In 2010 the UK agreed to extend loans to the Republic as part of the international bailout which followed the financial bust. Thirteen years on, the Republic can undertake borrowings at a rate of two percentage points below UK levels and the debt burden is falling, compared to high borrowing and rising debt in the UK. It is a remarkable turnaround, though also a cautionary tale of how losing control of national finances, decisions leading to a dip in economic performance and an atmosphere of political upheaval can very quickly lead to a reversal.
1. The latest:
The differential between the Republic and the UK came into sharp relief this week. The UK raised new borrowings on two-year debt at an interest rate of almost 5.7 per cent, the highest in more than two decades and the highest on any debt sold by the UK government since 2007. The equivalent rate on two-year Irish debt is around 3.25 per cent.
Meanwhile the National Treasury Management Agency (NTMA) announced this week that it has little need to raise extra debt given the strong government surplus, the high level of cash in hand – €25 billion – and the limited need to refinance maturing debt over the next couple of years.
ving raised a lot of cash when interest rates were at rock bottom levels, it expects the average interest rate on all outstanding Irish debt to remain at around 1.5 per cent over the next couple of years, meaning that, despite higher interest rates, the immediate impact on the Irish exchequer will be limited. Over time, the average will inevitably rise but for now it can raise new long-term debt at around 3 per cent.
2. The trends:
Rising inflation and interest rates and the withdrawal of central bank supports has meant government borrowing costs have risen sharply across the world since the exit from the pandemic. The UK has fared particularly badly – with benchmark 10-year yields in the Republic of around 2.8-2.9 per cent comparing to 4.6-4.7 per cent in the UK.
The price at which governments can borrow from the market is determined by a range of factors. A key one is the amount countries need to borrow. The Republic’s borrowing needs are now low with the exchequer finances in surplus and predicted by this week’s summer economic statement to stay there.
Notably, despite significant additional spending planned in the budget and some cut in taxes, the budget is forecast to be in surplus by a cumulative amount of over €45 billion in the three years 2024 to 2026. And that is after a €10 billion surplus this year. After a big surge in borrowing during the pandemic – fortunately at very low rates – the improving trend evident in 2018 and 2019 reassumed and the Republic has benefited from a huge tax surge, due to strong growth and corporate taxes.
[ Surging tax revenues provide Government with war chest ahead of budgetOpens in new window ]
[ NTMA says Government debt could fall below €200bn by end of decadeOpens in new window ]
Across the Irish Sea, it looks very different. UK borrowing surged, as did the Republic’s, during the pandemic but with slower post-Brexit growth and a less healthy underlying position, it has remained high since. One key issue is that debt repayments for a lot of UK gilts are at floating rates and are adjusted for inflation and so have risen significantly. The vast bulk of Irish borrowing is at fixed rates.
UK borrowing was around 5 per cent of GDP in the year to March, some £137 billon (€160 billion). If the Republic was borrowing at the same rate as the UK, we would – in very rough terms – currently have a deficit of around €20 billion compared to an expected surplus this year of €10 billion. Because it needs to borrow a lot more, the UK is forced to pay up to lenders.
3. Inflation:
The other key reason why UK borrowing rates are currently so high, particularly for shorter term debt of around two to three years, is that inflation there is higher than in the euro zone and investors believe that means Bank of England interest rates will have to remain higher than those set by the ECB.
UK inflation in May was running at 8.7 per cent with euro zone inflation at 6.1 per cent. Financial markets are now expecting that Bank of England interest rates, currently at 5 per cent will peak at 6.25 per cent next year. And some analysts fear they could go as high as 7 per cent. The ECB deposit rate, which it pays to banks for money lodged with it overnight and which is considered by the ECB to be its key base rate, is currently at 3.5 per cent and is expected to peak around 4 per cent, still a painfully sharp rise but not as high as the UK.
4. UK dangers:
The prospect of higher interest rates threatens to slow the UK economy, hit the public finances and have a very significant impact on the UK housing market. UK house prices are running around 3.5 per cent below last year’s levels but analysts fear demand is now being squeezed by higher rates.
Many borrowers are on fixed rates, but 20 per cent of these will have to refinance next year and 20 per cent the following year. Forecasters believe house prices could fall significantly, particularly if UK base rates go to 7 per cent – much then would depend on whether the Bank of England could reduce rates next year, with inflation tamed.
In the Republic, house prices are running 3 per cent plus ahead of last year, though they have been showing some signs of weakness. The extent of divergence between the UK and Irish markets in the months ahead will be one to watch.
5. The lessons:
The obvious takeaway is that the Republic is benefiting from stable public finances, which look solid even if some of the froth comes off corporate tax receipts. The debt interest bill has, remarkably, fallen in recent years despite rising borrowings, due to the low interest rate of new borrowings. This is a significant boost to the public finances and contrasts with what is happening in the UK.
The Republic does, however, have a high cash debt level of €225 billion. While the Republic’s debt to GDP level if well below the UK – where it is close to 100 per cent of GDP – when Irish debt is measured as by the more realistic GNI*, there is not much difference. The NTMA has said that this could fall below €200 billion in the coming years, but only if the proceeds of some of the surpluses of the coming years are used to pay it down, effectively by not refinancing maturing debt and repaying the money from cash reserves.
There will, however, be many other calls on the surplus – paying for investment, being put in a fund to meet future bills and so on – and the Government has yet to decide exactly how to manage this, with key decisions due to be made before the budget. For now, however, the Republic is clearly reaping the dividend of prudence, and of soaring tax receipts.
