The text of Peter Sutherland’s speech to the Institute of Directors is below:
Notwithstanding the successful auction of €1.5bn of government debt on Tuesday, there is no doubt that in recent weeks (and in particular in the last two weeks), Ireland’s position in the debt markets has deteriorated markedly and the sale came at a high cost. This has been the consequence of a number of factors. Some of these are objective facts about the dire state of our public finances. Others are the result of market perceptions. It is hardly surprising at present that there is an air of fatalism consistently nurtured by negativism but it is surely not in our character to give in to this. We can and will get out of this mess if we have the will to do so.
Let me say a word first about market perceptions. We seem to have a remarkable capacity to damage our public image abroad. The prevailing and understandable sense of depression in Ireland is made worse by a media often seemingly intent on presenting the worst perspective on current events. The recent Barclay’s analyst report, which was wrongly presented by some in the Irish press as being far more negative than it actually was, is a case in point. You may say, “Well so what? Those professionally concerned with our credit worthiness surely do not decide their approaches on the basis of second hand commentary on an analysts report?” Well, yes and no. The national media reaction is taken seriously and market reactions are often instantaneous.
It is time that we separated two big issues, the underlying budget deficit and the bank crisis. The first of these presents a very challenging issue but it can be dealt with if we have the collective will to do so. The collective will can only result from an understanding of the facts. We are running a revenue to spending gap of circa €20 billion p.a. and simply cannot continue to do so. As Willem Buiter, formerly of the London School of Economics, said this week, the cost of borrowing is becoming unsustainable. Our national debt is accumulating still at an alarming rate as a result of government spending but is being obscured as an issue in public debate by the constant and intense focus on the nature and effects of the banking crisis. Terrible though these are, they are identifiable and should be considered separately.
Unfortunately the budget deficit is not going to be solved by growth because the required level to do this is outside any reasonable forecasts. Furthermore growth is not going to be adversely affected by the right kind of cuts. Even if things go reasonably well in the global economy the most that the majority of commentators expect is anaemic growth in the US and a broadly similar pattern in the EU. Whilst the likelihood of a double dip in the OECD countries is small we are not going to be driven by an external locomotive in Europe or the US to very high growth rates. We can, of course, do something about our own growth prospects ourselves. The Nordics have proved this. This however can only really be based on improved competitiveness and this in turn requires many more hard decisions. Competitiveness is all about productivity. Our costs are still far too high. We have really failed to benchmark our costs – particularly but by no means exclusively, wages and salaries – to other European countries. If we did so it would be apparent that we are still way above average in many areas particularly in the public sector and this says nothing about pension costs. We have to recognise that as currency devaluation is not an option downward flexibility in wages and prices is essential to avoid unemployment. We also have the McCarthy Report recommendations which remain largely untouched. I wonder how many of our politicians or commentators have actually read it. These show viable routes to cost reduction. The Competitiveness Council too has been pointing out the path for years but has largely been ignored.
The figure of €3bn has been postulated as the improvement to be sought in the next budget. We are told that this is all that the political system can bear but if all the mainstream political parties accept that more is required (although disagreeing perhaps about where to find the 3bn) and are prepared to say it, we can find a way. The Governor of the Central Bank has said we should do so. These cuts involve pain. But the alternative is much greater pain through the higher cost of borrowing if we fail to act decisively. Further as a result, the scale of future adjustment would be higher. Almost a year ago we acquired a credibility that is in danger of being lost. We acquired it because of a brave budget. Since then others in the periphery have stepped up to the plate too and some appear to be going further than we have contemplated. They have been politically helped to do so initially by the example of Ireland. We now have to step up to the plate yet again to recreate confidence. We will be given no benefit of doubt and reliance on growth is not going to work. Our GDP growth may look reasonably good but we live in the context of a weak external environment and tax returns are much weaker than expected.
A number of alternatives to the approach I have outlined have been muted. One of these is to aim for a much slower rate of budgetary adjustment. Allegedly this will keep the economy in a more positive state. This simply will not fly as an option. Any weakness in one budget will be punished by the market in a manner which we will be unable to take. In any event it is often a shorthand for avoiding decisions that will in fact result in greater efficiency. So also with the argument about restructuring our debts or default. This would leave us without the capacity to manage our own affairs or to raise finance effectively at all. It simply is not an option to choose. So we must follow the painful but plausible course of continuing to reform our economy in a manner that removes the glaring inefficiencies and excesses of the past.
The Financial Times amongst others has put forward the classical market economist case for the removal by the government of its support for bondholders. Superficially this may appear appealing and I believe that countries in Europe and elsewhere will eventually introduce a legal infrastructure to allow for the orderly winding down of banking entities and instil moral hazard. However a bank resolution process in Ireland now is the not the answer to the current problems we face. While agreeing in principle that bondholders should not be protected because they take risks in making their investments and should take the consequences if these go wrong, to remove such protection now in the case of Anglo-Irish Bank might well not be a wise course of action for a number of reasons. If a Bank Resolution Process such as that introduced in the UK were to be passed to allow an orderly winding up and to expose bond holders of subordinated debt and senior debt (not covered by current explicit guarantees issued) then the total maximum saving through creditors taking losses would be €5.1bn. The reason why the figure is only €5.1bn is because as bonds have matured since September 2008 they have been paid off at par and new funding has come from the ECB, the Irish Central Bank and explicit government guaranteed new bond issuance. Presumably the other element in the balance sheet namely depositors would continue in any scenario to be protected So whatever the total figure works out as being only a small proportion could be saved. The risk of taking any such action is that the price would then be paid by the remaining Irish banks which still require external capital and funding and by the Government itself who then need to deal with the increased losses arising from a more immediate wind down of Anglo Irish Bank. This view is postulated on the current state of incomplete knowledge as to the actual figures relating to both Anglo Irish Bank and AIB.
Incidentally no other OECD country (other than Iceland) has allowed a major retail bank to default on its senior debt. While the UK has a special resolution regime it has never used it to restructure senior debt. The FT proposal is flawed in theory and extremely damaging in practice.
The “collateral damage” of such a decision would be very serious. For a small country such as Ireland to default on government guaranteed debt when the funding position of the government (and the other Irish banks) is already precarious, would surely precipitate a funding crisis both for the sovereign and the banking system as a whole.
A broader default would also bring few benefits but huge costs. Ireland’s principal fiscal problem is its large primary deficit (rather than a large outstanding debt level). Compared with countries that have large outstanding debt levels, default is a relatively unattractive option for Ireland (because such an option would do nothing to address Ireland’s primary deficit but would cut off its ability to fund its deficit).