News Brendan Keenan

Wednesday 3 September 2014

Brendan Keenan: Debt relief, not fiscal probity, is best way to restore confidence

Published 13/09/2012 | 05:00

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TO everything there is a season, and a time to every purpose under heaven. The season for talking about debt relief, and engaging in the purpose of getting it, is upon us.

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Most of the talking, though, was done out of season, quite some time ago. It was all the rage in the immediate aftermath of the crash. The talking -- sometimes shouting -- was largely irrelevant, since nothing could be done about debt at the time.

Commentators were right to point out what was coming. Government gross debt of €80bn when the crisis struck will reach €190bn next year. Government assets have more than halved from €36bn to €16bn.

But there is no such thing as precautionary debt re-structuring, or defaulting on debt which has not yet been incurred, so there was little point in banging on about it back then. Not unless one was advocating the draconian policies required to avoid such an explosion in debt.

Nuclear option

Very few were willing to go there. An exception was UCD's Professor Morgan Kelly, who did suggest the best choice might be what could be called the "nuclear option" -- getting rid of most of €15bn deficit in a couple of years to prevent the emergence of a serious debt problem.

He recognised that this was unlikely to happen, and it didn't. Instead, the official programme is for gross debt to rise to 120pc of GDP next year -- at which point it is meant to peak as a percentage of output.

This is the much-discussed difference between Ireland and Latvia. Perhaps it was the best choice for Ireland's particular circumstances, but the burgeoning interest bill on the accumulating debt means the actual deficit this year, at €13bn, will be exactly the same as in 2008.

All the cuts and taxes have reduced it by just €5bn since it peaked at €18bn in 2009; even though more than €20bn has been taken out in Budgetary corrections in that period.

There is a deeper flaw. Output was meant to grow healthily over the remaining period of the bailout, which would have provided revenues to help bring down the deficit. More importantly, the €200bn debt would automatically become a smaller percentage of a growing GDP.

The troika and the Government have a lot riding on this. "Front-loading" was meant to ensure that after the chill of austerity things would thaw from next year on. That is clear in the figures where, although the value of output grows by 12pc over the next three years, the debt ratio remains unchanged because actual borrowings grow by some €20bn.

This is a knife-edge calculation which leaves no room for slippage. Slippage, though, is already under way.

Lower growth than forecast could leave even net debt peaking at levels which make a full return to bond markets implausible. There is no mistaking the IMF's raising of the once taboo issue of unaffordable debt in this week's reports. It identifies clear threats to Ireland's return to the markets, both from bank debt and lower than forecast growth.

With better timing than many, the issue has been raised by former finance minister Alan Dukes -- a man who knows how to crunch a few numbers. In a paper for the Institute for International and European Affairs (www.iiea.com), he argues that the "fundamental problem" in the euro crisis is the overhang of debt.

There is public debt, private debt and banking debt. Ireland has all three in spades. As the IMF observed, an improved position in any one can generate improvements in the others. But which debt should be tackled first, and how?

Ireland has the unenviable distinction of carrying more bank debt on the public purse than anywhere else. The Anglo rescue adds almost 20pc of GDP to the national debt. Removing that would certainly reduce the debt to perceived sustainable levels.

Another IIEA paper, by former Ulster Bank chief economist Pat McArdle goes through the options, and the importance of reducing the debt burden. He agrees with Goodbody Stockbrokers' Dermot O'Leary's recent analysis that all proposals for direct EU assistance on bank debt are fraught with difficulty.

Most observers, both inside and outside government, now agree that the most likely response will involve just a reduction -- significant, but not dramatic -- in the annual cost of the Anglo rescue, rather than any straight debt relief.

The IMF report seemed to confirm this. There may well be versions of Anglo Irish, as yet unquantified, in other parts of Europe, so one can see why there may be reluctance to set precedents. Even so, separating bank debt, which had nothing to do with fiscal irresponsibility, would be a neat way maintaining discipline on public finances while making it more likely that they can be made sustainable.

For precisely these reasons, the IMF does want the new European rescue funds to invest in the remaining Irish banks. For the moment, though, there is strong resistance to such direct involvement, from both governments and the ECB.

Mr Dukes thinks this resistance to collective action is the problem -- and the problem could prove fatal. He believes that a number of euro states, including Ireland, have unsustainable debt levels but that national defaults or re-structurings would threaten the entire single currency.

He reminds EU leaders that, by letting the markets get ahead of them in 1992, governments could not save the linked currency system of the time. The recent downgrade of various Irish assets by Moody's used the standard phrase of the "unlikely" prospect of an Irish default, but the accompanying analysis did not make it sound all that unlikely.

Mr Dukes argues instead for a default on all eurozone debt. The default as a whole would be modest, but enough to generate savings which would then be allocated so as to reduce the debt of all member states to sustainable levels (generally regarded as less than 100pc of GDP).

New arrangements would have to follow, including the present fiscal and banking union proposals. In my view the original "no-bailout" rule would have to be resurrected and, this time, they would have to mean it.

Anything along these lines seems even less likely than rescues of individual countries. The mantra is still that fiscal probity on its own can restore confidence, stability and growth. We shall find out who is right in due season. The season may not be far away, but could still come too late for the purpose of saving the euro.

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