Stability for Ireland and the Eurozone

by Shane Fitzgerald

A trio of leading economic experts have addressed the IIEA in recent weeks on the topic of Ireland’s sovereign debt crisis. Tellingly, each of them spent as much time speaking about the European dimensions of Ireland’s problems and their solutions as they did talking about domestic factors.

First was Klaus Regling, CEO of the European Financial Stability Facility, who delivered a keynote address on Ireland and the Euro to a packed house on 27 April.

Two days later, Daniel Gros, Director of the Brussels-based Centre for European Policy Studies, gave a presentation to our Economists Group titled Ireland and the Euro Crisis – Is There Light at the End of the Tunnel?

And this week, Professor Karl Whelan of University College Dublin gave his own Economists Group talk on Ireland’s Sovereign Debt Crisis.

In considering the three presentations together, perhaps most noticeable is the extent to which each expert emphasised the corrosive role of uncertainty in the Irish economy. In this they all agreed with the Governor of the Central Bank, Patrick Honohan, whose January speech to the Institute on Ireland’s banking system focused on the necessity of reducing tail-risks so as to dampen uncertainty and restore vital confidence.

Daniel Gros’ speech focused on a novel approach to meeting the Irish sovereign’s funding needs, which he has since elaborated on in a numberofrelated articles. His analysis centred on the fact that although the Irish government has a huge foreign debt, the Irish private sector holds a large amount of foreign assets. If these assets could be ‘mobilised’, Ireland’s burden would be greatly reduced. So he suggests that:

Irish pension funds and life insurance companies should somehow be ‘induced’ to invest their entire portfolio of gilts in Irish government bonds.  The €25 billion in financing that this would yield for the government is equivalent to the entire contribution of the IMF to the rescue package … Given the scale of foreign assets owned by Irish residents there should be no need for the government to depend on the funds of the EFSF and the IMF, which are very expensive in both political and economic terms.

Gros’ presentation caused quite a stir and provoked much fruitful debate, both on the day and online in the weeks that followed.

As could be expected given his prominent role in the European economic policymaking establishment, Klaus Regling’s arguments were somewhat more orthodox (though the orthodoxy of EU economic policymaking is certainly finding itself stretched of late). He emphasised that the assistance programme for Ireland has three objectives: to strengthen and overhaul the banking sector; to restore fiscal sustainability and correct Ireland’s ‘excessive deficit’ by 2015; and to promote reforms that will allow Ireland to return to robust and sustainable growth.

He went on to describe the other elements of the EU’s crisis response, making particular mention of the European Stability Mechanism, the permanent rescue mechanism for troubled Eurozone states that is set to replace the EFSF.

Confirmed details of the ESM are confined to what is contained in a ‘term sheet‘ released in March but aleaked version of the Treaty to establish the ESM appeared yesterday on the eurosceptic OpenEurope blog. For a comprehensive analysis of the term sheet, see Jean-Victor Louis’ contribution to this collection from the European League for Economic Cooperation (pages 17-39, pdf).

It is envisaged that the ESM will be an intergovernmental organisation under public international law, operational from mid-2013. It will provide financial assistance in the form of loans (or, exceptionally, through intervention in the primary debt market) to euro area Member States, within programmes of strict conditionality. It will have an effective lending capacity of €500 billion, with total subscribed capital of €700 billion made up of paid-in capital of €80 billion and committed callable capital and guarantees of €620 billion.

A crucial difference between it and the EFSF will be the fact of private sector involvement in any future sovereign rescues. This will be done on a case-by-case based on debt sustainability analysis and will follow established IMF policies. To achieve this, so-called Collective Actions Clauses (CACs) will be inscribed in all new euro area government bonds from June 2013. However, ESM loans will enjoy preferred creditor status over ordinary bonds (though not so preferred as IMF loans, which will remain on the top tier of creditors to be paid back if a so-called ‘credit event‘ occurs).

This is where Karl Whelan picked up an interesting thread. After delivering a comprehensive overview of Ireland’s fiscal position and plans, he addressed the implications of a further EU-IMF deal for Ireland, which he reckons is likely to become necessary at some point in the near future. Prof. Whelan noted that a second deal in the next couple of years would be set against a backdrop of ‘bailout fatigue’ and inevitably involve the ESM.

Considering the planned preferred creditor status of ESM loans, he wondered whether that status, combined with the even more preferred status of IMF loans, might cause private investors to become even more wary about buying Irish bonds. The absence of private investors would make it very difficult for Ireland to escape the ESM and to return to the bond markets on normal terms. In this way the ESM might act as a ‘black hole’ from which Ireland would struggle to escape. Such a result is in nobody’s interest.

But Prof. Whelan went on to note that current events in Greece are likely to have a great effect on the EU’s future approach to sovereign debt problems. If a ‘soft restructuring’ of some sort occurs in Greece without calamitous result, then this approach will begin to look more attractive as a solution to Ireland’s situation.

The details of the ESM seem to be largely agreed and are set to be finalised at an EU summit in little over a month. But a battle continues over the issue of private sector involvement. Berlin is adamant that this must be a legal requirement (with one eye on the fact that the Bundestag and Constitutional Court must both be persuaded not to veto the Mechanism). Paris, with many allies, prefers a more political finesse to avoid scaring off investors.

Although the EU’s policy responses to the financial and sovereign debt crisis have been many and major, the establishment of the ESM trumps all of the ad hoc, temporary or sectoral initiatives that we have seen to date. It is a major step towards whatever new mixture of economic, monetary and political union emerges from the still-scalding crucible of this crisis. Its parameters are of vital import not only to troubled peripheral economies such as Ireland but to all the citizens and nations bound together by the European Union, so the coming weeks are crucial.

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