EU-IMF open to proposals they consider realistic

 

ANALYSIS:Despite the election rhetoric, the major elements of Ireland’s bailout are fixed

WHILE IT is early days yet, the interim report issued yesterday by the IMF indicates that the programme under the Memorandum of Understanding (MoU) has got off to a good start, with all targets having been met so far. Looking ahead, the publication of the economic parts of the various election programmes has delineated more clearly the key differences among the four major parties. While earlier talk of tearing up an obscene agreement has been softened somewhat, renegotiation of various aspects of the MoU has become the mantra on everyone’s lips.

But how far do these proposals depart from the MoU and what scope exists for modifications?

Leaving aside for now the troubling question of how to interpret Brian Lenihan’s decision, announced yesterday evening, to postpone further bank recapitalisation (agreed with the IMF and ECB and due to take place before the end of February), the IMF is unlikely to be perturbed by the more rhetorical references on the hustings to sending 10 good men (or women) to batter down the walls of Brussels and sort matters out. The IMF takes a phlegmatic approach to things said during election campaigns. What matters to it is not what politicians say now, but rather what turns out to be feasible and realistic.

Even without a change in government, it is normal that all elements of an MoU be reviewed regularly and adjustments agreed in light of changing circumstances and shifting priorities. It is critical, however, that the overall thrust of the programme, as well as, broadly speaking, its main sub-elements, be retained. The IMF would prefer to call this standard process “review and (possible) modification” rather than “renegotiation” – but that is largely semantics.

THE OVERALL BUDGETARY TARGET

Labour has said that it will seek to extend the deadline for reaching the EU Stability and Growth deficit target of 3 per cent of GDP by an additional year, to 2016. It therefore proposes an accompanying reduction in the size of the fiscal measures to be taken between 2012 and 2015. The position of Fine Gael is not entirely clear at this stage – it has referred to a different concept, namely, achieving a balance in day-to-day spending by 2016. An important implication (at least of the Labour plan) is that the debt ratio would end up even higher than forecast currently, due to the extra financing needed under this stretching-out approach.

Although the magnitudes involved in this proposal do not appear that enormous in the greater scheme of things, one doubts that the EU-IMF would be willing to go along with it, especially when the ink is only a few months dry on the current agreement. The target date for achieving the fiscal target, which was originally set at 2013 by the Government some months ago, has already been pushed back several times.

So as not to undermine credibility in the Government’s commitment, a possible outcome might be some understanding that the feasibility of the MoU’s timeframe could be subject to reassessment at some point down the road after a good early track record has been established.

In parallel, a question mark could be put against the exact size of the budgetary adjustment required in 2012 – again, this would be discussed towards the end of this year.

EXPENDITURE CUTS VERSUS TAX INCREASES

Compared to the MoU/Fianna Fáil position of a 2:1 bias in favour of expenditure cuts, Fine Gael wants to shift the balance further, to about 2.5:1. Labour wants to go in the opposite direction, aiming at a 1:1 division between expenditure reductions and tax increases.

The IMF is rather unlikely to adopt a hard-and-fast position on the exact mix of fiscal policies. Reflecting a slightly right-of-centre ideology, and in common with the views of many economists, it might prefer greater attention to the expenditure side.

From its viewpoint, however, what matters most is that whatever alternative taxation proposals or cuts are suggested, they are realistic and feasible. Simply referring to savings to be got via efficiency improvements and reducing waste, fraud and abuse would not be credible. This issue would be relevant when considering the sensitive issue of further cuts in the public sector payroll. It could also arise quite soon. All parties seem to have shied away from discussing the MoU’s call for a review (interpreted by many to mean consideration of further reductions in staff and/or pay) should the efficiency savings envisaged under the Croke Park agreement not materialise by the end of July.

On the taxation side, Labour proposes to raise the income tax burden. While probably not exactly welcomed with open arms by the IMF (for the same disincentive reasons as raised by Fine Gael) such a proposal is unlikely to be vetoed, provided the numbers add up. On the other hand, Sinn Féin’s plan for a wealth tax would be given short shrift.

All three parties support the Government position of no change in the corporate tax rate regime which, in any event, is not mentioned in the current MoU.

STRUCTURAL POLICIES AND THE MINIMUM WAGE ISSUE

What has to be kept in mind is the need to preserve a key objective of the MoU, namely, to improve overall competitiveness. The MoU addresses several sub areas, including labour market flexibility and competition policy. It is not atypical that progress on such a fairly wide front proceeds somewhat unevenly. However, failure to deliver on any one single measure rarely becomes, in itself, a deal breaker, especially if other parts of the programme, in this case fiscal adjustment and banking restructuring, remain on track.

The proposal by all three Opposition parties to reverse the fall in the minimum wage needs to be considered in that light. Progress on other aspects of labour market flexibility (namely, modifications of sectoral wage agreements) could turn out to have been sufficiently strong that some readjustment in the minimum wage is not considered a fatal blow. Another alternative is to find room for additional expenditures favouring lower income groups such as those on the minimum wage. It might also be that, post election, Fine Gael does not end up according quite the same priority to the minimum wage issue.

BANKING SECTOR

Leaving aside the issue of bank debt and the matter of the postponed recapitalisation, none of the Opposition parties has raised major issues with respect to the banking restructuring proposals outlined in the MoU. A technical visit by the IMF this week to review progress in this area should not in itself raise any alarms – one will have to get used to the kind of close monitoring that is part of the deal. Suggested schemes to encourage more bank lending would not necessarily be discouraged, provided they were sound and sensible and could be accommodated within overall budgetary constraints. The Labour proposal to create a State investment bank (which has appeared regularly in previous party manifestos) might encounter some scepticism, given the generally less than successful experiences with similar institutions in other countries.

BURNING THE BONDHOLDERS

A major element in all parties’ programmes is the call to renegotiate the debt owed to bondholders. Implicit in the tone of the Fine Gael and Labour (and even more so Sinn Féin) positions is the idea that the MoU can be adjusted so as to achieve this objective.

There are two aspects to this. First, as Fianna Fáil has rightly argued, because Ireland is in a currency union, the matter could only be addressed jointly with our euro partners. Those suggesting that this be approached with some caution have been inaccurately and unfairly portrayed as wanting simply to protect the interests of “greedy banks”. In fact, restructuring has quite often been a component of the resolution of debt problems in the past with the full involvement of the IMF (Mexico in the early 1980s is a good example).

The problem is much more a pragmatic rather than a moral one – to try to determine whether and when a solution can be identified, within a euro-zone-wide context, that strengthens the stability of the overall financial system and encourages associated existing and future flows of credit. The latter matters crucially for countries like Ireland and Greece who will be contemplating a return to the market at some stage. Various possible approaches are being explored currently. Rather than seeing this as primarily a matter of negotiation between Ireland and the EU, the most effective role for the new Irish government would be to contribute constructively to the debate on how to meet these common objectives.

Sinn Féin’s approach, however, is different in that it advocates a unilateral default, à la Argentina or Russia. However, these countries were not members of a currency union. After having been shut out of international financial markets following the default, they could – and did – print their own money to finance any emerging budget deficit. It can certainly be argued that a logical consequence of the Sinn Féin position is abandonment of the co-operative approach and even of the euro itself.

A second aspect (not touched upon by any of the parties) concerns how much could the budgetary savings from a bond restructuring operation actually turn out to be. Both the Central Bank and the European Central Bank have provided massive financing to Irish banks and some of this funding was lent to enable banks to repay not only deposits but maturing bonds. Thus some of the bond holders may have escaped a possible restructuring net.

RENEGOTIATING THE INTEREST RATE

Achieving a better deal on the interest rate on the EU-ECB part of the loan is high on the agenda of all the parties. This will depend less on the degree of Irish insistence and more on broader euro zone decisions. In the case of the IMF, however, the rate is not “negotiated” – it is the same for all countries.

Although much rhetoric is being expended on this issue, the amounts potentially involved should be kept in perspective. A one percentage point reduction in the interest rate on the €45 billion loan would imply annual budgetary savings averaging about €250 million during 2011-2013, with the savings doubling thereafter so long as the loan is outstanding. This amount will not have a significant impact compared to the budgetary gap of about €19 billion.

Some policy elements of the Fine Gael and Labour programmes, taken separately, might touch, but probably not go too far beyond, the margins of what could be eventually agreed as part of the regular revisions of the MoU. This would be even more the case for a joint programme for government involving some compromises.

However, the major elements of the MoU are fixed because of underlying economic realities. As regards the financial terms (including the question of debt restructuring), the new government, irrespective of its precise composition, will do its best, but what transpires eventually may be largely out of its hands.

Assuming they have done their homework and are aware of these realities, it is difficult to escape the impression that the Opposition political parties have decided deliberately to talk up the gains from our adopting a tougher negotiating position.

But such is the normal stuff of political campaigns everywhere. It will not come as any surprise to the IMF or the EU nor faze them unduly.


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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