Irish bailout actions display credibility the Greeks lack

 

ANALYSIS:The failure of Athens to tackle fiscal woes is as clear to the troika as Dublin’s progress

ALTHOUGH THE size of the fiscal deficits of both Greece and Ireland are broadly similar (10-11 per cent of gross domestic product), Greece’s debt to GDP ratio is far higher. It is likely to significantly exceed 150 per cent this year, compared to just over 100 per cent for Ireland.

Moreover, Greece’s growth potential, at least in the short term, is hindered by major obstacles to domestic and foreign investment, while Ireland has a broader export base linked to a thriving multinational sector.

The key problem for Greece seems to have been an inability to take decisive and credible budgetary action, including effective spending control mechanisms.

In addition to major statistical misreporting of the fiscal gap, and despite the strong oversight presence of the EU/ECB/IMF troika for over a year now, credible measures to reduce the Greek fiscal deficit towards a sustainable level have been lacking.

By contrast, the Irish Government has takensignificant steps to reduce the expenditure/revenue gap. Admittedly, there is a long way to go. To reduce the deficit from 10.5 per cent of GDP to about 3 per cent will require further major and difficult efforts over several years.

But so far, the signals and actions from the Government, both previous and current, have been unambiguous: there is no realistic alternative. This matters enormously when it comes to outsiders’ perceptions of the credibility of the Irish commitment.

Why the difference between Greece and Ireland, given they are both facing broadly similar external financial pressures?

First, it seems the Greek economy has long-standing structural rigidities, including a culture of non-payment of taxes; exceptionally intrusive regulation in many areas of trade, commerce and the labour market; and a large, inefficient public enterprise sector that needs to be privatised.

Experience elsewhere shows that, unfortunately, dealing successfully with rigidities like these is often a long and very painful process. Reform-minded governments have to confront, in addition to formidable legal and institutional obstacles, strong opposition from a wide array of interest groups that have benefited from highly favourable arrangements that may have been in place for decades or generations.

On the other hand, Ireland’s adjustment problem, while enormous, seems more straightforward. The Irish economy is not heavily regulated, solid mechanisms to monitor and control public spending in a technical sense are in place, tax administration is rated highly by international standards and those public sector enterprises remaining are not seen as a major drag on the economy.

In the succinct words of Peter Nyberg, the author of the recent Commission of Investigation into the Banking Crisis report, the problem is more simply that for several years Ireland, in the aggregate, lived beyond its means. Nyberg observed, as a result, it has become necessary that, for some time, Ireland will be forced to adjust and live below its means.

In this context, there is a second, key difference. Unlike Greece, where major differences reportedly exist among the government party on the need for reform, Ireland has experienced a high degree of internal agreement both as to what is broadly required to address the fiscal problem and within what timeframe this has to be accomplished.

To be sure, tensions will inevitably arise within the Government as the next set of contentious budgetary measures looms in the coming months. These tensions may emerge from key issues, including the reform of the sectoral wage arrangements; the implementation of the Croke Park agreement and, possibly, the related issue of public sector pay; and the cuts that will be needed to achieve the 2012 budget target.

Nevertheless, there is no reason to suppose that broad public support for the Coalition strategy will not be maintained, especially since the Government, rightly, will be seeking to spread the burden of adjustment across some groups such as the legal and hospital consultancy sectors. These have been perceived to have escaped relatively lightly to date.

It is true that, more than in the case of the underlying budgetary imbalance issue, the separate, vexing question of how (and possibly by whom) the one-time bill associated with the banking fiasco is to be settled continues to be the subject of considerable debate.

But arguably, at least this latter bill is now known with a high degree of certainty. On the other hand, the financial risks associated with the fiscal outlook depend on the Government’s political ability to follow its stated course. Here is where credibility and political commitment really matter, especially to outside observers.

While Ireland has gradually regained some credibility and breathing space, Greece clearly has not. The recent reported indications by the IMF that they were prepared to consider withholding the next portion of the bailout funding was an explicit recognition of the Greek authorities’ failure to address their underlying fiscal woes. The IMF, under long-standing rules, cannot lend into a situation where the country will nevertheless remain unable to pay its contractual obligations. In other words, the IMF is prohibited from disbursing its funds to a country where a disorganised debt default is quite likely to occur.

The IMF’s stance could therefore be seen as seriously raising the stakes. It amounted essentially to saying that if the Greek government does not take sufficiently strong and credible fiscal measures – which it has not to date but is likely to be forced to under the new arrangements signed off on yesterday in Luxembourg – the IMF will not continue its funding and the EU may not give money to fill the gap.

Although not stated openly, in principle these alternatives could be accompanied – were the benefits seen to outweigh the costs – by another element: an organised rescheduling of Greece’s debt. In this case, the potential disorganised debt “default” could be transformed into an agreed restructuring arrangement and the IMF, provided the financing arithmetic added up, could be in a position to continue its funding.

The costs of a recourse to sovereign debt restructuring are high, not only for Greece but for the euro area as a whole. Moreover, there is an understandable reluctance on the part of the international community to be seen as “rewarding” via a rescheduling a country that professes an unwillingness and/or inability to take the painful measures necessary.

Where would this leave the valiant efforts of others such as Ireland to resolutely tackle their problems? While a debt restructuring might end up as part of the solution, fundamentally the problem can only be solved by the Greeks dealing successfully with their own internal financial disequilibriums. If they fail to do so, sooner or later, under a worst-case scenario, the threatening spectre of Greece leaving the euro zone cannot be excluded.

Such an outcome would have enormous consequences for Greece and presumably, many in Greece realise this. But, at the end of the day, for one’s membership of a common currency area to remain viable, a credible commitment to adhere to the broad fiscal rules of the union is essential. And talk of a possible restructuring of Greek debt will not alter that basic reality.

So is Ireland is the same boat as Greece? The Irish situation and outlook is quite different.

The fiscal programme is so far on-track and is fully funded from official non-market sources until the end of next year. Moreover, some margin of manoeuvrability has been gained as there is likely to be at least €10 billion in savings relative to the amount provided for under the bailout package to recapitalise the banks.

The Government has therefore decided to postpone receipt of some of the bailout funds this year in order to have a reserve available that could be drawn upon in the future.

In these circumstances, the issue of whether or not Ireland will be in a position to “return to the markets” by end of 2012 has been overblown in recent public commentary. If market conditions turn out to be not favourable at that point (perhaps partly as a fallout from some form of Greek debt restructuring), the Government would have the flexibility to delay the timing and extent of a return given the bailout funds that would still be at its disposal.

And if some, more modest, supplementary bailout funds from the EU-IMF were to be needed at some stage to ease the transition to full access to normal market funding, this would hardly be a catastrophe. Nor would a request for such funds be likely to be refused,assuming Ireland had successfully completed most, but perhaps not quite all, of the fiscal adjustment needed.

Regardless of the Greek situation, it is essential that the current approach of the Irish authorities not be thrown off course. Were, say, a Greek sovereign debt restructuring – by some voluntary or involuntary mechanism – to take place, it should not serve as a clarion call for Ireland to pursue the same route. Any such restructuring is likely to entail major reputational costs and Greece will seek to avoid it for as long as possible. Even if, under a worst case scenario, there were to be a Greek exit from the euro zone, it should not necessarily lead to a questioning of the euro zone’s viability for peripheral countries such as Ireland which can demonstrate their determination to adhere to the basic fiscal rules of membership.

It is also important, in a period of financial uncertainty, to dispel any fears and unfounded rumours that could have significant negative effects on market confidence.

The Irish authorities should, therefore, continuously and consistently emphasise to the markets and the public at large their key message: the Irish programme is on track, the Government intends to keep it on track, and the funding mechanisms and amounts are firmly in place to be able to manage any risks of collateral damage resulting from events associated with the Greek crisis.


DONAL DONOVANwas a staff member of the IMF from 1977 to 2005 before retiring as a deputy director. He is adjunct professor at the University of Limerick and a visiting lecturer at Trinity College Dublin