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No vote will stymie efforts to cut bank recapitalising costs

Throughout the Fiscal Compact referendum campaign a wide range of issues have been raised, many unrelated to the treaty itself.

Helpfully some facts have also emerged. First, Ireland's access to the European Stability Mechanism (ESM) fund is conditional on treaty ratification.

Second, Ireland is already committed, under European law, to the fiscal rules contained in the treaty. In essence, the treaty merely enshrines these same rules in Irish law, as a condition for access to ESM funds.

Failure to ratify the treaty will raise concerns on the future funding of the Irish sovereign. In this context one might reasonably expect households and companies to rein in their spending, threatening to depress the economy further.

Ireland's sovereign funding dilemma is far more urgent than treaty naysayers would have one believe. It has become an article of faith that the EU/IMF programme ensures funding out to the end of 2013.

However, the programme assumes the Irish sovereign raises €14.1bn of market financing in 2013. These funding needs could be met by eroding the State's €14bn of liquid cash balances, but would leave government funding in a precarious position ahead of the large €8bn bond redemption in January 2014.

Earmarked ESM funding for Ireland will probably need to be put in place by early 2013 at the latest.

With the euro area in recession, Greece's participation in EMU uncertain and concerns on Spain's debt position and banks re-emerging, a sharp improvement in European bond markets seems unlikely in the near term. So the funding ramifications of a No vote today could be felt far more quickly and far more acutely than many expect.

Additional expenditure cuts and tax rises in Budget 2013 would be one option to reduce Ireland's funding needs in the event of a No vote. And the Budget 2013 projections will be made in the context of a weakened euro area economy.

The euro area recession clearly threatens the export- led growth envisaged in Budget 2012, sufficient to return the economy to 3pc nominal growth by 2013 and stabilise the debt to GDP ratio close to 120pc.

There is a severe risk the debt/GDP ratio could rise well above 120pc. A 1pc shortfall in the nominal growth of the economy through 2012-2015 could push up the debt/GDP ratio by close to 10 percentage points. In this scenario ESM access becomes even more important with higher deficits raising funding needs.

Ireland's access to the ESM for sovereign funding needs has been a key issue in the referendum campaign.

However, perhaps less understood is that the ESM could potentially play a part in reducing the costs of recapitalising Ireland's banks.

Just this week Spanish Prime Minister Rajoy suggested the ESM should be able to bypass national governments and recapitalise banks directly,

This raises the tantalising possibility that the ESM may eventually be used to help reduce the costs to the Irish Government -- currently around 40pc of GDP -- of recapitalising the banks.

But the ESM would require a change in its mandate to recapitalise banks directly. However, clearly a No vote in the referendum will remove any possibility of using the ESM to reduce the cost to the Government of recapitalising Ireland's banks.

Thus far, the debate on reducing Ireland's recapitalisation costs has focused on the IBRC, the former Anglo Irish Bank. Under current arrangements the Exchequer is required to raise €3.1bn per annum to pay down promissory notes with IBRC.

The prospect of restructuring Ireland's promissory note payments to IBRC first emerged in September 2011 when the Finance Minister indicated burden sharing on Anglo Irish Bank's unsecured bonds would not be pursued. Since September, the view that a restructuring of these payments could help improve the sovereign's debt position has gained traction.

It is difficult to explain the complex flows of funds between the Exchequer, IBRC, Central Bank and EU/IMF. But, put simply, IBRC is a bank entirely in state ownership. So restructuring payments from one organ of the State, the Exchequer, to another, IBRC, can have no fundamental impact on the State's debt position. Any excess interest earnings by IBRC will eventually accrue to the Exchequer. Indeed, the promissory note payments are effectively the most cheaply funded part of Ireland's general government debt, a 1pc loan from the Irish central bank's ELA facility.

It is a little worrying that rescheduling promissory note payments to state-owned IBRC could ever have been characterised as a method to reduce Ireland's debt.

However, the emphasis on the promissory notes also reflects political factors. There is some recognition that the promissory notes represent an undue burden on the Irish public finances.

The IMF's fourth review of Ireland's programme acknow- ledged the lack of burden sharing with unguaranteed bond holders has been perceived as a measure to protect the European banking system, and called for additional European support for Ireland's recovery.

A second political factor is that ELA funding for IBRC is effectively monetary support to the Irish sovereign, extended against the collateral of the promissory notes.

So any proposals to replace ELA support with longer-term ESM funding may receive support from the ECB, keen to avoid the taboo of central bank support to individual euro area governments.

This week the ECB rejected proposals by Spain to recapitalise Bankia with government bonds as collateral for short-term borrowing with the ECB, a proposal with striking similarities to the current funding of IBRC.

For now speculation on any restructuring of the promissory note payments remains just that. We have yet to see the long-awaited technical report from the troika on restructuring IBRC's funding, and no firm publication date has been announced.

We have little idea what is actually being proposed, and the chances of success for any proposals that may emerge. More recently, Minister Noonan has suggested that a transfer of the banks' loss -making tracker mortgages might also be included in a restructuring of the promissory note payments.

Thus far, the Government has been determined not to link the outcome of the referendum with any prospective deal from Europe. Indeed, any additional support for Ireland will inevitably be characterised as a second bailout, an impression some European policymakers will still seek to avoid.

Many of the ideas proposed domestically to help Ireland's debt sustainability may ultimately have an extremely slim chance of European support. Nonetheless, Irish voters should be aware that a No vote on the fiscal compact treaty may not only jeopardise Ireland's immediate funding needs but also restrict access to a key tool, the ESM, constraining the Government in pursuing policies to help reduce the cost of recapitalising Ireland's banks.

Conall MacCoille is chief economist at Davy

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