What happens if we use the lifeline?

DAN O'BRIENlooks at some of the issues that might arise if Ireland can no longer raise funds on the international bond markets

Will Ireland seek and be granted a bailout?

Although it is possible that the cost of borrowing will fall sufficiently in the new year to allow the Government to borrow, it is increasingly difficult to see this happening.

Investors have all but lost faith in the Irish Government’s capacity to repay all its debts, as current conditions in the bond market show. In the first half of 2008 bond investors began to seek a premium for holding Irish Government debt. Since then this premium, which is measured by the “spread” between Irish Government bonds and the least risky equivalent bonds (those of Germany), has been widening in fits and starts. The past two weeks saw the premium ballooning to the point where Irish Government debt is judged to be as risky as Greece’s at the time of its bailout.

What does this mean in practice right now?

If the National Treasury Management Agency (NTMA), the entity which borrows money for the Government, attempted to auction off new bonds, it would be unlikely to find takers. If it did manage to find buyers, the interest rate they would seek would be exorbitant.

Would a bailout lead to the ending of the Government’s guarantee of personal bank deposits?

No. The purpose of any bailout would be to maintain as much stability as possible so that disruption to economic activity is minimised. A functioning banking system is essential to that process, so maintaining a guarantee on deposits would be necessary in any context.

Who would Ireland go to if the Government came to the point of believing that a bailout was unavoidable?

Extensive discussions would take place bilaterally with other European governments and in the context of the euro group of finance ministers (their next meeting takes place in Brussels on Tuesday).

The European Commission, the European Central Bank and the International Monetary Fund (IMF) would also be involved.

Collective agreement would be needed as to when and on what terms Ireland would be lent money from the €750 billion EU-IMF envelope created in May 2010. This would be laid down in a document known as a Memorandum of Understanding.

Where would the money come from?

The lion’s share would be made available from the new European Financial Stability Fund (EFSF). It was established in early May of this year and become operational in August. It is based in Luxembourg and run by German national and former Commission and IMF official Klaus Regling, who wrote one of the reports on the Irish banking crisis commissioned by the Government earlier this year. Its closest institutional link is to the German Debt Management Office, that country’s equivalent of the NTMA, which would carry out the market operations needed to issue EFSF bonds.

Rates on these bonds would be similar to those of Germany because EFSF has obtained the best possible rating from all three of the major credit rating agencies.

The next largest contributor would be the IMF, which has committed €250 billion to the overall package of €750 billion. The European Commission would be the smallest contributor, having earmarked €60 billion to the wider fund.

Could Ireland bypass its euro area partners and go directly to the IMF?

In theory, any member of the IMF can apply for assistance. In practice, however, there is no prospect of this happening. As a member of the euro zone and a party to the agreement establishing the EU-IMF bailout mechanism, this is the route Ireland will go should it require assistance.

Besides, it is very unlikely that the terms of an IMF bailout would be better than an EU-IMF arrangement.

What rate of interest would Ireland have to pay for the bailout cash?

There is no certainty about this. Typically, when the IMF is involved, it sets a rate that is affordable for the country concerned but not one that could be considered as attractive in any way. Olli Rehn said in Dublin this week that an IMF pricing mechanism would be used in the event of any country tapping the fund. In any event, the interest rate would be lower than current market rates.

What conditions would be imposed in return for a bailout?

Nobody knows for sure, but additional pain would be all but assured. The EFSF describes the terms as coming under “very strict policy conditions”.

Governor of the Central Bank Patrick Honohan said on Wednesday that any bailout would require the Government to proceed broadly as it currently plans. This is probably true of the magnitude of the adjustment, but its composition is likely to be different, with deeper structural changes on the expenditure side in particular.

Would an increase in the corporation tax rate be a condition of any bailout?

Very unlikely. All those involved in a bailout are doing so out of enlightened self-interest – not helping a failing euro area country would result in multiple negative consequences for the euro area as a whole and international financial stability. Their main interest is to put bailed out countries back in a position where they can sustain themselves independently.

In Ireland’s case, anything that undermines the foreign-owned sector, which is the most dynamic in the Irish economy, would lessen the chances of recovery. Moreover, neither the commission nor the IMF in its reports on the Irish economy has ever advised Ireland to raise its corporation tax rate. Finally, the terms of any bailout must be agreed unanimously by all 16 euro area countries.

Is Ireland different from Greece?

Yes, in a number of respects. First, the Greek bailout predates the establishment of the EFSF and was funded directly by the other member states (including Ireland) and the IMF. Second, Greece went into the crisis with a very large public debt and much of this debt was short term.

Together, these facts meant that it was constantly raising money on the bond market to repay maturing debt (called “rolling over”) as well as raising money to finance its deficits. In effect, it was living hand to mouth and when the markets stopped lending to the country it was forced to seek assistance immediately.

Ireland still has a breathing space because the NTMA pre-borrowed in the past and has a cash buffer that will cover the difference between Government revenues and expenditure until the middle of next year.

In addition, the NTMA has no significant rolling over to do until November 2011, when €4 billion in bonds mature and will have to be repaid.

Third, Ireland also has the National Pensions Reserve Fund which could be tapped. Indeed, this might well be a condition of any bailout – other countries may not be supportive while Ireland maintains a sovereign wealth fund.

In the event of a bailout, would it make sense to default on bank bonds?

The calculus for Ireland of burning bank bondholders would change in the event of a bailout. The main reason for not burning them now is because the same people may then stop lending to the Government. If a bailout is resorted to, there will be no short-term need to borrow from them.

However, other European countries would be likely to resist this as it would affect their financial institutions. The EFSF also says that its loans could be used to support banks.