an oifig buiséid pharlaiminteach parliamentary budget office

An Oifig Buiséid Pharlaiminteach Parliamentary Budget Office

National Debt – An OverviewApril 2020

https://www.oireachtas.ie/

SéanadhIs í an Oifig Buiséid Pharlaiminteach (OBP) a d'ullmhaigh an doiciméad seo de réir na feidhmeanna atá leagtha síos san Acht um Choimisiún Thithe an Oireachtais, 2003 (mar a leasaíodh),mar áis do Chomhaltaí Thithe an Oireachtais ina gcuid dualgas parlaiminteach. Féadfaidh an OBP aon fhaisnéis atá ann a bhaint as nó a leasú aon tráth gan fógra roimh ré. Níl an OBP freagrach as aon tagairtí d'aon fhaisnéis atá á cothabháil ag tríú páirtithe nó naisc chuig aon fhaisnéis den sórt sin ná as ábhar aon fhaisnéise den sórt sin. Tá baill foirne an OBP ar fáil chun ábhar na bpáipéar seo a phlé le Comhaltaí agus lena gcuid foirne ach ní féidir leo dul i mbun plé leis an mórphobal nó le heagraíochtaí seachtracha.

DisclaimerThis document has been prepared by the Parliamentary Budget Office (PBO) in accordance with its functions under the Houses of the Oireachtas Commission Act 2003 (as amended) for use by the Members of the Houses of the Oireachtas to aid them in their parliamentary duties. It is not intended to be either comprehensive or definitive. The PBO may remove, vary or amend any information contained therein at any time without prior notice. The PBO accepts no responsibility for any references or links to or the content of any information maintained by third parties. Staff of the PBO are available to discuss the contents of these papers with Members and their staff, but cannot enter into discussions with members of the general public or external organisations.

Key Messages 2

Overview of Government Debt 3

Debt in an Economic and Monetary Union 5

Gross Debt v Net Debt 7

Interest Rate 9

Combined Debt 13

EU Fiscal Rules 15

The Relationship between Interest Rates and Economic Growth 16

Risks of a High Level of Debt 17

An International Perspective 19

Conclusion 20

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� National�Debt�–�An�Overview

Contents

n The COVID-19 pandemic will cause a slowdown in the economy and extra Government spending will be needed

to tackle the crisis. This will cause the Government Debt to rise.

n Government Debt is currently high in historical and international terms.

n The government can currently borrow at low interest rates. These interest rates may fall further due to the

additional monetary stimulus provided by the ECB in response to the pandemic. All key sectors of the economy

are now heavily indebted, including households, non-financial corporations and the financial sector.

n Despite low interest rates, Ireland’s repayments on its debt are relatively high. In 2018, Ireland’s interest

payments were 6.4% of government revenue. This was the fourth highest in the EU. If interest payments were

as high as was expected in Budget 2015, interest payments would be 10.3% of government revenue.

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National Debt – An Overview

Key Messages

In March 2020, the Government announced two fiscal packages allocating €6.7 billion to tackle the economic

consequences of the COVID-19 pandemic. It is likely that there will need to be further fiscal packages. Their size

will depend on the duration and severity of the pandemic and how quickly the economy and consumer confidence

rebounds. This means the Government will run a Budget deficit in 2020 and they will need to borrow additional funds.

The pandemic started to have economic and fiscal consequences in March 2020, therefore there is no annual budgetary

data on its impact.

This paper looks at the debt level before the COVID-19 pandemic occurred. Governments borrow money for several

different reasons. It can be used to fund tax cuts and spending (e.g. health, education, social welfare). It can also be

used to finance investment in infrastructure. In certain circumstances it can benefit the economy as it can support

long-term infrastructure projects or a fiscal expansion during a recession. However, a high level of debt can pose

substantial risks for a country.

As larger economies can generally sustain a higher level of debt than small countries, debt is measured as a

percentage of GDP. This also makes it easier to compare debt levels across countries. Ireland’s debt-to-GDP ratio is

currently 59%. This is below the EU average and the 60% threshold set by the Stability and Growth Pact. However,

using a more appropriate measure of economic activity for Ireland (GNI*), the debt-to-GNI* ratio is 100.2%,

significantly higher than the EU average.

Ireland was not always a highly indebted country. In 2006 the debt-to-GDP ratio reached a record low of 23.6%,

which was the sixth lowest in the EU. However, the level of public debt in Ireland rose dramatically during the financial

and economic crisis of 2008. The public debt rose to approximately €215 billion and the government debt-to-GDP ratio

peaked at 120% in 2012. Since then, the economy has recovered and the debt ratio has improved. However, Government

Debt is still high in historical and international terms and will rise further in 2020 as Ireland runs a deficit, and as

GDP is likely to fall.

Assessing Ireland’s level of public indebtedness in an international context, Ireland has been above the interquartile

range1 of Government debt of EU Member States since 2008 (Figure 1). While still above this range in 2018, there has

been a significant improvement.

1 The IQR is the difference between the first quartile (which holds 25% of the EU MS’s debt-to-GDP values) and third quartile (holding75% of the EU MS’s debt-to-GDP values). The IQR of EU (28) countries is 27 EU countries debt to GDP ratio and Ireland’s debt to GNI* ratio.

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Overview of Government Debt

Figure 1: Government debt in an international context

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Interquartile range of EU (28) countries

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Ireland GNI*

Source: AMECO for EU Member States and CSO for Ireland.

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The fiscal capacity to address macroeconomic and financial vulnerabilities is even more important in a monetary union,

as monetary policy is centralised. For a member state, there may be times when a country-specific counter cyclical fiscal

policy is needed to tackle issues such as overheating in an expansive monetary policy setting (i.e. low interest rates).

Figure 2 shows two decades of economic growth for the eleven founding European Monetary Union states (EMU)2.

Ireland has followed roughly the same cycle as other Euro states (i.e. the Irish economy grows and contracts at the same

time as other members). However, Ireland generally experienced faster growth when economies were growing and much

deeper recessions. This ‘boom bust’ cycle of the Irish economy is an issue for managing public finances as the common

monetary policy is more aligned to less volatile economies.3

Figure 2: Nominal economic growth for founding EMU states

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Ireland GNI*

1999

2000

2001

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2004

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2007

2008

2009

2010

2011

2012

2013

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2017

2018

%

Other founding EMU countries, GDP

Source: Eurostat for other EMU states and CSO for Ireland.

Note: GDP growth rate for founding EMU states and Modified GNI growth rate for Ireland. The GDP calculation

is the output approach and the Modified GNI is at current market prices.

2 The founding countries of the European and Monetary Union in 1999 are Belgium, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Spain, Portugal, Austria and Finland.

3 https://www.irishtimes.com/business/economy/does-ireland-s-roaring-economy-have-a-soft-centre-1.4113679

https://www.independent.ie/opinion/columnists/shane-coleman/shane-coleman-the-yoyo-approach-gets-yet-another-airing-on-budget-groundhog-day-35120106.html

https://www.irishtimes.com/business/economy/crisis-mindset-persists-even-as-cash-floods-into-exchequer-1.4129665

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Debt in an Economic and Monetary Union

One of the functions of a central bank is to prevent overheating, in other words, “to take away the punch bowl just

as the party gets going”4. This may not happen to Ireland, in fact, the opposite could happen, where the central bank

could stimulate overheating in the Irish economy in this asymmetric monetary union.

In terms of the Convid-19 pandemic, this is not likely to be an asymmetric economic issue as the virus is in every

member state of the EU. The co-ordination response from the European Commission in terms of fiscal rules and other

supports and the rapid monetary expansion by the European Central Bank (ECB) suggests that this response is more

co-ordinated than the initial response to the Global Financial Crisis of 2008.

The ECB’s monetary expansion includes making available €3 trillion in refinancing operations. The ECB has also

announced a new Pandemic Emergency Purchase Programme of €870 billion. This equates to 7.3% of euro area

GDP. In addition, European banking supervisors have enabled an extra €120 billion of capital for banks to mobilise.5

These funds will mitigate some of the negative effects of the pandemic and the associated uncertainty.

4 Authers, J. (2011) “The punch bowl has to go but the timing is key” https://www.ft.com/content/97565b48-5ca3-11e0-ab7c-00144feab49a

5 European Central Bank (2020) “Our response to the coronavirus emergency” https://www.ecb.europa.eu/press/blog/date/2020/html/ecb.blog200319~11f421e25e.en.html

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Government debt can be assessed in terms of gross debt and net debt. Gross debt refers to the Maastricht debt

definition6. Gross debt consists of the stock of the following financial liabilities: currency and deposits; securities

other than shares excluding financial derivatives; and loans. However, it excludes several important liabilities such

as pension liabilities, insurance technical reserves and other accounts payable. On the other hand, net debt is defined

as gross financial liabilities minus financial assets.

Net financial wealth can be used as a proxy for net debt. Figure 3 shows net financial wealth across the EU expressed

as a percentage of GDP. While all countries hold debt, they also have a stock of financial assets. For countries that

hold a significant stock of assets, net debt may present a more accurate picture. For example, Finland has a relatively

high debt to GDP ratio, but it has positive net financial wealth (i.e. its stock of assets is greater than its debt). While

Ireland holds assets (such as its investment in commercial banks by the state as a result of the 2008 financial crisis),

its financial net wealth is still below the EU average. It has the ninth lowest net wealth in the EU expressed as a

percentage of GDP and the seventh lowest expressed as a percentage of GNI*.

However, using net wealth as a metric has limitations. For instance, the Comptroller and Auditor General has

questioned how likely it would be to recover the investment made in the three commercial banks7. The value of the

bank investment would be influenced by timing, in terms of how much are the shares worth when they are sold.

6 Eurostat (2014) Measuring Net Government Debt: Theory and Practice https://ec.europa.eu/eurostat/documents/1015035/2041365/Measuring-net-government-debt-theory-and-practice.pdf/0c4f104d-856c-4818-adbf-cfc7ea07ad9c

7 Comptroller and Auditor General (2019) “Cost of banking stabilisation measures as at end-2018” https://www.audit.gov.ie/en/Find-Report/Publications/2019/2018-Annual-Report-Chapter-2-Cost-of-Bank-Stabilisation-2018.pdf

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Gross Debt v Net Debt

Figure 3: Financial net worth

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Liabilities Financial net worth

Source: Eurostat.

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The various quantitative easing programmes8 have resulted in low interest rates. This means that governments can

borrow at low interest rates. While interest rates have been low for almost a decade, this low interest rate environment

is very unusual. For most of the twentieth century, there was a high or medium level of interest rates (see figure 4).

Figure 4: Money Market Rate

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Money Market Rate

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Source: World Bank.

The National Treasury Management Agency (NTMA) manages public assets and liabilities.9 In response to the low

interest rate environment, the NTMA has adopted a strategy of ‘locking-in’ low interest rates, lengthening the average

maturity of the debt and reducing the share of variable rate instruments. This strategy has resulted in lower interest

payments by the state. For example, in the 2016 Budget documentation, interest payments in 2019 were expected to

be €6.66 billion. However, the actual cost of debt servicing was €4.68 billion.

8 A quantitative easing programme is when a central bank buys government bonds or other financial assets. This increases the money supply and bank liquidity. This should increase investment and consumption, which stimulates economic growth. It is usually undertaken when interest rates are approaching zero and can’t be relied upon to boost the economy.

9 National Treasury Management Agency (2019) Mission and Values https://www.ntma.ie/about-the-ntma/mission-and-values

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Interest Rate

Figure 5 shows the various projections of general government interest expenditure from the last 5 budgets (2016-2020).

There is a consistent revision downwards of the cost of servicing the debt, attributed to the low interest rate environment

generated by the European Central Bank. The quantitative easing policy by the central banks is a significant assistance

to the Irish government in managing the public finances over the last few years.

Figure 5: General Government Interest Expenditure

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7000

2016 Budget Forecast

2016

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2018

2019

2020

2021

€ m

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2017 Budget Forecast 2018 Budget Forecast

2019 Budget Forecast 2020 Budget Forecast

Source: Department of Finance.

Figure 6 shows the maturity profile of government debt till the middle of this century at present. In 2018, Ireland issued

over €17 billion in benchmark bonds with a weighted average maturity at issuance of 7 years, and a weighted average

yield at issuance of 1.06%10. Thus, the cost of servicing the existing debt will not change significantly in the short to

medium term.

10 National Treasury Management Agency (2019) 2018 Annual Report https://www.ntma.ie/annualreport2018/#p=4

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Figure 6: Maturity Profile of Government Debt

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Fixed Rate/Amortising Bonds

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Floating Rate Bonds

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Source: NTMA.

The favourable maturity profile of the debt is evidenced in the credit rating by the major rating agencies. There is

an ‘A’ credit rating from all three major rating agencies and this supports Ireland’s favourable market access.

Table 1

Rating Agencies Long-Term Outlook

S&P Global AA- Stable

Fitch Rating A+ Stable

Moody A2 Stable

Source: NTMA (2020) Investor Presentation https://www.ntma.ie/uploads/general/NTMA-Investor-Presentation-

January-2020.pdf.

While this rating might look impressive, there are four levels above A+, which are: AA-, AA, AA+, and AAA. Germany

has a debt rating of AAA from all three main rating agencies which could result in lower debt servicing. The rating

before the crisis for Ireland was a rating of AAA from all three main rating agencies11.

11 Department of Finance (2019) The Economics of Public Debt https://assets.gov.ie/7966/358209fadcd24556ab2648fecee5a2d3.pdf

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Figure 7: Interest rates 2018

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Lower Debt to GDP,Higher Interest rate

Higher Debt to GDP,Higher Interest rate

IRELANDGNI*

IRELANDGDP

Lower Debt to GDP,Lower Interest rate

Higher Debt to GDP,Lower Interest rate

1 20 3 4

Deb

t to

GD

P %

Average Interest Rate %

Source: Eurostat, CSO for Modified GNI*.

Generally, countries with a high level of debt pay higher interest rates as lenders consider that there is a risk of

non-payment by the country’s government, so the cost of new borrowing will be higher than for countries with more

fiscal credibility. While Ireland’s debt to GDP ratio is below the EU average, when expressed as a proportion of GNI*

Ireland has a very high level of debt in relation to the size of its economy (see Figure 7). However, in 2018 Ireland

paid a relatively low rate of interest on this debt compared to other countries. No country with a higher debt to GDP

ratio than Ireland (measured as a proportion of GNI*) pays a lower interest rate. At the same time there are ten countries

with a lower debt ratio that pay a higher rate of interest on their debt.

In terms of the Covid-19 pandemic, the closing of non-essential sectors, the restrictions on peoples’ movement and

the rise in unemployment will have a detrimental effect on the Irish economy. The IMF estimates that for each month

that non-essential sectors remain closed, there will be a 3 percent drop in annual GDP.12 The negative effects of

higher budgetary deficits will be mitigated by the increased quantitative easing by the European Central Bank (ECB).

Following the ECB’s announcement, Government 10 year bond yields fell, which will result in lower borrowing costs

for the Irish state.

In addition, the European Stability Mechanism (ESM) has an available lending capacity of €410 billion, equal to

3.4 percent of GDP of the Euro area.13 Furthermore, the ESM has a precautionary credit line to respond to the economic

challenges arising from the COVID-19 virus, in particular, the Enhanced Conditions Credit Line. The funds made available

could amount to up to 2 percent of the member state’s GDP.

12 IMF (2020) “Europe’s COVID-19 Crisis and the Fund’s Response” https://blogs.imf.org/2020/03/30/europes-covid-19-crisis-and-the-funds-response/

13 European Stability Mechanism (2020) “Klaus Regling at Eurogroup video press conference” https://www.esm.europa.eu/press-releases/klaus-regling-eurogroup-video-press-conference-2020-03-24

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Government debt must also be examined in the context of the prevailing private debt in the economy, specifically

household debt, non-financial corporation debt and financial debt. The combination of debt might be an important

driver of macro vulnerability to a global economic shock. In terms of the Irish economy, all key sectors of the economy

are now heavily indebted, measured as a percentage of GDP.

The four graphs below illustrate the debt in the government and the private sectors, including household and

corporation sectors from 2002 to 2017. A comparison with Germany is provided, as an economy that is more in line

with the Fiscal and Stability Growth Pact/Maastricht Treaty. These graphs show the dramatic growth in Irish debt,

especially in comparison to the steady state of debt in Germany.

The EU has a surveillance framework called the Macroeconomic Imbalance Procedure (MIP) scoreboard14. This aims

to identify emerging imbalances in the economies of the Member States and encourage Member States to tackle these

economic risks. The MIP scoreboard has a private sector consolidated debt-to-GDP threshold of 133 per cent15.

The graphs below show that Ireland is significantly above this threshold. However, this is driven by the debt of

multinational companies. These companies have few links to the domestic financial system and thus, are not a significant

risk to the domestic banking system. The corporate debt figure could give an inaccurate picture of the level of debt that

Ireland would ultimately be responsible for.

In terms of household debt, the total value of household debt amounts to €136.9 billion or around €28,000 per person

in 2019.16 This figure is on a downward trajectory from its peak during the Celtic Tiger era. For instance, household debt

to Gross Disposable Income (GDI) was 126% in Q3 2018, a significant decrease from debt to GDI of 212.1% in 2009.17

Despite this reduction, Ireland still has the fourth highest household debt-to-GDI in the EU.

14 Parliamentary Budget Office (2018) European Semester 2018 – and how it interacts with Ireland’s Budget 2019, Briefing Paper 1 of 2018 https://data.oireachtas.ie/ie/oireachtas/parliamentaryBudgetOffice/2018/2018-01-15_european-semester-2018-and-how-it-interacts-with-ireland-s-budget-2019_en.pdf

15 The 133 per cent threshold was set based on the 75th percentile of the private debt ratios of EU Member States over the period 1995-2007.

16 Central Bank of Ireland (2019)Household debt continues to decline but remains fifth highest in the EU, https://www.centralbank.ie/news-media/press-releases/press-release-household-debt-continues-to-decline-but-remains-fifth-highest-in-the-eu-23-october-2019

17 Department of Finance (2019) An analysis of Private Sector Debt in Ireland https://assets.gov.ie/7079/dc2b93dbcf1d40af9e01c2920c90acd3.pdf

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Combined Debt

Figure 8: Comparing Combined Debt of Ireland and Germany 2002-2017

Private Debt (financial corporations, corporations and households) – % of GDP

Non-Financial Corporate Debt (all instruments) – % of GDP

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Household Debt – % of GDP for Germany, % of GNI* for Ireland

Government Debt – % of GDP for Germany, % of GNI* for Ireland

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Source: Eurostat.

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The management of government debt is facilitated by the ability of the State to access international capital markets,

roll debt over and refinance it. The government is required to pay interest on the debt, instead of funding other public

spending. This can become a significant financial issue if both interest rates and government debt are high. This is

what happened in Ireland during the 1980s. This meant that a substantial portion of government revenue was used

to service the debt and was not spent on public services or counter cyclical tax reductions.18

The 2011 revision of the Stability and Growth Pact (SGP) resulted in a more stringent framework for EMU States

to change their budget deficit and debt to a more stable and sustainable trajectory over the medium term. These EU

Fiscal Rules, specifically the Expenditure Benchmark (EB), limit the net growth rate of government spending to the

medium-term potential growth rate of the economy.19

The EU fiscal rules also state that if the debt ratio is above 60% of GDP, the excess over 60% must be reduced at

an average annual rate of 1/20th. The average speed of debt reduction is assessed in a backward-looking and forward-

looking manner, in the context of the economic cycle. This could potentially promote reducing the principal of debt

(and thus interest payments).

There are two general indicators of the debt, firstly, the absolute value of the debt and secondly the value of debt

relative to the size of the economy, as measured by GDP, modified GNI, or other measures. Ireland’s experience of

the debt reduction rule highlights a measurement difficulty. In recent years, Irish debt as a measure of the size of the

economy, would indicate a very significant debt reduction, whereas the absolute value of the debt is consistently around

the €200 billion mark between 2014 to 2018.20 This discrepancy can lead to complacency regarding the risks associated

with government debt.

It is important to note that in response to the Covid-19 virus outbreak, the European Commission has relaxed the fiscal

rules for Member States. Specifically the Commission will exclude the budgetary effects of one-off fiscal measures

taken to counter the effects of the COVID-19 pandemic. The Stability and Growth Pact allows for these exemptions.21

18 Burke, S. (2000) “No longer a matter of life and debt” https://www.irishtimes.com/business/no-longer-a-matter-of-life-and-debt-1.237197

19 Bedogni, J. & Meaney K. (2017) EU Fiscal Rules and International Expenditure Rules, https://igees.gov.ie/wp-content/uploads/2016/06/EU-Fiscal-Rules-and-International-Expenditure-Rules.pdf

20 CSO (2019) Government Financial Statistics (https://www.cso.ie/en/statistics/governmentaccounts/governmentfinancestatisticsa/).

21 European Commission (2020) “Coordinated economic response to the COVID-19 Outbreak” https://ec.europa.eu/info/sites/info/files/communication-coordinated-economic-response-covid19-march-2020_en.pdf

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EU Fiscal Rules

https://statbank.cso.ie/px/pxeirestat/Database/eirestat/Government%20Finance%20Statistics/Government%20Finance%20Statistics_statbank.asp?sp=Government%20Finance%20Statistics&Planguage=0&ProductID=DB_GF

https://www.cso.ie/en/statistics/governmentaccounts/governmentfinancestatisticsa/

The stock of debt grows every year by the average interest rate paid on the debt. If GDP grows faster than the

interest rate, the debt-to-GDP ratio will fall. Conversely, when interest rates are above the economic growth rate,

the ratio will rise. This also places more pressure on the public finances for sustaining the level of debt and interest

payments.

Since 1971, there were fifteen years where economic growth was lower than short term interest rates. This mostly

occurred during the 1980s and the Financial Crisis (2008-2010), where the interest rate exceeded the economic

growth rate. Economic growth rates were higher than short-term interest rates for 30 years during this period,

including from 1994-2007 and from 2011 to 2018.

Figure 9: Economic growth and Interest rates

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Nominal short-term interest rates

Nominal long-term interest rates

Source: AMECO.

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The Relationship between Interest Rates and Economic Growth

There are several risks associated with a high level of debt. While countries do not usually pay back debt, if investors

fear that a country would not be able to meet its obligations, they could refuse to roll it over and refinance it. This could

trigger a default and cut countries off from capital markets.

Furthermore, while advanced countries generally do not repay debt, they do pay interest on the existing stock of debt.

A high stock of debt means a government will have to pay back higher interest payments. To fund these additional

payments, governments may have to increase taxes or cut spending. Despite low interest rates, Ireland’s repayments

on its debt are relatively high. In 2018, Ireland’s interest payments were 6.4% of government revenue. This was the

fourth highest in the EU, see Figure 10.

Figure 10: Interest payments as % of revenue 2018

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9

Ital

yPo

rtug

alG

reec

eIc

elan

dIr

elan

dU

nite

d K

ingd

omSp

ain

Cypr

usH

unga

ryCr

oaO

aSl

oven

iaB

elgi

umM

alta

Rom

ania

Pola

ndAu

stri

aSl

ovak

iaFr

ance

Lith

uani

aD

enm

ark

Net

herl

ands

Ger

man

yLa

tvia

Czec

hia

Finl

and

Bul

gari

aSw

itze

rlan

dSw

eden

Nor

way

Luxe

mbo

urg

Esto

nia

%

Source: Eurostat.

It is important to note that these interest payments are lower than what was expected. For instance, in Budget

2016, the cost of servicing the debt in 2019 was expected to be €6,654 million. Whereas in Budget 2020, the cost was

recorded as €4,678 million. This is a significant saving for the government. If interest payments were as high (in 2018)

as was expected in Budget 2015, interest payments would be 10.3% of government revenue.

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Risks of a High Level of Debt

Table 2 shows a consistent reduction in the projected cost of general government interest expenditure in the last

five budgets. In the past, this has allowed the Government additional flexibility, and enabled more fiscal space for

the Budget. In an event of a significant rise in interest rates, higher than anticipated, this could place some limitations

on the public finances.

Table 2: General Government Interest Expenditure

€ millions 2016 2017 2018 2019 2020 2021

2016 Budget Forecast 6,583 6,714 6,725 6,654 6,655 6,385

2017 Budget Forecast 6,203 6,085 5,960 5,734 5,378 5,036

2018 Budget Forecast 6,187 5,895 5,645 5,560 5,385 5,035

2019 Budget Forecast 5,805 5,293 4,984 4,733 4,534

2020 Budget Forecast 5,234 4,678 4,017 3,700

Source: Department of Finance. Bold numbers in the table indicate final outturn figures.

While interest rates are currently low and have a long maturity, there is potential that interest rates could rise

over the coming years. This would cause interest payments as a proportion of revenue to increase significantly.

The current low interest rate period is unusual by historical standards.

Governments’ can run into problems if they are not able to meet interest obligations. If it borrows money to meet

these payments, the country could enter a debt interest spiral. This is where debt continues to increase and eventually

becomes unsustainable.

To avoid these risks, government could implement a debt reduction target. In November the Minister for Finance

announced it would implement an 85% debt to GNI* target by 2025. However, this would not involve paying down

debt. The stock of debt would remain at its current level. The ratio would simply fall because GNI* is forecast to grow

by 3.5-4% over the coming years. All else equal, this would leave interest payments at existing levels. In future, failing

to reduce the stock of debt could leave Ireland exposed to swings in interest rates.

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The vulnerability of national debt is further compounded by the high level of international debt. According to the

International Monetary Fund, global debt accumulates to $188 trillion, historically an unprecedented figure. This

means debt is over 230 percent of world output22. The public sector makes up around one-third of the total debt

level and the private sector, households and companies, make up almost two-thirds of total debt.

Similar to Ireland, a factor in the high level of international debt was the financial crisis of 2008. IMF research has

identified that governments support to financial institutions amounted to $1.6 trillion during the 2008 crisis.23

The example of the Financial Crisis and the Sovereign Debt Crisis in the Eurozone clearly highlights how a sudden

catastrophic event resulted in countries increasing debt and having to implement fiscal consolidation measures.

States that are now highly indebted could be more fragile to any shock that initiates an international and sustained

downturn, as seen in 2008.24

While the international environment highlights the risks, experience from other countries can also highlight the

solutions to public debt. This includes macroeconomic and structural policies to stimulate economic growth as

well as fiscal adjustment policies that aim to generate primary budget surpluses. Research on European economies’

experience of debt reduction suggests that fiscal consolidation measures such as reducing expenditure appear to

be more effective than tax increases or limited fiscal adjustments. In addition, during periods of economic expansion,

governments should adopt a counter cyclical fiscal strategy and aim for budget consolidation rather than providing tax

or other fiscal reductions.25 This thinking perhaps can be seen in the EU programme for Greece where there are primary

budget surplus targets for the country, even after the end of the assistance programme.

Furthermore, an investigation by IMF researchers26 into the determinants of significant debt reduction identified the

key role of strong economic growth and large and lasting fiscal consolidation efforts, in terms of reducing expenditure

costs and a favourable external environment in terms of strong growth in international markets. The other factors which

provide fiscal discipline and assist in debt reduction are the initial level of debt, the cost of debt servicing and if there are

fiscal rules governing the budgetary process. This investigation into the factors that determine the probability of a large

debt reduction used a data set that spans more than four decades for a large sample of developed and developing

economies. For Ireland as a small open economy, the role of international markets is important for growth and

development, which in turn drives relative debt reduction.

22 IMF (2019) Twentieth Jacques Polak Annual Research Conference Debt: The Good. The Bad. The Ugly https://www.imf.org/en/News/Seminars/Conferences/2019/03/08/2019-annual-research-conference

23 Kim, Y. J & Zhang, J (2019) “Debt and Growth” https://www.imf.org/en/News/Seminars/Conferences/2019/03/08/2019-annual-research-conference

24 Stein, J (2019) “Can Policy Tame the Credit Cycle?” https://www.imf.org/en/News/Seminars/Conferences/2019/03/08/2019-annual-research-conference

25 Nickel, C., Rother, P. & Zimmermann, L. (2010) “Major public debt reductions: lessons from the past, lessons from the future” (https://voxeu.org/article/major-public-debt-reductions-lessons-past-lessons-future).

26 Amo Yartey, C. & Turner-Jones, T (2014) “Global Large Debt Reduction: Lessons for the Caribbean” (https://www.elibrary.imf.org/view/IMF071/20625-9781484369142/20625-9781484369142/ch04.xml?language=en&redirect=true&redirect=true&redirect=true&redirect=true).

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An International Perspective

https://voxeu.org/article/major-public-debt-reductions-lessons-past-lessons-future

https://voxeu.org/article/major-public-debt-reductions-lessons-past-lessons-future

https://www.elibrary.imf.org/view/IMF071/20625-9781484369142/20625-9781484369142/ch04.xml?language=en&redirect=true&redirect=true&redirect=true

https://www.elibrary.imf.org/view/IMF071/20625-9781484369142/20625-9781484369142/ch04.xml?language=en&redirect=true&redirect=true&redirect=true&redirect=true

https://www.elibrary.imf.org/view/IMF071/20625-9781484369142/20625-9781484369142/ch04.xml?language=en&redirect=true&redirect=true&redirect=true&redirect=true

The COVID-19 virus outbreak and the dramatic economic restrictions will have a significant effect on the public finances.

Given the unprecedented scale of business closures to prevent the spread of the COVID-19 pandemic, extra spending will

be needed to help mitigate the impacts on individuals affected. This additional spending will result in a budget deficit in

2020. Lower tax receipts (e.g. income tax, VAT and excise) will result in an even larger deficit. This will cause debt levels

to rise and depending on the duration and scale of the COVID-19 pandemic, this could be by a substantial amount.

Ireland currently has a high level of Government debt (in both international and historical terms). This problem is

compounded by the fact that the other key sectors of the economy are also heavily indebted, including households,

non-financial corporations and the financial sector. However, the government can currently borrow at low interest rates.

It benefits from an ‘A’ credit rating from all three major ratings agencies. The NTMA has adopted a strategy of ‘locking-in’

low interest rates, lengthening the average maturity of the debt and reducing the share of variable rate instruments,

resulting in lower interest payments. Furthermore, recent monetary stimulus from the ECB should reduce borrowing

costs further. This puts Ireland in a better position to deal with the COVID-19 pandemic.

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Conclusion

Contact: [email protected] Go to our webpage: www.Oireachtas.ie/PBO Publication date: April 2020

mailto:[email protected]

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