Cause and Effect in European Politics and Law

EU believes Ireland will pull itself out of the swamp

Ralitsa Kovacheva, October 9, 2010

The situation in Ireland was among the main topics discussed during the first day of the informal meeting of European finance ministers in Brussels. The recent numbers announced by the local authorities showed that the costs of bank restructuring in the country will reach 50 billion euro, which will lead to sky-high budget deficit of 32% of GDP. This is the biggest deficit in the euro area since the creation of the single currency in 1999. Two-thirds of the amount is due to the state aid for banks, which is over 32 and a half billion euro so far.

The latest data show that the government will have to set aside 6.4 billion more (and maybe another 5 in case of unexpected losses) for Anglo Irish Bank. Allied Irish Banks (AIB) needs 3 billion and Irish Nationwide Building Society will receive 2.7 billion, the Financial Times wrote. Of these three banks, AIB was the only one included in the European stress tests conducted this summer. The results showed that AIB has passed the test, but is close to the threshold and will need additional capital, although far less than the current 3 billion euro.

“The rescue costs for this one bank represent a staggering 21 per cent of Irish GDP and almost twice the cost of the Finnish crisis in the early 1990s”, the newspaper wrote.

"That particular nightmare the government has had to live with, the Irish people have had to live with, and I have had to live with since September 2008. We're now bringing closure to that", Finance Minister Brian Lenihan said.

Because the new data the country should prepare a new budget plan with consolidation measures and structural reforms by 2014. The government still insists that until then it will be able to limit the budget deficit according to the requirements of the Stability and Growth Pact. For this purpose, however, spending cuts or tax increases amounting to 7.5 billion euro will be necessary. An urgent review of the budget for 2011 will also be needed, although the government has already undertaken spending cuts. As the Minister of Finance said, “I don’t expect that hospitals will have to close or schools will have to close, but I do expect a fundamental reappraisal of the public sector will have to take place in which we secure absolute value for money in the delivery of services”.

The big issue is whether Ireland will resort to the rescue fund for the euro area, like Greece (by the way, in contrast to Slovakia, Ireland did not use its financial woes as a pretext to refuse to participate in the so called European Financial Stability Facility). At this stage, both the local authorities and the EU claim that this is not necessary. The country canceled two bond auctions in October and November, having already gained market financing of 20 billion euro this year and according to finance minister it will not be necessary to return to capital markets by July next year. In the last days of September the price of insurances against Ireland's default reached a record high of 519 basis points after it became clear that more funds would be needed for banks' resolution.

In a special statement the Eurogroup finance ministers backed the Irish government's determination to tackle the problem, expressing confidence that these measures would prove successful and that at this stage, the Irish budget did not need emergency external financing. The President of the European Central Bank President Jean-Claude Trichet and EU Economic and Monetary Affairs Commissioner Olli Rehn also stated explicitly that they believed in Ireland's ability to cope on its own. They explained that the Irish authorities were working in in close cooperation with the Commission and the ECB in preparing the budget plans for the next four years.

The issue was discussed with the IMF Director Dominique Strauss-Kahn, who also took part in the meeting of the finance ministers, and the common position is that emergency assistance is not required. The measures which were undertaken in the last two years by the Irish Government on fiscal consolidation have yielded results, so we believe that the country will cope successfully in the current situation, Olli Rehn said.

Analysts quoted by media, also believe that Ireland, unlike Greece, has options for action. According to Gary Jenkins, quoted by the Financial Times, “The big difference between Ireland today and Greece in May is that Ireland is fully funded and has no need to return to the bond market soon. They are in a difficult financial position, but at least they have some time to restore market confidence.”

John Fitzgerald, a research professor at the Economic and Social Research Institute of Ireland told EUobserver, that the biggest difference between Ireland and countries like Greece, Spain, Italy and Portugal is that balance of payments is going to move into surplus this year. "The private sector will be paying more than the government is borrowing. That makes the Irish situation very different", the analyst said.

The country suffered severely from the bursting of the real estate bubble and banking crisis raging, but its economy began to recover. Alarming signals came from an unexpected contraction in GDP in the second quarter of this year. Even in the optimistic trend of economic development, in the next four years the government will have to fight hard to hold the financial situation under control.