Sooner or later, Irish default threat must be dealt with

BUSINESS OPINION:As the EU, IMF and ECB conduct the first review of our programme of repair, they must accept it as a two-way process

THE NEW Government has just been given a big lesson in expectation management. As the marketing types are so keen on reminding us: it’s all about under-promising and over-delivering. They didn’t.

The Government’s problem was trying to pretend it could solve over a few weeks a problem that is going to absorb most of its energies over the next five years. We are in this for the long haul and as if to underscore the point, the European Union/International Monetary Fund/European Central Bank troika arrives in town this week for the first of many quarterly reviews of the programme agreed last December.

It would be a mistake to see these meetings as the national equivalent of having our homework checked.

They are a two-way process and unless the troika wants to see its €67.5 billion wasted, it will listen to what Ireland has to say. And as Ireland’s economic growth waxes and wanes over the next couple of years, the issues brushed aside last week – such as burden sharing – may or may not re-enter the picture.

But, as of today, three months into the programme, they remain where they were when the deal was done: off the table.

The Government may suffer a similar loss of face over the other issues it now feels Europe “owes us” something on: longer-term financing for the banks from the ECB; a lower interest rate on the bailout; and some peace on the corporation tax issue.

Again the chances are that the troika does not yet see the case for tweaking the plan.

It would seem then that we must soldier on with the current plan for the time being, but we can take some comfort that when and if it does become clear it is not working, there will be help on hand.

The reason for such confidence is that by failing to act premptively to retune the plan to ensure Ireland’s viability, the troika is backing itself into a corner.

The longer the European Union, the International Monetary Fund and the European Central Bank persist with implementing the current plan once it becomes clear it is not working, the more likely it becomes they will find themselves grappling with the consequences of a potential Irish sovereign default.

It seems like an extraordinary risk to take, but not out of kilter with the “kicking the can down the road” policies that are as often as not Europe’s response to complex challenges. Indeed the European Stability Mechanism – which will allow for default – is due to be up and running by 2013, and many of the more fatalistic commentators see Ireland collapsing into its arms and defaulting at that stage.

This view assumes that Europe has given up on us and the country is effectively on a trolley in the hospital corridor until a bed becomes available in 2013. It also assumes that the troika is not aware of exactly how big a disaster that would be and how far the tentacles of the Irish problem run into the rest of the euro zone.

One suspects they do – and if they don’t, they could do worse than talk to John Whittaker of the management school at the University of Lancaster. In a recent paper on intra-euro-zone debts (www.lancs.ac.uk/staff/whittaj1/eurosystem.pdf), he points out something that should have been blindingly obvious: the Irish banks don’t really owe the ECB €146 billion, they actually owe the other national central banks (NCBs) in the euro system the money and by extension the other euro zone governments.

Not only that, the money they owe them is secured on Irish Government bonds and Irish Government-guaranteed securities.

“In the event of Irish – or Greek – sovereign default, it is not clear whether losses would fall on NCBs or on the ECB. But this is of little relevance as the NCBs are the ECB’s shareholders and the Bundesbank is both the largest shareholder and the largest euro system lender. Losses of the Bundesbank would be for the account of the German treasury,” argues Whittaker.

Looked at from this perspective, the other euro-zone governments are directly on the hook for €146 billion should Ireland default. They are also locked into this exposure as long as default looks even remotely likely as the chances of the Government-owned banks replacing their euro system lending with other funds are pretty slim under such circumstances.

Hopefully the realisation of the same might focus minds over the next few weeks.