Ireland is plagued with debt it cannot repay and remains exposed to euro contagion
FOR many, Ireland is the poster boy for how to deal with a banking crisis. I disagree. Lauded by European governments for its quick decisive actions, Ireland effectively contributed to bailing out the entire European banking system and, in doing so, has left a legacy of bankruptcy that puts huge financial pressure on its citizens for generations to come.
If Anglo Irish Bank – which was nationalised, bailed out and then wound down by the Irish government – had been a US institution, the equivalent debt would have been in the region of $3.5-$4 trillion (£2.2-£2.5 trillion). Yet, the Irish government guaranteed this debt, as well as that of Bank of Ireland and Allied Irish Bank.
“Ireland is not Greece” is a statement frequently heard in Ireland. This is true. The Irish need for a bailout was not due to profligate public spending. Before the global crisis, Ireland was running a budget surplus and also possessed one of the lowest debt levels in the developed world. But the government failed to heed the warnings from clued-up economists, with one Prime Minster even stating that “the boom is getting boomier”. As the coffers swelled on the back of property transaction taxes, income taxes were reduced accordingly. When the property bubble burst, the revenue stream all but dried up, thus creating the deficit.
The governing party at the time of the bank guarantee has been replaced by the coalition government of Fine Gael and Labour. As one would expect, the mandate of this replacement government promised the Irish a substantial amount, but has so far delivered little. Understandably, the opposition lack credibility both within parliamentary debates and among the Irish population as a whole. The fiscal pact, vetoed in the UK, is not a sufficient solution either. It simply maintains the status quo and – similar to monetary union – attempts to force a one-policy-fits-all fiscal framework on vastly different economies.
Ireland’s unemployment rate has grown to over 14 per cent – levels not seen since the 1980s. Around 1,000 citizens emigrate every week. And the Irish housing market is depressed, with values down some 50 per cent. The Irish Central Bank has also slashed its growth forecast to 0.5 per cent this year, down sharply from the 1.8 per cent forecast in October 2011.
Certain issues continue to rankle. One in particular is the repayment of €1.25bn (£1.04bn) to unsecured bondholders of the now defunct Anglo Irish Bank. The government maintains that the repayments are necessary to restore fiscal reputation and keep international investors happy. Just over €28bn in outstanding aid needs to be pumped into the former banking powerhouse, through the execution of promissory notes – a payment of €3.1bn is due at the end of next month. Had it not been for these liabilities, Ireland could have avoided the need for the EU/IMF/ECB troika bailout.
The insistence that it would have been catastrophic if Ireland’s government had not stepped in holds no water. It was merely a bank and cannot be compared to a sovereign like Greece. In the future, ECB policy will no doubt lead to higher interest rates as the need to address inflation once again becomes part of the key mandate. This scenario means that Ireland’s terms of trade will deteriorate, reducing competitiveness in the export sector and almost certainly ensuring the economy is driven into external deficit.
As a result, there is a strong likelihood that Ireland will breach the targets set by the pact and the automatic penalties that entails are almost a foregone conclusion. The economy is fragile and there is a deafening scepticism that a state with a debt ratio well over 100 per cent, unclear growth prospects and a continuing deficit will succeed in funding itself.
To all intents and purposes, global equity markets have seen recovery. Is this down to renewed confidence? I would argue that for the most part the recent equity rally is fuelled by central bank monetary policies and ECB long term refinancing operations (LTRO). The LTRO measures merely address liquidity, not the core of the problem in Europe. The ECB has also insisted that it is a temporary arrangement. The day of the cheap carry trade for the banks will not last forever.
It’s almost impossible to quantify how bond markets will react later this year, especially when the inevitable Greek restructuring goes ahead.
The rhetoric that we have turned a corner, either in Ireland or Europe, is without basis. Greece’s issues will affect Cyprus; Austria is all-too-closely connected with Hungary. Portugal’s woes will inevitably be to the detriment of Spain. The contagion effect didn’t disappear as soon as Ireland took a bailout, if anything the disease became an epidemic.
Brenda Kelly is a senior market strategist at CMC Markets.