Irish economy is now at its most vulnerable
Ireland’s debt/GDP ratio has now reached levels that give serious cause for concern – and it will continue to rise over the short to medium term, writes RAY KINSELLA
IN THE absence of transformational economic and social policy changes, a sovereign debt crisis is now all but inevitable. Whether such a crisis would ignite, or be part of, a more generalised crisis in the euro zone is not yet clear.
The cost of borrowing by Ireland on the international markets is now the highest for any of the peripheral countries other than Greece – we are paying a premium of about 3.5 per cent over the rate for comparable German bonds despite both countries being members of a monetary union. The “risk premium” demanded by international investors has, since 2008, remained at consistently elevated levels.
This is despite of four unprecedented deflationary budgets over the past three years intended to impress financial markets. It is notwithstanding open-ended support for the Irish banking sector both from the European Central Bank (proportionately more for any of the other financially stressed countries) and also from the Government in the form of open-ended recapitalisations of the banks and the removal of tens of billions of euro in toxic loans from their balance sheets.
Meanwhile, the Irish economy continues to contract. The extent of the contraction has been greater than for any other OECD country. The contraction has been greatest in the enterprise sector, which supports the whole edifice of our health, education and social services.
The existing and prospective growth rate of an economy is, together with interest rates, central to its capacity to service its debt burden. Current forecasts project growth in gross domestic product (GDP) in excess of 3 per cent for 2011, as well as an average annual growth of 4 per cent from 2011 to 2014. These forecasts are hardly credible given the external environment.
If the Government’s technical assumptions for growth between 2011 and 2014 are over-optimistic, it follows that current policies and strategies based on such assumptions are equally obsolete.
The rise in unemployment is now headed for the benchmark level of 15 per cent.
Even more disturbing is the increase in long-term and youth unemployment. A growing number of people have not worked for over a year.
They will soon be joined by the casualties of this year’s Leaving Cert blood-letting, with thousands of students being effectively “shut out” of higher education.
Ireland’s debt/GDP ratio has now reached levels that give serious cause for concern. This ratio will continue to rise over the short to medium term because of:
- The burden of interest payments on an escalating stock of national debt;
- Increased borrowing arising from unemployment-related social transfers;
- The downgrading of Irish sovereign debt by rating agencies over the last year; and
- The inevitable rise in international interest rates from present wholly exceptional levels.
It would be challenging enough for an economy in the whole of its health to fund a current deficit equivalent to over 14 per cent of GDP (the out-turn for 2009, including the transfers to Anglo). Given the present state of the economy, it is hardly feasible for much longer – not even where Ireland is back-stopped by the European Central Bank and by Germany.
All of the guarantees in the world cannot protect a country from the consequences of an adjustment strategy that imposes too many cuts on productive investment in too short a time-frame, and with too little emphasis on rebuilding the economy.
Only the impressive debt-management capability of the National Treasury Management Agency has got us this far.
Yet – extraordinarily – budgetary policy continues to be based on reducing the deficit to 3 per cent of GDP by 2014.
An international recovery will not come to our rescue before 2014 – and even if it did, the impact of unemployment would be muted.
In May a European Council meeting to sign off on a €100 billion rescue package for Greece threatened to spiral out of control. The markets were thoroughly spooked, and there was a very real prospect of sovereign debt contagion spreading across, and beyond, Europe.
During a frenetic weekend, the council established a European Financial Stabilisation Mechanism, supported by a three-quarters of a trillion euro set of measures, aimed at “getting ahead” of the markets. It hasn’t allayed market uncertainties. It has not reduced Ireland’s funding costs even though we were one of the prospective beneficiaries.
An initiative on this scale cannot be attempted a second time. It is foolish to believe that central banks and policymakers can continue to pull rabbits out of a hat. At some point, markets will cease to believe.
A possible second EU sovereign debt crisis also needs to be seen in the context of the current “bond bubble”. Yields on government bonds – including those of Germany – have been driven so low that they do not truly reflect the market, or credit or political risks. In such an environment, a sovereign debt crisis would have unpredictable but almost certainly catastrophic consequences.
The Irish economy is now more vulnerable than at any time since the crisis began. The process of rebuilding the economy has not even begun, while the public finances have not being stabilised, and neither is there any end in sight to the costs being generated by the banking crisis.
The mythologies and the revisionism that have been nurtured in Ireland in recent times are now being deconstructed by events.
The budgetary decisions and fiscal strategy have not been “courageous”; they have been wrong, and the case for believing this has been argued in these pages.
Equally, there were alternatives, and these too have been spelled out, including, it should be said, the critique by Tasc and others.
What does it take?
Bernard Lonergan said: “A civilisation (for which read country) in decline digs its own grave with relentless insistence. It cannot be argued out of its destructive way.”
That’s about right.
Prof Ray Kinsella is author of Rebuilding Trust in Banking: Regulation, Corporate Governance and Ethics in Banking