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Impact of Promissory Note replacement with sovereign debt Back
Impact of Promissory Note replacement with sovereign debt announcement February 7th 2013: The event is a rescheduling of debt, that, while it impacts the time value of debt obligations in a positive way for the Irish Exchequer (estimated future interest savings by economic forecasters of between €500 million and €1 billion per annum, including the NTMA, the agency charged with managing the Irish sovereign debt) does not affect the nominal, monetary value of debt expressed in the debt figures on the Finance Dublin Debt Clock.
The rescheduled debt proportion of the national debt currently represents approximately 20 per cent of the total debt, and will fall to c.18 per cent within a year, at the current rate of deficit-fuelled debt accumulation that continues.

The event is a rescheduling of debt, that involves both a radical readjustment of the debt repayment schedule forwards, and an effective reduction in future debt servicing outgoings.

While this impacts the time value of debt obligations in a positive way for the Irish Exchequer, by effectively reducing the actual rate of interest outgoings for the Exchequer on this slice of the national debt (about 20 per cent) it does not affect the nominal amount, as no haircut, or default is involved in the effective replacement of the "Promissory Note" with conventional senior sovereign debt.

The effective savings on the present value of the debt can be calculated using the following formula:

PV= FV/(1+r); Where: PV = the "Present Value" of the debt (an economic concept), and FV= the "Future Value" of the debt, and "r" = the rate of interest on the affected slice of the national debt that will be paid in the future, expressed as a decimal fraction over the life of the debt of total interest outgoings.

An estimate only of the future rate of "r" can be made because the interest servicing will reflect future interest rates, (which may rise in the medium term, once the current phase of global "Quantitative Easing" ends).

The above makes no assumptions about the behavioural impact of the transaction - e.g. whether it might result on the relaxation of levels of fiscal discipline that would otherwise have happened - with the outcome being an acceleration of debt accumulation in the years to come, for example through response to demands to relax "austerity". Accelerated debt accumulation as a result of a relaxation of "austerity" on foot of this deal would effectively unwind the savings from the transaction in the form of new kinds of hidden taxation, notably through a relaxation of targets for Exchequer spending of any form, capital, current, or pay/pensions in the years ahead.

Nor does it make any assumptions about another (monetary rather than fiscal) form of hidden taxation: inflation.

It's all about the "r"
The successful conclusion of the Promissory Note deal illustrates a consistent application by the Irish Government of an approach highlighted in postings on the Finance Dublin Debt Clock page on this site since it was launched in 2009, i.e. that rescheduling rather than default, haircuts, or 'burning the (Government guaranteed) bondholders' was the most viable and wise option available for a modern state such as Ireland dependent on foreign direct investment, not the least based on a moral committment to the principle of 'my word is my bond' in business, finance, and banking.

The deal involves a significant alteration in the "r" of the above equation, with the "FV" left intact, as the principled undertaking of the Irish sovereign.

As the continuing experience of Argentina shows, even though its Government defaulted on its debt over a decade ago (2001), the problems persist, with the president of the country, Cristina Kirchner as recently as last month hiring a private jet to fly internationally, for fear a Government owned jet would be impounded. As the Argentinian experience is showing, default on Government debt brings negative unintended consequences that cannot be predicted for many years to come.

The consensus amongst Irish commentators has largely swung around to an understanding of this perspective, as evidenced by the reaction by the large majority of commentators in markets and the media to the announcement on February 7th.
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