Tom McDonnell & Michael Taft: Even before the wording has been published and a referendum date named there is one issue that looks set to dominate the debate over the Fiscal Treaty; namely, what future financing options does Ireland have in the eventuality of a ‘No’ vote. While we are not taking a position on the substantive issue in this post, the following is intended to aid the debate by helping to answer that question.
The ‘Indispensable’ Condition
First, regardless of the Treaty vote, Ireland is guaranteed funding under the current programme – as long as it meets its targets. A Yes or No vote will not change this.
In the event of a No vote with Ireland unable to fully return to the markets, what would the situation be?
‘ . . . the granting of assistance in the framework of new programmes under the European Stability Mechanism will be conditional, as of 1 March 2013, on the ratification of this Treaty by the Contracting Party.’
This clearly states that new financing under the European Stability Mechanism is contingent upon ratification of the Treaty. However, we would put the following points that suggest that the issue contains potentially significant ambiguity.
First, the text of the European Stability Mechanism Treaty states that there are two conditions for providing support for ESM members:
‘The purpose of the ESM shall be to mobilise funding and provide stability support under strict conditionality, appropriate to the financial assistance instrument chosen, to the benefit of ESM Members which are experiencing, or are threatened by, severe financing problems, if indispensable to safeguard the financial stability of the euro area as a whole and of its Member States.’
The two conditions for support under the ESM appear to be (a) a member-state requires assistance, and (b) such assistance is ‘indispensable’ to the stability of Euro area. The indispensable clause, not surprisingly, is stated four times in the ESM treaty; unsurprising as this is the purpose of the ESM – to safeguard the Eurozone’s stability.
For argument’s sake, let’s assume Ireland – a member of the ESM but having voted No in the referendum – is in demonstrable need of financial assistance; and further, it can be objectively established that, without such assistance, there is a threat to Eurozone stability (issues of both state and bank default which may arise if assistance isn’t forthcoming). A literalist reading of the Fiscal Treaty would seem to settle the issue – Ireland, if voting No, would be excluded from the fund. But how final is this literalism?
‘Indispensable’ to the financial stability of the Euro area does not become less indispensable merely because Ireland, an ESM member, has not incorporated rules (rules that it has already agreed to) into its constitution through a process unique in the Eurozone – that is, a popular referendum. It is difficult to imagine a situation where the financial stability of the Eurozone (and Eurozone countries from Spain to Germany) is at risk and the resolution of that risk is barred because of a referendum result in a member-state. This would effectively undermine the intent of the ESM and its ability to respond to financial risks in the Eurozone.
What this crisis has shown is the flexibility of the Eurozone and EU institutions to respond to the crisis, whether we agree with the policies or not. For instance, the European Central Bank is legally barred from acting as a lender of last resort to sovereign states. But that did not stop it from, first, participating in the secondary bond markets and, second, from providing over €1 trillion in liquidity to European banks through their Long-Term Refinancing Operations (LTROs). The LTRO was intended to indirectly ease pressure on Spanish and Italian bond yields and was effectively a roundabout method of overcoming the bar to lend to sovereign states. Both of these were innovative and flexible responses. This resort to flexibility has implications for Ireland in the event of a No vote.
The Fiscal Compact refers to ‘new programmes under the European Stability Mechanism’. The ‘new’ may provide some flexibility, especially if Ireland is unable to re-enter the market and seeks a continuation of the current programme. This could be buttressed by the statement by the EU Heads of State or Government in July of last year. This, too, is definitive:
‘We are determined to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes.’
Minister Michael Noonan confirmed this after the summit:
'There is a commitment that if countries continue to fulfil the conditions of their programme the European authorities will continue to supply them with money even when the programme is concluded . . . The commitment is now written in that if we are not back in the markets the European authorities will give us money until we get back in the markets.’
That both the EU leaders commitment and the Minister’s statement followed on from agreement to establish the ESM – with the same clause that disbursement of funds is based on the same ‘indispensability’ condition referred to above – suggests that there is considerable room for all sides to manoeuvre, even in the eventuality of a No vote. We are not suggesting that this is a definitive outcome. However, resort to a literal reading could lead us to the conclusion that Ireland, even if voted Yes, could be denied funding under the ESM if it was concluded at EU level that assistance was not indispensable to Eurozone stability. We seriously doubt this scenario which is why literal readings of one section of one treaty can lead us to unjustified conclusions. This holds when discussing the outcomes of either a Yes or No vote.
Alternative Sources of Funding
Regardless of the above, there is a credible argument that Ireland, in the eventuality that it needs a second bailout, has access to funding sources apart from the ESM; namely the IMF. This is the same ‘insurance’ or ‘back-stop’ that all EU countries are entitled to as members of the IMF. More EU countries have accessed IMF support than EU support in the last decade: Latvia, Lithuania, Poland, Bulgaria, Romania, Hungary, and Estonia.
The IMF programmes have recently undergone considerable reform in order to tailor support for the specific need of a country. Further support from the IMF does not necessarily have to come via the Extended Facility that Ireland currently participates in. Some of these programmes may even be more suitable to the Irish economy than an ESM programme modelled on the current one. This is because IMF programmes can provide credit lines on a precautionary basis. In these circumstances, Ireland may be able to enter the market even on a partial basis but have recourse to the IMF if and when further support is needed. A particular strength of some of these programmes is that Ireland may not have to draw down any funds (though it would make a ‘down-payment’ to participate in the particular programme).
There is a range of programmes that Ireland may be able to avail of:
Stand-by Arrangements with high-access precautionary provisions. The IMF describes this as its ‘workhorse lending instrument’.
The Flexible Credit Scheme which does not carry with it any conditions (and which the IMF claims ‘reduces the perceived stigma of borrowing from the IMF’.
The Precautionary and Liquidity Line is another line of support which provides finance and, according to the IMF, ‘is intended to serve as insurance and help resolve crises’.
Rapid Financing Instrument provides a quick response to an outside shock – including economic shocks.
These programmes are separate from the current Extended Facility programme we are in. Some have conditions attached to them; one does not (the Flexible Credit Scheme). They have a range of participating and payback periods, with provision for roll-over. We are not suggesting that Ireland would comply with all of the above; however, it shows the considerable potential sources of funding. There are two issues that might arise in considering these alternatives.
First, will Ireland be eligible for future financing? IMF financing is based on quotas assigned to each country with programmes laying down specific amounts that can be lent. However, all the programmes have exceptional access policy whereby limits are waived – with the exception of the Flexible Credit Line which, in any event, has no cap on funding.
In fact, for many countries there is a natural progression from the type of IMF funding Ireland is currently in (an Extended programme) to the programmes listed above. Poland is an example which started out in an Extended Programme, progressed to a Standby Arrangement and is now in a Flexible Credit Line which has no conditions attached. Ireland could make a similar progression.
Second, it has been suggested that the IMF actually regards Ireland as a high-risk country and may, therefore, refuse to lend further. In the first instance this would certainly be curious. To date, Ireland has abided by the programme that the IMF itself helped design (it’s fairly typical of IMF extended facilities). If the IMF suddenly claimed Ireland was too risky, this would be tantamount to an admission of their own failure. Would Ireland be penalised by the IMF for adhering to a programme that the IMF helped designed?
There is a strong argument that Ireland fulfils all four criteria for an ‘exceptional access’:
(a) The member is experiencing or has the potential to experience pressures resulting in a need for Fund financing that cannot be met within the normal limits.
(b) There is a high probability that the member’s public debt is sustainable in the medium term. However, in instances where there are significant uncertainties that make it difficult to state categorically that there is a high probability that the debt is sustainable over this period, exceptional access would be justified if there is a high risk of international systemic spillovers.
(c) The member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding.
(d) The policy program of the member provides a reasonably strong prospect of success, including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment.
We would draw attention to the condition in (b); in particular where exceptional access is justified if there is a high risk of international ‘spillovers’. There is a strong argument that Ireland is in such a situation. That the IMF participated in the current bail-out, despite the staff country report in December 2010 stating that Ireland would entail ‘substantial risks’, only confirms their determination to participate in programmes where the risks of spillovers are significant.
Another issue is the scale to which Ireland has already borrowed from the IMF. Currently, Ireland is the third largest debtor to the IMF – behind Greece and Portugal. Poland has a similar level of contingent debt, while Mexico is much higher – though these countries are in the Flexible Credit Line have not drawn down funds. There is a limit to which a country can borrow – even if complying with the provisions of the exceptional access. The IMF has lent a considerable amount to EU countries already and while it still retains considerable reserves, and while further precautionary lending to EU countries would not impact unduly, the possibility of larger countries needing assistance (Spain, Italy) could squeeze available funds to Ireland.
Taking all of the above on board, that the IMF has decided to extend its assistance to Greece in the form of a second bail-out suggests that Ireland would be a credible candidate for further support if it cannot access the international markets. If so, this could be a viable alternative to ESM funding.
Appalling Scenarios and a Legitimate Debate
None of the above can be certain. But that is no reason to resort to counter-posing ‘appalling scenarios’. Some argue that Ireland will be frozen out of both market and institutional funding if we vote No. Clearly, this would be an appalling scenario. Others argue that it would never come to this because of the impact on the Eurozone (defaults, contagion) – another appalling scenario.
This is not a satisfactory way to debate this issue. This will trap us in a ‘race-to-disaster’ debate which will be particularly uninformative. We have attempted to outline concrete scenarios for Ireland apart from the ESM. Whether these would become available is a subject for legitimate debate. The fact that Ireland may have a secure safety net with IMF funding is likely to induce cooperative, if ad hoc, relationships with the EU. Competing disaster scenarios will only undermine our understanding of these difficult issues.
In one respect, debating non-market funding has an air of unreality about it – if we are to heed the Government’s dismissal of a second bail-out as ‘ludicrous’. The fact that this issue is being taken seriously is a testament to the common sense of the debate. While we respect the fact that no Government will intentionally play down the prospect of being able to borrow on the international markets, in our own opinion a second bail-out is a real and probable outcome of current policies.
And this is not in the best interests of the Irish economy, whether that support comes from the IMF, the EU’s ESM , some other ad hoc EU support or any combination of these.