Thursday 21 March 2019

EU concession still long way from facing reality

Interest rate cut only means the inevitable default will be smaller than expected, says Colm McCarthy

FACE THE MUSIC: Taoiseach Enda Kenny, pictured in Achill Island last week at the opening of the Great Western Greenway, should bring forward the budget to October in a bid to bring down
the budget deficit and restore market credibility. Photo: Michael McLaughlin
FACE THE MUSIC: Taoiseach Enda Kenny, pictured in Achill Island last week at the opening of the Great Western Greenway, should bring forward the budget to October in a bid to bring down the budget deficit and restore market credibility. Photo: Michael McLaughlin

As ministers head for the beaches after the close of the new Government's first parliamentary session, there should be no self-congratulation or talk of corners being turned.

The reduced interest rate and extended loan repayment dates offered by the EU at the Brussels summit on July 21 may represent the first break to have come Ireland's way since the resort to financial rescue in October of 2010. But the overall value of these measures is minor and the situation has changed from impossible to somewhere between hopeless and desperate.

The likelihood is that Ireland will not be able to borrow in the markets for the foreseeable future, without further and more substantial modifications to the existing arrangements with Europe. The Brussels deal has brought a small improvement in the market rate of interest on Ireland's sovereign debt, but this means only that the default will be smaller than previously expected, not that the risk of default has been removed.

There has been no relief from bank debts shouldered by the Irish Exchequer even though the principle of imposing losses on imprudent lenders was conceded in the case of Greek sovereign bondholders.

Each and every concession to Ireland in the Brussels deal was made available also to Portugal. The twin motivations were the avoidance of disorderly default in Greece and of contagion to Italian and Spanish bond markets, rather than any acknowledgement of inadequacies in the EU/IMF 'rescue' deal for Ireland.

The principal beneficiaries of European policy towards Ireland are those who bought bonds from insolvent Irish banks. Meanwhile, those who bought bonds from an insolvent Greek government are expected to bear at least some of the burden. Whatever relief the package contains for Ireland was grudging, inadequate and arose coincidentally from a belated attempt to solve problems elsewhere in Europe.

Events in the Italian and Spanish bond markets during the week suggest that this belated attempt could fail sooner rather than later. In the secondary market, bond yields for these two countries remain at levels which led quickly to bailout for Greece, Ireland and Portugal. The week in Spain ended with the announcements of an early election and a possible further downgrade from one of the ratings agencies. The spread of contagion to Italy and Spain has not been contained so there will be further emergency EU summits and further opportunities for Ireland to unshackle itself from the punitive terms of the European 'rescue'.

Policy needs to focus on what can be done in Ireland, as well as on the actions which can be taken to improve the terms of the EU/IMF deal. The budget deficit remains at quite unsustainable levels and there is no prospect of escape from the debt crisis until a credible path to budget-balance emerges.

It is now three years since the first budgetary restraints were introduced by the late Brian Lenihan, who took over at Finance after Bertie Ahern's departure as Taoiseach in May 2008. But even with a series of budgets, mini-budgets and cuts packages since then, the deficit remains at over 10 per cent of GDP. No country can expect a welcome in today's sovereign credit market without a deficit in low single figures, or at least headed decisively in that direction. More progress should have been made under the last government and the new one has passed up the opportunity to take further fiscal action before December.

When David Cameron and his Chancellor George Osborne took over in the UK last year, they too faced a daunting budgetary challenge. They chose to put through a pre-cooked emergency budget inside six weeks, blaming the previous administration and gaining valuable credibility in the markets. It is a pity Enda Kenny and his colleagues did not use their political honeymoon to do the same.

However, a comprehensive spending review is under way and there is no reason why the next budget could not be brought forward to October. It could also bring forward some fiscal measures already pencilled in for later years. If a budget bringing the 2012 deficit below eight per cent of GDP could be enacted in October, it would begin the restoration of market credibility and the prospect of restoring some degree of control over our own affairs. It would, of course, be deflationary. Increasing taxes and cutting expenditure is always deflationary in terms of immediate impact. But when it is universally understood that expenditure cuts and tax increases are inevitable, bringing them forward, and removing uncertainty as to the composition of the package, should be less deflationary than spinning it out indefinitely and permitting gratuitous uncertainty to flourish.

One of the reasons why Ireland has been shut out of the sovereign credit markets is the perception that, in addition to the known accumulation of sovereign debt, there may be further exposures for the Exchequer lurking beneath the waves in the murky wreckage of the banking system.

During the week a semi-state body announced an annual loss for 2010 of over €1bn, an event that would have convulsed national politics a few years ago. But this body was Nama, the 'bad bank' which has purchased dud property loans at a discount from the Irish-owned banks and which booked the loss to reflect the continuing decline in property values since the valuation date employed, which was November 2009.

Nama has eight-and-a-half years left to unload its loan and property portfolio and pay down its debt of about €30bn. If it falls short, the Exchequer is exposed for the balance. It is too early to get despondent about Nama, but the risk of a shortfall is real. In addition, the Central Bank has Exchequer assurances for a further €50bn or so in funds advanced to the banks whose ability to repay depends in large degree on the same property market. So the Irish Exchequer is seen as heavily indebted but also exposed to further contingent liabilities which will crystallise unless property prices stabilise and recover.

Any borrower who has underwritten the liabilities of others is in a weaker position than it would be on the basis of its direct debts alone. The lenders will worry if you personally owe €100,000. They will worry a lot more if you owe the €100,000 and have also guaranteed mortgages right left and centre for the rest of the family.

In addition to reducing the budget deficit as quickly as possible, the Government needs to argue consistently that any realistic prospect of re-entry to the bond market requires relief from the intolerable Exchequer burden arising from the Irish property and banking bubble.

It is entirely fair for our European partners to observe that we have brought this on ourselves but it is equally fair to note that in picking up the tab, the Irish are 'taking one for the team', in the phrase of Sharon Bowles, the British MEP who chairs the Economic and Monetary Affairs Committee. The team, in the form of the EU Commission, the European Central Bank and the Franco-German political leadership, persist in the pretence that the protection of creditors of the bust Irish banks, at the expense of the Irish Exchequer, represents some form of generosity to Irish citizens and taxpayers.

Fortunately, the existing deal with our European partners is impractical as well as unfair. It has not worked, it will not work and there will be further rounds of modifications as Europe gropes towards a resolution of the banking and sovereign debt crises. It will not be enough, in regaining solvency, for the Irish Government to avoid further pay-offs to bondholders in Anglo and Irish Nationwide. The Irish Exchequer's contributions to bank rescue have already destroyed the sovereign's capacity to borrow. There is still an opportunity to avoid default on the sovereign debt of the state, but the ability to avoid this outcome is being undermined by the obligations undertaken to investors in bonds issued by insolvent banks.

The restoration of that ability requires, in addition to vigorous reductions in the budget deficit, that the remaining costs of rescuing the Irish banks be shared with their creditors and with the European institutions whose defence of bank bondholders has helped to create the current untenable situation.

It would be nice if both sovereign and bank bondholder obligation could realistically be met. If they cannot, the choices need to be understood both here and in Europe.

Colm McCarthy lectures in economics at UCD. He headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure Progra-mmes, An Bord Snip Nua. He also authored the report into the semi-state sector from the Review Group on State Assets and Liabilities

Sunday Independent

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