Bailout has steadied us for difficult road ahead

 

OPINION:On sober, measured reflection of the EU-IMF rescue programme – things could actually be a whole lot worse . . .

THE TRAUMATIC events of the last couple of months are unparalleled in the economic history of this State. Now though that we have had a chance to enjoy some respite over the holidays, it is useful to try to take stock.

What has been achieved over the last several weeks? Where are we going economically and financially over the next four years? And what might lie beyond 2014-2015 when the programme agreed with the International Monetary Fund and the European Union will have expired?

There are some positive sides to what has taken place, although admittedly, this may only seem apparent after one thinks about what could have happened instead.

In the first place, the State’s funding needs are fully taken care of for the next several years. The continual worrying about the next bond offering and the latest negative and unfair pronouncements from the rating agencies are over – at least for now.

Schools and hospitals have not been closed and the public payroll continues to be met. This might seem a trivial achievement to some, but there are more than a few cases of countries with difficulties not any greater than ours who have encountered real problems in continuing to provide basic services.

Second, we have obtained funding at interest rates that are much less than what we would have had to pay on the market – if we could have got the funds at all. Also, the rates charged are exactly the same as those for any other country borrowing in similar circumstances – no better or worse.

Of course it would have been nice if the IMF had done us a favour and given Ireland the money at a special rate, but the IMF does not owe us anything. Indeed, a key principle underlying its operations is, and always has been, equality of financial treatment. Political talk of a “rotten financial deal . . . that will have to be renegotiated” is just pure rhetoric based on ignorance of the basic facts.

Third, despite all that has happened, Ireland still has a functioning banking system. Again, this achievement, modest though it might seem, should be seen against the background of much worse outcomes elsewhere. There are quite a number of instances where runs on the banks have led to their closure.

Fourth, the euro, while fragile, has not collapsed and we can still exchange it freely in any amount. Some readers will be old enough to remember the dark days of the sterling crises of the 1960s when individuals were not permitted to take more than £5 sterling to finance an entire holiday.

The recently voiced complaints that the Irish bailout was more about saving the euro than helping us are somewhat puzzling. Are we not a fully paid-up member of the euro with as much interest as everyone else in seeing it thrive and prosper? Or would we now prefer to leave what we may think is a weak currency area to “go it alone” with a new currency of our own? One can only wonder how external lenders, in the present circumstances, might react to this idea.

Finally, the recent painful measures have not led, as sometimes happens, to major strikes, riots or worse. There has been an acceptance, albeit a grudging one, of the reality with which we are faced and a broad consensus that there is no viable alternative.

This will not, of course, prevent politicians asserting otherwise and we can expect a ramping up of the rhetoric about “tearing up” the agreement over the next few months as the election approaches.

This will not worry Ajai Chopra and his IMF colleagues – they are accustomed to seeing the fund used as a political football. They will not expend a lot of effort trying to decipher what the Opposition might be saying, but they will devote their time to scrutinising the weekly and monthly numbers sent from Dublin. As far as the IMF is concerned, it is not what people say that matters, it is what they do.

TURNING TO the numbers themselves, we are by now quite familiar with the budgetary adjustment figures of €15 billion, €6 billion etc, but how do the numbers translate to the economy more broadly? The recent IMF staff report justifying Ireland’s request for the IMF loan contains some interesting and useful analysis.

Part of the focus is on the growth outlook. The IMF is somewhat less optimistic than the Irish authorities who see better prospects for export growth and a recovery in consumption. However, these differences are relatively marginal in the greater order of things.

Growth forecasts are probably somewhat difficult for the ordinary citizen to grasp. A more useful indicator may be the ability of the average consumer to acquire goods and services, whether produced domestically or imported. This variable is known, technically, as real private consumption.

Using this measure as a yardstick, according to the IMF forecast, by 2015 total real private consumption, roughly speaking, will have fallen back to the 2006 level. This might be somewhat optimistic, of course, and it is also true that the level of investment will have fallen precipitously because of the post-crash housing slump.

Even if we return to somewhere in the earlier part of the last decade, we will still have retained the huge boost in living standards that occurred during the “good” part of the Celtic Tiger period. Under this scenario, Irish living standards would probably be somewhere in the middle of the European average, compared to being close to the top at the height of the boom.

Considering that two decades earlier we were nearer the bottom vis-a-vis our European counterparts, such an outcome would not appear too gloomy.

However, while the picture on average does not look too disastrous, this will be of little consolation to people hard hit, particularly those out of work. Here the picture is much bleaker. Both the IMF and the Irish authorities agree that the unemployment rate is likely to remain at about 10 per cent or so even by 2015.

The problem seems to be that during the boom period the labour force swelled, driven by immigration, mainly from eastern Europe, and returning Irish emigrants.

As we all know, many of the jobs they filled were in construction-related sectors and in areas benefiting from the overall boom conditions. These jobs have now dried up, while some retrenchment in the public sector payroll is also in prospect.

Part of the adjustment in the labour market has already occurred via a return of some immigrants to their home countries, but many have stayed and seem to be well embedded in the economy, particularly in the service sectors.

Given the drop in employment possibilities, the brunt of the problem is thus being borne first by older workers who face major difficulties in retraining and switching occupations and second by school and university leavers entering the labour force.

Faster-than-expected growth would, of course, help ease the problem, but the IMF is rightly cautious about hoping for too much from the foreign-owned export sector, pointing out that its operations are relatively capital intensive, which constrains the potential for major employment creation.

Consequently, indigenous export industries are likely to offer better prospects on the employment front. It is encouraging that according to the latest figures these have recently been doing well. So too has the traditional agricultural sector. The ability to boost domestic exports will depend critically on our cost competitiveness. Here the recent, and possibly further, fall in private sector wages from their unsustainable high boom levels will play a major role. The measures contained in the Government’s programme aimed at reducing other structural obstacles to competitiveness will also help.

THE REDUCTION in the minimum wage has been controversial on social grounds but in terms of employment creation it has to be considered a move in the right direction. The Irish minimum wage was among the highest in the OECD. For example, in the Washington DC area (where the IMF resides) the minimum wage is about $7.60, compared to the Irish (pre-adjustment) level of €8.65. This must surely give one pause for thought.

Although the above elements will help, it is probably inevitable that with unemployment expected to remain so high, some part of the adjustment will be reflected in net emigration. Although discussing this subject is a minefield for any politician, it is part of the economic reality we face.

One very positive aspect of the current situation is that there has been little evidence of any backlash against recent immigrants on the grounds that they are “taking jobs” from the Irish. This xenophobic phenomenon is all too common in other European countries and we deserve more credit, as an open and tolerant people, for not going down that route.

Our sense of social cohesion will also be manifested in the way we handle continued large-scale unemployment. During the last crisis period in the 1980s, apart from the benefits received from the State, transfers between family members helped many unemployed people get by. This is likely to again prove necessary.

By 2015, will the prospects be brighter? The IMF report devotes considerable analysis to what Ireland’s debt profile might look like at that stage. However, the outlook on that score, as many commentators have pointed out, is not too encouraging.

Depending on what is assumed about the extent of additional assistance the banks end up needing, the debt-to-GDP ratio is forecast to “stabilise” at between 100 and 120 per cent of GDP by 2015. Technically this means that provided the budget, after taking out interest expenditures, is in approximate balance from then on out, the debt-to-GDP ratio would not rise any further. According to the IMF, the budget, assuming the adjustments take place as planned between now and then, would be very close to this required point by 2015.

However, the forecast notes that if there were “shocks” such as much lower economic growth (perhaps due to a weaker world economy) and/or a sharp rise in interest rates, the debt ratio would be much higher, closer to 150 per cent, by 2015. Unfortunately, shocks of this sort over the next five years – or beyond – can by no means be ruled out.

What this implies is that whatever precise debt-to-GDP ratio prevails in 2015, it is not likely to be considered sustainable, as it would leave the economy much too vulnerable to unexpected adverse events. A ratio well over 100 per cent would be excessively high by international norms and not consistent with maintaining a sufficient degree of underlying fiscal stability as a member of the euro area.

ONE WAY out of the problem would be if Ireland were to experience much faster growth than projected. Following the crisis of the 1980s, the very rapid drop in the Irish debt ratio (from 120 per cent to 30 per cent) occurred partly because of very tight budgetary policies that allowed debt to be repaid. However a major factor was the exceptionally fast growth rates of more than 6 per cent on average we experienced for many years. This cannot be expected to recur, at least to anything like the same extent.

So what might end up happening? While an extra adjustment of a few points of GDP or so might well be wrung out of the budget, further major fiscal retrenchment is not likely to be on the cards. Some inflation might help to reduce the real value of the debt (not that the ECB would ever admit to thinking about this), provided that there are enough interest payments fixed in nominal terms. Of course, inflation is a tax by another name.

What may be inevitable by that stage – if not before – is that, finally, the much- vaunted “haircuts” for creditors could be in place. It is understandable that, given the short-term preoccupation with trying to stabilise the financial system within the euro area this issue has been put off for now.

The EU and the ECB are realists though and know only too well that debt ratios in excess of 100 per cent are simply not sustainable. Judging by the media reports, the IMF is even more aware of this unpalatable fact.

Assuming there is at some stage a co-ordinated initiative vis-a-vis creditors, part of the deal – as has happened elsewhere – will undoubtedly be a commitment by debtors to continue fiscal stringency and not, for example, to go out and immediately spend the savings from debt reduction. And who would monitor such a package?

The task would fall to the IMF – even if it is not contributing much by way of further financing. This would suggest that Chopra is not likely to be able to say goodbye to Dublin until quite some time after 2014.

In sum, we are not banjaxed, as some commentators would have it, but without the umbrella of the euro and the associated help from the IMF and the EU, we almost certainly would have been. The road ahead will be difficult, but it is not impossible, especially if one keeps in mind the progress we made up to the earlier years of the past decade – progress which will not be lost.

Good luck, contributions from creditors at some stage, as well as continued involvement of the IMF are all likely to form part of the eventual solution. We have dug a big hole for ourselves and it will take quite some time to get out.


Donal Donovan was a staff member of the IMF during 1977-2005 before retiring as a deputy director. He is currently adjunct professor at the University of Limerick and a visiting lecturer at Trinity College Dublin

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