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On Thursday, May 31st, the Irish will vote in a referendum ‘For’ or ‘Against’ the so-called fiscal compact, as the Treaty on Stability, Coordination and Governance in the eurozone is known. The treaty was signed by 25 countries (excluding UK and the Czech Republic) and is currently in the process of ratification. Ireland is the only country to vote on its adoption in a referendum because this is required by the country’s constitution.

The treaty aims at tightening the budget discipline in the EU and especially in the euro area, mainly by requiring countries to balance their budgets and to coordinate their economic policies. The European Commission is entitled to monitor their compliance and to bring countries in breach to court. It came to its creation when, because of Britain's resistance, European leaders failed to agree on changes in the EU treaties. However, the adoption of the fiscal compact is considered a strong signal to markets that the eurozone is headed toward greater integration and better fiscal discipline. Because, although it does not directly address the euro’s structural flaws nor the need to get the eurozone economy growing, there is hope that the fiscal compact will buy politicians more time to come up with workable solutions, Hugo Brady wrote, analyst with the Centre for European Reform.

While in Europe there is a dispute between supporters of austerity on the one hand, and the need for growth, on the other, the majority supports the view that clear and strict fiscal rules with the necessary guarantees of compliance, are an important first step towards regaining market confidence and a precondition for fostering economic growth. Why then there is a risk the Irish to say "No" to the fiscal compact?

The balance of forces

The coalition government in Dublin, which consists of the Christian Democratic Fine Gael and the Social Democratic Labour Party, campaigns in support of the treaty. It is also backed by the main opposition party Fianna Fail and the largest business organisation in the country, Hugo Brady writes. He cites opinion polls showing that 47% of voters would vote in favour of the treaty, 35% against and 18% are still undecided. The problem is that the government enjoys too low support among voters - only 23%, while the hard-line nationalist party Sinn Fein polled 21% and quite expectedly is against the fiscal compact.

The government’s situation is further complicated because, according to Irish law the government is forbidden to use public money to campaign in support of the treaty, and the law obliges the media to provide equal public broadcasting time to both sides of the argument, Hugo Brady notes. "This means that the No campaigners are benefiting from ample media coverage, despite representing a very small number of seats in Ireland’s parliament."

And the main arguments of both sides are "fear" and "anger," the analyst says.

"Yes" because of fear

The main argument of the fiscal compact proponents is the fear that its rejection could deprive Ireland of access to the permanent eurozone bailout fund - the European Stability Mechanism, which is to start operations in July. Ratification of the Stability Treaty is a precondition for borrowing from the fund. Ireland will continue to receive funds under the current rescue programme from 2010, amounting to 67.5 billion euros, which is funded by the temporary rescue fund EFSF, the IMF and bilateral loans from Britain, Denmark and Sweden. But the programme expires in the end of 2013 and Dublin is then expected to have returned to financial markets to raise funding at a reasonable price.

The first signs of returning investor confidence are here, Ireland is the best performer among the countries with bailout programmes (the others are Portugal and Greece), but the economic prospects are still uncertain and a possible rejection of the fiscal compact can easily destroy the fragile market confidence and make another European loan needed. The treaty’s opponents reply to this by saying that nobody in Europe will allow Ireland to fail and drag the eurozone along, so even if the treaty is rejected, the country will still be eligible for borrowing from the bailout fund. And even if not, Dublin could always ask for an IMF loan, without having to cede more powers to Brussels.

This argument, however, seems increasingly irrelevant, having in mind the situation in Greece. The previously unthinkable hypothesis of a Greek euro exit is now considered a possible option, while the euro area and its partners are preparing contingency plans. And if the firewall fails, no one in the euro area is insured against any future shocks.

"No" because of anger

The Irish are still offended by the way their country was forced to ask for a bailout, although they resisted to the last. But the market pressure on Dublin was spreading to the south, towards Portugal and Spain, so the European partners exerted relentless pressure on the Irish government to ask for help in order to calm financial markets. The Irish are also angry and tired of austerity measures, tax increases and higher unemployment. So "conditions are therefore set for a protest vote," Hugo Brady says.

In his view, there are reasons to believe that the Irish people will still approve the treaty. "Generally, referendums tend to favour the status quo because voters fear taking risks." Moreover, it covers only the economic policy so it is much less likely the debate to be deflected to some unrelated but sensitive issues like abortion or the creation of a European conscript army, for example, as was the case with the referenda on the ratification of the Nice and Lisbon treaties, the author recalls. Certainly, if the answer of Ireland is "Yes" Europe will rest with relief. But what if it is "No"?

If anger votes, fear will win

A negative vote would be the equivalent of a "credit event" in European politics, Hugo Brady argues. Although it will bring grist to the mill of French President Francois Hollande and his supporters, stating that the fiscal compact must be complemented by growth measures, the result will not soften Germany's resistance against the eurobonds and turning the ECB into a lender of last resort. "Simultaneously, a No vote would inflame opposition against austerity in Greece, Italy and Spain and may trigger calls for referendums to be held on the treaty in other countries." Eventually the markets will interpret the message as a political helplessness and lack of a rescue plan for the euro, and fear will once more take control. The interest rates of Spain and Italy will rise sharply and ultimately "the crisis would return to where it was in November 2011 – before the fiscal compact was agreed – when some felt European leaders had only ten days to save the eurozone."

However, continuing Mr Brady`s thoughts, this time they will probably have no more than 10 hours. Spain is literally on the edge, the black hole of its banking system is going to swallow a large part of the already destitute public finances, and its borrowing costs are at levels where the "rescued" countries were forced to seek bailouts. Italy is wobbling like an ocean liner, headed straight toward the Spanish iceberg that will sink it, aided by the weight of its huge debts. In this situation, even a butterfly perched on the rudder could change the course. We saw the first encouraging signs in Greece, where three weeks before the replay of the elections on 17 June, one of the two major parties guarantors of the bailout programme - the conservative New Democracy, has started to regain popularity. A positive vote in the Irish referendum will revive hopes that the catastrophe can be avoided.