Gillian Tett’s Financial Times column today praising the Irish government’s approach to fiscal adjustment relative to that of Greece, Spain or Portugal is welcome. Without doubt, the government has taken a brave approach to fiscal adjustment and the public reaction to it has been one of remarkable tolerance. However, I think we need to be careful about overdosing on external and self-praise and concluding that we’re somehow out of the woods on the fiscal front.
I was a guest on RTE’s Late Debate program last night and heard Fianna Fail TD Frank Fahey declare that the UK had greater fiscal problems than Ireland. This judgment was perhaps based on the fact the UK is also running a large budget deficit. However, it is worth factoring in that the UK has provided discretionary stimulus of about 2 percent of GDP and has allowed its automatic stabilisers to fully function, while we have had to go in the opposite direction by applying fiscal contractionary measures and cutting back on automatic stabilisers by reducing unemployment benefits. The comparable size of the two deficits hides the underlying reality that, without denying the tough road ahead for the UK, our path towards fiscal stability is a tougher one.
Beyond the deficit, there is little doubt that financial markets are also concerned about the potential costs of the banking situation due to recapping Anglo and INBS (and perhaps more for the two big banks at some point), losses from NAMA and the sovereign’s commitments under the guarantee.
In relation to the latter, I noted on the radio show (near the end) that the fact that the NTMA has €27 billion in its coffers is also regularly cited as a reason not to be too worried but that one needed to remember that the Irish banks covered by the guarantee have maturing loans prior its expiry that exceed this figure and that this represents a risk factor. Deputy Fahey immediately declared that it was irresponsible of me to suggest we should be reneging on bank senior debt and that he couldn’t understand why academics like me have been going around recommending this.
In relation to this, I’d note (a) That’s pretty clearly not what I said (b) That hasn’t been my position over the last year and there’s tons of public record to illustrate that. However, even if one supported a guarantee for senior debt, that doesn’t mean you have to ignore the risks associated with such guarantees, which are very real.
The fact remains that, for all the talk about international praise for our approach, the market judgment on our fiscal situation as of last week was one that questioned its sustainability. That Irish bond spreads have fallen as much as they have since Sunday’s announcement is an indication of how reliant we are now on EU support.
It may be that the ECB’s secondary bond market interventions are enough to keep our primary bond market open but then again they may not (we don’t know much about these interventions yet). If not, then the possibility of having to call on the emergency fund at some point is very real. And if that comes to pass, the adjustment program that would be put in place will undoubtedly be very tough.
An important unknown is whether such a package should involve the Irish government backing off on the full scale of its support for the banking sector, for instance by focusing its support on the two main banks and depositors in other banks and letting other institutions fail. Over the past year, the argument against letting institutions fail has often revolved around the potential repercussions for our ability to borrow in the sovereign bond market, but a program like this will be only implemented if we have already been shut out of this market.
The other argument against letting institutions fail relates to financial stability but this could play either way. Yes, the failure of one institution could undermine confidence in the rest. However, if the government only has a finite amount of EU\IMF money to play with and finite time horizon to sort itself out, then a credible commitment to back the part of the banking sector that matters may work better than an incredible attempt to maintain a blanket support.
Quite possibly, I’ll be castigated for not wearing the Green Jersey by even contemplating this scenario and discussing the options that may be open to us at that point. But since ubiquitous Green-jersey-thought was a major part of what got us in to this mess in the first place (with the notable exception of Morgan Kelly and a few others) I won’t worry too much about that.