Department of Finance, Dublin

With the Anglo Irish Bank in big trouble and Irish bonds hitting record highs in Europe the fate of the Irish banking system and the overall economy is not looking so good.

The European Commission is in the process of making a decision on what it plans to do with the Anglo Irish Bank – the bank that was nationalized two years ago.

The decision is one of two; will the bank be forced to close shop or will it receive the backing to survive and pull through its insurmountable debt.

An economist at Morgan Stanley said this week although Ireland has taken measures to overcome the hangover from the credit boom, a “successful outcome requires the economy to become more competitive and also, and more crucially, a global economic recovery," Amit Kara said.

Kara said he is “confident” that the small country will be able to “roll over debt” in the weeks ahead.

He even sees Ireland surpassing countries like Spain in its effort to overcome debt.

"Though Ireland faces serious long-term challenges, its liquidity position is healthy and its banks should have sufficient ECB-eligible collateral to significantly offset the funding impact of upcoming debt redemptions," Kara explained.

"Given the underperformance of recent weeks, we see scope for Irish bonds to regain some ground against Portugal and Spain in particular, once the initial round of government-guaranteed bond redemptions has taken place over the first two weeks of September," he added.

However investors are still worried. The Irish banking system is now solely dependent on the European Central Bank for a bail out which is causing concern but more worrying for investors is the risk associated with Ireland’s decision to guarantee the country’s lenders.

"The key concern for bond investors is the significant contingent risk on the Irish state arising from the establishment of the National Asset Management Agency (NAMA) and the government guarantee scheme for bank liabilities," Andrew Rowan, a fixed income strategist at Morgan Stanley, added.

Rowan said although it’s a tumulus time he sees the country pulling through.

"The scale of capital requirements for Anglo Irish Bank in particular has put Irish spreads under pressure in recent weeks and concerns abound in the market over the potential for further capital needs for this institution," he said.

"It is likely the sector has enough un-pledged collateral to significantly cushion the liquidity impact of the upcoming redemptions, although at the cost of further increasing dependence of the Irish banking system on the ECB," Rowan added.