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Brendan Keenan: Hole in public finances can only be closed by 'burning' citizens

ON a clear day you can see forever, the romantic song says. In a week or so, the electoral dust will begin to settle and we will be able to see the landscape a bit more clearly. How far ahead we can peer, though, is open to doubt, but we will have to try.

The landscape may change very quickly. The critical EU summit is only a month away. The European Union is not the place to get anything done quickly, but something will have to happen and, while the March summit may not finish the job, it will have to continue on the road to a more stable framework for the single currency.

Other things will be happening too. Next month is meant to see the final tally for losses and capital requirements at the Irish banks.

Looking at the huge list of outside consultants and invigilators at the latest testing of the Irish banks, I could not help but think of the arguments over the absence of video referees at soccer matches.

For the banks, there are umpires everywhere, to convince spectators that this time they have got the score right. It beggars belief that as late as last year, EU supervisors, including the Irish, took part in elaborate stress tests of banks which, is now clear, were totally inadequate.

Who did the EU authorities think that would fool? The benighted citizens who pay for all this, certainly. But the corporate depositors, or the bond markets?

Not only were they bound to arrive at the truth but, when they did, the end result for Europe's troubled banks was bound to be worse than when the skewed tests were done.

Now there is a second chance to find out the Irish score. This time, to continue the sporting parlance, it is a decider. The course of events for the new government will depend as much on these stress tests as on anything else.

The official line is that the banks will not need more than the €10bn already set aside to give them a comfortable capital cushion.

That seems a bit odd, set against the €25bn fund available in the EU/IMF agreement. The official line is that this is only to give comfort to depositors and lenders, and should not be needed.

The comfort bit has not worked, which may partly be blamed on the fact that official lines on the banks are now widely discredited.

If, by some chance, the referees and umpires agreed that, this time, the official line is correct, it might not immediately restore confidence in the Irish banks, but it would make life a lot simpler for the government.

There would be much greater clarity on the public finances, which means a clearer message could be delivered. That is important, after the thick fog of claim and counter-claim generated by the election.

Even on this scenario, the appalling cost of the banking crisis would be close to €60bn, or 36pc of GDP. As the recent report from Goodbody Stockbrokers points out, that may make it the worst banking crash ever recorded in a developed economy.

That cost is bound to be a running sore for the government. It will be raised with each tax increase, spending cut or disappointment in economic performance.

Nevertheless, if the administration does not have to start by, say, injecting a further €15bn from the fund this year, the banks may lose some of their venomous political sting.

There will be no obvious added cost from the banks (the reality is a long-drawn out affair) and attention will shift to the downsizing of the banks still in business and the possible sale of some, or all, of them.

The danger is that the banks continue to dominate the next couple of years, as they did the last couple. The reason it is dangerous is that the banks, for all the billions, are not the more intractable of the twin debt crises. That honour is reserved for the public finances.

The first reason is one of scale. If debt were to reach 115pc of GDP in 2014, as Goodbody's "baseline" forecast says, half of the increase since 2009 would be down to banks and half to the deficit in running the country.

The difference is that while, ultimately, the banking cost is fixed, the deficit is open-ended.

Banking costs may be reduced in the end by "burning" bondholders of one kind or another. The same can be done with national debt.

But the actual deficits can only be closed by "burning" the citizens.

The purpose of the scorching is becoming clearer as the fog lifts. It is to create a "primary" surplus -- before interest costs are added.

The reason that is the target is that, unless there is a sufficient surplus, the debt burden just keeps getting worse.

Goodbody makes the less common point that it is not feasible to re-structure or default on national debt unless it results in a primary surplus after the debt is written off.

Markets will remain closed to the country until the adjustments to taxes and spending needed for such a surplus are made.

The primary balance has featured in the election campaign. One hopes the new Finance Minister will make it an explicit target, rather than the EU-driven general government deficit, or the rather more depressing Exchequer deficit.

It will be a moving target, depending on the rate of growth and the real (after inflation) interest rate.

Most people think the forecasts in the four-year plan are too optimistic, and the rate of interest charged by the EU temporary funds too high.

If they are right, the surplus required to stabilise the debt would be of the order of €5bn, which compares with a deficit of around €11bn this year.

That looks impossibly high. Lower interest rates and a longer timeframe may be required.

But there can be no gainsaying the need to eliminate the €11bn primary deficit. The consequences of doing that will dominate the politics of the next five years.

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