion to €13 billion at the end of this year . Also, unlike recent years when much of the money borrowed during the last crisis fell to be refinanced, there is no debt maturing next year. So we can expect to see the NTMA trying to take advantage of the current super-low interest rates to raise significant sums again next year to fund State borrowing, particularly early in the year when it is guaranteed that ECB bond buying will be around current levels. For big investors, the low interest rate environment worldwide means there is no alternative but to buy what is available, even at tiny yields. For now, anyway, governments worldwide, supported by central banks, have a ready market for the bonds.
4. When do we pay the bills?
The good news is that low interest rates are reducing the amount debt payments are limiting Ireland’s ability to spend in other areas. This was a key constraint after the last crisis, when the interest bill cost us more than 12 per cent of all revenue collected at one stage. Now it is around 4 per cent. In today’s terms, that’s a gain of not far off €7 billon a year. Yet, higher borrowing does, of course, push up repayments in future from what they would otherwise be.
Also, the outlook for interest rates, beyond next year, looks likely to be for continued low borrowing costs as the world economy gradually crawls from the economic wreckage. At some stage ECB supports will wind down and borrowing costs will start to move higher. But many experts believe we are now in an era of permanently lower rates.
This week the IMF said the outlook for interest rates meant most countries would not need to engage in austerity measures to get their public finances back in order. They could afford to carry a larger amount of debt forward, though would need to close their deficits over time to stop adding to it. The fact that growth rates were likely to exceed interest rates on debt was a key factor, the IMF said, as this makes it much easier to reduce the debt burden over time.
Work by the Irish Fiscal Advisory Council (IFAC) has suggested that Ireland can avoid the kind of austerity seen after the last crisis, though it might need some modest tax increases or spending cuts to get the public finances back in track after the crisis is over. In the longer term, the IFAC has also warned that the Government faces pressure from an ageing population and other demands on spending which have to be funded, and also faces the risk of overreliance on corporation tax.
The Government strategy is to try to keep borrowing and debt here in line with other core EU states to avoid being seen as an outlier. Market sources point out that the tag of being in a group of troubled countries – to so-called PIIGS – was a big problem last time. Staying with the pack gives some insulation in case there is an unexpected turn in the markets, or a faster than expected recovery, say in 2022, does start to see interest rates heading higher.
The challenge for the public finances will, in time, be to wind down the emergency supports as the pandemic passes, and thus cut the deficit. However, with a big increases in core spending – and some of the pandemic bills in areas like health sure to persist – there will be a need to find revenue to meet these ongoing costs.
This is why a new commission on tax and welfare was announced in the budget. Using the IMF analysis, Ireland – and other countries – could live with higher debt caused by the once-off costs of the pandemic. But ongoing higher spending, and there is plenty planned too in the programme for government, needs to be paid for.
The traditional analysis, as put forward by the Department, is that if the exchequer finances are in surplus before debt payments and growth is above interest rates, then the debt burden can fall quickly. At some stage, some kind of EU rules may also be reimposed. But how fast borrowing needs to be reduced – and what is the appropriate stance of budget policy after that – will be a huge issue in Irish politics and economics in the years ahead.
