Critical phase as Ireland prepares to exit bailout

Enda Kenny’s confirmation that Ireland will exit its bailout on December 15th made headlines around the world this weekend, as international media seized on the prospect of Ireland becoming the first euro zone country to exit a bailout programme.

In reality, Ireland’s strict adherence to the tough terms of its bailout and a fall in Irish bond yields has meant there has been little doubt over the country’s ability to graduate from its programme without the need for a second bailout.

What is at issue now is whether Ireland will be able to make the tricky transition from a financial assistance programme to full private market funding entirely unaided. Having depended on quarterly instalments from the troika over the last three years to fund itself, Ireland will now venture back to the markets, issuing bonds to investors in the primary debt markets.

Precautionary programmes are part and parcel of IMF bailout programmes, but as Minister for Finance Michael Noonan pointed out on Saturday, Ireland differs from other countries in that it has built up a cash pile of €25 billion.

The NTMA has been gradually raising money in the markets since June 2012, a process that has seen a strong demand for Irish debt. Irish bond yields – which soared in the weeks before the November 2010 bailout – are now trading below 4 per cent, much lower than countries such as Italy. Significantly, Irish bond yields are also much lower than other bailout countries, a divergence which indicates that investors no longer view peripheral countries collectively, a sign that the dreaded phenomenon of contagion in the euro zone has receded.

Credit line
Nonetheless, Ireland is entering a critical phase in its passage back to full economic sovereignty, as it decides whether to apply for a precautionary credit line.

Two options are open if it opts for a support mechanism – a so-called PCCL credit line or an ECCL credit line, both of which are offered by the euro zone’s bailout fund, the ESM. The second option, which would guarantee eligibility for the ECB’s bond-buying programme, would involve more intrusive surveillance, though it is worth noting that Ireland will be subject to post-programme surveillance in any event by the troika.

Despite repeated claims from euro zone figures that it is up to Ireland to decide on a credit line, in reality a decision will be made in close discussions with the troika.

Crucial here will be the result of the stress tests, or "balance sheet assessments" currently being undertaken by the Irish Central Bank which must be submitted to Brussels and Frankfurt by the end of the month. "We need to see the outcome of the asset quality review in the coming weeks, to be 100 per cent sure about the exit mechanism", a European Commission told The Irish Times yesterday.

Irish banks
Minister for European Affairs Paschal Donohoe insisted yesterday the Irish banks were "well capitalised" and have been "well-scrutinised", but the prospect of mortgage arrears problems lurking in the books of Bank of Ireland, AIB and Permanent TSB is a worry.

ECB executive board member Jorg Asmussen said yesterday that there were still risks for Ireland as it prepared to exit its bailout, specifically regarding its banks and its deficit which is much higher than the European average.

As with all interactions between Ireland and its lenders, discussions will involve a delicate balancing act between the interests of the programme of the country and the interest of the euro zone.

Preserve the euro
How far Ireland will be able to push its own agenda is uncertain. However, Europe will be reluctant to sign off on any plan that could jeopardise the relevant calm in the markets since the ECB pledged last summer to do "whatever it takes" to preserve the euro.

Despite tentative signs of a nascent economic recovery in the euro zone, Europe’s economic situation is still extremely fragile, with concern in particular about the high debt levels and lack of fiscal reforms in countries such as Italy and France.

Next year’s European bank stress tests could destabilise things if banks are revealed to have significant capital holes. Whether the euro zone is prepared to allow Ireland to go it alone without an insurance policy will be the crucial question in the coming weeks.