BUSINESS OPINION:The problem is the size and the term of the Anglo debt, not the interest we are paying
A REDUCTION in the rate of interest on the Anglo Irish promissory notes is being held out by many as some sort of holy grail of Irish economic recovery.
The thinking seems to be that a reduction in the extortionate rate of interest charged on the €31 billion note would significantly alter Ireland’s debt dynamics and ease our return to the debt markets and thus economic sovereignty.
According to this school of thought, the perfidious European Central Bank once again stands between us and the sunlit uplands.
And once again this seems to have come as something of a surprise to Frankfurt, which was somewhat nonplussed when quizzed about the note last week, saying that given that the note is in effect a contract between one part of the Irish government and the other it was really nothing to do with them what interest rate was charged.
They are substantially correct. The promissory note was dreamt up as a way for the Government to inject money in Anglo Irish Bank.
Instead of having to put €31 billion in at one go, the Government in effect gave Anglo an IOU, which pays interest – aka a promissory note.
Anglo can then take this note to a bank, which will exchange it for cash subject to a discount reflecting the risk that the Government might not be good for the debt.
The net effect is that Anglo gets its money up front but the Government gets to stretch the payments over 20 years, or the life of the notes.
However, given the Government’s credit rating and the general way of the world the only bank that is prepared to perform this bit of financial alchemy is the Central Bank of Ireland and by extension the European Central Bank.
This is the critical piece of the jigsaw because the involvement of the Central Bank means the transaction is largely circular and the cost to the State closer to 2 per cent or less.
It works as follows. The Government pays something like 5 per cent interest on the note – the yield is around 8 per cent – which Anglo takes to the Central Bank, which accepts it as security for a loan for which it charges around 3 per cent. Anglo pockets the interest margin.
The Central Bank is in turn getting the money it lends to Anglo from the ECB at a much lower and not disclosed rate which is reported to be 2 per cent or less. It keeps the difference. The real cost to the State is the rate at which the ECB provides cash and it is far from penal.
It is thus – as the ECB claims – within the Government’s own power to significantly reduce the interest rate on the promissory notes, but there would be no gain to the State.
There might even be a cost. The interest rate was set at a high rate because the ECB could only go along with the whole arrangement if it appeared to at least resemble a real commercial transaction.
Otherwise the bank would be accused of subsidising the Government, which it cannot – as we all know by now – do.
The high interest rate gives the decision by the Central Bank to lend almost face value against the note a veneer of plausibility and allows the ECB play along. If the rate is cut, then this fiction is undermined and along with it the credibility of the ECB and its ability to support the transaction.
There would appear then to be more than a little disingenuousness on both sides. The Government – as the ECB says -– could indeed cut the rate, but there would be little gain other than allowing them manufacture a political victory and some positive headlines.
The ECB, however, would have to go along with it in so far as they would need to indicate that they still judged the promissory notes to be a commercial transaction and thus the notes would be eligible for indirect discounting via the Central Bank.
It is hard to see the holy grail shining anywhere in all of this.
It seems far more likely that the Government simply wants to replace the whole edifice with a cheaper form of funding, presumably from the revamped European rescue fund.
The nuance in the Taoiseach’s comments last week “there is an intense level of discussion about the negotiation of an alternative to the promissory notes”, should be noted. The problem is the size and the term of the Anglo debt, not the interest we are paying.
