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The myth that we have lots of options about our debt

THE composition of December's Budget will determine whether Ireland can retain a degree of independence in economic policy. Failure to restore confidence in the State's ability to borrow and to guarantee credibly the borrowing of its banks will result in an abrupt erosion of economic sovereignty. There is no policy option available that is not deflationary.

The Government has chosen to withdraw from the international credit markets for the rest of this year because it cannot find lenders at reasonable rates of interest. In September, the huge amounts that became repayable by the guaranteed banks were repaid with funds borrowed from the European Central Bank, since our banks are unable to roll over their borrowings in international markets in any useful amount.

The Government needs to borrow enormous additional funds over the next several years in order to fund its "austerity" programme, a programme which would see a further and substantial increase in the national debt. That debt is heading, under the austerity programme, to levels that have already spooked the markets. Yet there is endless discussion about how much should be cut from the deficit next year, as if this country were perceived as a gilt-edged credit risk, free to borrow whatever we feel is needed.

The Irish Government is now seen as the weakest credit risk in the eurozone, barring only Greece, which lost the ability to borrow and is already in an IMF/European bailout. Our banks are struggling to borrow at all in the international markets, even with a government guarantee. The Government's intention to borrow more than €40bn extra during the years to 2014 (the austerity programme is one of substantial additional borrowing) has been accepted by all political parties, with the exception of Sinn Fein, as necessary, both to comply with the rules of eurozone membership and to reassure the lenders that the rocketing debt total will be stabilised at a level that will prove sustainable.

If the lenders conclude that Ireland is not a credible risk, as they did in the case of Greece, they will decline to lend. The Government would be unable to finance itself in the markets for the first time in the history of the State.

Against this background, the Economic and Social Research Institute (ESRI) report released last Thursday created quite a commotion. The institute seemed to be saying that the 2014 target, which would see fresh annual borrowing down to below €5bn per annum from almost four times that figure, would be too deflationary and should ideally be abandoned.

The report has emboldened some commentators to debate afresh the desirability of the target to reduce borrowing below the €5bn level. But an illusion of choice appears to have been created where none may exist. The critical issue in this debate is simple: how much leeway is actually available about additional borrowing, given the rapid increase that has already occurred in outstanding debt, the fragile condition of the banking system and the nervousness in the international capital markets?

The ESRI's most recent report has been interpreted as endorsing views expressed by the Irish Congress of Trade Unions, Sinn Fein and others, which proceed from the assumption that there is some worthwhile leeway: the Government could reduce the deficit more slowly than is planned, and accumulate a larger ultimate debt. Whether this is precisely what the ESRI intended to say is not entirely clear, since the report seems to accept that the 2014 target will not be abandoned.

A puzzling aspect of the report is the heightened concern, compared with earlier ESRI analyses, about the deflationary impact of tighter budgets. It has been clear since mid-2008 that Ireland was facing into a prolonged period of fiscal contraction, which means lower spending and higher taxes. The policy setting was going to be deflationary and the ESRI's numerous reports in the interim have acknowledged this. The concern about the impact of deflationary fiscal policy is entirely reasonable but the delayed timing of this particular intervention is a surprise.

Ireland is a member of the eurozone, is heavily indebted to the European Central Bank and may ultimately, if domestic policy fails to reassure lenders, have to join Greece in a European rescue. Some commentators have been suggesting that the 2014 deficit reduction target is being imposed by the EU, and that we have no choice but to obey unless we renegotiate. This line of reasoning assumes that, should the EU relent and open the door to greater borrowing and a higher ultimate debt mountain,

the lenders would come smiling through the door grasping eagerly for the increased supply of Irish Government bonds. This view is contradicted by the recent behaviour of the bond markets and the effectively forced temporary withdrawal from borrowing.

We could borrow only as much as markets would voluntarily agree to lend, and the lesson of the last six months is that this amount may be no more than the EU has specified, and may even be less. Why else were the banks unable to pay off September's maturing bond debt through fresh borrowing in the market? Why did the authorities decide to cancel October's bond auction and depart the bond market until the New Year?

Even if we could treat the markets as a no-limit ATM for the Government, it does not follow that the correct amount to borrow is to keep going until the machine gobbles the card. Debt is a burden, particularly when real interest rates are punitive, and a prudent policy would seek to control debt accumulation even if easy credit was available.

The mantra that poor little Ireland has been targeted by the dreaded bond market is a regular accompaniment to the siren calls for more borrowing. The reality is that the bond markets have been targeted by Ireland, and have finally woken up to the risks. In the long run, an attentive bond market is the economy's friend and a more effective discipline on errant policy than any amount of Brussels-originating surveillance.

Failure to gain re-admission to international credit markets in the New Year would mean inability to fund either the Government or the banks, and would necessitate early resort to bailout. This would mean the supervision of Irish economic policy, perhaps in considerable detail and for many years, by officials of the International Monetary Fund and the EU Commission. There are solid reasons, apart from national self-esteem, for seeking to avoid this outcome.

First, there is no reason to expect bargain interest rates from these lenders, nor is there any reason to expect a longer rope. Second, the supervision of policy could be highly intrusive, perhaps even punitive, given the involvement of rival EU-member states with agendas coloured by the hubris and self-indulgence that they detect in Irish behaviour during the Bubble. This may be unfair, but that does not make it unrealistic. Finally, Ireland is a trading nation that must live on its wits in the globalised economy. It will not help to admit that we were witless enough to end up in bailout.

There is no policy available that does not involve a deflationary stance over the next several years. It is time to desist from the exploration of unavailable options and get ahead of the curve.

Colm McCarthy lectures in economics at UCD. He has headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure: An Bord Snip Nua

Sunday Independent