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Economic Division | Annual report on public debt in Ireland Page |
ANNUAL REPORT ON PUBLIC DEBT IN IRELAND
SEPTEMBER 2018
Economic Division | Annual report on public debt in Ireland Page | i
Contents
Page
Contents i
Tables and figures ii
Executive summary iv
1. Introduction and background 1
2. Debt developments : 1995- 2017 2
2.1 Debt developments in nominal terms 2 2.2 Debt developments as a percentage of national output 2 2.3 Decomposition of change in debt-to-GNI* ratio 5
2.3.1 The primary balance 6
2.3.2 The ‘snowball effect’ 7 2.3.3 The stock-flow adjustment 8
2.4 Role of banking support 9 2.5 Summary 10
3. Irish debt developments in a European context 11
3.1 Ireland relative to other EU Member States 11
3.2 3.3
Ireland relative to the euro area Ireland relative to other advanced economies
12 13
4. Structural aspects of Irish public debt 15
4.1 Composition of public debt 15 4.2 Interest rates 16
4.3 Maturity profile of public debt 18
4.4 Ownership of bonds 19
4.5 Credit rating of public debt 19
4.6 Net public indebtedness 20
4.7 Contingent liabilities 21
4.8 Summary 21
5. Burden of debt 22
5.1 Interest-to-revenue ratio 22
5.2 Debt-to-revenue ratio 23
5.3 Debt as a fraction of the national pay-bill 24
5.4 Summary 25
6. Forward-looking analysis 26
6.1 Short- and medium-term debt forecasts 26
6.2 Future debt ratio targets 26
6.3 Debt sustainability analysis – shock to the baseline scenario 28
6.4 Summary 30
7. Conclusion 31
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Tables, figures, boxes and appendices
Page
Tables
Table 1 General government impact of banking support 10 Table 2 Economic cycle and the public finances – Ireland and other small MS 13 Table 3 Irish sovereign credit ratings 20
Table 4 Net debt 20 Table 5 Forecasts for gross debt 26
Figures
Figure 1 Gross public debt 2 Figure 2 Evolution of the debt-to-GNI* ratio 3
Figure 3 General government debt: 1924-2017 4
Figure 4 Primary balance 7
Figure 5 Drivers of ‘’snowball effect’’ on government debt 8
Figure 6 Contributions to the stock-flow adjustment 9
Figure 7 Debt dynamics in the EU during the crisis 11
Figure 8 Public finances in the euro area 12
Figure 9 General government debt per capita 2016 14
Figure 10 Composition of Irish debt 15 Figure 11 Effective interest rate on Irish public debt 16
Figure 12 Irish yield curve 17
Figure 13 Maturity profile of Irish government bonds/official debt 18
Figure 14 Holders of Irish Government Long-term Bonds 19
Figure 15 Contingent liabilities 21
Figure 16 Debt interest-to-revenue ratio 22
Figure 17 Debt-to-revenue ratio 24
Figure 18 Debt as a fraction of the national pay bill 24
Figure 19 General government debt in Ireland and the debt reduction rule 27
Figure 20 Total Age-Related Expenditure 28
Figure 21 GNI* shock 30
Figure A1 Decomposition of annual change in debt-to-GNI* ratio 32 Figure A2 Decomposition of annual change in debt-to-GDP ratio 32
Figure A3 Yield on Irish 10-year paper relative to German equivalent 33
Figure A4 Primary fiscal balance 33 Figure A5 Effective interest rate in EU Member States 34
Figure A6 Net public indebtedness 34
Figure A7 Debt interest expenditure relative to total expenditure 35
Figure A8 Trend in Irish sovereign credit rating 35
Figure A9 Increase in public debt from crisis 36
Figure A10 Tax-to-nominal GNI* elasticity 36 Figure A11 WAM of Irish government bonds / EU-IMF programme loans 37
Figure A12 Outstanding volume of floating rate notes 37
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Boxes
Box 1 Public debt – a longer term perspective 4 Box 2 Derivation of the change in the debt ratio equation 6
Box 3 How does Ireland compare with other small countries in the EU? 13
Box 4 Quantitative easing and sovereign borrowing costs 17
Box 5 Growth-damaging effects of public debt 23 Box 6 Impact of ageing on the public finances 28
Appendices
Appendix Additional variables monitored by Department of Finance 32
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Executive Summary
The purpose of this report is to provide a comprehensive diagnosis of public debt dynamics in Ireland. It is the Department’s second annual report on public debt. As well as updating the analysis set out in the previous report, an important innovation on this occasion is the incorporation of ‘modified Gross National Income’ into the analytical framework. A decade after the onset of the global financial crisis, the public debt overhang in Ireland remains significant. At the end of last year, for instance, outstanding public debt amounted to over €200 billion, the equivalent of €42,000 for every person resident in the State. On a per capita basis, public debt in Ireland is the third highest amongst the world’s advanced economies, surpassed only by Japan and the US. Reducing public indebtedness, therefore, remains an important challenge. Continuing to run deficits while simultaneously carrying a large debt-stock increases the vulnerability of the public finances to an economic shock. Moreover, in an increasingly unpredictable external environment there is no room for complacency. Ensuring continued fiscal sustainability must remain a priority, especially in view of unfavourable demographics in the coming decades. Given the risks, prudent management of the public finances is essential and it will be important that the fiscal accounts are balanced over the economic cycle, as provided for in legislation. In addition, there needs to be a fiscal buffer so that the automatic stabilisers can provide counter-cyclical support to the economy in the event of a shock. Public debt expanded significantly on foot of the banking crisis; a symmetric approach, whereby the proceeds from asset disposals are used for deleveraging purposes, is appropriate. Windfall receipts should be used to retire debt. Under a baseline scenario of continued economic growth the debt-to-national income ratio can be expected to decline further. However, structural reforms that boost domestic employment and income levels are also important, as these can impact favourably on the burden of debt. The best way of reducing the debt-to-income ratio is to boost income levels. Reforms that unlock the growth potential of the economy – including those which boost productivity – have a lasting benefit on domestic income levels.
Economic Division | Annual report on public debt in Ireland Page | 1
Annual report on public debt developments August 2018
1
Section 1 – Introduction and background This is the Department’s second annual report on public debt in Ireland. As well as updating the analysis set out in the previous report,2 an important innovation on this occasion is the incorporation of ‘modified Gross National Income’ into the analytical framework for monitoring debt dynamics. Expressing public debt as a fraction of this macroeconomic aggregate provides a better insight into public debt dynamics than traditional aggregates such as Gross Domestic Product, but it was unavailable at the time of publication of last year’s report. As the tenth anniversary of the collapse of Lehman Brothers approaches – an event which triggered the deepest global financial crisis since the Great Depression and which had Ireland at its epicentre – the public sector in Ireland continues to accumulate debt. At the end of last year, outstanding public indebtedness amounted to just over €201 billion; an increase to €209 billion is projected for next year.3 A headline deficit was posted for last year and a (modest) deficit is anticipated for this year. This is in contrast to other small, open economies in the European Union also at a mature phase in the cycle: analysis set out in this document shows that many small countries are close to full-employment (like Ireland) and running headline budgetary surpluses. Running a headline deficit increases the vulnerability of the Irish public sector balance sheet to a deterioration in the economic environment. The purpose of this report is to provide a comprehensive diagnosis of public debt dynamics in Ireland. It is structured as follows. To put the current situation in context, a backward-looking perspective is provided in section 2, where the evolution of debt since the mid-1990s is presented. In section 3, recent debt dynamics in Ireland are contrasted with those elsewhere while, in section 4, key structural features of Irish public debt are highlighted. A forensic assessment of the burden of debt is undertaken in section 5. A forward-looking perspective is provided in section 6 where a debt sustainability analysis is also presented. Policy-relevant conclusions are outlined in section 7.
1 This report was produced by the Economic Division of the Department of Finance, and does not necessarily reflect the views of the Minister of Finance or the Irish Government. The focus of this report is General Government Debt, a measure of the total gross consolidated debt of the State, compiled by the Central Statistics Office. The analysis in the report is based on data available as of end-July. 2 The 2017 report is available at: https://www.finance.gov.ie/updates/department-of-finance-annual-report-on-public-debt-in-ireland-2017/ 3 See Stability Programme, April 2018 Update, Department of Finance, available at: https://www.finance.gov.ie/updates/draft-stability-programme-update-2018/
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Section 2 – Debt developments: 1995 – 2017 The evolution of public indebtedness since the mid-1990s – the earliest period for which general government debt figures are available – is presented below. 2.1: debt developments in nominal terms The outstanding financial liabilities of the public sector from the mid-1990s onwards are set out in figure 1. Several developments are noteworthy. Firstly, public indebtedness was remarkably stable over the 1995-2007 period, averaging around €43 billion per annum. Secondly, the onset of the financial crisis had a major adverse impact on public indebtedness in Ireland, with a massive accumulation of debt observed over the 2008-2013 period. At end-2013, public sector obligations peaked at €215 billion, a five-fold increase from the level immediately preceding the crisis. Finally, a modest reduction in outstanding public indebtedness occurred in 2014, largely due to the winding down of the Irish Banking Resolution Corporation (IBRC).4 The level of public debt has been broadly stable at just north of €200 billion since then.
Figure 1: Gross public debt, € millions
Source: CSO and European Commission (AMECO database).
2.2: debt developments as a percentage of national output In order to put these obligations into context, it is standard practice to express public debt as a fraction of some measure of national income, such as Gross Domestic Product (GDP). However, GDP is not an accurate representation of Irish income levels and, indeed, has become less-and-less representative of domestic income levels in recent years (see
4 IBRC was formed in 2011 from the remaining assets of Anglo Irish Bank and Irish Nationwide Building Society. In early-2013, the Government replaced the €25 billion promissory note obligations (used to recapitalise Anglo Irish Bank and Irish Nationwide Building Society) to the eurosystem with long-term (maturities of between 25 and 40 years) floating rate bonds; the non-promissory note obligations of IBRC were transferred to the National Asset Management Agency and the process of winding down IBRC began.
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Department of Finance, 2018).5 In short, GDP is substantially inflated by the activities of parts of the multinational sector which, in some cases, have little tangible effects on actual domestic income levels. Researchers in Ireland have traditionally focussed on Gross National Product (GNP) or Gross National Income (GNI) as measures of domestic living standards, given the large multinational footprint in Ireland. However, many of the relatively new phenomena are also contaminating these macroeconomic aggregates. An important side-effect of a large multinational footprint is that the information content of various fiscal ratios (with GDP as the denominator) can be extremely limited. Nowhere is this side-effect more stark than for the ratio of public debt-to-GDP – while this ratio has fallen significantly in recent years, almost all of the decline has been due to the increase in nominal GDP, with at least part of the increase in the latter due to financial engineering rather than actual improvements in domestic incomes. The upshot of this is that assessing debt dynamics through the prism of GDP gives an overly benign picture of developments. To address this short-coming, the Central Statistics Office (CSO) publishes an alternative indicator of domestic income, referred to as ‘modified Gross National Income’ (hereafter referred to as GNI*).6 While not perfect, the signalling properties of the debt-to-GNI* ratio are far superior to those of the debt-to-GDP ratio.
Figure 2: evolution of the debt-to-GNI* ratio, per cent
Treaty refers to Treaty on the Functioning of the European Union (TFEU); protocol 12 attached to the Treaty sets out 60 per cent of GDP as the reference value for public debt. Source: European Commission (AMECO database) and CSO.
5 GDP and modified GNI – explanatory note, Department of Finance, April 2018, available at: www.finance.gov.ie/wp-content/uploads/2018/05/180504-GDP-and-Modified-GNI-Explanatory-Note-May-2018.pdf 6 As recommended by the Economic Statistics Review Group (ESRG, an independent group of economists established by the CSO to identify inter alia alternative metrics for measuring the size of the Irish economy). The report of the ESRG is available at: www.cso.ie/en/media/csoie/newsevents/documents/reportoftheeconomicstatisticsreviewgroup/Economic_Statistics_Review_(ESRG)_Report_Dec_2016.pdf
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Box 1: public debt – a longer term perspective The CSO compiles general government data in accordance with standards set out under the European System of Accounts, 2010. These data are standardised across the European Union, but are available only from the mid-1990s in Ireland. To address this important data-gap, Fitzgerald and Kenny (2018)* have analysed data from the annual Finance Accounts (the audited annual financial statement of the Exchequer produced by the Comptroller and Auditor General) to ‘back-cast’ the (explicit) liabilities of the public sector to 1922 (the year in which the Irish State was founded). While the treatment of some items in the Finance Accounts is not entirely consistent over the period, various adjustments / interpolations allow for the construction of a broadly consistent historical time series (figure 3).
Figure 3: general government debt: 1924-2017, per cent of Gross National Product
Data pre-1995 provided by Prof. John Fitzgerald.
The data show a very modest level of debt relative to national income (GNP) at the time of the foundation of the Irish State. However, the debt ratio had reached 40 per cent within the first decade of independence, although it stabilised at around this level in the subsequent decade. In the mid-part of the last century the debt ratio began to creep upwards once again, before stabilising at around 60 per cent during the 1960s. A sea-change occurred in the mid-1970s, when successive governments adopted activist fiscal policies in an effort to stabilise demand in the face of the oil price shocks at the time. Ireland, of course, was not unique in this regard, with many OECD economies adopting Keynesian-style, demand management policies. Between the mid-1970s and the late-1980s, the debt ratio in Ireland increased by around 70 percentage points, peaking at just under 120 per cent of GNP in 1988. With the government at the time finally getting to grips with the fiscal crisis in the late-1980s, and the (not unrelated) subsequent convergence of living standards towards European norms, the ratio of debt to national income fell sharply during the 1990s/2000s. However, the collapse of the public finances and the life-support extended to the banking sector resulted in a sharp increase in public debt in 2008-2011 (discussed below).
* Managing a Century of Debt, John Fitzgerald and Sean Kenny, available at: https://www.tcd.ie/Economics/TEP/2018/tep0118.pdf
Figure 2 presents the evolution of the debt-to-GNI* ratio since the mid-1990s. For completeness, the debt-to GDP ratio is also shown, although the focus of the analysis in this document is the debt-to-GNI* ratio (the two ratios move more-or-less in tandem until
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2008/09 which is when some of the major distortions to the Irish GDP figures began to emerge). In terms of the debt-to-GNI* ratio, three distinct phases can be observed. During the first phase, the ratio declined steadily, with a peak-to trough decline of nearly 60 percentage points recorded over the period 1995-2007. In the second phase, which covers the most acute phase of the inter-related crises (banking, fiscal and economic – the so-called ‘doom loop’7), the debt-to-GNI* ratio rose by around 137 percentage points over just five years, an unprecedented pace of increase in debt-to-income for an advanced economy (at least outside of war-time). The debt-to-GNI* ratio peaked at just under 170 per cent in 2012. Economic recovery and the improvement in the fiscal accounts ushered in a new phase from 2013 onwards. Since then, the ratio has fallen by 55 percentage points, reaching an estimated level of 111 per cent at the end of last year. 2.3: decomposition of change in debt-to-GNI* ratio To probe a little deeper, it is useful to decompose the annual change in the debt ratio into its constituent parts. As set out in box 2, the change in the debt ratio (expressed as a fraction of some measure of income – GDP, GNP or GNI*) is equal to the sum of:
the primary balance = the headline balance excluding debt interest payments;
the ‘snowball’ effect = the difference between nominal growth and the interest rate;
the stock-flow adjustment = a residual term.
Figures A1 and A2 in the appendix show the contribution of each of these components to the change in the debt-to-GNI* ratio and, for completeness, the debt-to-GDP ratio. Developments in each of these components are described below.
7 The ‘doom loop’ refers to the adverse feedback mechanism between economic activity, the financial sector and the fiscal accounts in many European countries during the financial crisis. Weakness in the financial sector necessitated public support which, by raising public indebtedness, raised the cost of sovereign borrowing. This, in turn, raised the cost of capital. Furthermore, many European banks incurred reductions in their shareholders equity given the significant volumes of sovereign debt on their books and in their capital levels if they chose not to filter out the mark-to-market impact. Profitability and capital were also impacted by the need to provide for additional non-performing loans (due to weaker economic conditions). Rebuilding capital buffers reduced the flow of credit, further depressing economic activity. Lower levels of economic activity further impaired the financial sector and raised public deficits, generating a vicious downward cycle. The creation of a fully-fledged European-wide Banking Union was one of the main policy responses at a European level to break this sovereign-banking nexus.
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Box 2: derivation of the change in the debt ratio equation The annual change in the debt-income ratio can be decomposed into three sub-components in order to better understand debt dynamics. To see how this is arrived at, consider that the stock of debt at time t (Dt) can be represented by:
𝐷𝑡 = 𝐷𝑡−1 + 𝐷𝐸𝐹𝑡 + 𝑆𝐹𝐴𝑡 (1)
Where DEFt = headline balance at time t SFAt = stock-flow adjustment at time t Noting that: 𝐷𝐸𝐹𝑡 = r ∗ 𝐷𝑡−1 + 𝑃𝐵𝑡 Where PBt = primary balance at time t (headline balance less interest payments) r = the effective (average) interest rate paid on the stock of debt Then (1) can be re-written as:
𝐷𝑡 = 𝐷𝑡−1 + r ∗ 𝐷𝑡−1 + 𝑃𝐵𝑡 + 𝑆𝐹𝐴𝑡 (2)
Thus, the stock of debt at time t is equal to the stock of debt in the previous period (t-1), the primary balance in time t, interest payments in time t and an adjustment (referred to as the ‘stock flow adjustment’) to take into account residual factors. Rearranging (2) gives:
𝐷𝑡 = (1+r) ∗ 𝐷𝑡−1 + 𝑃𝐵𝑡 + 𝑆𝐹𝐴𝑡 (3)
Expressing (3) as a share of income (𝑌𝑡) gives:
𝐷𝑡
𝑌𝑡 =
(1+𝑟)∗ 𝐷𝑡−1
𝑌𝑡∗
𝑌𝑡−1
𝑌𝑡−1 +
𝑃𝐵𝑡
𝑌𝑡 +
𝑆𝐹𝐴𝑡
𝑌𝑡
Letting lower cases denote the share of output and noting that 𝑌𝑡
𝑌𝑡−1 − 1 = g = nominal growth, then:
𝑑𝑡 = (1+𝑟)
(1+𝑔)∗ 𝑑𝑡−1 + 𝑝𝑏𝑡 + 𝑠𝑓𝑎𝑡
Subtracting dt-1 from both sides of the equation gives:
𝑑𝑡 − 𝑑𝑡−1 = [ (1+𝑟)
(1+𝑔) −1] ∗ 𝑑𝑡−1 + 𝑝𝑏𝑡 + 𝑠𝑓𝑎𝑡
Re-writing gives:
𝛥𝑑 =(𝑟−𝑔)
(1+𝑔) ∗ 𝑑𝑡−1 + 𝑝𝑏𝑡 + 𝑠𝑓𝑎𝑡
2.3.1: the primary balance The evolution of the primary balance since the mid-1990s is shown in figure 4, which decomposes the primary balance into its estimated structural and cyclical components as well as one-off factors. Over the period 1995-2007, primary surpluses were recorded each year, averaging 3.9 per cent of GNI* per annum. On the basis of the commonly-agreed methodology for assessing the output gap, most of this surplus was structural in nature (though in reality this was not the case).8
8 One of the main shortcomings of this commonly agreed methodology is that it did not flag fiscal imbalances during the lead-in to the crisis.
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The rapid deterioration in the public finances is evident from the emergence of a substantial structural primary deficit in 2008 which widened subsequently. This reflected the collapse in taxation revenue as well as the support provided to the banking sector at the time. The most outstanding figure is, of course, the primary deficit of 38 per cent of GNI* in 2010, with banking supporting accounting for about two-thirds of this. Nevertheless, even leaving this aside, the underlying structural deficit was still significant at nearly 10 per cent of GNI*.
Figure 4: primary balance, percentage points of GNI*
Only one-off receipts in excess of 1 per cent of GNI* are considered here. These are almost exclusively related to the financial sector. The cyclical / structural components of the primary balance are unobservable and so all figures are estimates. Source: Department of Finance estimates based on CSO data for primary balance.
The consolidation of the public finances (the improvement in the structural primary balance) as well as cyclical recovery (the improvement in the cyclical primary balance) led to the re-emergence of a primary surplus in 2014. This has subsequently widened and, last year, a primary surplus of 2.6 per cent of GNI* was recorded, the largest since the mid-2000s. 2.3.2: the ‘snowball effect’ Figure 5 shows the growth rate of GNI*, the effective interest rate and the difference between these two variables since 1995. From the mid-1990s until the eve of the crisis, the growth rate of the economy exceeded the effective interest rate on public debt, i.e. rt < gt, which ceteris paribus reduced the debt ratio. The strong growth rate was a function of the upward convergence, in real terms, of Irish living standards to European norms until around 2001 / 2002 and, subsequently, the emergence of an unsustainable, credit-fuelled property bubble. This very strong real income growth, together with relatively high economy-wide inflation, effectively eroded the burden of public debt. This passive decline in the public debt ratio, i.e. arising from the expansion of the denominator, conceals the fact that the monetary amount of outstanding debt was broadly unchanged over this period, a common feature internationally.
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The snowball effect, which had been debt-reducing up to 2007, went into reverse between 2008 and 2012, mainly as a result of nominal output growth moving into negative territory for a number of years, i.e. rt > gt. The economic recovery has had a favourable impact on the snowball, with the growth rate of GNI* exceeding the effective interest rate from 2013 onwards; debt management operations (detailed in section 4) have helped keep a lid on the effective interest rate.
Figure 5: drivers of ‘snowball effect’ on government debt, percentage points of GNI*
Source: Department of Finance calculations.
2.3.3: the stock-flow adjustment The stock-flow adjustment (SFA) is a residual term which takes into account the fact that changes in the stock of outstanding debt arise for reasons unrelated to the deficit in a period. The SFA captures factors such as valuation (including exchange rate) effects, cash versus accruals accounting, privatisation receipts, etc. Figure 6 shows the contribution of the SFA to debt accumulation over the period. Up until the end of the last decade, the SFA was mainly debt increasing; since the crisis the SFA term has largely balanced out. On four occasions the SFA term has exceeded 10 per cent of GNI*. A very large positive contribution (i.e. debt-increasing) from the SFA was recorded in 2008, arising from debt management operations (the accumulation of large liquidity buffers) that year as a forward-looking response to the deterioration in market conditions at the time. In 2010, the SFA was debt-decreasing on foot of liquid assets and equity transactions as well as the reduction in assets in the national pension reserve fund and social insurance fund. The debt-increasing contribution from the SFA in 2011 was mainly the classification of IBRC liabilities within the general government sector; the reversal in 2014 was due to the winding down of IBRC.9
9 The liabilities of IBRC were classified within general government in 2014 (with retrospective application to 2011) as a result of the switch in the general government accounting framework from the European System of
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nominal implicit cost of debt - nominal GNI* growth ratenominal GNI* growthnominal implicit cost of debt
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Figure 6: contributions to the stock-flow adjustment, percentage points of GNI*
Highlighted data-points are those for which the SFA exceeds 10 per cent of GNI*. Source: Department of Finance calculations.
2.4: role of banking support Finally, it is also worth elaborating on the thorny issue of fiscal support for the financial sector during the crisis, given that Ireland’s banking crisis was one of the most costly in history (see figure A9 in the appendix). Table 1 shows the annual revenue and cost to the State from direct support to the banking system, i.e. the impact on the general government balance each year.10 While the gross cost of financial support amounted to €64 billion (37.4 per cent of 2011 GDP; 50.5 per cent of 2011 GNI*), not all of this directly impacted upon the general government sector. Some of the costs, for instance, were met from the National Pensions Reserve Fund (a fund inside the general government boundary). The key takeaway is that the cost of capital injections during the most acute phase of the financial crisis in 2009-2011 amounted to nearly 36 per cent of GNI*. The net cost of supporting the banking sector last year amounted to -0.1 per cent of GNI*. The support generated a revenue stream (in the form of dividends, etc.) for the general government sector of 0.8 per cent of GNI* but involved outlays (such as interest expenditure) of 0.9 per cent of GNI*. Importantly, the State disposed of 29 per cent of its equity stake in AIB in June of last year,11 generating revenue of just under €3½ billion (1.2 per cent of GDP; 1.9 per cent of GNI*). However, as this is classified as a financial transaction under accounting
Accounts 1995 standard to the 2010 standard. While IBRC has subsequently been wound down, there are some residual IBRC liabilities which are part of general government debt. 10 Last year’s report provided a comprehensive analysis of the support provided to the banking system since 2009 and, accordingly, only a synopsis is provided here. 11 The receipts were paid to the Exchequer in both June and July.
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rules, these receipts are not classified as general government revenue. The proceeds are being used to reduce general government debt.
Table 1: general government impact of banking support, per cent of GNI*
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
revenue: 0.1 0.7 1.4 2.4 2.4 2.1 1.5 1.3 1.0 0.8
- guarantee fees 0.1 0.3 0.8 1.0 0.7 0.3 0.1 0.0 0.0 0.0 - interest 0.0 0.3 0.4 0.8 1.2 0.8 0.5 0.3 0.1 0.0 - dividends 0.0 0.0 0.0 0.3 0.4 0.6 0.5 0.6 0.4 0.4 - other 0.0 0.0 0.1 0.4 0.0 0.4 0.4 0.4 0.4 0.4
expenditure: 0.1 3.4 28.9 7.5 2.1 1.7 1.5 2.5 1.0 0.9
- interest 0.1 0.5 1.5 1.7 1.6 1.4 1.0 0.8 0.6 0.5
- capital injections 0.0 3.0 27.4 5.6 0.2 0.0 0.0 1.3 0.0 0.0
- other cap.transfer 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 - other 0.0 0.0 0.0 0.1 0.3 0.4 0.5 0.4 0.4 0.4
net cost * 0.0 -2.8 -27.6 -5.0 0.3 0.3 0.0 -1.1 0.0 -0.1
headline deficit -8.4 -17.4 -41.6 -17.3 -11.2 -8.0 -4.8 -3.1 -0.8 -0.6
underlying deficit ~ -8.4 -14.6 -14.1 -12.3 -11.4 -8.4 -4.8 -1.9 -0.8 -0.4
* a negative number implies a net cost to the general government sector of banking support while a positive number implies a revenue gain. ~ the underlying deficit is the headline deficit excluding banking-related support. Rounding can affect totals. Source: Eurostat and CSO.
2.5: summary In summary, while it continues on a downward trajectory, the debt-income ratio remains elevated at around 111 per cent of GNI* at the end of last year. The analysis in this section shows that strong nominal income growth continues to do the heavy lifting: the outstanding stock of debt continues to rise and the debt-income ratio is only declining because of the ongoing cyclical recovery. An important corollary of this is that any shock to the denominator, i.e. nominal GDP or GNI*, would expose the high level of public indebtedness (the numerator).
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Section 3 – Irish debt developments in an international context Figure 7 puts Irish debt dynamics since the beginning of the crisis in a wider European context. The Irish data are set out in both GNI* and GDP terms.
3.1: Ireland relative to other EU Member States The crisis had, to varying degree, a detrimental impact on the public indebtedness of all EU Member States. Public indebtedness increased across the board, with particularly severe increases recorded in Greece (78 pp), Spain (65 pp), Slovenia (60 pp), Portugal (62 pp) and Cyprus (54 pp).
Figure 7: debt dynamics in the EU during the crisis, per cent of GDP
Source: Department of Finance calculations based on European Commission (AMECO) data.
However, the increase in Ireland (96 pp of GDP; 137 pp of GNI*) was the largest of any EU Member State, and reflects the three-pronged nature of the crisis (banking recapitalisation, collapse of transitory tax revenues, declining nominal GDP).
Figure 7 also shows that the decline in the debt ratio in Ireland since its peak (-51 pp of GDP; -55 pp of GNI*) has been the largest in the EU28. In the vast majority of Member States the debt ratio has peaked, i.e. the 2017 figure is below the peak. For the EU as a whole, 2017 marked a turning point, with the first annual decline in the debt ratio since the crisis began recorded last year. In all Member States, with the notable exception of Malta, the debt ratio is now higher than at the beginning of the crisis. Ireland’s debt-to-GDP ratio at the end of last year was lower than the corresponding figure for the EU28. Twelve Member States (BE, EL, ES, FR, HR, IT, CY, HU, AU, PT, SI, UK) had a debt-to-GDP ratio in excess of Ireland’s. However, just three Member States (EL, IT, PT) had a debt-to-GDP ratio in excess of Ireland’s ratio of debt-to-GNI*.
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3.2: Ireland relative to the euro area The evolution of the public finances in the individual Member States that comprise the euro area is are especially important, given the potential for spill-over and contagion effects in a currency union. Indeed, the very existence of fiscal rules stems from the heightened possibility of negative externalities arising from a single, centralised monetary policy in tandem with multiple, decentralised fiscal policies.12
Figure 8: public finances (stock and flow) in the euro area, per cent of GDP
Greece is excluded for visual reasons. Bubble size relates to magnitude of GDP. Debt is expressed as a fraction of GNI* for Ireland. Source: AMECO database.
Figure 8 shows the deficit and debt ratios for euro area Member States in 2017 (both variables are expressed as a percentage of GDP, with the exception of the debt ratio for Ireland which is expressed as a fraction of GNI*; Greece is excluded as its debt ratio would distort the chart). Debt developments in the euro area mirror those in the EU28 as a whole, with the debt ratio in the euro area falling last year for the first time since the crisis began. The positive growth surprise in the euro area undoubtedly played a role in improving the headline deficit and in reducing the debt ratio. On a more granular basis, Spain is now the only euro area Member State currently subject to the requirements of the corrective arm of the Stability and Growth Pact; the European Council has given Spain a deadline of 2018 to bring its deficit below, in a durable manner, the 3 per cent of GDP Treaty reference value. At the height of the euro area crisis in 2012, 14 of the then 17 participating Member States (including Ireland) were subject to an excessive deficit procedure (23 of the then 27 European Union Member States).
12 Given this unique structure, legally-binding fiscal rules (the Stability and Growth Pact) were a pre-condition for Germany’s participation in monetary union.
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Twelve euro area Member States currently have a debt ratio in excess of the 60 per cent of GDP threshold set out in the Treaty. This includes the four ‘large’ Member States (DE, FR, IT, ES), although the debt-to-GDP ratio in Germany is relatively close to the threshold. Several smaller Member States (LU, LT, LV, SK, EE, MT) are running headline surpluses / modest deficits and have debt ratios well below the Treaty reference value (box 3).
Box 3: how does Ireland compare with other small countries in the EU? While difficult to be precise, it is clear that following five or six years of very strong growth, the Irish economy is closing in on ‘full employment’. However, a notable feature of the public finances is that, even at this advanced stage of the economic cycle, public expenditure still exceeds revenue, with the Government resorting to borrowing on international capital markets to fund the difference. How does this compare with similar economies in the European Union? This year, 13 of the 28 Member States are projected to run headline surpluses. The table below shows the unemployment rate, the headline government balance and the stock of government debt for a selected set of small, trade-dependent economies in the EU. The countries shown are those with relatively low unemployment rates (the definition of ‘full employment’ differs across countries).
Table 2: economic cycle and the public finances – Ireland and other small MS, per cent of GDP
unemployment rate^ GG balance GG debt
Czech Republic 2.9 1.6 34.6
Denmark 5.7 1.0 36.4
Luxemburg 5.6 1.5 23.0
Malta 4.0 3.9 50.8
Netherlands^^ 4.9 1.1 56.7
Slovenia 6.6 0.0 73.6
Sweden 6.7 1.3 40.6
Ireland 6.7 -0.3 111.1*
GG = general government. *GG debt per cent of GNI*. ^ per cent of labour force. ^^ while not a ‘small’ MS, the NL is not one of the ‘big four’. Source: European Commission Spring 2018 forecasts.
The stand-out feature of this table is that other small Member States operating close to capacity are running headline surpluses; the public finances in Ireland, on the other hand, remain in the red. While the deficit is small, it begs the question as to what would happen the headline deficit if the economy was subject to an economic shock, which is particularly relevant at the current juncture, given heightened external uncertainty.
3.3: Ireland relative to the other advanced economies It is worthwhile comparing Ireland’s debt not just with EU Member States but with other advanced economies, given that the global financial crisis also affected many countries outside of the EU. At the end of last year, public debt amounted to just over €201 billion, the equivalent of around €42,000 for every person resident in the State.13 To see how this compares with other countries it is necessary to, firstly, convert these figures to a common currency and, secondly, to adjust for the different purchasing power among countries. Purchasing power parity (PPP)
13 The Irish population was 4,792,500 in April of last year.
Economic Division | Annual report on public debt in Ireland Page | 14
exchange rates are currency conversion rates that both convert to a common currency and equalise the purchasing power of different currencies. OECD data relating to debt per capita on a PPP basis (figure 9) are insightful in this regard.14
Figure 9: General government debt per capita in 2016, current PPPs – thousands of US dollars
By construction, debt / capita = (debt / GDP) * (GDP / capita). Hence, debt per capita is affected not just by the debt / GDP ratio but by income per capita also. Source: OECD.
Ireland’s debt at $60,000 per capita is amongst the highest in the developed world, behind only that of Japan and the US. Japan, it must be acknowledged, is an outlier, having a debt ratio in excess of 200 per cent of GDP ($96,000 per capita); its capacity to accumulate large and rising government debt without any significant risk premium is often attributed to its ability to finance government debt domestically as well as its large stock of net external assets. Leaving aside Japan, Ireland’s debt per capita is the second highest in the OECD behind the US which, of course, is home to the deepest and most liquid capital markets in the world.
14 The OECD is an organisation of 37 high-income economies; Ireland was a founding member in 1961.
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Section 4 – Structural aspects of Irish public debt A fuller assessment of the State’s credit-worthiness should also take into account complementary information, including structural aspects of public indebtedness. The most important of these are detailed below. 4.1: composition of public debt The composition of public debt is an important factor in assessing a sovereign’s creditworthiness. The composition of the Irish government’s €213.4 billion liabilities at end-July by debt instrument is set out in figure 10 below.15
Figure 10: composition of Irish debt at end-July 2018, € billions
Rounding can affect totals. The ‘other’ category includes inflation-linked bonds. It also includes consolidation adjustments in respect of debt, including Government bonds, held by general government entities. Source: NTMA and CSO.
At the end of last year, 55 per cent (€111 billion) of outstanding debt consisted of fixed rate government bonds (benchmark treasury and amortising bonds).16 A further 8 per cent (€15.5 billion) of general government liabilities related to the outstanding balance of floating rate notes (FRNs) issued in 2013 to replace the IBRC promissory notes held by the Central Bank of Ireland.17 Over the course of last year, the National Treasury Management Agency (NTMA) purchased, and subsequently cancelled, €4 billion of FRNs from the Central Bank of Ireland, reducing the outstanding balance to €15.5 billion at year-end. State savings, short-term paper and ‘other’ debt instruments constituted a further 15 per cent (€29.1 billion) of the total.
15 Public debt has increased since the end of last year due to normal debt management operations. 16 Amortising bonds are those which make equal annual payments (on their coupon date) over their lifetime. 17 The initial amount of FRNs issued by the NTMA and exchanged for the promissory notes held by the Central Bank of Ireland was €25 billion. The Bank is disposing of these in line with a minimum schedule (see figure A12 in the appendix).
€123.2€44.9
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The remaining 22 per cent (€45 billion) of the stock of outstanding debt at end-2017 relates to official sector funding, i.e. outstanding loans secured under the joint EU-IMF Programme. The reduction in this category of debt in 2017 reflects the early repayment of the residual IMF loan facility and the bilateral loans from Sweden (c. €0.6 billion) and Denmark (c. €0.4 billion). This funding was replaced with cheaper marketable debt, thereby generating interest savings. The remaining programme-related debt is composed of loans from the EFSF, EFSM18 and the bilateral loan from the UK (c. €4 billion). The first of these loans matures in 2019. 4.2: interest rates The sustainability of public debt is a function not just of the stock of debt but also the cost of its servicing. The decline in the cost of market-based funding – partly due to the policy-induced reduction in risk premia as well as the non-standard monetary policy (‘quantitative easing’) being implemented by the eurosystem19 – has had a very favourable impact on the cost of servicing Irish debt (see box 4). In particular, active debt management by the NTMA has enabled the rollover of maturing debt at lower, more favourable rates.
Figure 11: effective interest rate on Irish public debt, per cent
Effective interest rate = (interest payments in year t) / (stock of debt in year t-1). Source: Department of Finance calculations.
From a debt sustainability perspective, a noteworthy feature is that the vast bulk of Irish sovereign debt – over 95 per cent of the total – is at fixed rates, when account is taken of the interest rate hedging that is in place to protect against floating rate exposures. Through active debt management, the NTMA has been able to lock-in considerable volumes of debt at relatively low rates. This reduces the exposure of the economy to an interest rate shock – in the event of an increase in sovereign borrowing costs, the incremental cost of debt (i.e. the marginal cost of additional debt) would take some time to pass-through to the average cost of debt (the effective interest rate).
18 EFSF is the European Financial Stability Fund (a euro area facility); EFSM is the European Financial Stability Mechanism (a EU28 facility). The European Stability Mechanism (ESM) replaced the EFSF in 2012. 19 Comprising the European Central Bank and the National Central Banks of euro area Member States.
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The effective interest rate continued to decline last year (see figure 11), reaching just 2.9 per cent, its lowest level since these data were first compiled in 1995. The European Union average (see figure A5 in the appendix) was 2.4 per cent, with Northern European Member States typically incurring the lowest interest costs.
Box 4: quantitative easing and sovereign borrowing costs A key factor underpinning the decline in the effective interest rate in Ireland (and other euro area) countries has been the stance of monetary policy. Central banks can influence the short-term policy rate but have less influence over longer term rates which, naturally enough, are determined by the demand for and the supply of government debt. In normal circumstances, changes in the policy rate will tend to pass-through to longer term rates – the so-called monetary transmission mechanism. In the aftermath of the euro area crisis, however, changes in the policy rate had little influence on longer term rates. To address this breakdown in the monetary transmission mechanism, the eurosystem adopted in January 2015 non-standard monetary policies involving large-scale purchases of euro area sovereign debt in the secondary market (non-bank corporate debt has also been purchased, albeit on a smaller scale).
Figure 12: Irish yield curve at end-July, per cent
Source: Macrobond.
At end-July 2018, the eurosystem had purchased just under €29 billion of Irish sovereign debt under this programme; around one-quarter of the debt issued by euro area sovereigns is now on the eurosystem’s balance sheet. This additional demand for euro area sovereign debt has reduced long-term interest rates and led to a generalised flattening of the yield curve (the interest rate on debt of different maturities) in Member States, including Ireland (figure 12). However, quantitative easing will shortly come to an end, given the recovery in the euro area economy. The Governing Council has decided to halve the pace of bond purchases after September (having already halved the pace of bond-buying in January of this year), and ending purchases in December. The eurosystem will not, however, begin the process of reducing the size of its balance sheet; it will replace its holdings of maturing debt with additional purchases.
Economic Division | Annual report on public debt in Ireland Page | 18
4.3: maturity profile of public debt The redemption profile of Ireland’s long-term marketable and official debt at end-July 2018 is set out in figure 13. During 2017, the NTMA issued €16.2 billion in new benchmark bond funding via two syndications (€8 billion) and seven dual-bond auctions (€8.2 billion).20 The weighted average yield of last year’s issuance was 0.89 per cent. Moreover, there has been a bias towards long-term issuance, with the weighted average maturity of last year’s issuance at 12.4 years. In addition, in line with its stated intention to diversify its issuance over the long-term, the NTMA also issued Ireland’s first inflation-linked bond (€0.6 billion) last year. The sale of €0.2 billion of ultra-long term debt via smaller private placements brought total medium / long-term issuance to €17 billion last year.
Figure 13: maturity profile of Irish government bonds / official debt end-July 2018, € billions
Note that the figures in the chart are unaudited figures. *Government bonds include NTMA repo activity, amortising bonds adjusted by sink factor and inflation linked bonds adjusted for current value. While the inflation linked bond principal repayment will be linked to the Eurostat Harmonised Index of Consumer Prices (HICP) for Ireland, excluding tobacco, it is protected against a fall in the index over the life of a bond. ** UK Bilateral loan figures reflect the effect of currency hedge transactions. ***EFSF loans reflect the maturity extensions agreed in June 2013. ****EFSM loans are also subject to a seven year extension. It is not expected that Ireland will have to refinance any of its EFSM loans before 2027. However, as they are back-to-back loans, the revised maturity dates of individual EFSM loans will only be determined as they approach their original maturity dates. The graph above reflects both original and revised maturity dates of individual EFSM loans. Source: NTMA.
These transactions help to improve debt sustainability by locking in low interest rates with longer maturities. The estimated weighted average maturity of outstanding Irish government bonds and programme loans stood at just under 11 years, a figure that compares favourably by recent standards (see figure A11 in appendix).
20 Includes the proceeds of non-competitive auctions.
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Economic Division | Annual report on public debt in Ireland Page | 19
Having said that, significant redemptions – the ‘twin chimneys’ in 2019 / 2020 – should be highlighted. These refer to the c. €34 billion of maturing bonds and programme loans that need to be refinanced in the next two years and, in part, stem from the bonds issued around the turn of the last decade when the financial crisis began to bite. While not insignificant, it is also worth noting that in late-2014 – immediately prior to the first of the early repayments to the IMF – the amount of debt maturing in 2019/2020 was c.€47 billion. Through active debt management, including pre-funding, the NTMA has significantly reduced refinancing requirements over the next two years. 4.4: ownership of bonds The ownership structure of Irish government bonds, i.e. by resident and non-resident, is an important dimension that also warrants attention. This is because, in an extreme scenario, an abrupt withdrawal of non-residents from the Irish sovereign debt market could adversely affect financing costs (an abrupt withdrawal of residents is also possible but heightened risk aversion is often associated with ‘home bias’). Figure 14 shows the holders of Irish government bonds at the end of last year. The data show that non-residents held 56 per cent of the total Irish public debt, with Irish residents holding the remaining 44 per cent. Credit institutions and the Central Bank accounted for the largest amount of Irish resident holdings at €51.7 billion, followed by the non-bank financial sector at €3.8 billion.
Figure 14: holders of Irish Government long-term bonds – December 2017, € millions
Source: Central Bank of Ireland.
4.5: credit rating of public debt The Irish sovereign’s credit rating continues to improve, following upgrades from several rating agencies – Moody’s, Fitch and R&I – over the course of 2017. Several reasons for the credit rating upgrades were cited, including a declining general government debt-to-GDP ratio, falling debt servicing costs, the improving health of the banking sector and a continued
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Economic Division | Annual report on public debt in Ireland Page | 20
improvement in the fiscal balance. Ireland’s long-term rating is now firmly cemented in the ‘A’ category with all of the main agencies (table 3).
Table 3: Irish Sovereign Credit Ratings, end-July 2018
The evolution of the rating since the crisis is set out in figure A6 in the appendix. Source: NTMA.
4.6: net public indebtedness General government debt is a measure of the gross liabilities of general government at a point in time. In any analysis of public indebtedness, it is important to recognise the other side of the government balance sheet, i.e. that the general government sector has also accumulated considerable financial assets (such as cash and loan assets).
Table 4: net debt at end-2017, per cent of GDP and GNI*
per cent of GDP per cent of GNI*
Gross debt 68.4 111.1 Financial assets 9.3 15.0 Net debt 59.2 96.1
Source: CSO
At end-2017, general government financial assets amounted to 15 per cent of GNI*, mainly in the form of currency and deposits (table 4). Thus, net public indebtedness amounted to 96.1 per cent of estimated GNI*.21 Importantly, this figure does not include the value of the equity that the State holds in the domestic banking system. This was valued at €11.2 billion (3.8 per cent of GDP) at end-June 2017.22 It is government policy that the State will divest itself of these assets over time, with the proceeds used to retire debt. In addition, it is anticipated that the National Asset Management Agency (NAMA) will return a profit of c. €3-€3.5 billion to the State, while the State has received c.€580 million from claims made on the liquidation of IBRC. The ultimate level of dividend cannot be known until all remaining tasks in the liquidation have been completed. As the timing is unknown, these potential receipts are excluded from the net debt figure.
21 The evolution of net public indebtedness over time is shown in figure A6 in appendix 2. In principle, this would be a better means of assessing cross-country debt dynamics, given that financial assets can be used to meet obligations. However, cross-country comparisons of net indebtedness are hampered by inter alia different definitions of financial assets mainly due to a lack of consistency in the classification of financial assets that can be liquidated at short notice. 22 Valuation undertaken by Ireland Strategic Investment Fund (ISIF). Available at: http://isif.ie/portfolio/performance/overview/
Rating Agency Long-term rating Short-term rating Outlook
Standard & Poor's A+ A-1 Stable
Moody's A2 p-1 Stable Fitch Ratings A+ F1+ Stable DBRS A (high) R-1 (middle) Stable Trend R&I A a-1 Stable
Economic Division | Annual report on public debt in Ireland Page | 21
4.7: contingent liabilities Contingent liabilities are obligations of the Government which are potential, as opposed to actual, in nature. In other words, these become actual liabilities of the general government sector only if certain events transpire.
Figure 15: contingent liabilities, per cent of GNI*
Note that the time-series begins in 2009. Source: CSO.
Figure 15 shows outstanding contingent liabilities over the period 2009-2017. As is evident, these have declined significantly in recent years and the downward trend continued last year, with accumulated contingent liabilities of just 3.7 per cent of GNI*. To put this into perspective, contingent liabilities amounted to just over 180 per cent of GNI* less than a decade ago (mainly in the form of guarantee to the financial sector). Outstanding contingent liabilities consist of two main components. The first is government guarantees which amounted to €1.6 billion (0.9 per cent of GNI*) last year, mainly in the form of guarantees provided to the financial sector. The second relates to off-balance sheet Public Private Partnerships (PPPs) and Concessions23 which amounted to around €5 billion (2.8 per cent of GNI*) last year. 4.8: summary The analysis in this section has complemented the standard debt-to-income measures with an assessment of important structural aspects of Irish public debt. By and large, these structural features enhance the sustainability of public debt in Ireland, with further improvements evident during 2017.
23 The main distinction between PPP and Concession contracts is the source of revenue to the private partner. For PPP contracts, the majority of revenue comes from the public partner in the form of unitary payments for the use of the asset. For concession contracts, the majority of revenue comes from the end-users of the asset.
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Section 5 – Burden of debt In order to gain a fuller insight into the burden of public debt in Ireland, it is important to review and assess a more comprehensive set of variables rather than simply focusing exclusively on debt-to-income measures. Trends in several variables are considered below. 5.1: interest-to-revenue ratio The interest burden of public debt is perhaps best assessed by examining trends in the interest-to-revenue ratio. A high ratio signals a high proportion of revenue is needed to meet annual obligations and vice versa. Figure 16 shows that while this ratio has been on a downward trajectory in Ireland since 2013, it remains relatively high by EU standards (the EU ‘norm’ is defined here as observations in the second and third quartiles). Last year, debt interest payments absorbed just under 8 per cent of general government revenue (see figure A7 in appendix); in other words, €1 of every €13 spent by the State is absorbed by interest payments.24. This compares with a figure of just 3 per cent immediately before the crisis. Figure 16: debt interest-to-revenue ratio, IE relative to EU28 second and third quartiles
Shaded area shows the 25-75 percentile range for EU28; the green line shows the evolution of Irish position. Source: Department of Finance calculations based on European Commission (AMECO) data.
As highlighted later (box 5), the debt-growth nexus is affected by debt interest payments which impair the growth rate of the economy by limiting the amount of growth-enhancing expenditure or by increasing the effects of distortionary taxation.
24 Note that net interest expenditure is lower once account is taken of Central Bank income arising from its holdings of the FRNs; most of this income is ultimately remitted to the Exchequer.
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Box 5: growth-damaging effects of public debt The relationship between economic growth and public debt is far from simple. Despite a significant volume of empirical work, economists have not identified a consensually-accepted threshold for the debt-to-GDP ratio above which debt exerts a drag on the pace of economic expansion. Indeed, some have argued that there is no universal threshold with a range of structural factors (e.g. maturity profile, etc.) being as important, if not more so, than the debt-ratio itself. There is, however, more consensus on the channels through which the accumulation of public debt can exert a break on economic growth and living standards. Broadly speaking, these channels can be grouped according to the time dimension involved. In the short-term, high levels of public debt impair the Government’s ability to smooth the economic cycle. Leaving aside the issue of discretionary budgetary measures (which, from a stabilisation perspective, many economists are sceptical of), there is a broad consensus that fiscal policy should operate in a counter-cyclical manner, with the automatic stabilisers providing the first line of defence. High and rising levels of public debt, however, can reduce the scope for the automatic stabilisers to provide counter-cyclical support. This, in turn, can increase the volatility of output, with a detrimental impact on the supply-side of the economy inter alia by lowering the endowment of labour (through so-called ‘hysteresis’ effects). Over the medium- and longer-term, excessive levels of public debt impair the government’s capacity to provide public services. Higher levels of public indebtedness generally involve higher debt service costs; in most advanced economies debt service payments are a ‘first charge’ on revenue: they must be paid in advance of other expenditures and do not require a vote in Parliament. Higher debt servicing costs, therefore, reduce available resources for expenditure in other areas, including more growth-friendly expenditure. While one alternative is to finance the interest expenditure via additional taxation, it must be acknowledged that taxation is distortionary, with higher levels of taxation inevitably reducing the growth potential of an economy. The interest rate is another transmission channel through which excessive public debt weighs on economic growth. The accumulation of more-and-more public debt involves additional risk; creditors will naturally demand a premium to compensate for the possibility that debtors may be unable to meet their future obligations. Because sovereign borrowing costs are the benchmark through which interest rates across the remainder of the economy are set, rising public debt raises the cost of capital throughout the economy. This is the so-called ‘crowding out’ channel. By definition, accumulating debt, i.e. running deficits, reduces national savings which, in turn, bids up interest rates. Higher interest rates ceteris paribus reduce investment and, accordingly, the amount of capital per worker (which ultimately depresses labour productivity). Modern growth theory emphasises the importance of productivity as the fundamental driver of living standards. Finally, there is an inter-generational equity issue. To the extent that accumulating debt increases the burden on future generations, the rationale for debt accumulation is important. Accumulating debt in order to finance increases in the public capital stock can boost the growth potential of the economy; however, the accumulation of debt to finance current consumption has no direct impact on growth potential, with the burden borne by future generations.
5.2: debt-to-revenue ratio An alternative metric for assessing the burden of debt is the debt-to-revenue ratio, which is set out in figure 17. The trend in this ratio is similar to that for the debt interest-to-revenue ratio; after peaking at 3.5 per cent in 2012, the debt-to-revenue ratio fell to 2.6 per cent last year. Moreover, it remains significantly higher than pre-crisis levels and is at the higher end of the European Union spectrum.
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Figure 17: debt-to-revenue ratio, IE relative to EU28 second and third quartiles
Shaded area shows the 25-75 percentile range for EU28; the green line shows the evolution of Irish position. Source: Department of Finance calculations based on European Commission (AMECO) data.
5.3: debt as a fraction of the national pay-bill Figure 18 expresses debt as a fraction of the national pay-bill, i.e. the total annual remuneration of all employees in the State. A key benefit of this approach is that the national pay-bill figures are not distorted by the multinational sector and, in particular, the high profitability of this sector in Ireland.
Figure 18: Debt as a fraction of the national pay bill
Source: Department of Finance calculations.
In the mid-1990s, outstanding public debt amounted to around 1.8 times the national wage bill. While nominal debt was largely unchanged over the period 1995-2007, the expansion in the workforce combined with higher per capita earnings lead to a significant increase in the
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national pay-bill (the denominator). As a result, the ratio of outstanding debt to the pay-bill fell to a low-point of 0.6 in 2007. Thereafter, both the numerator (the increase in outstanding public sector liabilities) and denominator (the decline in the wage bill on foot of falling employment levels post-2008) had a detrimental impact on the ratio, which peaked at 3.0 in 2013. In more recent years, the ratio has resumed a downward trajectory, largely on foot of the expansion in employment, reaching 2.3 last year, its lowest level since 2010. 5.4: summary A host of metrics presented in this section confirm that the burden of public debt in Ireland remains relatively high, both by historical and international standards.
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Section 6 – Forward-looking analysis From a policy perspective, it is also crucially important to understand the sensitivity of the debt-to-income trajectory to alternative assumptions for key driving factors such as nominal growth and interest rates.
6.1: short- and medium-term debt forecasts While it is generally understood that GDP overstates the level of economic activity in Ireland, international obligations25 require the production of debt-to-GDP forecasts. The Department’s latest forecasts for nominal debt, debt-to-GDP ratio as well as debt-to-GNI* are set out in table 5.
Table 5: forecasts for gross debt, per cent (unless stated)
2017 2018 2019 2020 2021
Gross nominal debt, €bn 201.3 206.3 209.4 207.7 211.4
Debt-to-GDP 68.4 66.0 63.5 60.2 58.7
Debt-to-GNI* 111.1 108.9 105.2 99.9 97.6
Forecasts do not include potential equity sales in a number of financial institutions, nor any surplus that NAMA / IBRC may return to the State. Due to the significant revision of GNI* in the 2017 National Income and Expenditure annual release, debt-to-GNI* forecasts are based on the growth rates from the SPU applied to the 2017 outturn for GNI*. Source: Stability Programme, April 2018 Update, Department of Finance.
Gross nominal debt is projected to rise over the period 2018-2021. Under the central scenario that underpins the projections, the pace of income growth (both GDP and GNI*) should exceed the pace of nominal debt accumulation with the result that debt-income ratios should decline. However, the debt-to-GNI* ratio still hovers at around 90 per cent by the end of this decade. 6.2: future debt ratio targets Article 126(2) of the Treaty sets out that compliance with budgetary discipline is assessed on the basis of “whether the ratio of government debt-to-GDP exceeds a reference value, unless the ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace”. Protocol 12, annexed to the Treaty, sets this reference value at 60 per cent of GDP.26 Reforms to the Stability and Growth Pact (hereafter the ‘Pact’) adopted in 2011 in response to the crisis sought inter alia to operationalise the correction of ‘excessive’ debt. In particular, regulation 1467/9727 states that where the debt-to-GDP ratio exceeds the 60 per cent ceiling, it will be considered as diminishing sufficiently and approaching the reference value at a
25 The Stability and Growth Pact, for instance, is formulated in GDP terms. 26 An ‘excessive’ deficit is defined as 3 per cent of GDP. At the time of the negotiation of the Maastricht Treaty, the estimated potential growth rate of the euro area was 3 per cent. Assuming an inflation target of 2 per cent, this would equate to medium term nominal growth of 5 per cent in the euro area. In the long-run, an annual deficit of 3 per cent combined with a nominal growth rate of 5 per cent would result in the debt-to-GDP ratio converging to 60 per cent (i.e. 3/5) of GDP. 27 As amended by Regulation 1177/2011; this is the so-called corrective arm of the Pact.
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satisfactory pace if the differential between a Member State’s debt ratio and the reference value declines by 1/20th per annum as a benchmark.28 This is known as the ‘debt correction rule’. However, for Member States subject to the excessive deficit procedure prior to the revision of regulation 1467/97, a three-year transition period applies following the correction of the excessive deficit. Ireland’s excessive deficit was corrected in 2015 (with formal abrogation in 2016); this means that next year will be the first year in which the full requirements of the debt correction rule will apply.
Figure 19: general government debt in Ireland and the debt reduction rule, per cent of GDP
Source: CSO (outturn) and Department of Finance (forecasts).
To gauge Ireland’s compliance with the debt correction rule, figure 19 sets out an illustrative trajectory for the debt-to-GDP ratio over the period to 2025. The projection to 2021 is based on the Department of Finance projections sourced from the 2018 Update of the Stability Programme, with key inputs (primary balance, effective interest rates, nominal growth) kept unchanged thereafter in order to construct a central scenario to 2025.29 The green line shows the path for the debt-ratio that is consistent with compliance with the (backward-looking) debt-correction rule set out in the reformed Pact. As is clear, reasonable assumptions for nominal GDP, interest rates and the primary balance imply compliance with the debt correction rule, and suggest that the 60 per cent threshold should be achieved in the early part of the next decade.
28 On average over a three year horizon. In the decision-tree, there are backward- and forward-looking elements as well as the concept of debt adjusted for the impact of the economic cycle. While these are not detailed here, more information is available in the ‘Vade Mecum’ on the Stability and Growth Pact. 29 The figures beyond 2021 should not be considered as a formal forecast; instead, the figures for key inputs are simply held unchanged at 2021 levels in order to construct a baseline scenario.
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Box 6: impact of ageing on the public finances While Ireland’s population is currently one of the youngest in the EU, Ireland’s demographic profile is set to change considerably over the coming decades. For instance, Eurostat’s 2015-based population projections suggest Ireland’s old-age dependency ratio (the number of retirees as a fraction of the number of people of working age) is set to double over the next 35 years. While there are currently around 5 people of working age for every person aged 65 or over, by 2050 this ratio will be just over 2. This ‘greying’ of the population will have adverse implications for the public finances, with demographically-sensitive components of public expenditure set to increase significantly in the coming decades. Analysis by the Department of Finance^ projects an increase in total age related expenditure of 4.1 percentage points of GDP over the long-term, peaking at 20.0 per cent of GDP in 2060. The largest component of the projected total age-related expenditure is pension expenditure, accounting for around one-third of age-related expenditure in 2070. When scaled by GNI*, total age-related expenditure is projected to increase by 6.0 percentage points over the long-term, from 22.1 per cent in 2016 to 28.2 per cent in 2070 (figure 20).
Figure 20: Total age-related expenditure, per cent of GNI*
Source: Ageing Report 2018, Department of Finance calculations
In addition to increased expenditure pressures in areas such as pensions, health care and long-term care, population ageing will reduce the productive capacity of the economy, mainly (though not exclusively) due to a slowdown in the growth rate of labour supply. The annual growth rate of potential GDP is set to fall significantly from around 4.3 per cent per annum over 2016-2020 to 1.8 per cent per annum over 2021-2050. ^ Population ageing and the public finances in Ireland, Department of Finance (forthcoming)
6.3: debt sustainability analysis – shock to GNI* While the figures presented in figure 19 can be considered a reasonable baseline scenario over the medium term, it is appropriate to test the sensitivity of the debt path to different macroeconomic assumptions. The conventional approach to assessing debt sustainability – and that employed by multilateral institutions such as the IMF and the European Commission – involves an assessment of the sensitivity of the debt path to a range of macro-fiscal shocks:
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in effect a fiscal ‘stress test’.30 Within this framework, debt sustainability is achieved once the debt-GDP ratio is stabilised and subsequently put on a downward path. On the other hand, de-stabilising debt dynamics arise when mutually-reinforcing forces lead to an explosion of the debt ratio. In last year’s analysis, three shocks to the baseline were presented. The analysis showed that the debt path is sensitive to nominal GDP and, of course, nominal GDP is very volatile in Ireland. On the other hand, the debt trajectory is relatively insensitive to interest rate shocks, given the large share of fixed rate debt and the elongated maturity profile. Both of these findings are consistent with analysis conducted by inter alia the IMF.31 Finally, the analysis showed that the debt path is sensitive to a combined macro-fiscal shock, i.e. a shock that involved a large one-off shock to the headline balance that was compounded by a deterioration in the economic situation. The economic environment, especially on the external front, is increasingly uncertain. It is important, therefore, to assess the trajectory for the debt ratio in the event of an economic shock. In the analysis below, a shock to nominal GNI* is calibrated. Although purely hypothetical, this can provide an indicative order of magnitude or variance around central assumptions for the debt path. In order to capture the pure dynamics, no policy change is assumed; in reality, it is reasonable to assume that policy would respond accordingly if the debt ratio deviated significantly upwards from the current trajectory. Finally, the impact outlined is assumed to be broadly linear, but it should be noted that non-linear responses are regular. In order to calibrate a GNI* shock, a number of purely technical assumptions are made. Firstly, the source of the shock is unspecified. Instead, nominal GNI* growth over the period 2018-2020 is reduced by a half of a standard deviation in the outturn over the past decade. This equates to a nominal growth rate which is 3.5 percentage points lower than in the baseline scenario. Post-2020, the nominal growth rate is assumed to gradually revert to that which underpins the central scenario thereafter, i.e. there is a permanent, downward ‘level-shift’ in GNI*. Secondly, the fiscal feedback is captured by assuming that the revenue-to-GNI* ratio is unchanged and that the level of primary expenditure is unchanged (an approach that broadly follows the toolkit of the IMF). The rationale for this approach is the assumption of unity for the elasticity of taxation revenue to nominal GNI* (figure A10 in the appendix); hence the revenue-to-GNI* ratio should be unchanged over time. The rationale for the unchanged primary expenditure level is the assumption that this aggregate is, for the most part, unrelated to the economic cycle – unemployment expenditure, which is a relatively small component of primary expenditure, is the only component that is cyclical in nature.
30 In its fiscal transparency assessment (2013), the IMF recommended that the Ireland authorities publish their own version of a debt sustainability analysis, demonstrating the interaction of the new fiscal rules. Available at: https://www.imf.org/external/pubs/ft/scr/2013/cr13209.pdf 31 See, for instance, article IV report on the Irish economy. Available at: https://www.imf.org/en/Publications/CR/Issues/2018/06/28/Ireland-2018-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-the-46026
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Thirdly, because of the no policy change assumption, the deterioration in the primary balance is assumed to increase sovereign borrowing costs, with each 1 percentage point deterioration adding 10 basis points to the effective interest rate. Finally, the SFA is assumed to make no contribution, positive or negative.
Figure 21: GNI* shock, per cent of GNI*
Due to the significant revision of GNI* in the 2017 National Income and Expenditure annual release, debt-to-GNI* forecasts are based on the growth rates from the SPU applied to the 2017 outturn for GNI*. Source: Department of Finance calculations.
The analysis shows that, without policy intervention, the debt-to-GNI* ratio is around 25 percentage points higher than baseline by the mid-part of the next decade (figure 21). Importantly, however, the debt ratio remains on a downward trajectory, although this simple simulation demonstrates that the debt path in Ireland is highly sensitive to assumptions regarding nominal GNI*. 6.4: summary In summary, under the baseline scenario of continued economic growth, the debt ratio should continue to decline over the next decade or so. A key lesson of the crisis, however, is that tail risks – low probability but high impact shocks – can, and do, materialise. The analysis in this section has shown that the trajectory for the debt ratio is very sensitive to nominal income growth. In an extreme scenario, policy intervention could be necessary to ensure sustainability.
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Section 7 – Conclusion
The forensic analysis detailed in this report shows that, notwithstanding the decline in the debt-to-income ratio, public indebtedness remains high in Ireland, both by historical and international standards. In an increasingly unpredictable external environment, including the possibility of rising sovereign borrowing costs, high levels of public indebtedness raise the vulnerability of the Irish economy. A key policy priority, therefore, must be to reduce the level of public debt. Unfavourable demographic trends in the coming decades – an ageing population and a rise in the old-age dependency ratio – further highlight the importance of reducing public debt before these adverse demographic factors arise.
There are several strands to this. It is essential to prevent the build-up of additional debt in nominal terms. This involves ensuring fiscal discipline including by running a balanced budget over the economic cycle. It also involves using windfall receipts for debt reduction, including those arising from the disposal of the State’s banking assets. It is important to continue to reduce the burden of debt. This can be achieved by further enhancing credibility in order to minimise refinancing costs for the Irish sovereign. While sovereign borrowing costs have, in all likelihood, bottomed-out, it is crucial to minimise the risk premium, i.e. the spread between Irish and ‘core’ euro area borrowing costs. While this risk premium has been reduced on foot of Ireland’s enhanced reputation, an important lesson from the crisis is that reputation, while hard-won, can be easily lost. The avoidance of pro-cyclical budgetary policies is a key part of reputation enhancement and boosting credibility. The burden of debt can also be reduced by implementing structural reforms that boost the growth potential of the economy – raising the level of employment, incomes, etc. Eliminating barriers to entry – in the professions for instance – would be welfare-enhancing. In addition, there is scope to reduce barriers to labour supply, increase participation rates and boost productivity.
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Appendix: additional variables monitored by Department of Finance
Figure A1: decomposition of annual change in debt-to-GNI* ratio, percentage points of GNI*
Source: Department of Finance calculations.
Figure A2: decomposition of annual change in debt-to-GDP ratio, percentage points of GDP
Source: Department of Finance calculations.
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Figure A3: yield on Irish 10-year paper relative to German equivalent, basis points
Data cover the period since the beginning of stage three of EMU to end-July 2018. Source: Macrobond.
Figure A4: primary fiscal balance, per cent of GDP
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Economic Division | Annual report on public debt in Ireland Page | 34
Figure A5: Effective interest rate in EU Member States, per cent
Effective interest rate = (interest payments in year t) / (stock of debt in year t-1). Note that the effective interest rate in Greece is relatively low due to the measures put in place (grace periods, etc.) to minimise the debt burden. Source: European Commission (AMECO Database).
Figure A6: net public indebtedness, per cent of GNI*
Source: CSO.
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Figure A7: debt interest expenditure relative to total (non-banking) expenditure
CoE is compensation of employees, i.e. the public sector pay bill. Intermediate consumption is the purchase of other (non-labour) goods and services by general government. Expenditure is in general government terms. Source: CSO and Department of Finance calculations.
Figure A8: trend in Irish sovereign credit rating
Source: NTMA.
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Figure A9: Increase in public debt from crisis, per cent of GDP
Start of crisis in brackets. Source: IMF systemic banking crises database.
Figure A10: tax-to-nominal GNI* elasticity
D_ refers to the change in GNI* and the change in taxation revenue. Annual data over 1995-2017. Source: Department of Finance calculations.
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Figure A11: WAM of Irish government bonds & EU-IMF programme loans, years
WAM = Weighted Average Maturity. * For the years 2013-2017 the WAM figures are estimates reflecting certain assumptions about the extensions to EFSM loan maturities granted in 2013. Source: NTMA calculations.
Figure A12: Outstanding volume of floating rate notes, € billions
FRNs relate to the bonds issued to replace the promissory note obligations to the eurosystem. Source: NTMA.
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