Note: I had not seen Karl’s post before writing this one, so it is not meant as a response. Since the two posts cover somewhat different ground I hope they are complementary.
The argument is increasingly heard that if Greece is allowed a write-down on its debts then Ireland should be allowed a similar treatment. Unfortunately, a number of different things seem to get jumbled together in the discussion: the costs and benefits of default on State debt; the costs and benefits of default on senior bonds in the former Anglo and INBS; and the costs and benefits of restructuring the promissory notes. I don’t pretend to have all the answers, but it seems worthwhile to try to disentangle the different elements.
(1) Implications of a Greek write-down for the possibilities of an Irish write-down
There is almost universal agreement that Greece’s debt is unsustainable. Largely against the will of the Greek government, the EU/IMF funders are demanding burden sharing with private sovereign bondholders. This is unlikely to ease the austerity burden being imposed on Greece. The immediate benefits will go the official funders in the form of reduced loans that they have to make to Greece.
So could Ireland follow the same path? While we are certainly not out of the woods in terms of debt sustainability, the situation here is quite different. The debt to GDP ratio is projected to peak at about 118 percent of GDP in 2013. Irish bond 9-year bond yields have fallen from a peak of around 14 percent to about 8 percent now – still far too high to return to the markets but reflecting increasing confidence that Ireland will avoid default despite the chaos in the European crisis-resolution effort. Whether or not you believe that Ireland’s debt is sustainable, a move by Ireland to default on its sovereign debt is likely to be badly received by the official funders. There is no guarantee that official support would continue to be forthcoming. Loss of that funding would require the deficit to be closed cold turkey, with the austerity having devastating effects on living standards and the economy. Even it official funding continued, it is highly unlikely that the required austerity measures would be lessened. My conclusion is that it is hard to see a short- to medium-term gain from defaulting, with huge downside risks.
Longer-term, a default would obviously enough lower the amount of money we have to pay back. Against this would have to be weighed the cost of the loss of the asset of creditworthiness/reputation. Defaults can sometimes be viewed as “forgivable” if undertaken (or forced) as a last resort. The reason is that they don’t reveal that much about the country’s underlying willingness to honour its debts. A default by a country that can pay is quite different, and would involve a huge reputational loss for a country that begins with a strong reputation. Creditworthiness for a country with a large debt, a volatile economy and a large dependence on inward private investment is extremely valuable. I find it hard to see how a cost-benefit analysis would support trying to voluntarily follow a Greek default precedent.
