Special Report 07 - FEOGA Borrowing
Published on 22 December 1995
Summary of Findings
The Department of Agricuhure, Food and Forestry borrows funds on a bridging finance basis to meet the cost of purchasing commodities for intervention storage and to fund payments in respect of certain schemes under the Common Agricultural Policy (CAP). The Department is subsequently reimbursed by the EU at agreed rates. Borrowing levels have fallen considerably in recent years mainly as a result of reductions in intervention stocks following reform of the CAP.
The examination focused on
- how efficiently the Department engaged in borrowing activities
- how well the associated risks were managed
- the lessons which can be learned for the future.
No formal policy statement has been drawn up by the Department in relation to its borrowing activities. However, the general aim of the Department is to minimise the extent and cost of borrowing. In our view, there is merit in drawing up a policy document.
Borrowing in Foreign Currencies 1983 to 1994
Between 1983 and 1994, recoveries of £436m from the EU more than covered the actual interest costs of £363m. However, as a consequence of engaging in foreign borrowing during this period, there were further costs in the form of exchange losses totalling £89m, which were not recoverable, resulting in a net shortfall of £16m. Nevertheless, foreign borrowing was still more economic since the equivalent cost of domestic borrowing of £509m would have resulted in a shortfall of £73m.
The strategy of borrowing in foreign currencies during the period was generally well managed, particularly through borrowing in currencies within or aligned to the Exchange Rate Mechanism. However, in December 1992, as a result of a shortage of other currencies, borrowing was undertaken in Japanese yen. The borrowing of £85m in Japanese yen cost a net additional £5.8m compared to borrowing in Deutschemarks.
The Currency Crisis
Exchange losses of £66m, of the total of £89m, were realised mainly as a result of the currency crisis. The net effect of the devaluation on the Department's debt portfolio was largely similar to that on the foreign component of the National Debt. The Department was unable to switch to domestic borrowing at the time of the currency crisis as this would have been in contravention of Government policy.
Reversion to Domestic Borrowing
A conversion back to Irish pounds was carried out on a phased basis with the consent of the Department of Finance up to May 1994. The conversion in the early part of the year, when the Irish pound was relatively strong, resulted in an estimated gain of £7.5m compared to what would have been achieved later in the year.
The overall strategy of borrowing in low interest foreign currencies during the 1983 to 1994 period was reasonable. It could be argued that, as the Department's transactions were exclusively in Irish pounds, some portion of the portfolio should have been denominated in Irish pounds.
In respect of the borrowing after May 1994, based on an analysis of the potential interest savings and the currency risks involved, we are of the view that the Department is correct in funding its entire borrowing requirement in domestic currency in present circumstances.
The Management of Future Borrowing
We identified a number of options which could be considered in relation to the management of the borrowing.
Flexibility in Borrowing
Under existing procedures, the Department borrows mainly for periods of one month. We concluded that the Department should determine the period of the borrowing after an analysis of interest rates and yields. While any outcome projected on such a basis can never be guaranteed, an analytical approach gives the best prospect of borrowing economically. As an example of what could be achieved using an alternative borrowing term, we have calculated that, had the Department borrowed half of its funds on a weekly rather than a monthly basis over the first six months of 1995, an interest saving of over £100,000 could have been made. (This is for illustration only. The actual saving would depend on the proportion of funds borrowed on this basis.)
Identifying a Core Borrowing Requirement
There appears to be merit in setting a core funding requirement which could be borrowed over a longer term at a fixed rate of interest. The purpose of this would be to fix a proportion of interest costs in order to manage the risk that arises since all its debt is currently exposed to interest rate increases. Our analysis of recent borrowing levels shows that a core element of borrowing of £100m would not have resulted in over-borrowing by the Department at any stage since January 1994.
It is our view that the Department should consider using Forward Rate Agreements (ERAs) in the management of its domestic borrowing. ERAs would allow for the fixing of future interest costs.
Should the option of borrowing in foreign currencies be considered, we would recommend the use of forward foreign exchange contracts and currency swaps as an efficient means of managing the currency risks involved.
At present, the Department does not have the expertise to engage in treasury management operations. It could be beneficial for the Department to periodically receive the advice of the National Treasury Management Agency (NTMA) in this regard since the timing of treasury management interventions is crucial to their successful deployment.
The NTMA provides the Department with a facility of £100m. Any extension of this facility would directly impact on the National Debt which has to be managed in conformity with criteria laid down for economic convergence at EU level. Borrowing at rates achieved by the NTMA during the first six months of 1995 would have reduced interest costs by £119,000 and, on that basis, the option of assigning the borrowing and treasury management functions to the NTMA as an agent could be cost effective. Such a move, however, would need to be considered in the context of the wider debt management strategy of the State.