Friday, October 1, 2010

Ireland buys itself more time but clock is ticking

DUBLIN: Publication of Ireland's "colossal" bill for bailing out its banks has removed a major uncertainty for markets, but the problem of how to tackle the underlying deficit remains the real monster in the room, according to a Reuters analysis report on Thursday, Sept 30.

Finance Minister Brian Lenihan has bought Ireland some time to get its fiscal house in order by cancelling bond auctions for the rest of this year, but that will be just a stay of execution unless he can come up with a credible four-year plan in November to get the budget back under control by 2014.

"Ireland is still very much on probation," said Ciaran O'Hagan, bond strategist at Societe Generale in Paris.

"We have more certainties around the banks now but the banks were never the bugbear for investors, it's the deficit."

A worst-case estimate of over 50 billion euros, or nearly a third of economic output, to clean up after the Irish banks and their "Celtic Tiger" era of reckless lending is -- as central bank head Patrick Honohan put it -- "colossal". [ID:nLDE68T04M]

But that cost is a one-off which can be spread over a decade, and around 10 billion euros of it can be sourced from a national pension fund pot of 24 billion euros.

A recurring and far more serious issue is the underlying deficit which, even after deducting the bank burden, is expected to be an eye-watering 12 percent of GDP this year, four times the EU limit and the worst shortfall in the union.

The government says that level of indebtedness means it is raises just 3 euros in taxes for every 5 euros it spends.

The yield on Irish 10-year paper hit a euro lifetime high of nearly 7 percent this week on fears Dublin couldn't afford to bail out its banks and cut its deficit in a fragile domestic economy.

But given the country is fully funded until the middle of 2011 and has cash reserves of 20 billion euros on top of that, the risk of Lenihan having to tap external help from the European Union or the IMF was never a credible threat, at least for this year. [ID:nLDE68Q1YP]

"They (IMF) would laugh in his face, they would tell him 'spend the cash you have at home first of all'," said O'Hagan.

"The ESFS (European System of Financial Supervisors) is meant for countries that have no cash, Ireland has tonnes of cash."

Despite a precipitous climb in its borrowing costs in recent auctions, Ireland's average rate of interest over this year was 4.7 percent and analysts have said the government could have continued issuing small amounts of debt at higher levels next year without pushing its overall average interest rate to an unsustainable level.

BIG HEADACHE

What does risk becoming unsustainable, and fast, is the underlying shortfall.

Irish interest rates eased back a touch after Thursday's announcement but the only hope of them falling significantly is if Lenihan can get a jumpy coalition government to agree to additional spending cuts and tax hikes above 3 billion euros for 2011 and sign off on a harsh four-year plan.

Prime Minister Brian Cowen's parliamentary majority is wafer-thin but political analysts believe three by-elections early next year will be the trigger for an early general election, not the latest austerity measures.

While opposition deputies make political capital out of lambasting the government for Ireland's sorry state they know that with the country's heavy reliance on international investors they would have to administer similar measures if they were in power.

In many ways, the biggest headache for Lenihan is trying to find, after three austerity budgets in two years and economic growth faltering, what to slash.

To prevent strikes and social unrest, the government has agreed a deal with unions not to cut public pay any further and while this may be one of the biggest spending lines, Lenihan will be reluctant to revisit this agreement despite the deterioration in Ireland's finances.

Instead, he will likely focus on cutting social welfare, the health budget and widening the tax base to include low income earners, currently around 50 percent of the labour force, who don't pay income tax.

Lenihan's track record on pushing through fiscal pain is good. Before the banks blew out the numbers, Ireland was lauded for its tough action on the budget.

But a lot has changed since then.

"Markets may be less forgiving in future if the underlying problems turn out to be even worse than the government has now admitted," said Peter Dixon, an economist at Commerzbank. - Reuters


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