Ireland must protect itself against economic relapse


OPINION:Christine Lagarde rightly emphasised yesterday in Dublin the need to take steps to prevent slippage

This week’s visit to Dublin of Christine Lagarde – the first ever by an International Monetary Fund head to Ireland – was a major milestone. It reminded us that, at least for the moment, Ireland continues to rely on a bailout from the IMF and the EU to fund the day-to-day needs of the State. That Ireland finds itself in such a situation would have been inconceivable only a few years ago.

Yet, despite many dire predictions, we have so far “lived to tell the tale” and more. Slowly but surely – and at considerable, but to a large extent unavoidable, cost, as emphasised by Lagarde – the fiscal excesses of the property boom have been worked off. Green shoots have started to appear on the growth and employment fronts while the banking sector is stable, albeit fragile. There has been some easing of the debt burden with more in prospect, while Irish bond yields have fallen dramatically.

IMF heads customarily do not visit countries where programmes are failing or where there are likely to be major anti-IMF demonstrations – this they leave to their staff. Lagarde’s presence in Dublin is thus especially significant. She has not visited Greece or Portugal or, for that matter, Spain or Italy recently. The IMF, with its share of failures over the years, is naturally anxious to celebrate a “success story”.

Barring any sudden disasters, it is virtually a foregone conclusion that the Government will meet all the agreed budgetary targets and this will mark Ireland’s formal “exit” from the programme.

However, the IMF head rightly emphasised the need to plan and to take appropriate precautions so as to prevent any relapses. One of the purposes of her visit was to discuss with the Irish authorities how this might best be achieved. As Ireland is set to be the first country to exit the euro debt crisis, the handling of its case will have important ramifications for other exiting countries later.

There are two risks to consider. First, a major resurgence of the euro debt crisis can by no means be ruled out. Apart from the ever-present Greek problem, the anti- austerity message of the recent Italian elections, continuing adjustment fatigue in Spain and Portugal, and the new Cyprus bailout, all underline that there is a long way to go before stability is assured for the euro area. A continuing euro wide recession coupled with renewed financial instability could have serious repercussions for Ireland, especially since Ireland’s debt burden remains the second highest in the euro zone after that of Greece. Lagarde’s message, that there is no room for complacency, surely is correct.

The second risk – naturally not mentioned explicitly by the Government or by Lagarde – concerns the possibility of domestic adjustment fatigue setting in after the end of the bailout. With a general election due in early 2016 at the latest, the budget for 2015 is bound to be a key component of the election campaign. And in keeping with a long-standing tradition in Irish politics and elsewhere, the temptation to provide pre-election budget giveaways will surely arise.

Aware of the possibility of slippages, so long as 25 per cent of EU bailout funding remains to be repaid the EU Commission will continue to “monitor” Irish budgetary performance, including by requesting (“insisting?”) that additional measures be taken if needed. However, the EU’s ability to enforce compliance, if judged by its record in the pre-crash years, has yet to be tested.

Apart from the EU, a more direct backup could be provided by the European Central Bank’s OMT (outright monetary transactions) programme. Under OMT (which has not yet been activated), the ECB will intervene in secondary sovereign bond markets as required. However, the sovereign in question would need to have “strict and effective conditionality” either under a full bailout or a “precautionary” programme designed and monitored by the European Stability Mechanism and expected to also involve the IMF.

The ESM itself has two precautionary arrangements on offer. Version 1 (called the precautionary conditioned credit line – PCCL) seems fairly strict as regards conditionality (including a sustainable debt, a track record of access to capital markets, and absence of risks to euro area banking system stability). This arrangement could last for up to two years. Version 2 (the enhanced conditions credit line – ECCL) is essentially a weaker version of the PCCL but would still be sufficient to qualify for access to the ECB’s OMT operation.

To add further to the alphabet soup of options, the IMF also has two possibilities. The first, the flexible credit line (FCL), is intended for very strong performers who might be hit by exogenous systemic shocks. Three countries (Poland, Colombia and Mexico) have already pre-qualified for FCL but have not accessed it. More suitable for Ireland might be the second version, the precautionary and liquidity line (PLL) which can last for up to two years and is intended for countries with a good track record of implementing sound policies but which remain vulnerable.

Irrespective of the approach taken, any of the above precautionary arrangements imply some degree of external monitoring of Ireland’s performance beyond 2013. One objection to such monitoring might be that the markets might react negatively to the perception that Ireland was still not entirely ready to stand on its own two feet . However, this is unlikely since lenders tend to appreciate some degree of official backup which lessens the risk they themselves could face.

A second objection might be more political: compared to a 100 per cent “clean exit”, the whiff of continued visits by, for example, Ajai Chopra and his merry men might be seen to take the shine off the success in “restoring Ireland’s economic and financial sovereignty”. To my mind this objection is misplaced. On the contrary, precautionary measures can be seen as a tribute to, and not a sign of, weakness in the achievements to date. Besides, the idea of regaining full economic and financial sovereignty in today’s interdependent and globalised world is somewhat illusory.

It is likely that Christine Lagarde, who is known to be especially proficient in such matters, has made a strong case to Irish officials for some type of continued backup or precautionary arrangement. It is to be hoped that our leaders will respond positively to such advice.

* Donal Donovan, a staff member of the IMF from 1978-2005 before retiring as a deputy director, is a member of the Irish Fiscal Advisory Council

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