Warning for Ireland over eurozone recession

Thursday 16 May 2013 23.36
The eurozone recession could be a 'central problem' for Ireland's full return to the financial markets
The eurozone recession could be a 'central problem' for Ireland's full return to the financial markets

A review of Ireland's bailout programme by an influential think tank has warned that a deepening of the eurozone recession could be a "central problem" for Ireland's full return to the financial markets.

It also warns that Ireland may need a second bailout if the return to the markets is not "robust".

The review, by the Brussels-based Bruegel think tank, concludes that as an open, flexible economy Ireland depends on growth in the European and world economies.

Furthermore, Ireland's partial success in Government bond sales so far does not mean that full access is guaranteed, the report's authors say.

"Certainly, the big fear is that the return to the markets will turn out not to be robust, requiring a programme later on," the report concludes.

Bruegel says, however, that the predictions of the effects of Ireland's bailout programme on economic recovery have largely been accurate.

However, the think tank reports that unemployment has remained higher than forecast.

In this regard, the report says, the results of the bailout programme have been "disappointing".

The authors argue that much of the Troika's input in terms of cutting spending and raising taxes in order to bring down the budget deficit had already been envisaged by the Irish authorities several months before the bailout happened.

If anything the Government's own plans in advance of the Troika's arrival were more "ambitious" in cutting the deficit.

This explains the "high degree of compliance" by the Irish authorities, as well as the sense of "ownership," the report finds.

The Troika programme "had little impact on the fiscal adjustment path, because it was already largely decided on and planned before the Troika arrived in Dublin".

Bruegel says the decision to frontload spending cuts and tax increases was "probably justified".

It adds that the fiscal adjustment was helped by the fall in wages and increase in competitiveness, and in turn the recovery in Irish exports.

The report quotes the Irish Fiscal Advisory Council's proposition that Ireland's deficit could fall to 2% in 2015, thanks to the promissory note dividend and the better than expected performance in 2012.

The Bruegel report also explores the controversy over Ireland's bank debt, and the decision not to impose losses on senior unsecured bondholders.

The authors point out that the decision to issue a State guarantee to the financial sector in September 2008 was an Irish one and not done "with outside interference".

They note that if the State had imposed losses during the lifetime of the guarantee, then it would have in effect have "defaulted".

According to the report, €19bn of senior unsecured debt (12% of GDP) could have been used to reduce bailout costs to taxpayers.

Since some of this was held by Irish banks and pension funds, imposing losses on all bondholders would have meant some cost to the national economy.

The authors noted that some observers had argued that there would have been minimal financial contagion if losses were imposed on unsecured senior bondholders associated with Anglo Irish Bank and Irish Nationwide.

In that case, the amount of unsecured debt amounted to €3.7bn.

If a haircut of around 50% had been imposed, the savings would have been around €1.9bn.

For the total banking system, a similar haircut would have imposed losses of some €9.5bn.

The authors report that the ECB was worried at the time about the effect such losses would have had on the Irish banking sector and its ability to raise funding, and "even more importantly for the euro area banking system".

"The Irish authorities could not act against the will of the ECB as they were dependent on significant ECB support in form of Emergency Liquidity Assistance (ELA)," the report finds.

The report says that, contrary to Irish public opinion, it was not clear that the owners of this debt were French and German banks.

However, the authors acknowledge that ECB board member Jörg Asmussen said in a speech in March 2012 that the bailout of Anglo was "to ensure no negative effects spilled-over to other Irish banks or to banks in other European countries".

The Bruegel review says that shareholders in the IMF had reservations about burning senior bondholders in Anglo, and, quoting forthcoming academic research, noted that the US Treasury Secretary at the time, Timothy Geithner, reportedly lobbied against imposing losses on senior bondholders.

"The US position was driven by fears of the potential negative effects of any such moves on the Credit Default Swaps (CDS) markets," the report states.

It is understood the forthcoming research quoted by the Bruegel report is by former IMF deputy director Donal Donovan and Antoin E Murphy whose book, the Fall of the Celtic Tiger, is due to be published this year.

In an article for the Irish Times in May 2011, Prof Morgan Kelly of UCD claimed that Mr Geithner had lobbied against losses being imposed on senior unsecured bondholders.

"At a conference call with the G7 finance ministers, the haircut was vetoed by US treasury secretary Timothy Geithner who, as his payment of $13 billion from government-owned AIG to Goldman Sachs showed, believes that bankers take priority over taxpayers," Prof Kelly wrote.

It is understood there has been as yet no official confirmation of this claim.