Economic indicators – and the growing numbers in employment – have been saying for some months now that Ireland has turned the corner since its spectacular collapse.
At the same time, the interest rates on Irish Government debt have never been so low, not even at the height of the Celtic Tiger.
The growing optimism about the economy is feeding into the historically low interest rates, but is not the explanation for them.
On Wednesday, in advance of the NTMA’s return to normal bond auctions, Irish bonds were yielding 3.028 per cent. That compared with a yield of 3.339 on similar Spanish debt and 4.482 on the Portugese. Greek bonds were paying 6.989 per cent, and German 1.594 per cent.
A Bloomberg graph, recording Irish bond interest rates, or yields, on the secondary markets going back to March 2004, showed that Wednesday’s rate was the lowest during the period.
It is a sharp recovery over less than three years – on July 15th, 2011, the rate was 14.037 per cent.
Protecting the euro zone
What has happened in the meantime is that the world's major central banks have come out in support of their economies and, crucially, the president of the European Central Bank, Mario Draghi, has said the ECB will do what it takes to protect the euro zone.
Because central banks have set their interest rates so low, banks and investors such as pension funds are able to make a profit by buying Government bonds.
They are encouraged to target countries such as Ireland, Spain and Portugal because the ECB has declared that it will back the euro periphery.
There is talk of Greece returning to the markets and Portugal building up a cash reserve.
The net effect, in the words of Ciarán O’Hagan, head of European rates strategy with Société Générale in Paris, is that “people have become very risk-loving”.
While these international factors are driving down Irish interest rates, the low rates are also being encouraged by strongly positive indicators from the Irish economy, recent changes to the view of Ireland held by ratings agency Moody’s, and the effect on the Irish economy of improvements in the US and the UK, as well, of course, as the Government’s progress in dealing with its deficit.
O’Hagan says that when a country’s debt is large relative to its economy, the interest rate is a major issue.
Portugal’s taxpayers, he says, paid dearly for the outbreak of political instability in that country last year.
According to Jim Ryan, of Dublin financial services firm Glas Securities, investors have not been looking primarily to protect their principal investment since Draghi's declaration that the ECB would do whatever was required to protect the euro.
Safe harbour
Funds that had been receiving low yields from, say, German bonds, where they were glad to have their funds in a safe harbour, have moved those investments to the periphery in search of higher returns.
Ryan points out that the shift does not just affect sovereign bonds, and gives Tuesday’s issue by Bank of Ireland of €750 million in corporate bonds, at a rate of 1.8 per cent, as an example of the appetite that exists.
O’Hagan says the low rates that currently apply have given Ireland some respite, which it should use for getting its debt under control.
What would really help Ireland, he says, would be economic growth and inflation, both of which would reduce the relative size of the debt.
He points out that the International Monetary Fund and others have been issuing strong warnings about the hazards that lie ahead for many advanced economies, because of aging populations and lingering high debt-to-GDP ratios.
Getting debt ratios down is a key part to preparing for the next crisis, and low interest rates are an aid to achieving that objective.
Important issue: Interest on debt
The interest rate Ireland has to pay on its bonds, or to put it another way, on its national debt, is a very important issue for the public finances because of the size of Ireland's debt relative to the size of the economy.
The money owed to bondholders, the troika and people who have put money into State savings, minus the cash balance held by the State, is €175 billion.
Various interest rates apply to the different elements
that go to make up this
debt , but the Department of Finance at the time of the last budget said the State pays approximately 4 per cent on
its national debt. This figure is a blended rate.
In cash terms, the State expects to pay out €8.2 billion in interest on
the debt this year.
These payments will be the equivalent of 20 per cent of all tax revenue, or 4.8 per cent of gross domestic product, the department estimated.
In fact, Ireland has been paying its way since last year – apart, that is, from the interest payments on the debt.
Or, to put it the other
way round, if it wasn't for the debt, and the associated interest payments, we wouldn't have a deficit in the public finances. We have
been running what is called a primary surplus.
Given the size of the problem, any fall in the interest rate the State is paying eases the burden on the public finances.
Likewise, any rise increases the burden.
Interest rates on Irish bonds are currently the lowest in history, giving Ireland some welcome respite while it struggles to get its fiscal
house in order.
Prior to yesterday’s auction, the State owed €112 billion to bondholders, and €67 billion to the troika.
It has a cash hoard of €22.9 billion, which is in part designed to be a buffer for the State, which exited the troika programme last
year without a precautionary credit line.
