Taking on additional debt is “not consequence free” admits EU’s Eurogroup president

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The president of Eurogroup Paschal Donohoe has warned that taking on billions of euros in extra borrowing to offset the economic effects of the coronavirus pandemic will not be “without consequences” and will have to be skilfully managed.

Ireland, like Portugal, has benefitted from the European Central Bank’s Pandemic Emergency Purchase Programme (PEPP), meaning bond purchasing. The most recent figures — which related to the end January 2021 – show that the eurosystem had purchased over €10Bn of Irish sovereign debt since its launch in March 2020. To put it another way, the Central Bank is now the largest single creditor to the Irish Government.
The accumulative net purchases for Portuguese sovereign debt under the PEPP is around €20Bn to January 2021.
Paschal Donohoe, the Irish finance minister addressed the Irish-Portuguese Business Network (IPBN) in Lisbon on Friday 20 May shortly before Ecofin and Eurogroup meetings on 21 and 22.

Changes in fiscal policy

Donohoe discussed the question of possible changes in fiscal policy, especially given that the €700Bn borrowing that will be used to rebuild Europe’s economy through the Resilience and Recovery Plan will have to be repaid.
“It is so important to realise that the additional debt we have incurred is financed in a completely different way to the debt from the great financial crisis. It is financed at interests rates that are either at zero or below zero and for very long maturity periods and that will make a profound difference,” said the minister.
Giving the example of Ireland, Donohoe said that if “sensible decisions on managing public spending” were taken after the pandemic and people successfully got back to work, that would help the government deal in the short and medium term with the financial debt consequences of the pandemic.
“I am optimistic that we can avoid the harsh decisions (austerity) that we had to confront in the aftermath of the global financial crisis, but that is not to say, on the other hand, that borrowing will be consequence free,” he said.
Ireland is forecast to have the highest government debt per head of population in Europe this year, as the impact of Covid-19-related borrowings pushes the burden on each individual in the State up by almost €4,000 in 2021.
It means that, per capita, the Irish will shoulder a debt burden of almost €20,000 more than the EU average.
According to figures from the European Commission, Ireland is forecast to have total government debt of €241.6 billion for 2021, up by almost 10 per cent on 2020. When considered on a per-person basis, this means that the per person debt burden will be € 48,291 this year, the highest across the European Union and the UK.
Using a somewhat different calculation, the minister said: “If Ireland incurs €36Bn additional debt in an 18 month period and sees its debt go from €232Bn to €238Bn that is not consequence free”.
It also means that future policy announcements by Christine Lagarde will be far more important for both the Irish and Portuguese governments than in recent years because the ECB has kept the cost of borrowing artificially low for Ireland and Portugal as for other countries.
If Christine Lagarde and her team see inflation creeping up across the eurozone they could bring an end to the bond purchasing programme which could see borrowing costs go up for countries like Ireland and Portugal. The risk of another sovereign debt crisis is one Donohoe and his Portuguese counterpart João Leão and their successors may have to face.
However, Donohoe reassured: “The consequences will be different and I believe more manageable to where we were a decade ago,”he said.
“Where we will have to pay more is if we decide we want to spend more permanently. The savers of Portugal won’t finance Ireland becoming a permanently bigger state. They will expect us to pay for that ourselves. Just as we would expect that if the state in Portugal wants to become permanently bigger it would have to be paid out of taxes and borrowed in Portugal,” he said.

ECB and banking system — a dysfunctional relationship?

With the general idea among SMEs that business is still stuck with a dysfunctional banking system as a result of the financial crash in 2008, Donohoe says there were periods back then in which the banking system was dysfunctional, giving the example of Ireland with experience of what that looks like, and admits that some of the challenges within the banking system will continue to evolve, after two banks expressed their intent to leave Ireland.
But it is also true that there are needs that SMEs want met from the banking system which some feel are not being met well enough.
“We have an incredibly important SME community that is valued by the government which feels that all their needs are being easily met by the banking system, but that can be the first step to other difficulties. The relationship between companies looking for credit and supplying it, those looking for investment and funding investment always has a degree of tension particularly when we now have a very strong regulator in the background,” he said.
Donohoe referred to the SBCI (Strategic Bank Corporation of Ireland) in helping to assist the capital requirements of SMEs after the departure of two banks from the Irish banking sector.
The higher capital requirements for Irish Banks against their mortgage exposures compared to other European peers is just one of the reasons why foreign banking groups like Ulster Bank (Nat West) and KBC have chosen to exit the Irish market.
In this Donohoe also referred to the banks’ talks with Permanent TSB among other strategic banking counterparts about their potential interest in buying certain retail and SME assets, liabilities and operations.
“This is a really important development which might help us meet some of those needs in the future, but also from the State’s point of view it is why we have the SBCI (Strategic Bank Corporation of Ireland).” Its strategic goal is to ensure lower costs — longer term funding for Irish SMEs by flexible products with longer maturity and capital repayment flexibility, lower cost funding to financial institutions and market opportunities to new entrants to the SME lending market, thereby stimulating competition.
“It is why the government makes really important lending programmes available to deal with Brexit and lack of finance and we make them available through our banking system. We originate them so we can influence and change the price of those loans. There are challenges, but I believe we will be able to make progress on them,” he said, stressing that he respectfully disagreed that it was a dysfunctional relationship.

Alternative finance — risks and opportunities

Yet a lot of SMEs and startups in the market are getting their requirements from hedge funds and venture capital entities which tend to be far less regulated and that could bring risks as well as opportunities.
“In every transaction and economic development there are both risks and opportunities, I think it would be fair to say that a very low share of hedge fund activity is involved with the development of our SME community in Ireland.
“If we look at the role of seed capital and venture investors, it is the case that they are meeting needs at times where the existing banking infrastructure either does not want to meet or is incapable of meeting them,” he said.
In General, for riskier and long term developments led by SMEs they have a higher level of risk which Ireland’s banks don’t feel it is appropriate to be involved in. But there is an eco-system in Ireland that can meet financing needs, from an Irish State point of view it is the reason why ministers Donohoe, Humphreys and O’Donovan set up the €100 million Disruptive Technologies Innovation Fund in 2019 which must involve partnerships between enterprises, SMEs and researchers with a minimum ask of €1.5 million per applicant.
It is also why Enterprise Ireland has such an extensive array of programmes since the government recognises that there are needs that banks are not able to meet.

VAT rule changes

New VAT rules introduced by the EU which come into force from July 2021 will bring more harmonisation across the euro area. This may be good for online retailers after the pandemic has shown that was a dominant way of doing retail business. The question is if it is successful, will it lead to other harmonisations across the tax and social security systems?
“VAT has a particular role as a tax stream in the EU, it generates its own resources within the EU – meaning taxes that national governments levy a share of which is then used to help fund the EU. Sales taxes like VAT are an example of those taxes that lend themselves to a more easier degree of harmonisation as they are really important for the operation of the single market and other taxes lend themselves less easier to harmonisation,” said the Eurogroup president.
Donohoe says there will be more efforts to have a common form of taxation on things like plastics, but other taxes regarding income, business and social security are less likely to be quickly harmonised.
A regular visitor to Portugal who has spent holidays in the country over the years, Donohoe said he had first hand knowledge about how wonderful the country is and how important bi-lateral relations between the two countries are.
Over the years and in different ministerial posts he has built up good relationships with different Portuguese ministers including Mário Centeno, the former Eurogroup president and current governor of the Bank of Portugal, as well as with current Portuguese minister for Finance, João Leão who has been present at all of the Euro Zone Finance minister meetings during Portugal’s presidency of the EU Council since January.
Donohoe’s current role is to coordinate the policy efforts of all of the finance ministers who share the Euro, in particular budgetary policy, banking policy and how it is formed and regulated. This involves constant engagement, dialogue and negotiation with finance ministers all over Europe and preparation for meetings which take place once a month.
He works closely with the European Central Bank to coordinate some policies, but there are other key policies, like interest rates and money supply, that are exclusively the domain of the ECB.

*The event “A conversation with Ireland’s Minister of Finance” was moderated by the chair of the Board of the IPBN, Aoife Healy