Budget discipline must continue as Troika exits
Seeking a standby arrangement would demonstrate prudence rather than weakness, writes Colm McCarthy
Published 03/11/2013 | 02:00
The Government has yet to decide whether to seek some form of continuing access to non-market loans from the EU and IMF when the full €62bn in official finance is drawn down at the end of 2013. The end of the Troika lending programme means that all of the State's borrowing needs, to repay maturing debt and to finance the continuing budget deficit, must henceforth be met entirely from market sources. This is the downside of regaining 'sovereignty'.
Ireland's ability to survive in the markets, without any further support from official lenders, depends on three critical factors. The first is the willingness of the Government to eliminate the budget deficit and thus the risk that the debt keeps growing. The second is the avoidance of new contingent liabilities, for example for future bank rescues. The final item is the availability of a backstop or standby arrangement from the official lenders, should there be unforeseen problems in the sovereign debt market.
The Troika is due to depart on December 15, but it is a terrible mistake to imagine that this somehow sets Ireland free to pursue whatever budgetary policy takes the politicians' fancy. You cannot spend what you cannot borrow, and from 2014 onwards, the Government will be constrained by the willingness of the sovereign credit market to finance the State.
It is insufficiently understood that the Troika lent money to Ireland when the markets would not. Had there been no loans from the Troika, expenditure cuts and tax increases would have been more severe, not less severe, than what has actually been experienced.
If the Government's commitment to deficit reduction is seen to waiver, the markets will punish quickly and without negotiation. The events of the summer of 2010, when the ability to borrow in the markets evaporated as the extent of contingent liabilities for the banks unfolded, should serve as a clear guide to what awaits when the official lenders depart.
On December 15, the State will have exchanged one set of lenders for another. Sovereignty will return only when the debt is under control and there is no further doubt about the credit-worthiness of the State. The recent Budget will not have reassured our returning taskmasters, the volunteer sovereign lenders: any politician, in government or opposition, who feels that December 15 represents some kind of licence to switch back on the national ATM machine has learned nothing from the events of the last five years.
There are budgetary obligations arising from EU and eurozone membership which will constrain Irish policy in the years ahead, Troika or no Troika. The country continues to run a budget deficit which exceeds sustainable levels and will, unless reduced quickly, provoke sanctions from Europe. But far more importantly, the budget gap and the maturing debts must be financed from 2014 onwards by volunteer lenders; this could become a binding constraint far sooner than any rap on the knuckles from European politicians.
Tight control of government spending is an unavoidable component in Irish macroeconomic policy for the foreseeable future. Further tax increases, and diminutions of tax breaks, are also on the agenda. Exit from access to Troika funds does not alter this simple reality. Indeed, it brings the commitment to budget balance into even sharper focus.
The second requirement, if the Irish State is to regain credit-worthiness, is the avoidance of any new liabilities for private sector debt. Individual eurozone members, regardless of the precariousness of their sovereign finances, remain fully liable for any further costs of bailing out bust banks. That would appear to be the position of the European Central Bank, notwithstanding the July 2012 European Council decision to 'break the vicious circle' between bust banks and bust sovereigns.
Speaking in Milan last Friday week, Jorg Asmussen, an executive board member at the European Central Bank, addressed a critical issue of eurozone policy. The issue is what happens if the 2014 stress tests on the banks reveal further capital holes?
In the course of a lengthy speech on eurozone policy, he stated: "One particular point needs to be stressed: credible national backstops must be put in place. If not, the credibility of the whole exercise is put at risk as the outcome will then almost certainly be negatively perceived by market participants. Doing this balance sheet assessment without a backstop in place would be a bit like getting on a boat in rough weather conditions, and not taking a life jacket on board."
Asmussen's strategy would mean, should the Irish banks need more capital, that the Irish Exchequer would be expected by the ECB to invest yet further billions in dodgy banks, on top of the €64bn already added to the Irish State's debt. The State would then have boarded a boat far more likely to capsize.
Entering year six of the eurozone banking crisis, it is simply extraordinary that senior ECB officials continue to occupy the never-never land where any and every eurozone member state is deemed to possess the willingness and capacity to produce, in unspecified amounts, 'national backstops' for the next round of bank re-capitalisations.
To be fair to Asmussen, he has tried to articulate some kind of coherent ECB position in his speeches since he was appointed. But the 'national backstops' speech in Milan contained no exceptions: each eurozone state, regardless of its current sovereign debt total or its past expenditures on bailing out bank creditors, is to be placed fully at risk for unknown future bailouts of yet more bank creditors.
There is a deep issue here. Does the ECB seriously believe that each and every eurozone member has, in the eyes of the sovereign credit market, an equal capacity to embrace further liabilities for the debts of insolvent banks? Is it the policy of the ECB that the insolvency of any bank is to be avoided while the insolvency of sovereign states is to become routine? The 'vicious circle' can only be broken by imposing the potential for losses on bank, as well as on sovereign, creditors. Is it ECB policy that bank creditors always come first, even in states struggling to access the sovereign debt market?
The third and final factor affecting Ireland's ability to survive without support from official lenders is the availability of a fall-back if things go wrong. As Ireland exits the official lending programme, there appears to be some belief that applying for a standby facility would constitute an admission of weakness. The circumstances in which a standby would be needed include circumstances entirely beyond the Government's control. There is a choice to be made and it is up to the Government to decide whether to seek such a facility. It cannot be imposed by the official lenders.
Since adverse developments outside the Government's control are easy to envisage, seeking a standby would demonstrate prudence rather than weakness. The economic calculus is straightforward. There are clear benefits from having a facility in place – market lenders will know that, if things go wrong, the borrower will have access to non-market funds and will be less likely to default. There appears to be no material costs. Any conditions likely to be imposed on a state seeking a standby facility will be no more onerous than the constraints already faced.
It is simply not the case that, once the Troika departs, Ireland can declare the end of austerity and resume partying on Exchequer largesse. Aside entirely from the EU budget rules which require continuing discipline, reliance on volunteer market lenders will impose its own rules. There would appear to be no incremental cost involved in seeking a standby, in the sense that the future course of budget policy is already determined. With or without a standby, there will be tight budgets for many years to come.
In order to make a success of exit from reliance on the dreaded Troika, the Government needs to stick resolutely to the path of budget discipline. Lenders need to know that Ireland will not be running any budget deficit at all inside a short few years. The European Central Bank needs to be informed that there will be no 'national backstop' for bust banks in Ireland. We have already given. Finally, the Government should seek a backstop arrangement from the EU and IMF as the Troika programme ends. Not to do so looks like a pointless piece of political bravado.