Confidence on public debt pile is sound – but a perfect storm is brewing

Conor O’Kelly, chief executive of the National Treasury Management Agency. Photo: Fennell Photography
Conor O’Kelly, chief executive of the National Treasury Management Agency. Photo: Fennell Photography

‘Almost irrespective of the external interest rate environment, we still expect Ireland’s annual interest bill to fall towards €5bn in the near term, from €6.1bn in 2017 and a peak of €7.5bn in 2014.” Thus spoke the man who manages the public debt pile, Conor O’Kelly.

It is confident-sounding stuff, particularly in the context of another eye-catching comment he made at the same time on the interest-rate cycle. “If the cycle is a 12-hour clock we are around 11 o’clock right now,” said the head of the National Treasury Management Agency (NTMA).

Is O’Kelly’s confidence in relation to debt-servicing costs warranted?

Let’s start with the good news. The NTMA has raised more than €11bn so far this year, and has almost twice that amount on hand in cash. Of this year’s new borrowings, the average maturity is 12 years, in part thanks to the longer dated bonds the agency has taken to issuing. The best news for the taxpayer is that the interest rate on the €11bn raised so far this year is just 1pc. Having locked in such low rates over such a long period is likely to explain much about O’Kelly’s confidence.

It should also be recalled that just a few short years ago the mandarins at the Department of Finance expected the State’s debt-servicing bill to be running at €10bn by now. The astonishing and historically unusual interest-rate environment since then, particularly in relation to government debt, has saved taxpayers a fortune.

There is more good news on the economy. Recent indicators, including last week’s raft of economic data, showed that the Irish economy is still growing solidly (that issue is discussed in more detail in my column in the main section of this newspaper). Economic strength is one of the most important factors investors consider when they lend to a government. So, provided economic growth continues, interest rates offered on newly issued debt over the next few years should remain contained.

But the less good news is the quite unprecedented series of short-term risks to the economy. In short, there is a perfect storm brewing out there.

Brexit is exactly 250 days away and this weekend a no-deal exit is looking more likely than ever. US trade aggression shows no sign of abating and if the US hits pharmaceuticals – by far Ireland’s biggest export across the Atlantic – the Irish economy’s main manufacturing motor could get clobbered. Add to that the feared turning of the credit cycle, which could unleash serious financial and banking instability. If these all come together to create the perfect storm for the Irish economy then all bets are off. But let’s make the rather big assumption that sense prevails in the Brexit fiasco and the White House, and focus only on what is happening in the international financial system.

Even if the current credit cycle ends in a period of financial instability, that does not necessarily have to cause wider damage – the October 1989 crash was an example of a financial event which was contained to the financial system and caused no broader economic damage.

The major problem for analysts, if truth be told, is that we are really no better at estimating financial bubbles than before.

Part of the explanation for that is the absence of good and comprehensive measures of asset price inflation – similar to those that capture consumer price inflation – that would allow for better understanding of developments across the aggregates of asset classes.

But what is clear – from stock indices, bond yields, commercial and residential property prices – is that there has been an unusually long run of high asset price inflation internationally. Some of the more bearish market watchers are predicting a major correction – US analyst John Maudlin even believes that the global “debt train” is about to crash.

Making accurate predictions with the available data is just not possible in my view, but the risks are clearly there. The running up of debt, which has fuelled asset prices, has certainly happened. The European Central Bank’s multi-trillion euro experiment in money-printing has also played its part in Europe, as have the same quantitative easing policies elsewhere.

The ECB will end its bond buying later this year. How that plays out in the years ahead is something nobody knows for sure, even if the very slow and gradual unwinding of quantitative easing by the US and British central banks, which is more advanced than that of the ECB, has gone smoothly enough so far. But other central banks don’t have the likes of Italy to contend with, a massively indebted country that is close to going Greek. What happens to its bond yields when Frankfurt’s safety net is removed remains to be seen, but it won’t take much to cause investors to panic, particularly if the Trumpian new government in Rome moves to implement election pledges that are currently in abeyance.

Ireland is not Italy. But neither are the public finances nearly as healthy as many other peer countries. The Government is still in the red. That is despite being half a decade into an economic upswing that is stronger than most other European countries. Accumulated public debt remains the fourth highest in the eurozone relative to annual government revenues.

Of the €200bn of debt outstanding, €35bn is due for repayment in 2019-20 alone. Those debts will have to be rolled over and new debt raised. If the economy slows or goes into recession, the deficit will widen and even more money will have to be borrowed.

Even if interest rates rise by multiples of their current levels this should be manageable, as O’Kelly recently suggested. Thus it would take a full-scale bond buyers’ strike over the coming years for real trouble to arise. That is unlikely, but far from impossible in today’s increasingly bizarre world.

Sunday Indo Business

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