Business Irish

Thursday 26 April 2018

It's not case of if, but when our default will happen

As Portugal joins Europe's bailout club, Roisin Burke looks at what a default would mean for Ireland

A must-read for financial types, The International Economy Magazine recently asked "a number of top thinkers" for odds on Ireland and other embattled eurozone countries defaulting.

Those polled included senior ex-US Treasury figures, German bank economists, respected academics and hedge and investment fund bosses. Of the 25, 18 thought it was either "certain" or "probable" that Ireland would go under outright or face significant haircuts of sovereign debt within three to five years.

Analysis from researcher Capital Economics puts Ireland's default risk at more than one in three.

"Call it what you like -- default, call it debt restructuring, re-engineering -- but it is now inevitable," UCD economist Ray Kinsella says.

"I don't think we're talking in 2013, I think we're talking in the near term. In my view the markets may push us to that in months. The EU/IMF orthodoxy is pushing our economy into enforced default."

If it happened, what form would it take, and would it make things better or worse? We've looked at some of the possible scenarios.

Eurozone exit

"Can I give you an almost unthinkable scenario?" offers Bill Blain of London bond brokerage New Edge.

"If we think out of the box here, the problem Ireland's got is it's stuck within the EU and relying entirely on the EU to pay its debts and to bail out its banks which have beggared its country.

"We know the only way a country can recovery is to grow. But within the euro, Ireland is caught with an austerity budget mandated by its European partners, and we're about to see interest rates rise across Europe because of the strength of the German economy.

"So let's think the unthinkable: get out of Europe, set your own growth pattern, set your own taxes, restructure the debt with whatever assistance is left, and I'm sure assistance would come from other places."

This doesn't mean going rogue on the EU. "This could be done with the agreement of the EU, that might suit the EU if Ireland and other countries were to exit. Until Ireland can generate growth through economic and national policy, it's stuffed," Mr Blain says.

Mr Kinsella thinks the faultline between the powerhouse German and other core economies versus tottering Ireland, Greece and Portugal means some kind of eurozone break-up based on default might be inevitable.

"With the Portugal bailout, this, in my view, spells the final fracturing of the eurozone; that's the bottom line. The eurozone is now divided into two tiers. An exit could have its benefits for Ireland, if it came with renewed control over our fiscal policy, including interest rates and exchange rates," he adds.

Relink with sterling

"Look at where the UK is in relation to the EU -- maybe that's a better place to be," suggests Mr Kinsella.

"If you look at Bloomberg and look at the credit default spreads [ie the markets' bets on the likelihood of countries defaulting]," notes Kinsella, "you'll see Greece, Ireland and Portugal benchmarked 10 per cent over Germany, which is right down at the bottom.

"And then trading alongside Germany, you'll see the UK, in spite of its own economic difficulties. It's outside the eurozone, there's commitment among its two leaders to address structural imbalances, and it has the economic autonomy that Ireland has now been deprived of.

"The financial markets like what they see, and so they have rated the chance of a UK default at pretty well zero. Compare that to Ireland -- within the eurozone, with an IMF programme and a set of resources which normally bring default risk right the way down, and in theory being aided by our 'partner' countries in Europe.

"Those data are telling us something very serious: they're telling us that the markets expect a default for Ireland in the near term.

"I think we may find ourselves forced by the economic orthodoxy being imposed on us outside the eurozone. There may be discussion about other countries coming with us or being forced out. On that basis I think there will be devaluation. And at that stage, Ireland will have to make up its mind about whether or not it would be in its interests to rejoin with sterling."

'Restructuring' €17bn of bond debt

Financial Regulator Matthew Elderfield told Reuters last week that while senior bondholders for AIB and Bank of Ireland continued to be sacrosanct, losses might be imposed on the holders of €17bn of senior bond debt in Anglo Irish Bank and Irish Nationwide, subject to ECB approval.

"I don't think the markets would punish Ireland if there was some form of default restructuring of that debt," says Sean Hawkshaw of investment house Kleinwort Benson. "Though with Portugal coming into the mix, it's likely the ECB will want us to toe the line even more on senior bond debt. But the markets understand that the bondholders have to manage risk."

Senior bank debt writedowns have been done elsewhere.

The Kazakhstan option

The cheapest bank bailout in history? That honour might go to Kazakhstan.

Reeling from a banking crisis and property market collapse, the former Russian state and major central Asian economy looked at what Ireland did to solve its problems -- then did the opposite. It agreed a partial default on senior debt with bondholders and ringfenced bank debt away from sovereign debt.

In early 2009, Kazakhstan's two big banks, BTA and Alliance, representing 13 per cent of the country's entire GDP, were on the edge of collapse. They were nationalised, and money was pumped into them. But after this point, Kazakhstan, unlike Ireland, moved beyond bailout, and on to a 'bail in', and entirely new stakeholder class.

"We looked at letting the banks go down, and decided against it," says BTA (Kazakhstan's 'Anglo') deputy chairman Berik Otemurat. "Our second option was to guarantee the debt. We looked at the significant burden this would impose on the state and said, 'no, we can't afford this'. Plus we didn't want to push additional banks toward state support."

The state hashed out a bail-in policy with the banks' senior bondholders, a large amount of whom were international. It got their agreement to write down a large part of their debt in return for an equity stake in the banks once redeemed.

Not that it was easy. "It took one-and-a-half years of negotiation," Mr Otemurat says, starting in April 2009 and ending in August 2010.

"We were talking for more than a year. We talked to each creditor and made it clear there was a danger of bankruptcy. It was never an option to put this burden on the taxpayers."

The cost to date has been in the region of €6.7bn rather than hundreds of billions. "The banks remained fully operational throughout the process."

We could still bear in mind the Kazakh example in relation to the Anglo/Nationwide senior bond debt.

Like Ireland, financial and legal advisers were hired, but unlike here, horse trading with creditors began immediately, and transparency was a watchword.

"We put everything on the table. We had due diligence from the start and made it a completely transparent process. Everything, every problem about the banks," Mr Otemurat says.

Kazakhstan had seven per cent growth in 2010 and the IMF forecasts growth of 5.4 per cent or more in 2011.

Orderly default

"One thing is very clear," Ray Kinsella says. "In the past three years, window after window of opportunity for Ireland has been banged closed. And we just haven't reacted. The economy is getting worse.

"The IMF/EU bailout is punitive in its terms and conditions, and it's not appropriate to Ireland.

"If the harshness of this leads us to being kicked out of the eurozone, we take a deep breath, we hold our nerve, we believe in ourselves. We take our courage in our hands; that's what we do.

"If we are going to default, let's do it in an orderly way, in consultation with the other peripheral countries, in good standing. And let's do it now. We won't last until 2013."

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