Alex Massie

Ireland Tries to Pacify the Bond Market

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Thursday is an important day for Ireland and, in the end, another reminder that Ireland's economic woes and the measures taken to alleviate them don't offer much of an example for other countries or their governments.

The Irish government is going to have to announce its plan for bailing out (or not) Anglo Irish Bank's bondholders. None of the options - outlined by the FT here - seem attractive. The political cost of meeting the bond market's hopes will be severe; the economic cost of not doing so could be equally horrendous.

Robert Peston has a good post explaining just why the Irish economic elite is so out of touch with the views of the man on the Drumcondra omnibus:

Ireland's dependence on credit from abroad is so great that the economic consequences of that credit being withdrawn would be catastrophic.

[...] Total foreign bank exposure to Ireland's economy is $844bn, or five times the value of Ireland's GDP or economic output. Of that, German and UK banks are Ireland's biggest creditors, with €206bn and €224bn of exposure respectively.

To put it another way, German and British banks on their own have each extended credit to Ireland greater than Irish GDP. Which doesn't sound altogether prudent, does it?

As for direct bank-to-bank lending, overseas banks have provided Ireland's banks with €169bn of loans, which is also greater than Irish GDP.

Here's the point: an economy as open and as dependent on foreign finance as Ireland's cannot afford to alienate its creditors. If those overseas lenders asked for their money back now, Ireland's recent fall back into a modest economic contraction could spiral into dark deep prolonged recession or even depression.

There are two big conclusions to be drawn. First Ireland's inability to let market forces take their course will be seen by many as another example of why the banking industry has lost any semblance of right to operate according to normal commercial freedoms.

Second, the Irish economy is hideously and perilously balanced between recovery and Armageddon.

The Irish government has extended till the end of the year its formal guarantees to protect from losses more than €400bn of retail and wholesale loans to Irish banks (banks' subordinated debt is excluded).

But, to state the obvious, those guarantees are only reassuring to creditors if the Irish government is perceived as able to honour its own debts.

The credit-worthiness of the Irish government is largely dependent on two related factors: the delivery of its promise to reduce the public-sector deficit from an unsustainable 14.3% of GDP in 2009 to less than 3% of GDP by the end of 2014; the stabilisation of losses at Irish banks that are being underwritten by the government.

[...] Of course, the great fear for the Irish government is that its putative virtue in making deep public spending cuts - and Mr Lenihan conceded that there are some big and painful decisions ahead - will further undermine confidence in the value of Irish assets, triggering further losses at banks, and thus eliminating the fiscal benefits of the deficit reduction programme.

Or to put it another way, it will be many months yet before Ireland can be certain it's over the worst.

For the background on the crisis at Anglo see Simon Carswell's piece "The Big Gamble" in Saturday's Irish Times.

Written byAlex Massie

Alex Massie is Scotland Editor of The Spectator. He also writes a column for The Times and is a regular contributor to the Scottish Daily Mail, The Scotsman and other publications.

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