(Corrects number of times Ireland has issued medium-term debt in fourth paragraph in article published Jan. 24.)
Talk to practically any investors in London and they will tell you Ireland is a shining example of a successful euro-area bailout program, a narrative that the country’s international creditors eagerly endorse.
So it might have come as a surprise when Finance Minister Michael Noonan said at a meeting with his euro-area counterparts this week that the Irish -- and Portuguese -- may get an extension on the maturities of some of their bailout loans.
This would help to reduce Ireland’s debt burden, of course. But why is it necessary if Ireland’s bailout has been such a success? The answer is simple: Ireland’s debt is not yet on a sustainable path, and the country needs more help to return to one if it’s to become the success story that many say it already is.
Clearly, Ireland hit some positive milestones recently. This month, the government issued medium-term debt for the second time since it was forced out of the bond markets in September 2010 -- and at lower borrowing costs than those attached to its bailout loans. The government also sold 1 billion euros ($1.3 billion) in Bank of Ireland debt, while the European Central Bank said last week that Irish banks had significantly weaned themselves off central-bank funding in December.
This is all good news, but out of sync with Ireland’s fundamentals. The economy remains reliant on foreign demand, and its main export markets -- the rest of the euro area, the U.K. and the U.S. -- are likely to contract or to grow slowly this year. The prospects for fostering domestic demand in Ireland don’t look good, either. The government agreed to its sixth austerity budget for 2013, and unemployment has been stubbornly high at almost 15 percent for the past year. As a result, both the public and private sectors will continue to drag on growth.
Ireland’s financial sector, which effectively bankrupted the nation, also remains a cause for concern. BlackRock Solutions was brought in to run independent stress tests on the nation’s banks in 2011, after which they were recapitalized according to BlackRock’s worst-case, stressed scenario. Most investors assumed this was the end of the Emerald Isle’s banking drama, but the auditor, a unit of BlackRock Inc., probably wasn’t pessimistic enough. At 1.1 percent, the European Commission’s growth forecast for Ireland this year is lower than BlackRock’s worst-case 1.4 percent -- and in my analysis, still too rosy. I expect Ireland to grow 0.5 percent in 2013. Either way, this is likely to leave a hole in the balance sheets of the Irish banks, whose debts the government has guaranteed and effectively holds.
Irish banks will also continue to suffer from their mortgage loans. Arrears on owner-occupied properties whose mortgage payments are more than 180 days overdue continue to rise and now account for a whopping 80 percent of total arrears. Many of the people who own these mortgages will default, depleting the banks’ capital ratios.
Partly because of these economic and financial headwinds, Ireland’s public finances remain unsustainable. The country’s debt burden ended 2012 at almost 120 percent of gross domestic product -- the fourth-highest in the euro area after Greece, Italy and Portugal. Ireland’s primary deficit also remains large, at about 4.3 percent of GDP in 2012.
If the financial crisis has taught us anything, it is that excessive public- or private-sector debts can be ignored for years. Once investors recognize the danger, though, they start charging the appropriate premium for borrowing, and the party comes to a screeching halt. Given the current market euphoria about Ireland, it could take some time for investors to start worrying, but shocks elsewhere in the region (Greece and Spain look like front-runners to provide one) may jolt investors back to reality. At that moment, Ireland would find itself shut out of the bond markets once again.
Ireland is right to be looking for extra help now, because the longer a debt overhang goes unresolved, the bigger the losses when a resolution is finally sought. One proposal suggested this week is to extend the maturities on some of Ireland’s bailout loans. If Ireland were to get the same 15-year extension that Greece received in December, that would reduce the Irish debt burden by fewer than 10 percentage points, to about 110 percent of GDP in net present value terms. That’s a drop in the bucket of what’s needed.
The Irish government hopes its banks will be retroactively recapitalized by the European Union’s permanent bailout fund, the European Stability Mechanism. That would significantly reduce Ireland’s debt burden, yet Germany has dug in against the idea and is unlikely to relent, at least until Chancellor Angela Merkel has cleared elections in September. Even if Ireland were to win this concession from its creditors, separating bank and state debt retroactively is like trying to unscramble an egg. The ultimate debt relief would be small.
The ECB could help keep Ireland’s borrowing costs low and facilitate its re-entry into the markets by buying Irish government bonds through the outright monetary transactions program. However, these purchases are only conducted if a country has submitted to conditionality. Senior government members have stressed to me how eager Ireland is to exit its bailout program and regain full fiscal sovereignty. It would be politically poisonous to exit one program with conditionality only to enter another.
A realistic solution is available. Last week, Ireland’s central-bank governor, Patrick Honohan, said good progress was being made in talks with international creditors to restructure the promissory notes that the government issued to guarantee failing banks. Currently, the state has to repay 3.1 billion euros every year through 2022 -- slightly less thereafter -- to the Irish central bank in order to honor those notes. The next repayment is scheduled for the end of March. A significant extension on the maturity of those repayments could make a real dent in Ireland’s mountain of debt.
The government has leverage it could use in the negotiations with its creditors. If Ireland were to default on the March promissory note (not a policy I am suggesting!), then Ireland’s creditors would be in a very difficult position: At the same time, they would be reluctant to pull the plug on their Irish success story and to set a moral-hazard-creating precedent by not doing so. Ireland’s creditors may, therefore, be willing to strike a deal to avoid having to eventually make such a difficult choice.
The Irish government has been reluctant to play hardball in negotiations so far, partly because it has gone to such lengths to appear the model student. Equally, Ireland’s creditors have resisted making concessions because it looks odd to praise a country as a success while saying it needs help to succeed. The sooner both sides abandon this charade, the greater the chances of Ireland becoming the model it is made out to be.
(Megan Greene is a Bloomberg View columnist and chief economist at Maverick Intelligence. Until 2012, she was director of European economic research at Roubini Global Economics LLC. The opinions expressed are her own.)
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