Breathing space for Irish economy

Taoiseach Enda Kenny and Finance Minister Michael Noonan

Beware of Greeks bearing gifts, the old saying goes.

And there is a downside to the great news we got last week, bundled in with the deal for Greece, that the terms of Ireland's huge debt burden are to be eased.

This gift -- and it is a gift because it had nothing to do with the Irish government's negotiating skills on the matter -- will give much needed breathing space to the Irish economy.

What happened last week was that a summit meeting in Brussels of the European leaders finally agreed a package of measures to prevent an imminent default by Greece on its massive debt and to ease the terms of the bailouts for Ireland and Portugal to prevent them going down the tubes as well.

The Euro zone leaders had little choice because if Greece had gone under the shock would have destabilized the euro, perhaps fatally, and spread a contagion of financial instability across the continent.

The deal gives Greece a second bailout worth €109 billion, on top of the €110 billion which they got in the first bailout a year ago. But it also involves significant changes to the financial rescue fund which was set up in Europe over a year ago to deal with the financial crisis. And that's where it gets interesting for Ireland.

The new measures are complex, but essentially they do two things. First, the amount of time countries like Greece and Ireland will get to repay the bailout money is being lengthened. Secondly, the level of interest charged on the bailout money is being reduced.

In the case of Greece, it was clear that there was no way the country could repay what it owed on the original timescale and at the original interest rate; in fact it seemed unlikely that they would ever be in a position to pay the debt off and the situation was getting worse, not better. Default was staring them in the face.
The new deal, which involves debt rollover and bond swops, changing old bonds for new bonds with lower interest rates, also extends up to 30 years the time Greece gets to repay.

It is, of course, a default, but a managed default which gives considerable protection to lenders. The lenders will lose heavily on the bond swop, but the new bonds will be guaranteed by the EU.

We're not in as big a hole as Greece. But in Ireland's case there was a growing realization that our debt burden was simply too heavy to bear, and that it would kill any hope of economic recovery here for decades.  
Under the new terms the interest rate on our bailout money is being cut by two points from an average of just under 6% to just under 4%. The annual savings on our interest bill will be at least €800 million a year (or over €1  billion when the rates on our bilateral loans from the U.K., etc. are reduced in line), a huge amount in terms of our budget.

And like Greece, we also get longer to pay the money back (or to refinance a lot of it in the markets, which is actually what will happen).  

Our problem is that we are seen as such a big risk that we are locked out of the markets and are unlikely to get back in at realistic rates for at least three or four years. Our bailout deal was originally for seven years, but the repayment time has now been extended to 15 years.

Again that takes huge pressure off us, and may mean that the markets will see us as less of a basket case. It doesn't mean that we should take 15 years to sort ourselves out. But the latitude is there if we need it.

Another very important change in the structure of financial arrangements in the EU will mean that we are guaranteed more EU money if we need it, if we remain closed out of the markets after 2015.  Again, this provides security going forward and takes the intense pressure off.

In return for all this the government has had to agree to join in discussions -- and maybe action -- on the tax structures of countries within the Euro zone. It has long been the aim of the EU to bring corporation tax and some other taxes as well in line across Europe to ensure a level competitive playing field for businesses across the Single Market area.

Ireland has been refusing to budge on its 12.5% corporation tax rate, but it seems that the government's stance on this has now shifted slightly. The wording of this part of the deal is not clear -- and the fudging may be deliberate to save our blushes.

But a fair reading of what was in last week's statement from the EU leaders indicates that Ireland's refusal to even consider any change on the 12.5% rate has ended.

For most people here that won't be such a big deal. In fact there is a suspicion that the interest rate reduction and repayment timescale extension we have now been given have been available to us for some time.
What stopped us getting a fairer deal was the grand-standing by Taoiseach (Prime Minister) Enda Kenny and the Minister for Finance Michael Noonan playing tough on the tax issue. In retrospect, this looks foolish.

None of this comes a moment too soon for Ireland. Just a couple of weeks ago the international bond market was valuing Irish government bonds at between 50 cent and 60 cent in the euro. That's pretty scary when you think that these are bonds issued by the Irish state, not Irish bank bonds which are a much riskier proposition.

There is, of course, a degree of interconnection between the two, given that the Irish state gave the blanket guarantee to all the borrowings of Irish banks, the infamous 2008 guarantee that has ruined the country and made the EU-IMF bailout necessary.

Even so, Irish government bonds are supposed to be the most secure Irish State guaranteed investment there is.

Yet the fact is that two or three weeks ago the markets had effectively consigned Irish government bonds to junk status level. One day I looked at the market nearly three weeks back the yields equated to a guaranteed 17.28% per year compound return on five-year Irish government bonds. The equivalent yield that day was 14.36% per year on 10-year Irish government bonds.

Even at those incredible yields, very few people were buying. What the market was effectively telling us very bluntly three weeks ago was that there was likely to be a massive default on Irish government bonds soon.

What has happened is a default of a sort. Two weekends ago the weekend the markets were still trying to make up their minds about the deal for Ireland, and we probably won't know how government bonds will settle for another week.

A lot of our problems, of course, go back to that disastrous blanket guarantee the Irish state gave to our banks in September 2008. Iceland, you will remember, let the lenders to their banks take the big hit. And a lot of people here now think we should have done the same.

You remember the joke at the time of the Icelandic banking crisis. What’s the difference between Iceland and Ireland? Answer: One letter and six months.

Might we have been better off burning the lenders to Irish banks as Iceland burned the lenders to their banks?  The argument back then was that if we did we would never be trusted by the markets again.

But here's an interesting comparison. On the same day nearly three weeks ago that the yield on five year Irish government bonds equated to 17.28% per year compound return, Icelandic five year government bonds were only yielding 5.57% per year.

The fact is that the markets are unlikely to be over-impressed by the new deal we have been given. Sure, it's a help.

But the debt burden remains huge and we have yet to face up to the huge cuts in spending that will be involved over the next few years to get us back on track.

Which is why we should beware of Greeks bearing gifts. The danger here is that people will get the wrong impression from the interest rate savings we have been gifted, the lengthened repayment period and the guarantee of access to more EU-backed money if we need it. There will be a temptation for people to think that the cutbacks needed to get our deficit down to a sustainable level can be put on the long finger.

People will be demanding that their local hospitals or schools are protected from cuts. People, being human, will say that because the government now will have an extra billion a year it does not have to pay out in interest, the same billion can be spent on services.

If we take that attitude, we will never get our massive budget deficit down. And if that happens, we will be looking for a second bailout like Greece before too long.