Brendan Keenan

Wednesday 20 August 2014

Brendan Keenan: A delicate balancing act that could pay off in the long run

Published 15/11/2013 | 02:00

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Chancellor Angela Merkel and Taoiseach Enda Kenny. Kenny has avoided the headache of getting a 'backstop' past Merkel's government.

YOU don't expect your house to burn down but most people take out insurance, just in case. The Government assures us that it does not expect to crash and burn when the country returns to borrowing in the commercial markets next year. It is so confident that it has decided not to take out insurance.

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The "insurance" would have been permission to borrow up to €10bn if things did go wrong in the bond market and the Government, as in 2010, could not borrow at affordable rates. At first glance, it looks like taking a big risk to make a "clean" re-entry to the markets without the protection of such a backstop.

Many eminent people think so, not least the Irish Fiscal Advisory Council, set up under European rules to think about exactly this kind of thing. It is also unusual, as the former deputy director of the IMF, Donal Donovan, has pointed out.

But there is more to this than a first glance might recognise. Ireland is the first country to go into a joint EU/ECB/IMF bailout – otherwise known as the troika – and the first to exit. It is not the same as the traditional IMF rescue.

It appears that any backstop would have had to be separately negotiated with the troika partners. In the case of the EU, that would mean getting it past the governments involved. In the case of Germany, supreme court rulings mean the parliament itself might have to approve.

All of that seems a great pity. The new rules in the eurozone look quite tough enough to keep Ireland on the straight and narrow. As a former bailout country, they also require Ireland to reduce its debt significantly each year – which means substantial Budget surpluses.

It would have been much better had the backstop been automatic if these rules were followed. But the new eurozone is not even half-built and there are no automatic mechanisms. The most important insurance would have been the one theoretically available from the European Central Bank, where it would guarantee to buy government loans at reasonable interest rates.

That would also require conditions and it is not clear what they would be – or whether they would be the same conditions that would apply to a backstop. The Fianna Fail leader was right about one thing: nothing is really clear about this decision, which makes it hard to make a judgment on it.

Certainly, one can easily understand why the Government did not want to give the impression that it was going into a second bailout – not even a "Bailout Lite," as some had christened it.

Besides, the house insurance comparison is not entirely fair. No insurance policy means no payout if the house is incinerated. But if a country cannot repay and replace its debts, something has to be done – either bailout or debt default, or a bit of both. So why pay the unpleasant political premium now?

One reason is to guard against temporary crises which disrupt markets for a while. Ireland's finances are still extremely stretched. It is more than possible that market lenders could shun Ireland because of panic caused by trouble elsewhere in Europe, or geo-political events in the Middle East.

In those circumstances, the right to call on the overdraft could prove very useful. Against that, the Government has built up €25bn in reserves by borrowing on the markets even as the troika was supplying the loans to cover day-to-day business.

A key decision is how quickly the Government makes use of that money to cover deficits which are still running at €10bn a year, and how much it holds in case of any such temporary difficulties. The National Treasury Management Agency (NTMA), which borrows on behalf of the Government, has said it will step carefully into the markets, with perhaps no large borrowings next year.

It believes the piggy bank will see the country through until the middle of 2015. That is a very long time in the political calendar. It would be a rare politician who would worry much about things that far ahead. But even in financial terms, Ireland's position should be much clearer by then – whether for better or worse.

It could be for the better. The latest optimistic forecasts for the UK economy lend support to the optimistic ones for Ireland, most notably from the Economic and Social Research Institute (ESRI), making a successful return to the bond markets more likely.

Success will be measured by further falls in Irish interest rates compared with German ones. The present difference is two percentage points. If the Government does get lucky on growth, it will have to make the most of its luck.

It took another risk when it slackened the 2014 Budget by €500m. That would have been a very useful cushion for the first year in the markets. They may yet get away with it – but not if it were to become a habit.

Irish Independent

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