Friday 14 December 2018

Colm McCarthy: Voting No is a leap in the dark that we can't afford

With no guarantee of bond market re-entry, Ireland may need more money from Europe, writes Colm McCarthy

Controversy over refinancing the promissory note could turn into a sideshow. Recent data from the Central Statistics Office (CSO) and an important report from the Central Bank suggest that the economic and financial outlook remains very challenging.

There is no guarantee that the current programme of emergency lending to Ireland will be followed by a successful return to the sovereign debt markets and an end to reliance on official lenders. A successful outcome to the programme depends almost entirely on events outside the Government's control.

Provided that no additional costs arise from rescuing banks and with a resumption of economic expansion, the Government's planned deficit reductions over the next few years are supposed to see Ireland's debt peaking at 118 per cent of GDP by the end of 2013. In this scenario, the plan is that the State will be able to borrow whatever it needs, both for smaller ongoing deficits and for refinancing maturing debts, from 2014 onwards, without any further loans from the EU and the IMF.

Whether this proves possible depends also on the state of the sovereign debt markets two years hence. If the markets remain in disarray, then re-entry on the substantial scale required could be impossible, even if all the other boxes are ticked.

Governments cannot summon up economic expansion, particularly over short time horizons. In an economy heavily reliant on international trade, the rate of economic growth over the next couple of years is largely outside the Government's control.

Compliance with the targets for deficit reduction may be achievable, even if economic growth does not return, since there is always a combination of tax increases and expenditure cuts that will reduce the deficit, even in a sluggish economy. But the targets will be very difficult to achieve unless State revenue is boosted by the timely arrival of economic recovery.

The CSO figures show that while economic output for 2011 was marginally ahead of 2010, what little growth there was occurred in the first half of the year. In the final two quarters, the economy declined. Early figures for 2012, including retail sales volumes, suggest that activity remains sluggish.

The central scenario in Ireland's financial programme envisages modest growth in 2012 but a strengthening recovery in 2013 and 2014. There is no concrete sign that recovery has begun.

Economists at the Central Bank, in their comprehensive macro-financial review, stress the risks to economic recovery deriving from a weak external environment. They note that Ireland is dependent, in particular, on developments in the United Kingdom, in continental Europe and in the United States. Only in the latter is there any sign of an improving macroeconomic outlook and even that is fragile. Another few years of depressed conditions in Ireland's main external markets is identified as a major risk and one that Irish policy can do nothing about.

The second risk identified is the potential for further unpleasant surprises from the banking system. The banks have been recapitalised and should recover their credit-worthiness if current estimates of loan losses are not materially exceeded. But it is in the nature of banking busts that the final bill is not known until debts to the banks have been paid down or definitively written off.

There is still no clear sign of stabilisation in residential or commercial property values and the limited availability of bank credit does not help. If economic recovery is delayed, there is a risk that loan loss provisions will prove inadequate and that further State assistance to banks will then become necessary. There is also a contingent liability for Nama, whose borrowings are supported by expectations of loan and collateral recovery which could prove optimistic.

The Central Bank authors are being realistic rather than alarmist. Things could work out well or badly and they are surely right to draw attention to the consequences of an unfavourable outcome.

The final component in the programme scenario for Ireland -- assuming that recovery arrives on schedule, deficit reduction is delivered and there are no more shocks from the banks -- is that the bond markets will roll out the welcome mat for Ireland from 2014 onwards. There is no guarantee that this will happen either, even if everything else works out as planned.

Europe's sovereign bond markets have been through something of a nervous breakdown in recent years, culminating in the Greek write-down of €100bn, the largest sovereign default in bond market history and the first in a developed country for 60 years. Even after this huge write-down, Greece's level of debt looks unsustainable and there are fears that Portugal has no realistic chance of bond market re-entry either.

Ireland may have the best prospects of the three 'programme' countries, but many observers think the other two have little realistic chance of escaping without further bailouts or sovereign debt restructuring. In Spain, the budget deficit has overshot the target and there are worries about further hidden losses in the banking system.

Ominously, the respected economist Willem Buiter, who has called the eurozone crisis better than most, has turned negative on Spain in a recent assessment.

He said: "Spain looks likely to enter some form of a troika programme this year, as a condition for further European Central Bank support for the Spanish sovereign and/or Spanish banks."

Problems for Italy or Spain in the bond market would make it more difficult for weaker countries to re-enter.

The deferral of the cash payment on the IBRC promissory note that was due yesterday is unimportant. In reality, the payment has been financed for only a year, through borrowing from the Bank of Ireland against a longer-term bond. There has been no change to the level of debt outstanding. Nor is there any recognition that a substantial portion arises because of the imposition on Ireland by the ECB of full repayment to unguaranteed bondholders in Anglo and other bust and defunct banks.

This deal does not open any obvious corridor to further negotiations. The Government needs to prosecute vigorously with Europe the case that debts the ECB has imposed on Ireland not merely inhibit Ireland's ability to deliver on the programme and re-enter the bond market, but are also an arbitrary and unprecedented imposition on a country that is already unable to finance itself.

The loss of investor confidence in European sovereign debt has been exacerbated by the ECB's insistence that bank bondholders come first and that the resolution of failed banks must be at the expense solely of taxpayers and sovereign bondholders.

The Government has announced May 31 as the date for the referendum on the EU's fiscal compact. Should Ireland be unable to re-enter the bond market on the required scale at the end of next year, alternative financing avenues will be required if sovereign default is to be avoided. The EU's permanent rescue fund, the European Stability Mechanism (ESM), will only be available to countries which accept the fiscal compact. Only those possessed of total confidence in bond market re-entry should ignore this.

In the event that the referendum is defeated and Ireland does not have ESM access, opposition politicians have been arguing that the country could still turn to the IMF in the absence of market access and of any further support from Europe. After all, the argument goes, we are members of the IMF independently of our membership of the EU and the eurozone.

This looks like wishful thinking. IMF members are normally limited to borrowing six times their pre-arranged fund quota. Ireland will have exceeded 15 times the quota by 2013. This exceptional amount was agreed only because the current rescue deal was done jointly with European lenders, whose loans rank junior to those of the IMF.

Remember that the IMF is not a central bank and cannot print money. Its resources are limited by the willingness of wealthier members to backstop its lending and there is already considerable impatience with the colossal amounts extended to European countries, the biggest loans the IMF has ever made.

This helps explain why IMF officials have been supportive of a better deal from Europe on bank rescue costs. They will likely be unable to help if Ireland does not graduate successfully from the programme and has also denied itself access to the EU rescue fund through rejecting the fiscal compact.

Sunday Independent

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