We are delighted to have recruited the services of banking and finance expert, Professor Bullion, who will provide regular reports on the the global financial markets and economy.
Ireland was not so long ago the ‘tiger economy’ of Europe, the so-called ‘Celtic Tiger’. High apparently sustainable economic growth and a strong emerging financial centre were amongst the hallmarks of the Celtic Tiger’s impressive success. Property and banking were boom sectors, but they were also subsequently the harbingers of crisis and meltdown.
Today, Ireland is one of the most troubled economies in Europe, a member of the so-called PIGS (Portugal, Ireland, Greece and Spain) group of economies. Ireland is not yet in the more dire straits of Greece, but it faces many of the same kinds of problems as Spain and Portugal. Greece, Ireland and Portugal are on many counts, though, the present three weakest economies in the eurozone.
On September 29, the yield on Ireland’s ten-year government bonds approached 7%, a record spread of 4.7 percentage points above the equivalent German bunds. During recent months a veritable tsunami of economic problems has beset Ireland. There has been a sharp drop in output during the spring and the cost of bailing out the banking system continues to grow. The latest £43.6 bank bailout is enormous by any standards. Unemployment is close to 14% (compared with the UK’s 7-8%).
It is not as if Ireland has not faced these challenges in a determined and pretty robust way. A key feature of the Celtic Tiger’s previous success was its flexible economy and this remains a plus. New taxes have been raised and public-sector wages have been cut.
During recent weeks the scale of Irish banks’ property-related losses has become clearer, together with the amount of public money needed to bail out the banks. A major problem is the final cost of bailing out the nationalised (in January 2009) Anglo Irish Bank, described by The Economist (October 2) as …’a hugely reckless property lender‘. In late September, the Ratings Agency Moody’s downgraded the junior and senior debt at Anglo Irish. The Irish Finance Minister (Brian Lenihan) has publicly stated that it is ‘unthinkable’ that Ireland or an Irish bank would default on senior debt.
The final cost of rescuing Anglo Irish Bank could be 34billion euros (£29.6 billion). This is much higher than that predicted (20 billion euros) just six months ago. A small group of London and US hedge funds have threatened to take legal action if the value of their holdings in the bank is reduced via the proposed rescue plan. The increased capital for Anglo Irish Bank and INBS (Irish National Building Society needs 5.4billion euros) will increase this year’s budget deficit to 32% of GDP. This is 10 times greater than permitted for euro member countries. The Irish Government had initially planned (and hoped) to keep its deficit to around 12% of GDP. Overall National debt is set to approach 100% of GDP (and some believe it could grow eventually to 150%).
Ireland appears to be at the brink. Nevertheless, the government is apparently determined to avoid a bailout from Europe. For the present, though, Ireland has postponed its monthly auctions of government debt until January. The hope is that the international markets will by then have recovered from the shock of the country’s massive bank bailout announced at the end of September.
But there are some positive signs. For one thing, the full extent of property-related banking losses and bank rescues appears to have been reached. Ending this uncertainty is a clear plus. The Irish Government is also attempting to take these hits up front (though it had little apparent choice). A lot will now depend on whether Ireland can produce a credible four-year budget plan to the European Commission in November in order to bring the budget back under control. In this process and during the rest of this year, Ireland’s present status as a low tax country will come under close scrutiny. Higher taxes in Ireland appear to be an inevitable fact of life. Although increased taxation must contribute to meeting the deficit, Irish ministers appear strongly wedded to keeping Ireland’s low (at 12.5 %) corporate tax rate.
Ireland’s rapid demise from Celtic Tiger to PIGS has been dramatic. On the one hand, it raises the potential of even closer control in the future on domestic national budgets by Brussels. But it also underscores some of the problems of being a euro-member country faced with events like the recent crisis.
Unlike Ireland, the UK has resisted previous strong moves (from the likes of Tony Blair) to join the euro. As a result, Britain retains full control of its currency and was able to exercise a monetary policy targeted at its own economy (rather than one set for the eurozone countries as a block).
Ireland, on the other hand, had its boom unrestrained by a monetary policy that was influenced primarily by the needs of Europe’s dominant economy, Germany. In the UK, the Bank of England’s policy exercised some restraint on the pre-crisis boom: interest rates were higher and money growth was generally lower than in the rest of Europe. Effectively, Britain was able to achieve a controlled 25% devaluation and to accompany its fiscal consolidation with a ‘quantitative easing’ through increased money supply.
It could be argued that, even so, Ireland’s membership of the eurozone conferred (and will bring) benefits that outweigh the costs of not being able to pursue on independent monetary policy. Nevertheless, the UK’s continued ability to practice an independent monetary policy has clearly been an important factor in its ability so far to meet the crisis. Of course, further ‘crisis tests’ may lie around the corner. For the present, through, the jury will be out for some time yet on the impact of the PIGS experiences for the future shape of the euro. In the months ahead, the immediate danger to the eurozone is if confidence was ever threatened badly in larger economies (like Spain and Italy).