Eligible Irish bonds a constraint on extending QE

The ECB has flagged the possibility of adjusting its asset purchase programme (QE) to  boost economic activity and move inflation closer to target. At the moment the Bank is buying around €60bn of assets a month, with over €50bn in the shape of Government bonds, with the intention of continuing until at least September 2016. One practical concern regarding extending that timeframe  is the supply of eligible bonds and that may well become more of an issue in the Irish market as we move through 2016.

The nominal value of Irish Government bonds  currently outstanding is €125bn, with some €95bn falling within the maturity range eligible for QE (over 2 years and under 30 years). Bonds yielding below -0.2% are also excluded under the current criteria, which affects a number of countries, notably Germany, but not Ireland. The ECB can buy up to 33% of bonds issued, so that implies an Irish figure of  €31bn.

QE started in March and purchases in the Irish market have averaged €0.8bn a month, bringing the total to €6bn at end-October. Plenty of scope left, therefore, except that the ECB and the Irish Central Bank  already hold Irish bonds, and that figure is included in the QE calculation. The Central Bank  acquired €25bn of bonds as part of the Promissory note deal, with €7bn  maturing within 30 years. The ECB’s holdings arose from the Securities Market Program , which operated for a time in 2010, and amounted to €9.7bn at the end of last year. We do not know the current position or how many will mature over the next two years but from the average maturity (4.5 years) it would seem reasonable to assume that  €7bn would redeem after 2017 and hence fall within QE eligibility.

On that basis the ECB and the Irish Central Bank may own an additional €14bn of Irish eligible bonds, bringing the total to €20bn  when adding the QE purchase to date. Absent any other changes that would mean that the ECB could buy an additional €11bn, which at the current pace of purchase implies a maximum of 14 months, taking us to the end of December 2016 or just three months beyond the current timeframe.

On the face of it, then, the scope for extending Irish QE is very limited, although two factors are likely to give the ECB some leeway, albeit not a great amount. The first is additional supply from the NTMA, with perhaps  €10bn issued in 2016, which would boost the eligible bond total by that amount if over 2 years in maturity. That would allow €3.3bn in additional QE , an extension of four months.  In addition , the Central Bank is required to sell at least €0.5bn of its bond holding next year and any sales would leave greater room for ECB buying of bonds held by the market. On that basis Dame Street may well sell far more than the minimum.

Early repayment of Ireland’s IMF debt

The Irish Government is exploring he possibility of  early repayment of the monies borrowed from the IMF and below we examine the issue.

How much does Ireland owe the IMF?

Ireland  arranged to borrow €22.5bn from the IMF as part of the bailout deal agreed with the Troika, although the fund actually lends in Special Drawing Rights (SDR’s) , the IMF’s unit of account, which is constructed as a basket of four currencies (the US dollar,  euro, Yen and Sterling) with the dollar having the largest weight followed by the single currency. Ireland drew down SDR19.47bn from early 2011 through to late 2013 and the loans have maturities ranging from 4.5 years to 10 years, with an average maturity of 7.3 years. The SDR ‘s value against the euro changes daily and at the time of writing buys €1.16 so Ireland currently owes 22,6bn in euro terms, although the loan has to be repaid in SDR’s. In that sense Ireland can be said to have borrowed from the IMF in four currencies.

What is the interest rate on the loans?

Ireland has borrowed from the IMF under the Extended Fund Facility and the rate charged is floating, depending on the 3-month SDR rate ( itself a weighted basket of rates in the four constituent currencies) and a surcharge. The SDR rate is currently only 0.05% (the euro and yen rates are actually negative) so the premium is much more significant. That depends on how much one borrows relative to ones contribution to the fund , or quota, which is determined by GDP, population and other economic criteria. Ireland’s quota is SDR1.258bn and a country can borrow up to 3 times that (or SDR3.77bn in this case ) at a 1% surcharge. Anything beyond that carries a 3% surcharge , rising to 4% if the loan term extends beyond three years

So how much is Ireland paying?

If we assume the loan term will average 7.5 years Ireland would pay 1.05% per annum on the first SDR3.77bn and on the remaining SDR15.7bn 3.05% over the first three years and 4.05% on the final 4.5 years. This gives an average blended rate of 3.15%. In fact the loan  also carried a one-off 0.5% charge so averaging that out over the term  and adding it to the cost gives an annual rate of 3.21%. This is an SDR rate of course and Ireland raises taxes in euros, so the NTMA will use the swap market to convert euros in to the appropriate basket of currencies. Consequently the NTMA quotes an average euro rate for the loan based on a 7.5 year maturity swap, and that was put at just under 5% in March of this year, implying an annual interest payment in euros of over €1bn on the IMF loan. Ireland’s total interest bill on all outstanding debt  this year is just over €8bn.

How much is Ireland paying in the market?

Bond yields have collapsed across the euro zone on the expectation that short term rates will stay low for a very long time and, probably, in anticipation of bond purchases by the ECB. Irish yields have fallen precipitously too, with a government bond maturing in 10 years currently trading at 1.85%, with shorter maturities at much lower  yield levels. It would therefore appears that Ireland could borrow much more cheaply in the market than the current cost of the IMF loan  and it would make sense to borrow at a longer maturity given the low level of current yields..  The Minister for Finance has mentioned a figure of €18bn for repayment and yields would presumably rise if Ireland announced a much heavier issuance schedule  than currently planned ( only €10bn was slated for this year in total) but even at ,say 3.0% for a 20 year bond , the saving would be around €360mn a year , not counting any additional costs involved in breaking the swaps.

What’s the problem then?

There are two issues. One is that the other members of  the Troika need to sign off on early repayment, which brings in EU Governments  and in some cases parliaments. The second is the Promissory note deal, which involved the Irish government issuing  €25bn in long term bonds to the Irish Central bank . The ECB was never happy with the transaction, believing it to be ‘monetary financing’, and insisted that the Central bank sell the debt into the market over time. The schedule for the latter is light, with sales of €0.5bn a year out to 2018 before rising to €1bn a year, but Draghi now appears to be linking any ECB support for early IMF debt repayment with a more rapid sale by the Central bank.

Does the Prom deal matter that much?

The Irish Government  borrowed the €25bn from the Central Bank , which in turn borrowed from the ECB, and  the Government pays  a floating rate coupon of 6-month euribor ( currently 0.2%) plus 262 basis points on the bonds , implying an annual interest payment of €700mn. That  means a  large profit for the Central bank as its borrowing cost is now virtually zero, and most of this profit is transferred to  the exchequer. If ,say, the Central bank sold €5bn into private sector hands that circular flow of income would be broken, costing the exchequer, with interest payments now leaking out into the investors who bought the bonds from the Central bank while the latter would use the proceeds  of the sale to repay the ECB.

So the ECB’s call is key?

The ECB’s view is therefore very significant, as a much more rapid sale of bonds by the Central bank, in return for a nod on the IMF repayment,  would reduce the benefit of  the latter, by driving up Irish yields and  via a reduction in Central bank and therefore exchequer income. It is an irony though, and one that may well be pointed out by the Irish authorities, that Draghi is now  keen for the  ECB  to  eventually embark on full scale bond purchases across the euro area, which some might view as ‘monetary financing’ too, although no doubt Frankfurt will argue that the cases are different.