Several articles in the press yesterday on why Ireland will require / need a second 'bailout' -
here's an excellent piece from Namawinelake and
here's a piece from Colm McCarthy.
This is an unedited version of my Sunday Times (January 15, 2012) article on the same topic.
In May 2011, as Greece was sliding
toward the second bailout, I conjectured that within 24 months, Ireland and
Portugal will both require additional bailout packages as well. This week, my
prediction has been echoed by the Chief Economist of the Citi, William Buiter.
According to Buiter, the costs of
borrowing in the markets are currently prohibitive and the expiration of the
€67.5 billion loans deal with the Torika, scheduled for 2014 will see Ireland
once again unable to borrow to cover remaining deficits and refinancing
maturing bonds. Ireland should secure additional funding as a back up, to avoid
seeking it later “in a state of near panic”.
Buiter’s suggestion represents nothing
more than a prudent planning-ahead exercise. In addition to Buiter’s original
rationale for securing new lending, Ireland is facing significant fiscal and
economic challenges that will make it nearly impossible for the State to
finance its fiscal adjustment path through private borrowing in 2014-2016.
Speaking to the RTE, Buiter said that
although Ireland’s situation was different from that of Greece, the economy
remains under severe stress from banking sector bailouts. Addressing this
stress should involve restructuring of the promissory notes issued by the state
to IBRC, as the Government was hoping to do in recent months. But it also
requires anchoring our longer-term fiscal adjustment path to predictable and
stable sources of funding at a cost that can be carried by the weakened
economy.
The Government will do well to listen to
these early warnings to avoid repeating mistakes of their predecessors.
On November 18, 2011, Carlo Cottarelli,
IMF Director of Fiscal Affairs Department gave a presentation in the London
School of Economics, titled Challenges of Budgetary and Financial Crises in
Europe. In it, Mr Cottarelli provided three
important insights into the expected dynamics for debt and deficits that have
material impact on Ireland.
Firstly, he showed that to achieve the
‘golden rule’ debt to GDP ratio of 60% of GDP by 2030, Ireland will be required
to run extremely high primary surpluses in years to come. Only Greece and Japan
will have to shoulder greater pain than us over the next 19 years to get public
debt overhang down to a safety level.
Secondly, amongst all PIIGS, Ireland has
the highest proportion of outstanding public debt held by non-residents (84%),
implying the highest cost of restructuring such debt. The runner up is Greece
with 65%. In general, bond yields are positively correlated with the proportion
of debt held by non-residents.
Thirdly, Cottarelli presented a model
estimating the relationship between the observed bond yields and the underlying
macroeconomic and fiscal fundamentals that looked at 31 countries. This model
can be recalibrated to see what yields on Irish debt can be consistent with
market funding under IMF growth projections for Ireland. Using headline IMF
forecasts from December 2011, 2014-2016 yields for Ireland are expected to
range between 4.7% and 6.5%. Incorporating some downside risks to growth and
other macroeconomic parameters, Irish yields can be expected to range between
5.3% and 7.0%.
Even in 5.5-6% average yields range,
financing Irish bonds rollovers in the market in 2014-2016 will be
prohibitively costly as at the above yields, Ireland's debt dynamics will no
longer be consistent with the rates of decline in debt/GDP ratio planned for
under the Troika agreement. This, in turn, means that the markets will be
unlikely to provide financing in volumes, sufficient to cover debt rollovers.
Thus, Ireland will either require new bridging loans from the Troika or will
have to extract even greater primary surpluses out of the economy, diverting
more funds to cover debt repayments and risking derailing any recovery we might
see by then.
What Butier statement this week does not
consider, however, are the potential downside risks to the Irish fiscal
stability projections. These risks are material and can be broadly divided into
external and internal.
Per external risks, the latest CMA
Global Sovereign Risk Report for Q4 2011, released this week, shows Ireland as
the 6th riskiest country in the world with estimated probability of
sovereign default of 46.4% and credit ratings of ccc+. Despite stable
performance of our bonds in Q4 2011, CMA credit ratings for Ireland have
deteriorated, compared to Q3 2011. And, our 5 year mid-point CDS spreads are
now at around 747 bps – more than seven times ahead of Germany. This highlights
the effect of a moderate slowdown in euro zone growth on our bonds performance.
Even absent the above risks, Irish debt
dynamics can be significantly improved by significantly extending preferential
interest rates obtained under the Troika agreement to cover post-2014 rollovers
and adjustments. Based on IMF projections from December 2011, such a move can
secure savings of some €9 billion or almost 5% of our forecast 2016 GDP in
years 2014-2016 alone (see chart).
CHART
Chart source: IMF Country Report
11/356, December 2011 and author own calculations
Looking into the next 5 years, there is
a risk of significant increase in inflationary pressures once the growth
momentum returns to the Euro area. A rise in the bund rates can also take place
due to deterioration in the German fiscal position or due to Germany assuming
greater role in the risk-sharing arrangements within the euro area. Lastly,
German and all other bonds yields can also rise when risk-on switch takes place
in post-recessionary period, drawing significant amounts of liquidity out of
the global bond markets. All of these will adversely impact German bunds, but
also Irish bonds.
On the domestic front, we should be providing a precautionary cover for
the risk of a more protracted slowdown in the Irish economy especially if
accompanied by sticky unemployment. The risk of deterioration in Irish primary
balances due to structural slowdown in the rate of growth in Irish exports
(potentially due to strengthening of the euro in 2013-2016 period or
significant adverse effect of the patent cliff on pharma exports) is another
one worth considering well before it materializes. Lastly, there is the
ever-growing risk that the markets will simply refuse to fund the vast
rollovers of debt which is currently being increasingly warehoused outside the
normal markets in the vaults of the Central Banks and on the books of the
Troika.
Overall, Ireland should form a multi-pronged strategic approach to
fiscal debt adjustment. Recognizing future risks, the Government should
aggressively pursue the agenda of restructuring the promissory notes issued to
the IBRC with an aim of driving down notes yield down to ECB repo rate and push for ECB acceptance of burden sharing imposition on IBRC bondholders
to reduce the principal amount of the promissory notes. Pursuit of longer-term
objective of forcing the ECB to accept a writedown on the banks debts
accumulated through the Emergency Liquidity Assistance lines at the Central
Bank of Ireland is another key policy target. Lastly, Ireland needs to secure
significant lines of credit with the EU at preferential rates for post-2014
period with longer-term maturity than currently envisaged under the Troika
deal.
Given the general conditions across the
Eurozone today, the last priority should be pursued as early as possible. In
other words, there’s no better time to do the right things than now.
Box-out:
The latest EU-wide statistics for Retail
sales for November 2011 released this week present an interesting reading.
Retail sector turnover index, taking into account adjustments for working days,
shows Irish retail activity has contracted by 0.4% in November 2011 year on
year. Overall activity is now down 5.2% on same period 2008, but is up 7.9% on
2005. For all the Irish retail sector woes, here’s an interesting comparative.
Euro area retail sales turnover is now down 2.5% year on year and 1.6% on 2005.
In terms of overall contraction in turnover, Ireland is ranked 15th
in EU27 in terms of the rate of contraction relative to November 2010 and
November 2008 and 12th in terms of contraction relative to 2005. Not
exactly a catastrophic decline. Once set against significant losses in retail
sector employment since 2008, these numbers suggest that to a large extent jobs
losses in the sector were driven by lack of efficiencies in the sector at the
peak of the Celtic Tiger, as well as by declines in revenues.