The debt deal dilemma

The Government’s renegotiation of the promissory notes, with the European Central Bank (ECB) agreeing to restructure €28 billion…

The Government’s renegotiation of the promissory notes, with the European Central Bank (ECB) agreeing to restructure €28 billion of bank debt, presents it with a new dilemma. How best to use the savings made: whether by easing up on budget cuts and trying to boost growth and employment, or by maintaining tight fiscal discipline.

Under the terms of the programme with the troika of international lenders (the IMF, ECB and European Commission) the Government has agreed to cut the budget deficit by €5.1 billion in the two years to 2015. The new debt deal, however, means the Government will, most likely, have to borrow €1 billion less than anticipated by 2015. But should these savings be used to ease the impact of austerity? Or should the Government use this windfall to reduce Ireland’s very high debt – a debt to GDP ratio of 120 per cent?

After six years of austerity measures, which amount to €28.5 billion in tax rises and spending cuts, a case for some fiscal easing can be made. The public have paid a heavy price since 2008 with lower living standards, reduced social benefits and higher unemployment. All of which they have accepted with stoic resolution. The gains from these sacrifices have mainly materialised in the form of lower borrowing costs. Yields on Irish sovereign bonds have contracted sharply since mid-2011, reflecting increased international confidence in Ireland’s economic recovery. However, that gain, although vital, has yet to produce clear and tangible rewards for an austerity-fatigued public. In time, perhaps, it will, but only if Ireland manages a successful exit from the bailout programme, hopefully later this year.

For the Government, the windfall savings achieved by the debt deal now require it to communicate clearly with different audiences. Yes, it can offer the public some modest hope that the burden of fiscal adjustment may be eased – albeit slightly. And it can also offer reassurance to Ireland’s lenders that any such adjustments will not affect its commitment to a 3 per cent deficit target by 2015.

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But before it can do either, it first needs to clarify its own thinking on the subject. The Government now needs to lower rather than raise public expectations about what measure of relief may be expected in next year’s budget. It must decide that in principle now. For it cannot allow Ministers to speculate publicly about the issue until budget day, thereby risking division between the Coalition partners and confusion among the public; all of which could spark an adverse reaction in international bond markets. That, in turn, would jeopardise a successful exit by the State from the bailout programme, damage international confidence and weaken the prospects of economic recovery.