An unedited version of my Sunday Times column for July 8, 2012.
Last week’s Euro zone rush to make some sort of a deal on
the common currency debt crisis was originally heralded as a ‘path-breaking’ event.
A week on, and the markets have largely discounted the deal, while internal
disagreements between the member states are tearing it to shreds.
Within a few days following the summit, heads of Bundesbank,
Deutsche Bank and Commerzbank came out opposing the core premises of the deal,
including the banking union. Finnish, Dutch and Estonian governments strongly
disagreed with the ideas of ECB engaging in direct purchases of sovereign
bonds, and equal treatment of ESM debt alongside private bondholders. German
and Slovak leaders have pledged to respect these countries positions. Austrian
parliament’s approval of European Stabilisation Mechanism (ESM) fund came with
some severe conditions attached, also altering the June summit conclusions.
Lastly, the ECB’s Mario Draghi was clearly guarded about the deal implications
for the ECB independence during his press-conference this Thursday.
Meanwhile, the markets have moved from an euphoric reaction
to the deal last Friday back to shorting the euro zone by Thursday, despite the
ECB interest rate cut.
Despite these, and other developments, the Irish Government continues
to put much hope on the June 28-29 deal. Rhetoric aside, the new deal can, at
the very best, allow Ireland to convert some of our government debts into the
debt held against Irish consumers and mortgage-holders.
The Government assumes that under the deal, ESM will be
allowed to retrospectively cancel government debts relating to banks bailouts
and convert these into debts held against the banks themselves.
Assuming this is correct, even though the actual agreement
does not mention any retrospective actions, Ireland will be able to move some
unknown share of its €62.8 billion total exposure to the banking crisis off the
government debt account. The Government has already admitted that it is
unlikely to recover any of the NPRF funds ‘invested’ in the banks. Which leaves
us with roughly €30-35 billion of promissory notes and other debts that can be
in theory restructured via ESM.
On the surface, this looks like a great opportunity, to
reduce our official Government debt from 117% of GDP to just over 100% of GDP.
However, the problem with this proposition is that it
ignores the actual nature of the deal and the likelihood of such a deal going
through.
Let’s start from the latter point.
For Ireland to restructure such a large amount of debt, will
require one of the following two options. Either all of the states involved in
ESM should be given similar retrospective considerations of past sovereign
recapitalisations of the banks , or Ireland must be deemed to be a special
case, warranting special intervention.
The former will mean that Germany, Belgium, the Netherlands,
Austria, not to mention Spain, Portugal, Greece and Cyprus will all have to be
granted access to the same restructuring process as Ireland. These states have
collectively pumped some €400 billion worth of taxpayers’ funds into their own
banking systems during the crisis. ESM’s lending capacity is €500 billion. In
other words, ESM will effectively have not enough funds to cover the second
bailout for Ireland and extensions of bailouts for Portugal and Greece, let
alone provide any backstop for Italy and Spain.
Italy has just raised its forecast budget deficit for 2012
by some 50%, while Spain will require €7-10 billion of additional fiscal cuts
to meet its 2012 target. Greece has been lax on tax collection during May and
June elections. The likelihood of these countries needing additional funds in
2013-2014 is rising, just as ESM lending capacity is shrinking.
The latter possibility would require making a convincing
argument that Ireland’s case is unique when it comes to the hardships of
recapitalising the banks. In addition, it will require proving that we
desperately need special help. This can only be done by admitting that our
deficit and debt adjustments, as envisioned in the multiannual programme with
Troika, are not sustainable. This would contradict all Troika assessments of
the Irish fiscal stabilization programmes to-date.
Now, let’s take a look at the more important point raised
above – the point about the actual nature of this deal. In a nutshell, even if
successful, the restructuring of our banks-related debts via ESM, as envisioned
by the Government, will accomplish little in terms of lifting the burden of
unsustainable debts off the shoulders of the economy.
The reasons for this conjecture are numerous.
Firstly, ESM will still require repayment of all the debts
transferred from the Government to the fund. Except, instead of the taxpayers,
the onus for repaying these debts will fall on Irish consumers.
Even an undergraduate student of economics knows that when
the market power is concentrated in the hands of a small number of players, any
taxes and charges imposed onto them will be passed directly to consumers. Now,
recall that under the Irish Government plans, Irish banking system is moving
toward a Bank of Ireland, plus AIB duopoly. In such an environment, the
repayment of banks debts to the ESM will simply involve higher banking services
costs to mortgagees and bank accounts holders.
Only a regulated duopoly, under certain conditions, can be
prevented from gouging consumers to pay charges, and even then imperfectly.
Yet, under the deal, the Government will be ceding control over the banking
sector to the ESM (who will own the banks and their debts) and the ECB (who
will act as the pan-Euro area supervisor of the banks). This means we can
expect mortgages and banking costs to rise and with them, foreclosures,
personal insolvencies and business liquidations to accelerate.
Secondly, per Irish Government statements, last week’s deal will
allow for relieving the burden of the banks debt and promises to restart our
economy back to growth. If the former proposition, as argued above, is
questionable, the latter is outright bogus.
Ireland’s crisis is not driven by who owns the banks debts.
It is driven by too much debt accumulated in all of the corners of our economy:
households, companies, Government, and the banks. But the swap of banks-related
debts from the Government to the ESM will not reduce the volume of this debt.
And the Irish economy will have an even lower capacity to
repay these debts after the swap.
The Government is already committed to taking €8.6 billion
out of the economy between 2013 and 2015. Most of it - €5.7 billion – is
officially earmarked for ‘cuts’ to the Government expenditure. However, majority
of the expenditure cuts are really nothing more than a concealed tax, as these
cuts reallocate the costs of services to the households. In the Budget 2012,
single largest expenditure reduction measure was a hike on private insurance
costs of medical services.
On top of this, further €1.5-1.8 billion will have to be
clawed out of the economy due to changes in the EU funding and reductions in
state revenues from banks guarantee and support schemes.
In short, put against the reality of Ireland’s struggling
economy and battered by the internal disagreements within the euro zone, the
so-called ‘seismic’ deal is now turning into a storm in a teacup.
Box-out:
Ireland’s much-awaited ‘return to the bond markets’ on
Thursday was greeted in the media by a number of erroneous reports. The truth
is simple as are the questions surrounding the NTMA motives for the auction.
Firstly, Ireland returned not to the bond markets, but to a short-term T-bill
market. Very short-term, in fact. The two markets are significantly different
to pretend the auction was a major breakthrough. Greece, in May this year –
amidst the on-going collapse of its economy and political turmoil, also
‘returned’ to the T-bill market. As did Portugal in April when it faced an
unexpected need for banks supports. Ireland itself last dipped into this market
back in September 2010, while facing an impending bailout. T-bills auctions,
therefore, are not exactly the vote of confidence. Secondly, 3 months-dated
bills are effectively risk-free and do not constitute a recognition of Irish
economic revival. Instead, they are backed by the Troika funds. As per
questions raised, one that stands out is why did NTMA need this auction to take
place in the first place? There is no need for the Government to borrow any
money short-term, as our receipts of the Troika funds are regular, fully funded
and without any uncertainty. It appears the whole exercise was about a public
and investor relations management by the Government. Thus, the only apparent
net positive from the auction is that we did not get rejected by the markets.
Then again, neither did Greece in May or Portugal in April.
