What might a second Irish bailout deal look like?

 

ANALYSIS:THE PASSAGE of the referendum on the fiscal treaty owed much to the argument that Ireland might need to use the new European bailout fund, the European Stability Mechanism, sometime late next year. How likely is it that Ireland will need a second bailout? And if, despite the Government’s best efforts, this cannot be avoided, is it a wholly bad outcome?

The prospects for Ireland being able to access sufficient market funding by late 2013 do not appear favourable. The lending environment for sovereigns in much of the euro zone has worsened steadily and, barring miracles in Greece and Spain, is unlikely to improve sharply soon. Notwithstanding Ireland’s Yes vote and continued adherence to the troika programme, we can’t avoid being affected by the general market nervousness. Ireland’s budget deficit, at 8-9 per cent of gross domestic product, remains the highest among debt-distressed euro zone members.

Even under favourable assumptions, without specific debt-alleviation measures, the debt to GDP ratio will be over 100 per cent – second only to Greece – for some time.

Despite encouraging words from European Central Bank president Mario Draghi, it is hard to be confident that the estimated €40 billion needed to cover the budget deficit and repay maturing debt obligations in 2014-2015 can be obtained at affordable market terms.

Of course, euro zone developments could take a decisive turn for the better and the Government is right to stick publicly to its timetable for a return to the markets. But if this turns out to be infeasible, what might a Plan B look like?

A second bailout could be for a period of one to two years, probably covering agreement on the 2015 budget deficit which is supposed to be reduced to 3 per cent of GDP. While the arrangement could be precautionary (ie funds only drawn upon should market funding fail to materialise), the economic targets and associated commitments would still be specified in a memorandum of understanding.

A package might comprise two broad elements. First, to the extent that important measures such as property charges and water charges had not yet been fully implemented, the programme would seek to nail these down. Very possibly, with the Croke Park agreement expiring at the end of 2013, further cuts in the public sector payroll may be needed to achieve the ambitious 3 per cent deficit target. The continuing deleveraging of the banks and their possible need for further capital requirements would also feature.

The Government might face difficulties in retaining sufficient public support for continued austerity measures along the above lines. However, there may be a silver lining. The second component of the deal could very well include direct action to reduce the debt burden to a sustainable level. Otherwise, the International Monetary Fund, in particular, might be unwilling to sign on.

The IMF has shown itself up to now to be more sympathetic to Ireland’s debt predicament, if only because its own policies prohibit it from lending money into an unsustainable debt situation. Early on in the euro debt crisis the IMF tended to defer to European objections that radical debt alleviation measures had to be ruled out. However, last year before continuing with the Greek bailout, despite strong European opposition (especially from the ECB), the IMF insisted on a major reduction in Greece’s debt owed to the private sector. Similar considerations could well come into play here. The IMF would want to see a forward-looking debt trajectory which will ensure a return to the markets and a definitive exit from any future dependence on official funding.

There are two broad approaches to address the Irish debt problem.

The first was to use the ESM to refinance directly the recapitalisation already injected into some banks without requiring an Irish government guarantee. Unfortunately for Ireland this route has been ruled out for the moment since, due to unyielding German opposition, the agreement with Spain last weekend requires that the bailout funds for their banks be channelled through the government. However, this will only work if the extra debt burden to be assumed does not make Spain’s sovereign debt unsustainable. If markets have doubts on this score, the issue might have to be reopened, thereby creating opportunities for Ireland.

The second more direct approach is to continue to try to obtain longer-term funding from the ECB for the Anglo promissory note. Based on last March’s experience with the first payment due under the note, it seems clear that a change in the ECB’s position will only come about if there is sufficient political support from the major shareholders, especially Germany.

Some may have been disheartened by the cool reception to the Taoiseach’s recent overtures to Angela Merkel on this matter following the referendum result. However, the response of the spokesman for German finance minister Wolfgang Schäuble in dismissing the suggestion of a new initiative used the phrase “for the moment”.

Such words are carefully chosen. Right now European leaders have much bigger fish to fry with the threat of a systemic crisis brought about by Greece and/or Spain. Although the message to Ireland at this point might be not to disrupt the bigger agenda, it does not preclude the issue being brought back to the table. In any event, a sustained and carefully executed diplomatic campaign will be required if the Government is to win out.

If it turns out that another bailout is necessary this should not be seen as an admission of defeat by the Government, especially since the determining factors to a large extent are beyond Ireland’s control.

It could also offer opportunities. Unfortunately, with or without another agreement with the troika, some further austerity will be required if Ireland is to achieve a sustainable debt position. But equally, alleviating the debt burden – the part missing from the current deal – may also prove essential. These two elements are the key ingredients for restoring Ireland’s creditworthiness in a lasting way. A second bailout could help to bring this about.

Donal Donovan was an IMF staff member (1977-2005), retiring as a deputy director. He is adjunct professor at UL and visiting lecturer at TCD. He is co-author with Antoin Murphy of a forthcoming book The Fall of the Celtic Tiger (OUP)

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