Have we been missing the Irish forest for the (ahem) Anglo Irish trees?
Uncertainty over how much the Irish government will have to fund Anglo Irish’s liabilities before it’s wound down has stalked the market recently.
That’s been wedded to fear that the country’s bad bank will take losses on the assets it’s taking off Anglo and other banks, despite heavy haircuts — but really, more bank losses than expected = ongoing crashes in real estate = fewer fiscal receipts for the Irish state.
Which, as Barclays Capital’s Antonio Garcia Pascual and Piero Ghezzi noted on Thursday, means the Irish sovereign is facing an even stickier situation in the medium term (click to enlarge chart):
In a relatively benign macroeconomic scenario, with medium-term real GDP growth of 3.0% and nominal yield of 5.0% and no further significant unexpected bank-related losses, the cumulative primary fiscal balance adjustment required over a five-year period (2010-14) is 11.5% of GDP…
…under a slightly less favourable macroeconomic scenario (real GDP growth of 2.5% over the medium term and nominal long-term yields at 5.5%), the cumulative primary surplus adjustment required to reduce debt to GDP to 60% by 2050 increases to 12.4% of GDP. Under a slightly more severe (but plausible) macroeconomic scenario (real GDP growth of 2.0% over the medium term and nominal long-term yields at 6.0%), a cumulative primary balance adjustment of 13.3% of GDP would be required over a 5 year period.
The difference between an 11.5 per cent adjustment and 13.3 per cent is more or less that between Ireland’s last big fiscal adjustment in the 80s, and… well… Greece under its current bailout. The more benign version is pretty tough in itself:
Under our more benign macroeconomic outlook, the proposed government fiscal programme would deliver a primary fiscal adjustment of about 10% of GDP over a five-year horizon. Therefore, even under the “benign” growth scenario (ie, with real GDP growth reaching 3% by 2015), the current government fiscal consolidation plans, while ambitious, would require additional measures to put the debt dynamics on a sustainable path. The fiscal plan would only manage to reduce the overall estimated fiscal deficit from about 12% in 2010 to about 6% of GDP by 2014.
And if Ireland added further cuts to its fiscal menu, this would provoke a difficult trade-off in terms of pushing growth even lower — which would depress fiscal receipts even further.
Similarly, the government has fewer and fewer ways left to support banks, having extended a short-term guarantee to help them cover a refinancing wave this month. External aid to banks — ECB liquidity — won’t be lasting forever, either.
Pascual and Ghezzi thus make quite a striking call (emphasis ours):
At this juncture, given the near-term liquidity conditions of the sovereign and the completion of funding requirements for 2010, we would argue that the Irish authorities’ do not need to seek an EU-IMF package…
However, the lack of fiscal space over the medium term to tackle future unexpected losses in the banking system does constitute a source of market instability. In our view, if the macroeconomic conditions deviate from our baseline recovery scenario and unexpected losses crop up in the financial sector, then the government’s best option at stabilising adverse market dynamics would indeed be by drawing on financial assistance from the EU-IMF to create further recapitalisation buffers and resolve unexpected financial sector losses.
It’s striking because Ireland is indeed funded for 2010 — not to mention that rates on its debt can be brought down (for now) by the ECB’s bond buying programme, and (indirectly) by investor perceptions that the EU will support Irish policy. But again — these policies can’t last forever.
Ireland would be a particularly good candidate for help because it already has a strong list of fiscal cuts (amounting to 5.5 per cent of GDP in 2010), Pascual and Ghezzi argue, and is making progress on fixing its banks. But it’s just too much to carry on the government’s own.
Whereas IMF help is looking much more practicable:
On the IMF side, the enhanced Flexible Credit Line facility recently approved by the IMF Board appears to be a suitable funding vehicle. Indeed, part of the financial assistance could be in the form of a flexible credit line, which could be drawn if the contingent liabilities acquired by the government do materialise.
This could be the case if the estimated 50% average haircut would turn out to be insufficient on the NAMA-transferred loans or, more importantly, if further recapitalisation would be required as a result of unexpected losses in non-NAMA portfolios – a likely scenario under current growth prospects…
Update – full note in the usual place.
Related links:
Irish borrowing costs rise – Irish Times
Irish government debt needs you – FT Alphaville
About that Irish downgrade – FT Alphaville