This is an edited version of my article in today's edition of the Irish Examiner.
Two weeks into September and the crisis in our sovereign bond markets continues unabated. Ireland Government bonds are trading at above 6% mark and given the perilous state of the Irish banks, plus the path of the future public deficits, as projected by the IMF, Ireland Inc is now facing a distinct possibility of our interest bill on public debt alone reaching in excess of 6% of GDP by 2015. [Note: by now, the magic number is 6.12% as of opening of the markets today].
Sounds like a small number? Here are a couple of perspectives. At the current cost of deficit financing, our Exchequer interest bill in 2009 was 1.7% of GDP or €2.8 billion. Within 5 years the interest bill can be expected to reach over €12 billion, based on the Government own projections for growth. By this estimate, some 30% of our expected 2015 tax receipts will go to pay just the financing costs of the current policies.
It is precisely this arithmetic that prompted the Financial Times this Monday to question not only the solvency of the Irish banking sector, but the solvency of the Irish economy. The very same inescapable logic of numbers prompted me to conjecture in the early days of 2009 that our fiscal and banks consolidation policies will lead to the need for an external rescue package for Ireland.
This external rescue package is now available, fully funded and cheaper (financially-speaking) to access than the direct bond markets. It is called the European Financial Stability Fund (EFSF). More than money alone, it offers this country a chance to finally embark on real reforms needed to restore our economy to some sort of a functional order.
The EFSF was set up to provide medium term financing at a discounted rate of ca 5% per annum for countries that find themselves in a difficulty of borrowing from the international markets. With effective yields on our bonds at 6.05% and rising – we qualify.
The EFSF requires that member states availing of European cash address the structural (in other terms – long term) deficit problems that got them into trouble in the first place. In Ireland’s case this is both salient and welcomed.
It is salient because, despite what we are being told by our policymakers, our problems are structural.
Banks demands for capital from the Exchequer – a big boost to Irish deficit last year and this – are neither temporary, nor dominant causes of our deficits. In the medium term, we face continued demands for cash from the banks. By my estimates, total losses by the Irish banks are likely to add up to €52-55 billion (ex-Nama) over the next three-four years. These can be broken down to €36-39 billion that will be needed in the end for the zombie Anglo, €6bn for equally dead INBS, at least €8 billion for AIB and up to €2 billion for the ‘healthiest’ of all – Bank of Ireland. These demands will come in over the next 24 months and face an upside risk should ECB begin aggressively ramp up interest rates in 2011-2012.
No economy can withstand a contraction in its GDP on this scale. Least of all, the one still running 5-7% of GDP structural deficits over the next 4 years. In 2009, banks demands for Exchequer funds managed to lift our deficit from 11.9% to 14.6%. This year, absent banks bailouts, our deficit will still reach around 11.3%. Only 3.3% of that due to the recessionary or temporary effects. In 2011, IMF estimates our structural deficit alone to be 7% and 5.9% in 2014.
Which brings us to the point that the use of the EFSF funds should also be a welcomed opportunity for Ireland.
A drawdown on EFSF funding will automatically trigger a rigorous review of our fiscal plans through 2015 by the European and, more importantly, IMF analysts. This is long overdue, as our own authorities have time and again proven that they are unable to face the reality of our runaway train of fiscal spending.
Since 2008 in virtually every pre-Budget debate, Minister Lenihan has been promising not to levy new taxes that will threaten jobs and incomes of the ordinary people of Ireland. In every one of his budgets he did exactly the opposite. Under the EFSF, the IMF will do what this Government is unwilling to do – force us to reform our tax system to broaden the tax base, increase the share of taxes contributions by the corporate sector and start shifting the proportional burden of taxation away from ordinary families.
Minister Lenihan has repeatedly promised reforms of spending. In every budget these reforms fell short of what was needed, while the capital investment was made to bear full force of the cuts. Drawing cash from the EFSF will make Mr Lenihan scrap the sweetheart Croke Park deal and start reforming current spending. Politically unacceptable, but realistically unavoidable, deep cuts to social welfare, public sector employment and wages, quangoes, and wasteful subsidies will become a feasible reality.
Starting with December 2009, the Irish Government faced numerous calls from within and outside this state (headed by the EU Commission and the IMF) to provide clarity on its plans to achieve the Stability and Growth Pact criteria of 3% deficit to GDP ratio by 2014-2015. The Government has failed to do this. Drawing funds from the EFSF will help us bring clarity as to the size and scope of fiscal adjustment we will have to take over the next 5 years.
Lastly, the EFSF conditions will include a robust change in the way we are dealing with the banks. Gone will be the unworkable Government strategy of shoving bad loans under the rug via Nama and drip-recapitalizations. These, most likely, will be replaced by haircuts on bond holders and equity purchases by the State.
Contrary to what the Government ‘analysts’ say, drawing down EFSF funds will not shut Ireland from the bond markets. Instead, swift and robust restoration of fiscal responsibility and more a more orderly exit of the exchequer from banks liabilities are likely to provide for a significant improvement in the overall markets perception of Ireland. After all, bond investors need assurances that we will not default on our debt obligations in the future. Only a strong prospect for growth and recovery can provide such an assurance. Ministerial press releases and Nama statements are no longer enough.
7 comments:
I'm not sure whether the EU stability fund is the best option for Ireland.
Any money from the EU would come with strings attached that IMF money wouldn't, specifically, it is more likely that Ireland would be forced to honour bank bondholders (as many of these are european based) under an EU scheme, whereas an IMF team would be quicker to burn those same bondholders.
Good stuff. Here's an interesting perspective from Baseline..
http://www.project-syndicate.org/commentary/johnson12/English
Constantin,
I have big reservations and concerns in that respect in particular when it comes to the IMF and their policies, but last not least also on the implementation of what you call a robust restoration of fiscal responsibilities.
I think the latter would require a well functioning and efficiently organised DoF, ahem.... need I say more?
IMF and EU, well, what did they do in Greece? They enabled capital transfer back to german and french banks, imposed austerity measures on the greeks and now? Greece crisis 2.0 is knocking at the door, even harder.
Yes, the simple, hence so beautiful debt arithmetic is striking, and leaves no doubts at all on our situation.
I always found it somewhat bigot how we pointed the finger at greece when we learned about the Goldmann Sachs/Government fraud of hiding massive debts.
Why?
Because exactly the same is happening all over the place, and not only in Ireland. Banks were drip feeding results and losses, demanding ever so higher bailouts as a result. Hiding debts is the name of the game they all play!
Or in other words, to use the analogy of Junkies again, Yeah mom, I sober up tomorrow, just one more shot!
For the germans a weak Ireland and Greece is a good thing, the mood of the german public has no tolerance left to bail out Club Med or ireland in my understanding,
I think, the Euro lie is showing it's true face these days, and hiding of debts was only one part of this lie.
Best
Georg
The Irish government is betting that the underlying viable Irish economy can support the huge burden that is being placed upon it and also that it can continue to borrow huge amounts of money.
If this bet succeeds then all we're faced with is long years of sub-par growth and, as the FT called it, "financial oppression" of the economically valuable people and businesses in the country.
Eventually, decades from now, the debt being accumulated now might eventually be paid off. Ireland will be much poorer than it would have been, but would appear superficially intact.
If the bet fails, then the Irish economy faces total disaster as people with mobile skills leave and as viable businesses die and fail and the ability to borrow enough money fades away - leaving both a dead economy and a catastrophic situation for the funding of civil servant pensions, i.e. no money any more.
The only bail out that Ireland needs is replacement of our current gamblers with people prepared to bet that, long term, we need to have viable business to reward hard-working people, and even to allow hard work to result in savings rather than confiscatory taxation. This means no marginal tax increases, means sharp cuts in spending, including ALL areas, and ideally means doing it in one hard and sharp move.
This would requires letting the recent economic damage fall on specific groups rather than attempting to spread it onto everyone. The groups would probably include mortgage holders (who are likely to be squeezed for every penny they borrowed on houses which should be let fall further in price), civil servants (whose index linked pensions and high salaries have to go), Judges (ditto), quangos (ditto), creditors and even depositors of Irish banks (oopsie), etc. Doing this would result in financial misery for many people. That's highly unfortunate, particularly if the govt does the usual and cuts things like benefits for truly unfortunate categories like the old and sick rather than cutting pay for civil servants and judges.
However, it might allow a clean future for many parts of the economy and for many people like graduates, children, etc..
So, there seem to be three likely scenarios.
One is that the government plans hurt everyone in the country a lot, and actually much more than an even share of the already existing damage, since there'll be interest on top. That's their current best case.
The second is that everyone in the country ends up entirely broke. That's what'll happen if the current bet fails and the economic curves go bad.
The alternate is to recognize that a lot of people have already been made poor by the boom and bust, and to let that sword fall. This MIGHT allow the rest of the population to rebuild something useful. Might.
It's what the IMF is likely to aim for if they come in.
The Irish government is betting that the underlying viable Irish economy can support the huge burden that is being placed upon it and also that it can continue to borrow huge amounts of money.
If this bet succeeds then all we're faced with is long years of sub-par growth and, as the FT called it, "financial oppression" of the economically valuable people and businesses in the country.
Eventually, decades from now, the debt being accumulated now might eventually be paid off. Ireland will be much poorer than it would have been, but would appear superficially intact.
If the bet fails, then the Irish economy faces total disaster as people with mobile skills leave and as viable businesses die and fail and the ability to borrow enough money fades away - leaving both a dead economy and a catastrophic situation for the funding of civil servant pensions, i.e. no money any more.
The only bail out that Ireland needs is replacement of our current gamblers with people prepared to bet that, long term, we need to have viable business to reward hard-working people, and even to allow hard work to result in savings rather than confiscatory taxation. This means no marginal tax increases, means sharp cuts in spending, including ALL areas, and ideally means doing it in one hard and sharp move.
This would requires letting the recent economic damage fall on specific groups rather than attempting to spread it onto everyone. The groups would probably include mortgage holders (who are likely to be squeezed for every penny they borrowed on houses which should be let fall further in price), civil servants (whose index linked pensions and high salaries have to go), Judges (ditto), quangos (ditto), creditors and even depositors of Irish banks (oopsie), etc. Doing this would result in financial misery for many people. That's highly unfortunate, particularly if the govt does the usual and cuts things like benefits for truly unfortunate categories like the old and sick rather than cutting pay for civil servants and judges.
However, it might allow a clean future for many parts of the economy and for many people like graduates, children, etc..
So, there seem to be three likely scenarios.
One is that the government plans hurt everyone in the country a lot, and actually much more than an even share of the already existing damage, since there'll be interest on top. That's their current best case.
The second is that everyone in the country ends up entirely broke. That's what'll happen if the current bet fails and the economic curves go bad.
The alternate is to recognize that a lot of people have already been made poor by the boom and bust, and to let that sword fall. This MIGHT allow the rest of the population to rebuild something useful. Might.
It's what the IMF is likely to aim for if they come in.
The Irish government is betting that the underlying viable Irish economy can support the huge burden that is being placed upon it and also that it can continue to borrow huge amounts of money.
If this bet succeeds then all we're faced with is long years of sub-par growth and, as the FT called it, "financial oppression" of the economically valuable people and businesses in the country.
Eventually, decades from now, the debt being accumulated now might eventually be paid off. Ireland will be much poorer than it would have been, but would appear superficially intact.
If the bet fails, then the Irish economy faces total disaster as people with mobile skills leave and as viable businesses die and fail and the ability to borrow enough money fades away - leaving both a dead economy and a catastrophic situation for the funding of civil servant pensions, i.e. no money any more.
The only bail out that Ireland needs is replacement of our current gamblers with people prepared to bet that, long term, we need to have viable business to reward hard-working people, and even to allow hard work to result in savings rather than confiscatory taxation. This means no marginal tax increases, means sharp cuts in spending, including ALL areas, and ideally means doing it in one hard and sharp move.
This would requires letting the recent economic damage fall on specific groups rather than attempting to spread it onto everyone. The groups would probably include mortgage holders (who are likely to be squeezed for every penny they borrowed on houses which should be let fall further in price), civil servants (whose index linked pensions and high salaries have to go), Judges (ditto), quangos (ditto), creditors and even depositors of Irish banks (oopsie), etc. Doing this would result in financial misery for many people. That's highly unfortunate, particularly if the govt does the usual and cuts things like benefits for truly unfortunate categories like the old and sick rather than cutting pay for civil servants and judges.
However, it might allow a clean future for many parts of the economy and for many people like graduates, children, etc..
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