Friday, 20 January 2012

Will Ireland Need a Second Bail Out?

Tom McDonnell: Willem Buiter of CitiGroup and formerly of the Bank of England's Monetary Policy Committee reckons that Ireland should negotiate a stand-by second bailout plan in the event it can’t re-access markets in 2013 on favourable terms. Inevitably the notion was attacked as 'ludicrous' by the Government and 'unhelpful' by the Commission. Words like 'fully funded' will bring a wry smile.

While Dan O'Brien argues it would be a mistake to pursue a second bailout at this time for strategic reasons, NamaWineLake, Colm McCarthy, David MacWilliams and Constantin Gurdgiev all argue that a second bailout is inevitable and desirable. I agree that a second bailout is inevitable. This bailout should be negotiated months before the State runs out of funding.

Ireland's debt maturity profile is here:

Coupled with the still gaping hole in the public finances (see page 15) and the unsustainable price (7.5%) for 10 year bonds (Bloomberg) it is clear that Ireland's funding position for 2014 is going to be very difficult.

A lot of course depends on developments in Europe, but on the balance of probability Ireland will enter a second programme of assistance in 2013. Because of the way it is structured, the current bailout mechanism (known as the EFSF) is not able to generate sufficient funds to undertake the level of bond purchases required to stabilise markets. The EFSF is inherently unstable because is is susceptible to a degenerative spiral in which less and less financially stable countries support increasing numbers of financially troubled countries - eventually the stable core simply cannot support the troubled periphery. The EFSF is already unravelling as part of a negative feedback loop and this process of unravelling will be accelerated by the recent downgrades. At any rate it is simply not feasible to expect countries like Italy and Spain to continue to support countries when they themselves are paying higher rates themselves to borrow.

The ESM (European Stability Mechanism) will replace the EFSF either in 2012 or in 2013, and if Ireland gets a second bailout it will be under the auspices of this mechanism. It is imperative that the design of the ESM differs from that of the EFSF. One option is to give the ESM a banking licence and access to ECB funding - and then allow it to buy sovereign debt directly and under defined protocols and conditions.

As part of dealing with the thorny issue of financing Ireland's debt burden, the Anglo promissory notes have understandably taken centre stage with Minister Noonan now promising that a technical paper on the issue is being prepared. Let us hope that the process will be transparent and evidence based and let us also hope that all advice and correspondence relating to the Anglo/INBS debt between the CBI/ECB to the Irish State will be released. The ECB has been notably intransigent on this point so far. The legacy of the Anglo debt is clearly a matter of grave national importance and its imposition on people living in Ireland was a scandalous transfer of wealth. The promissory note story and mechanism is variously explained here by the newly formed "Anglo: Not Our Debt" group, here by NAMA Wine Lake, here by Karl Whelan, here by politico and here by Seamus Coffey.

Ireland's medium-term debt sustainability is on a knife edge. The NTMA is forecasting a debt to GDP ratio of 119% in 2013 - equivalent to a debt to GNP ratio in excess of 140%. This places us firmly in the same ballpark as poor benighted Greece. Relief on the promissory note repayments is a way for all of the key parties to avoid a credit event in Ireland. Ideally this should involve write-down of the €30.6 billion principal but at the very least it should entail a five year holiday on repayments and an extension of the repayment schedule. Such a scenario would help give the economy a modicum of space to recover and offers the possibility that Ireland can manage its way out of the crisis. The alternative is to remain a ward of the official lenders for the forseeable future.

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