Despite the protestations of Ireland (from Brian Lenihan, the country’s finance minister), EU finance ministers have signed off (on 28th November) a bail-out package totalling €85bn. At the same time, they approved the broad principles of a ‘permanent mechanism’ for tackling future eurozone debt crises of this kind. This new plan is designed to head off possible future contagion risks (essentially, bad news about one country sparking off concerns and overreactions by financial markets about the problems of other countries ) for countries like Portugal and Spain.
The deadline for the plans for the new ‘permanent mechanism’ for intervention to secure stabilisation were accelerated from their original December target date. This new plan is designed to replace the existing €440bn eurozone rescue fund (which expires in 2013) with a permanent ‘European stabilisation mechanism’. Under the new plan, private investors will also play a role in any future debt rescheduling or collective actions attached to eurozone government bonds. The new European initiative is based on current IMF (International Monetary Fund) practices and experiences at a global level. These moves are designed to calm bond markets within the eurozone. They should also help clarify the involvement of the private sector in any government debt crises in the future.
The Irish package involves EU countries and the IMF providing funds up to a ceiling of €85bn and these may be drawn down over a seven and a half year period. These funds will be deployed broadly as follows:
- €50bn to help support Ireland’s public finances as Ireland brings in a €15bn austerity package over a four year period
- €10bn will help recapitalise Ireland’s stressed banks
- €25bn will be used as a contingency fund to help support (if needed) the Irish banking system.
Alongside this €85bn, Ireland and the IMF will put an additional €17.5bn and €22.5bn, respectively, into the bank contingency fund. Three bilateral loans from the UK, Sweden and Denmark complete the overall package. The average interest rate of the package is almost 6 percent, which Irish opposition parties argue is high, since the overall package effectively closes off shorter-term borrowing (at lower rates) by Irish banks from the European Central Bank (ECB). The average interest rate secured by Greece in May, for example, was significantly lower at 5 percent.
These strong moves to secure an effective Irish rescue package were preceded by market turbulance. Standard and Poor’s decision in late November to downgrade Ireland’s long term debt rating from double A minus to A was not unexpected. At the same time, European bank shares fell strongly as speculation mounted that even high ranked bondholders in Irish banks might be forced to take losses in the future, thereby propagating more contagion risks throughout the financial system. With soaring borrowing costs in Spain and Portugal, market concern was inevitably wider than the Irish crisis.
The Irish (and wider eurozone) crisis is still an unfolding story. In mid-December, the European Central Bank (ECB) announced an additional €10bn lifeline to help shore up the Irish banking system. This takes the form of a temporary liquidity swap facility with the Bank of England and it will give Ireland’s central bank more scope to offer emergency liquidity support.
Moody downgraded Ireland’s credit rating in mid-December by five notches from Aa2 to Baa1. Ireland was also put on ‘negative outlook’ over increased uncertainty about the country’s economic outlook and the government’s financial strength.
As the New Year develops, markets will need to absorb fully the full implications of the new Irish package. A lot will depend on whether Ireland can meet the austerity and economic growth targets that it has set. There is no doubt that the Irish banking system is going to change ‘beyond recognition’. A critical challenge will be to clean up Irish bank balance sheets (by removing bad loans) without renewing pressure on bank capital (for example, by precipitating further exceptional loan losses).
At the same time, the market remains concerned about wider eurozone pressures. With countries like Greece, Spain, Portugal and even Italy under the spotlight, market overreaction becomes a serious threat as 2011 unfolds. However, the latest measures to support Ireland and the new EU stabilisation mechanism should help to reduce the risks of market overreaction and contagion. The continued (albeit slow) recovery of the global economy is also fundamental. Nevertheless, uncertainty remains a problem for markets and analysts.
Professor Bullion
