Suffering contagion from bungled Cypriot rescue

'Ireland's vulnerability to wider euro-area stresses has been reaffirmed by euro area policymakers' handling of the Cyprus crisis." Thus did Moody's decide last week that it should leave in place the negative outlook it has for the Irish economy.

The decision was a blow for the Government which had hoped that Moody’s, the outlier in terms of its rating of sovereign debt, would be persuaded of the health of the economy by the State’s successful recent 10-year bond issue.

It had been the first such sale since Ireland entered the bailout and strong demand saw the NTMA raise €5 billion in debt, close to twice what the market had originally expected. At the time, it had been projected to have a significant impact on the State's credit rating. But that was before the Cyprus fiasco.

The damage done to the credibility of the euro zone – and the position of states, like Ireland, trying to emerge from bailout – was clear from the Moody’s statement.

It cited the “increased risk tolerance” of policymakers in addressing the financial crisis across Europe that was evident in their approach to Cyprus. The rating agency added that the “more uncompromising and less predictable approach to crisis management” meant assessing risk was a more uncertain business.

Thus, despite praising the State’s successful implementation of the bailout programme, its “steady progress in gradually regaining market access at an affordable cost of financing” – citing indeed the “well-received” 10-year bond issue – and expressing an expectation that the economy would grow at a moderate pace in the coming years, the agency felt unable to elevate the rating on our sovereign debt above junk, or the outlook from negative.

Ireland is not alone in suffering from the drip-feed of negative news and inept policy making and implementation across the bloc. Data compiled by the IMF shows that emerging economies are adopting a more cautious approach to the euro, cutting their holding of it by 8 per cent last year.

The Financial Times reports this morning that €45 billion of the currency was sold last year by developing countries. The euro now accounts for just 24 per cent of the reserves of those nations, down from 31 per cent in 2009 and the lowest since 2002 when the currency first came into physical use. By comparison, the dollar accounted for about 60 per cent of developing country reserves over the period.

Risky business
However, the tone of the Moody's statement points to a particular concern over the approach to addressing Cyprus's parlous position. After years of adherence to the primacy of keeping the euro zone bloc whole – even through the worst of the Greek backsliding on its commitments – the EU came perilously close to seeing all that work undone.

For that both sides share the blame. Without doubt, the Cypriot government engaged in reckless brinkmanship. Torn between its obligations as a member of the euro zone and its reliance on deposits of sometimes questionable provenance for the continued health of its financial services sector, it effectively placed itself on the edge of the precipice.

But the European Union cannot escape its share. Cyprus first sought assistance last June . There was plenty of time for the EU – building on the template developed in previous bailout programmes – to put together a package that would address both its concerns about Cypriot banks and that country’s need for financial assistance. Allowing sufficient wriggle room for the Cypriots to undermine the security of bank deposits all across Europe was an extraordinary lapse.

And the crisis is far from over. Spain waits in the wings – too big to be allowed to fail and too big even to bully, as was ultimately done in Nicosia. Italy struggles to form any government following the recent general election – with the only certainty from that poll being the increasing dissatisfaction of the electorate with austerity measures that have not yet begun to bite as deep as they need to.

And the contagion is spreading, with Slovenia the latest to be mentioned as moving closer to seeking its own bailout.

Ireland may be moving closer to the conclusion of its bailout programme but real recovery is possible only when the EU starts moving in one direction. Depressingly, as we enter April, that seems increasingly unlikely to happen this side of the German election in September.