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Sunday 21 September 2014

Brendan Keenan: Blood, sweat and fears in battle for eurozone

Ireland's bailout may be on track but the deficit means we won't see the end of the line for a long time

Published 26/08/2012 | 05:00

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MY favourite Churchill quotation is the one about the end of the beginning, as distinct from the beginning of the end. It is very clever -- and, even more, it fits so many situations.

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There it was, popping up again, when I read that "credit default swaps" on Irish government debt had fallen to the levels which obtained before the 2010 bailout.

It is difficult to know what to make of these complicated thingummies. They are generally described as the cost of insuring against borrowers not repaying their loans. That is their ostensible purpose but, as with most things in the financial industry, there is more to it than meets the eye.

In the real world, people insure things which belong to them. In the financial world, they can insure things which belong to other people. They can then sell the insurance policy at a profit, if the risk is seen to have increased and premiums become more expensive.

They can get even further from the real world than that; promising to buy or sell the CDS policies at an agreed price at some future date, without owning them at all. This caper was a key ingredient of the global financial collapse. It turned out that, unlike the real world (Quinn UK possibly excepted), the insurers had not actually set remotely enough aside to pay out on the losses.

They are still running around with no clothes on, as Warren Buffett might put it. Negotiations on the 50 per cent losses forced on Greek private lenders were complicated by the knowledge that, if the lenders were able to claim on their CDSs, the banking roof might fall in again.

A compromise was reached, but the problem has not been solved. It lurks in the background of the present Greek stand-off and gives Athens a much stronger hand than might be supposed, although it would take nerves of steel to play it.

So one is reluctant to set too much store by the apparently remarkable improvement in perceptions of Irish risk signalled by CDS costs. The trend will doubtless have been accelerated by traders selling them so as to avoid losses if their cost continues to fall.

At the same time, there has undoubtedly been an improvement. A better proof than swaps was last month's bond sale by the National Treasury Management Agency, where people actually lent the Irish Government money, rather than just trading existing loans on the basis of what they thought the future might bring.

It was, everyone agreed, quite a success, with most of the loans coming from foreign institutions. More is expected next month. But, the weary citizen is entitled to ask, what exactly has improved?

The bailout programme is on track, but no more than that, and the track is a long and winding one. A new paper from the Central Bank calculates that Ireland's budget correction will be twice as large as that required by Spain, Portugal and Cyprus (also now in bailout). Only Greece has to do more.

Even so, Ireland's deficit will remain larger than any of the others, including Greece, until 2015 at least. It is a chilling reminder of the extraordinary depth of the public finance crisis in this country. It is a necessary reminder too, since the public finances themselves feature remarkably little in the endless discussions of the country's plight.

Yet, despite having worse public finances, Ireland's bond yields -- the interest rate sought by lenders to the Irish Government -- are the lowest among this group of countries. They have even dipped below those of Italy at times. If it is the end of the beginning, it is hard to identify the equivalent of the defeat of Rommel's Afrika Korps which sparked Churchill's felicitous phrase.

The bailout programme has been followed, but, as demonstrated by household charges and college grants, sticking to it gets more difficult, not less.

The country has regained much of the competitiveness it lost, but is vulnerable to the wider eurozone crisis. The burden of debt will stabilise at very expensive levels, but Europe might deliver some relief on bank debt.

It all comes down to Europe. It may be significant that Portugal's interest costs have followed Ireland's downward. Portugal has better public finances than Ireland, but is less competitive, so the worry there was euro membership. The worry seems to be abating.

If the train is moving, those who don't climb aboard will seriously miss out. Buying Portuguese five year-bonds gives an annual return of 8.3 per cent. If the sellers bought them last year, they have doubled their money.

It may be the end of the beginning, not so much for Ireland as for the eurozone crisis. Markets now have to take into account that, behind all the confusion, bluster and downright fear, Berlin and Frankfurt may not let the single currency fail.

They will need a bit more convincing, though, before it can be called the beginning of the end of this bloody affair.

Sunday Indo Business

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