Playing for time in Ireland’s €20 billion ‘game changer’

Fourteen months ago, the Government hailed the deal on the Anglo Irish promissory notes as a game changer for Ireland, one that could save the taxpayer a colossal €20 billion in borrowing costs.

The problem now is that the deal appears to have been too good – at least for some of the key decision makers in Frankfurt.

Despite “taking note” of the deal last year, the European Central Bank was never comfortable with the arrangement that allowed the Irish State to swap the promissory note used to recapitalise Anglo Irish Bank for long-term Government bonds, viewing it as perilously close to monetary financing.

Blurring of policy
ECB president Mario Draghi stressed that the governing council would review the deal as part of its annual report. As recently as January, German Bundesbank chief Jens Weidmann said in an interview with The Irish Times that the transaction was "a blurring of monetary and fiscal policy that [. . .] risks being perceived as monetary financing ".

“Some might consider the transaction as a kind of a compensation for the Irish support to its banking system, but in my view such transfers should not be the business of central banks,” he said.

The sceptics were not confined to monetary hawks such as Germany. In recent months, central bankers from around the euro zone and other members of the governing council have expressed concern about the deal, as the deadline for the 2013 annual report loomed.

The question of how long the Central Bank would hold the bonds was always a key aspect of the deal. It committed to a programme of disposal in February “but only where such a sale is not disruptive to financial stability”.

One year on from the deal, financial stability has – however tentatively – returned to markets. Draghi’s pledge to “do whatever it takes” to save the single currency has calmed bond markets, and the debt of peripheral euro zone countries, including Ireland, is seeing strong demand, in part as investors shy away from emerging markets.

Ireland’s surprisingly strong economic performance since exiting the bailout has also bolstered the case for a quicker disposal.

Decision-makers
With yields on Ireland's 10-year Government debt now lower than those of other, larger euro zone economies, any sense that Ireland is in receipt of special treatment is eliciting little sympathy, despite the acceptance by many key decision-makers that Ireland was unfairly treated when it was obliged to bail-out bondholders.

The Central Bank in Dublin yesterday declined to give details of its disposal plan, although it is likely that some of the bonds have already been sold into the secondary market.

While the Government has always envisaged having to dispose of the bonds, an accelerated sell-off would force the State to surrender the benefit of the interest rate payments sooner.

Currently the exchequer pays the interest to the Central Bank, which, in turn, pays its end-of-year surplus to the exchequer. Once the bonds are sold, that interest will now be paid to the new bondholder.

With the State benefiting by about €900 million a year on the current €25 billion bonds, a sell-off of €1 billion would see the loss of an annual interest payment of about €36 million.

In the coming months, it will fall to Central Bank governor Patrick Honohan to decide when and how to offload the long-term bonds on the market.

The Department of Finance will be keeping a close eye on how any early sale could impact State coffers as it makes preparations for Budget 2015.