Irish debt crisis and the future of Euro

The problem with economic bubbles is that the existence of a bubble would only be identified once it goes bust! Until then, no one would heed to the cries of hard-core economists.

But experience is a great teacher subjecting you to exams first and then teaching you bitter lessons! Having gone through a global crisis, people are more aware of bubbles and their bangs.

The Irish financial crisis also started off with a bubble formation in the property market. Until it went bust in 2008 global meltdown, Irish banks were lending like crazy to property developers.

Anglo-Irish bank, now on the ventilator, was the craziest lender.

In a lending frenzy, almost all the banks in the nation vied for property developers’ business pie, resulting in a sharp upward movement in house prices and office-space costs.

Finally the house of cards came down with property prices tumbling down by a whopping 50-60%. Bad debts resulted out of reckless lending to property developers got accumulated.

Now the Irish republic is gearing up—and it is a slow-motion shift—to bail out the banks at a cost of 45 billion Euros! This means, the government will run a budget deficit equivalent to 32% of GDP this year!

Needless to say, Anglo-Irish bank is now nationalized. To save this bank alone, government must pump in 35 billion Euros!

Recently S&P had brought down the credit-worthiness of the Irish Republic.

The nation’s sad state of affairs was very much evident when it implemented two emergency budgets in October 2008 and April 2009, respectively, followed by a drastic cut in public pay in another budget in December last year!

In the bygone year, Irish economy shrunk by 10%; the worst in Europe.

The coming budget, slated to be unleashed this December means:

-Ireland should make 15 billion Euros in savings by 2014
-Public spending would be less by 4.5 billion Euros next year
-Tax rates would be up, to collect 1.5 billion Euros in 2011
-6 billion Euros in cuts will have to be effected immediately to bring down budget deficit down to between 9.5-9.75% of GDP.

Clearly, something has gone wrong with a nation ranking fifth in UN’s Human Development Index.

Known as the ‘Celtic Tiger’ the republic finds it humiliating to approach EU institutions for money, even as the figures tell us, it has already happened! ["It has been a very hard-won sovereignty for this country and the government is not going to give over that sovereignty to anyone.” said Irish Enterprise Minister, Batt O'Keeffe, which the BBC reported]

As of September, the European Central Bank has already lent 83 billion Euros to Ireland’s domestic banks and all Irish credit institutions getting 130 billion Euros by the end of October; the sum is equivalent to the value of Ireland’s current GNP!

But this lending phenomenon, having already breached a Central Bank’s basic policies of lending, cannot be expected to continue.

In such a scenario, Ireland will have to run to European Financial Stability Fund or to European Financial Stability Mechanism for respite.

The latter can lend up to 60 billion Euros while the former is capable of lending many times over sitting on reserves close to 440 billion Euros.

Further, there is the IMF ready to lend 50% of what Europe would provide.

Obviously, tax payers of Ireland are already over taxed making them redundant to be of any help.

The crux of the crisis
It is all about the banking system in Ireland.

Despite being State controlled, the banks in Ireland are finding it immensely difficult to borrow from other banks and financial institutions. Following the market mishap, foreign financial institutions are not keen on purchasing Irish government bonds or are willing to lend to Irish banks.

This has brought about a liquidity crisis in Ireland even as the government says it is fully funded until the middle of 2011 to carry on with routine affairs.

Meanwhile, Irish bond yields exhibited a free rise, signaling uncertainties and lack of confidence in the government’s ability to honour debts.

Political stability of the Fianna Fail-Green Party ruling coalition is also under threat with just a three-seat majority in Parliament.

Why Euro zone should worry?
Ireland being a Euro zone member country, its problems becomes Euro zone’s problem as well.

For instance, Spain and Portugal, two other Euro zone States, also exhibit the same state of affairs as Ireland, in stretched government finances.

With shadows of apprehension in the repayment abilities of the Irish government looming large, it is natural that the lenders are having concerns regarding the replenishment abilities of these two countries as well.

This would seriously inhibit both countries’ ability to borrow from international markets by pushing up bond yields.

Though Ireland is ‘fully funded’ until the middle of next year, the same may not be the case with Spain and Portugal pegging their expenditures on borrowed money!

The threat to Euro
With bond yields rising and bond values tumbling, the interest rates across the Euro zone member nations would rise. This would significantly harm their growth and development with lesser capital for industries.

The crisis thus, would spread to other member nations in the form of a second round of recession.

Since Euro is a multi-nation currency, devaluing Euro is deemed complicated if not impractical. This means, a general short-cut to fiscal and monetary growth through increased exports is out of question.

The only alternative is to tighten the belt and skip a meal! Some of the hard fiscal measures, including significant cuts in spending on welfare programs will have to be adopted.

The social repercussions of such an activity can give jitters to politicians.

In this context, it will not be erroneous to assume that certain Euro zone countries may force themselves out of the Euro embrace.

Portugal has already issued a warning in this regard. Its Finance Minister has urged Dublin to opt for the bail out and “do the right thing” for Euro.

In another instance, Expresso weekly quoted Portuguese foreign minister as saying, “I believe that the parties understand that the alternative to the situation we confront is eventually leaving the euro.” He was expressing his disgust at a political consensus not emerging to save the nation from the current crisis.

Clearly no one prefers austerity measures.

As published in: http://www.commodityonline.com/news/Irish-debt-crisis-and-the-future-of-Euro-33560-3-1.html