The irony of Ireland moving swiftly to trim its budget deficit — and still ending up as the new centre of a European crisis — makes good newspaper fodder. But there is something rather unfair about the island’s current predicament.
From Independent Strategy, who’ve got in for Belgium, but not Ireland. And who, incidentally, are generally pretty negative when it comes to sovereign crises:
We expect Ireland’s formal application to the EFSF/ ESM to be announced eventually. The Irish government is still resisting asking for support, arguing that it can fund itself and can see out the bond markets. But markets will force Ireland to take the money, with delay just increasing the expense.
Wait. Wait. The positives start soon. Including one brave investment call:
We are buying the senior bank debt because it is the condition of the banks that has driven the crisis in Ireland. Ireland’s sovereign debt was not the ultimate cause of the Irish debt crisis. However, sovereign risk now stands at the centre of the Irish debt crisis.
This is because much of the banks’ risks have been taken over by the government in the form of guarantees of bank liabilities, NAMA bonds, as well as through the creditworthiness of the promissory notes used to finance Anglo Irish Bank and other banks.
Alright, given that the EFSF will effectively gurantee bonds until 2013, the call might not actually be that ballsy. Meanwhile Ireland tapping the EFSF would … :
The tight feedback loops between the sovereign and the effectively nationalised banks mean that any improvement in perception of sovereign debt feeds straight through to a change in perception of the bank debt. This is exactly what access to EU funding for Ireland would achieve. As a consequence, the threat of haircuts to outstanding Irish senior bank debt would be dramatically reduced, as any haircut of bank senior debt would reignite the sovereign debt crisis.
But here’s the really positive stuff:
Longer term, we reckon that Ireland is solvent and capable of reducing its debt burden to manageable proportions within the next four years. Ireland is a liberalised, young, dynamic, export-oriented economy unlike any other in Europe. Market regulation is low; growth is sensitive to exports; domestic labour costs are now falling; and Ireland’s exports are not so dependent on China and Asia as others in Europe.
And this — we think — is the key bit:
Also, Ireland is unique in that it is cleaning up its banking bad assets by applying classic Scandinavian surgical methods. That takes the pain head on by writing down the bad assets and loans along with bank capital and putting the risks onto the sovereign balance sheet.
The result may be horrible budget and sovereign debt arithmetic for a while, along with falling asset prices (principally real estate) as the market adjusts to clearing prices and a huge fall in real GDP. But it will eventually leave Ireland with a reduced, but cleansed, financial system and no overhang of bad assets and loans from the bubble economy.
We have measured the risk of further banking losses on home mortgage loans to individuals and found that the maximum incremental damage to the sovereign balance sheet and budget would be about 7% of GDP compared to the existing 30% of GDP of debt incurred from the already budgeted bank bailout costs plus any potential NAMA losses on purchased bank assets.
And just going back to the wider-eurozone:
We are currently not taking a long euro position because a resolution of the Irish crisis is not synonymous with a resolution of the Eurozone sovereign debt crisis. It could be a circuit breaker in the broader Eurozone crisis or alternatively the precedent for other crises. Whether it is or not can be determined by the big picture perceptions – either that having fixed this crisis the EU can fix its successors or that an Irish deal opens the floodgates.
Politically, Germany is most at risk in this crisis. German Chancellor Merkel is exposed to criticism for implementing yet another bailout package that puts German taxpayers at risk. It does, however, appear Germany did push for Ireland to use EU funds, presumably hoping this would put a stopper on the Eurozone sovereign crisis. If it did, then the Germans could move forward rapidly to set up the successor to the EFSF that would include private bond-investor haircuts in any sovereign default or rescheduling.
And finally:
The Eurozone is painfully constructing a system that excludes both fiscal and monetary laxity, while at the same time suffering repeated crises from both. Whether the bumpy path towards the long-term virtuous goal or the expiation of past sins dominates market perceptions is a hard one to call, particularly when there is no anchor of stability in other major currencies. We will adjust the flight path to the winds of volatility and shift our euro stance accordingly. For the moment, we are lying low, having sold our long euro positions last week.
Full note — with oodles of charts and insets — in the usual place.
Related links:
The distorted European bailout – FT Alphaville
Morgan Stanley says Irish use of EFSF would be ‘circuit breaker’ - Bloomberg