Colm McCarthy expresses understandable frustration with the pace of developments in meeting the commitments made on June 29th(see here). Central to Colm’s criticism is what he sees as a fundamental inconsistency between the government’s claims of success in its crisis-resolution policies and calls for some form of official relief on banking-related debt.
Since the resort to an EU/IMF bailout in November 2010, the Government has pursued a strategy with two central components. The first is that Ireland’s debt is sustainable, since the economy is recovering and budgetary adjustment will be delivered on schedule. Ireland will re-enter the bond market and exit the programme at the end of 2013. The second is the pursuit of relief from a portion of the bank-related debt, on the grounds that it was improperly imposed.
Last week’s events should highlight once again the inconsistency of this strategy. If things are going fine, why is there any need for debt relief? The best case for debt relief (Greece was relieved of €100bn) is inability to pay.
The insistence that things are fine, that budget adjustments are on schedule, three-month Treasury bills can be sold and Ireland will exit the rescue programme next year, is a serviceable domestic political message. But it is also an open invitation to our European ‘partners’ to offer no assistance whatsoever outside the terms already agreed.
A better negotiating platform, and one with at least equal plausibility, is the following: that the debt is not sustainable and will reach 150 per cent of national income; the economy is flat and will remain so; the politics of further retrenchment are getting too difficult and debt relief is inevitable. The Government should quit behaving like the marketing arm of a debt-management agency.
Although I always hesitate to disagree with Colm, I don’t see the government’s strategy as fundamentally inconsistent. Since peaking at 15.81 percent on July 15, 2011, the yield on the benchmark 2020 bond has followed a strong downward trend to close at 4.53 percent on Friday (Bloomberg). Assuming a recovery rate of 50 percent in the event of a private-sector default, that the yield on the equivalent German bond represents the risk-free rate and risk-neutral investors, the implied probability of default peaked at 83.8 percent in July 2011 before more than halving to 39.7 percent on today.
Of course, a default probability of close to 40 percent is still very high. I think the main reason that the perception of default risk still remains so high relates to the uncertainty surrounding growth prospects. A poor outcome on growth could make the necessary fiscal adjustments to meet the conditions for official support without a private-debt restructuring politically – and possibly even economically – impossible. Adverse growth shocks will also do more damage to the ability to meet deficit- and debt-reduction targets the higher is the starting debt ratio.
Recognising the common interest in a successful return of Ireland to creditworthiness, there is a case for making adjustments to official policies that reinforces the improvements made so far. One such improvement would be to lengthen the period for paying down ELA and make continued access to that funding more reliable. By rewarding countries that meet their commitments rather than the opposite, such actions should also help to reduce official-lender concerns about moral hazard.
I worry that emphasising unsustainability under current conditions would suggest a weaker commitment to meet the conditions required for official support. Any resulting weakening of perceived creditworthiness could itself undermine growth by raising the spectre of Greek-style chaos. I believe it is better to emphasise that Ireland fully intends—and expects – to do what is necessary to avoid default, but there are certain factors that it simply can’t control. Recognising this, there is indeed a common interest in adjusting official support policies to further support a “well-performing adjustment programme.”