Friday 23 March 2018

Time for 'EU partners' to truly help

We can't simply dismiss populist calls for Ireland to default, but the solution to our debt problems lies with wider eurozone action, writes Jim Power

AT the launch of the MacGill Summer School report last Thursday, Pat Cox warned of the dangers of populist policy suggestions becoming the perceived wisdom and filling the policy void in this time of unprecedented economic and political crisis.

There is obviously some truth in what he is saying, but one needs to be careful about discarding ideas or suggestions on the basis that they might just be populist. In this time of unprecedented uncertainty, both in Ireland and in the eurozone as a whole, nobody has a monopoly on wisdom.

Describing something as populist is a way of stifling debate. But it is important that all views and ideas be given careful consideration. A so-called populist approach might just have worked in lessening the impact of Ireland's escalating banking crisis or could help us navigate the dangerous waters ahead. One such notion that has been doing the rounds is that Ireland should default on some of its debt, be it banking-related or pure sovereign debt. But this is far from a one-way bet.

Despite the economic growth numbers last week, which showed that the Irish economy experienced an economic expansion of sorts in the third quarter of the year, the economic environment is extremely difficult and fragile. Domestic demand, primarily driven by consumer and business investment spending, remained very weak during the third quarter, but exports are growing at an increasingly healthy pace, largely reflecting improving external demand and a more competitive exporting sector at home.

I am extremely concerned about Ireland's economic future over the next three years, however, particularly over the coming year. The reality is that between 2011 and 2014 the Government is going to take around €15bn out of the economy in tax increases and expenditure cuts. This is equivalent to roughly 10 per cent of gross domestic product (GDP); with 40 per cent of it due to be implemented in 2011. This comes on top of a similar correction since 2008. So in essence, between 2008 and 2014, Ireland will experience a fiscal correction equivalent to about 20 per cent of GDP. No country has ever experienced such a correction without devaluing its currency. Obviously Ireland does not have that luxury.

The fact is that Ireland is in the middle of an unprecedented economic and social experiment. It could work of course, but the odds would appear to be against that. I have serious doubts. The annual interest on our national debt by 2014 could well approach €10bn and that would not leave very much to run our very expensive country. And there are many other potential problems associated with our economic experiment.

As a believer in the fundamentals of the capitalist system, I still cannot come to terms with the notion that investors who invest in the bonds of banks, whether they are subordinated or senior

It would not be wise for us to unilaterally restructure our debt

bonds, should be insulated from potential losses, particularly those who invested in AIB and Anglo.

However, senior bondholders in the dysfunctional and reckless Irish banking system are being protected at massive economic and social cost to the Irish population. But there is not a lot that we can unilaterally do about that, because of the decision in 2008 to implement a blanket banking guarantee. That guarantee effectively turned private-sector debt into sovereign debt. It is conceivable that the EU insisted on this blanket guarantee in order to protect banks across the EU, particularly those in Germany who had built up a heavy exposure to the Irish banking system. That is also the most likely reason why our bailout did not allow for such an eventuality, despite the probability that the IMF would be amenable to the free market notion of investors losing money in a bad investment.

Instinctively I would not be in favour of a sovereign country reneging on its debt, particularly in the developed world. I do not share the same instincts in relation to banking debt. We could, of course, pass a banking resolution that could change that situation, but I am not sure it would be in Ireland's best interests. In many ways the die is cast. However, some type of default still appears highly likely for Ireland.

On balance I do not believe that it would be wise for Ireland to make a unilateral decision to restructure its debt, not least because this could turn off the ECB funding tap that is keeping the Irish banking system alive.

Thankfully, however, Ireland may not be forced to make that unilateral decision. It is highly probable that the Greeks will be forced to default at some stage over the next couple of years, and there is also a strong likelihood that Portugal and Spain could get into serious difficulty.

Consequently, the EU will be forced to come up with a solution if it wants to save EMU in its current guise. Such a solution could involve massive quantitative easing, greater fiscal union in the EU, or a decision from the centre (Germany) to fund the restructuring of debt across many EU countries. Doing nothing in the hope that Europe will muddle through is unlikely to work, unless we get a very strong cyclical recovery in the global economy over the next three years.

History teaches us that debt restructuring is not the end of the world and would not destroy Europe -- in fact, it would enhance Europe's longer-term growth prospects and ensure that systems are put in place that would prevent rogue states from misbehaving in the future.

Without some sort of European solution that would involve a restructuring of some of Ireland's debt along with other countries, I find it hard to believe that Ireland will be able to work through its current problems without catastrophic economic and social consequences. Our EU partners will simply have to alleviate the burden on Irish taxpayers. Iceland did restructure its debt and is now growing again, but Iceland did not have to leave the euro and recreate its currency. If Ireland unilaterally defaulted, we would most likely have to leave the euro and recreate our currency. That would not be easy.

Jim Power is chief economist at Friends First

Sunday Independent

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