Ireland Agrees on Repayment Deal with ECB, but Much More Is Needed

When Ireland’s banking crisis forced bailout assistance from the IMF/EU/ECB troika in 2010, the IMF was identified by the Irish public as the driver of harsh austerity measures. “IMF Out” placards were a common sight at protests around Dublin.

Several years later the IMF has become Ireland’s strongest advocate for recovery, openly supporting relief for the nation’s €64 billion bank debts. Conversely, the ECB has adopted the role of barrier to more lenient terms. Recent negotiations have revolved around the restructuring of loans known as “promissory notes”; effectively IOUs issued by Ireland in consultation with the ECB to fund the ailing Anglo Irish Bank and Irish Nationwide Building Society. The terms of the promissory notes were to pay €30.6 billion of the estimated €34.7 billion total cost of bailing out the two entities. Contentiously, the ECB prevented the Irish government from imposing losses on bank bondholders, claiming that such an outcome could create European instability.

Debate has centred on the requirement for Ireland to repay €3.1 billion annually over the next decade and smaller amounts thereafter until 2023. There have been concerns that the annual payment and costs associated with its interest may create nervousness abroad and impede Ireland’s planned exit from the bailout programme and subsequent return to markets later this year.

The IMF has distanced itself from the ECB’s requirement to protect Irish bank bondholders and has stated its support for more lenient charges on the promissory notes. Until Thursday, Ireland has unsuccessfully offered several proposals to the ECB over the last 18 months in an attempt to restructure the payment terms. Yet on Thursday apparent progress was made when Irish prime minister Enda Kenny announced that an agreement had been reached with the ECB for the promissory notes to be exchanged for long-term Irish Government bonds with maturities of up to 40 years (and an average of 34 years). Overall, there is an expected improvement in the budget deficit of €1 billion per annum, reducing it by 0.6% of GDP. Markets reacted favourably to the announcement with the October 2020 Irish bond yield falling to 3.952%; the lowest seen in an equivalent Irish benchmark bond since early 2007.

Regardless, the promissory note deal represents little progress for Ireland. The move will ease upfront financing requirements and inflation should erode repayment costs over time, but it will have only a slight impact on the current budget deficit of 8%. Getting to the stated goal of 3% by 2015 will still be painful. Public debt is close to unsustainable at 118% of GDP, far from the 25% level in 2007. It currently represents a €36,943 burden on each member of the 4.6 million population.

To help relieve the debt load, the IMF would like the €500 billion European Stability Mechanism, controlled by eurozone finance ministers, to take equity in struggling Irish banks. This seems unlikely as EU officials have commented that the ESM will not be used to retrospectively recapitalise banks, with Germany particularly opposed to taking on other nation’s bank debt. Indeed, eurozone creditors can blame Ireland for finding itself in this predicament, not only through the recklessness of its banks, but also via the Irish government’s 2008 bank guarantee that covered unsecured bondholders.

Since entering the troika’s bailout program, Ireland must be commended for its structural reforms and achievement of fiscal targets, resulting in nine positive reviews from the group. Importantly for such an open economy, reduced labour costs have improved competitiveness, boosting exports and resulting in expected GDP growth of more than 1.0% for 2012; a notable achievement during a year of broad European recession. Confidence was also advanced by the ability of NTMA (the entity that manages Irish government debt) to enter sovereign bond markets in 2012 and raise €4.2 billion. Outside endorsements were further underlined by the purchases of bonds by US investment firm Franklin Templeton; their holdings increased to €8.5 billion last year, almost 10% of the Irish market.

Even so, optimism must be tapered. While the unemployment rate has stabilised, it is still near 15% and has been helped by significant emigration. The Irish economy is effectively operating at two speeds: exports are growing, aided by the low 12.5% tax rate that attracts multinational firms, but the domestic situation is weakening. Investment and household consumption contracted last year. GNP, the total income remaining with Irish residents, was 0.5% according to the Economic and Social Research Institute (ESRI).

The political picture is also precarious. The government wants to review a 2010 public sector deal that protects all jobs and pay until the end of the year; a move that while necessary, will inflame unions. Large scale rallies against the debt burden took place across the country at the weekend and the restructuring of the promissory notes will do little to assuage protestors. Many observers believe Ireland should have demanded a complete write-down on its bank debt from the ECB rather than time extensions and a lower interest rate. While it would be a just campaign, the ECB’s uncompromising stance would render it fruitless. Pressure on the government to achieve some sort of promissory note deal was such that last week deputy prime minister Eamon Gilmore reportedly told EU leaders that failure to improve terms by March 31st would lead to the collapse of the current Fine Gael-Labour coalition.

Ireland’s current EU presidency status carries little influence with the ECB, an entity that does not want to have its independence ostensibly undermined by political pressure. The Irish government knows it must tread carefully in negotiations and be thankful for any positive modifications to its debt charges. Broader support from the EU is also limited. The recent strength of the euro poses an economic threat to the region, and Ireland’s relatively low corporate tax rate has understandably been the subject of criticism from EU finance ministers. Moreover, Europe is firmly in the mode of a two-tier structure defined by creditors and debtors. The creditors, led by Germany, have to satiate their own domestic political pressures.

The EU risks becoming permanently disjointed unless struggling nations such as Ireland are given the support they need to regain a strong economic footing. Ireland has rightly been portrayed as a role model for other nations such as Greece and Portugal that have received bailouts and adopted austerity. There will likely be more entrants into the bailout program. This is a time of crisis and in such circumstances flexibility is required. Ireland has shown its commitment, now it is time from the EU and ECB to do likewise.