Escape Velocity

Nearly three years after losing access to the sovereign bond market, Ireland appears to have built sufficient momentum to escape the troika’s orbit. Come early 2014, the country will no longer be subject to its quarterly visits and binding targets. The government will have succeeded in its number one political objective: ‘regaining our economic sovereignty’. But, what will really change?

When Ireland was first bailed out, I and many others thought it unlikely that the country could succeed in regaining market access by end-2013. In mid-2011, with interest rates on Irish government bonds soaring into double digits, such a benign scenario looked ever more remote.

Then, things changed. Increasingly, Ireland came to be seen as a special case, different from the struggling ‘Club Med’ countries. Irish bond yields fell dramatically, decoupling from those of Greece and Portugal. New ECB President Mario Draghi signalled that he was willing to do ‘whatever it takes’ save the Euro. Ben Bernanke, his American counterpart, kept the printing presses running, doubling down on his so-called ‘quantitative easing’ experiment. No doubt, this ‘easy money’ helped Ireland’s cause. High profile financiers made multi-billion euro bets on Ireland’s recovery story, and are already sitting on massive paper profits. The Irish banks also got in on the act, racking up significant holdings of Irish bonds rather than lending to businesses or households. Internally, economic pain may be manifest, but externally the mood music has been mostly positive.

While it is still possible that some precautionary mechanism will be put in place to back-stop the bailout exit, ensuring durable market access even in the face of financial volatility, it now appears the country has built up sufficient steam and credibility, not to mention a war chest of some €25bn, to stand on its own two feet. Surely this heralds the return of sovereignty and the end of austerity?

Firstly, a sustained benign global environment cannot be assured as Bernanke powers down those printing presses and as political pressures in Greece, Portugal and elsewhere continue to fester. Progress could be rapidly reversed if market jitters return.

Secondly, economic growth has continued to fall short of expectations. Without a pick-up in the coming years, the national debt could reach 130% or even 140% of GDP, raising fresh doubts about sustainability.

Thirdly, the banks are far from fixed. Debt write-downs are inevitable, and if these prove to be bigger than expected, taxpayers could be called on to foot the bill. Already, it is likely that the banks will need a public cash injection to meet the new capital adequacy rules by 2019. This would also push the national debt higher.

Fourthly, due to both EU rules and the exigencies of the bondholders who will finance Ireland’s debt and deficits (i.e. they will charge higher interest if it looks less likely that they will get their money back) the public finances will remain tight for many years to come. It could be the 2040s or later by the time the national debt falls below 60% of GDP. When the troika is gone, and austerity is over, there will not likely be an imminent return to the years of plenty.

Finally, to a certain extent fiscal sovereignty is a mirage. All borrowers face conditions set by lenders, whether private sector bondholders or public sector bureaucrats, and countries are no different. Of course, it will be symbolically important to ‘wave goodbye to the troika’, but in reality, little can be expected to change in the near term without a return to robust growth. Explicit constraints imposed by the ECB, Commission and IMF will be replaced by those implicit constraints imposed by financial markets.

There is always an alternative, of course. Now that tax revenues almost cover all spending bar interest payments (i.e. what is known as a primary surplus) Ireland could perhaps credibly threaten default in 2014 without having to balance its books overnight. Detonating this nuclear option, however attractive it may sound, would likely shut the country out of financial markets altogether – removing the option of running deficits in the near future – and / or see a return of multilateral lenders armed with conditions. While this would not make a Euro exit inevitable, it would certainly make it more likely. If the risks set out above were to materialise, however, the nuclear option could fast become the default option.

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