Posted on Tuesday 21 December 2010 byUlster Business
Although the Irish Government gets very little sympathy, interested observers should be aware that it has had to deal with the worst financial crisis in the history of the Republic of Ireland.
The Government has inherited the consequences of banking crises which, arguably, when they erupted, were largely the product of the banking system and partly enhanced by an excessive degree of loose regulation by several official authorities.
Looking back with the clarity of hindsight, bank lending in Ireland, north and south, increased far too rapidly and by too much. The lending spree should have been restrained but the international flow of liquid funds was largely unchallenged, the credit creation multiples were accepted and, given the history of capital gains through the property markets, capital borrowing tied to property development was thought to be secure.
Unfortunately, the bursting of the property bubble put all the economic and monetary forces into reverse. Over-extended credit was reined in, or, the banks attempted to rein it in. Property owners saw market values fall. Bank lending was no longer backed by adequate security.
The scene was set, potentially, for a dramatic banking collapse in 2008 which was avoided (narrowly) by Government action to guarantee bank deposits, followed by unparalleled Government borrowing and the particularly Irish institutional solution, NAMA (the National Assets Management Agency). The scale of the problem in the UK was smaller but the same sequence of loss of solvency and subsequent Government bail-out occurred.
The property crisis fed into the crisis in bank liquidity and bank solvency and, in turn, continued economic life depended on managing a massive Government borrowing requirement with its consequences for taxation and spending.
Economic history will criticise the activities of the banks. Less prominent, but just as important, economic history will congratulate the Department of Finance in Dublin led by Brian Lenihan on the early response. The exception which is now clearer, is that the Irish Government guarantees were too wide ranging.
Several of the banking institutions have continued to function on the equivalent of a life support machine. No bank failed to the point where deposits were not honoured. Morally, but not financially, some of the banks have failed.
Once the crisis erupted, the Irish Government earned respect for its complex administrative responses. Of course, there are critics. Wrongly, some criticise the Government because the corrective burden has fallen broadly heavily on the shoulders of the general population rather than the bankers. That argument rests on the flawed assumption that the bankers have been ‘bailed out’. In fact, most Irish bankers have paid and are paying a large price. The ‘bail out’ has, fortunately, benefitted the depositors who are themselves the general population.
The evolving consequences of the crisis have become clearer and have been more dramatic than was generally expected. Serious weaknesses lead to the arrival of the international rescue package sponsored by the EU, the European Central Bank and the International Monetary Fund. The rescue package is very large. It needs to be.
However, the whole Irish economy has not become a basket case. There are some features that show a varied picture.
First, and reassuringly, most of the main non-Government and non-banking parts of the economy, have continued to function remarkably well. Of course, the private sector has been affected by the fall in Government spending and the contraction of commercial credit and the restraint of the banks as they try to rebuild their capital reserves.
Second, without knowing that the banking and Government financial crisis was coming, the Irish economy has been well disciplined by its membership of the euro-zone. This has meant that there was no scope for a devalued Irish pound to enhance the competitiveness of Irish exports and deter imports. However, the potential scale of any devaluation is so large that the discipline of living with the fixed exchange rate of the euro was a lesser evil.
Third, Irish cost competitiveness is being hard won as Irish pay rates adjust to lower levels.
Fourth, international business investment has continued. A possible major loss of confidence, particularly in the USA has not been obvious. However, that reassurance should be qualified. It could be damaged if the Irish political scene produces a Government where there is disagreement about the best steps for ‘the national interest.’
The support of the European Commission and the European Central Bank has been critical in giving greater stability in the vulnerable period ahead.
The last stages of the Government and financial crisis showed much more serious difficulties than had been admitted at first. Holders of Irish bank debt, the bond-holders, withdrew large sums of money, leaving the European Central Bank as the last resort lender.
The European Central Bank, faced with needs that became unacceptably large, ‘blew the whistle’ and the rescue package was requested.
As this comment is being written, the end game is far from certain.
The best hope is that the Irish Government will become a responsible and stable organisation that can deliver the budgetary adjustments that are needed. These budgetary adjustments are also likely to be initial conditions for the rescue package to be made available. This combination would give a clear message to the people and businesses, north and south,for whom some certainty on the impact of decisions is necessary. An effective and efficient rescue deal would be good news. Stability and certainty would be significant improvements on the confusion that emerged in late November.
In contrast, a caveat should be entered about an unclear and painful delay in making necessary decisions. The worst case scenario is frightening to contemplate. The hope must be that the serious consequences of a failure to use the rescue package efficiently will itself be the driving force to bring the key stakeholders to their senses.
For Christmas, the Irish economies cannot expect a major upturn. Living with a controlled recession will be a better answer than a ‘free fall’ with inadequate protection. Just in case there might be a false Northern Ireland reassurance that all this is a ‘southern’ problem, northern businesses and employees will quickly appreciate that contagion in economic and financial markets cannot usually be prevented from crossing borders. Northern Ireland has a very significant interest in hoping that the Irish rescue package succeeds.
The actions of the Irish Government and the other Irish agencies are, on this occasion, critically important for the whole of the European Union, the Euro-zone and the stability and living standards of many millions of people.
Irish bailout in numbers
At the end of November the Irish government reached agreement with European finance ministers over a bail-out deal worth in the region of €85bn (£72bn).
The deal will see €35bn pumped into the Irish banking system and the remaining €50bn go towards the Dublin government’s day-to-day spending.
Taoiseach Brian Cowen also revealed a four year deficit reduction plan required for its deal with the EU and IMF bail-out. The plan – designed to save the state €15bn over four years – involves deep spending cuts that are likely to result in significant job losses.
The measures, listed below, caused thousands of protesters to take to the streets of Dublin, calling for an immediate general election – something Mr Cowen refused to do.
Some of the key announcements included:
• €10bn (£8.5bn) of spending cuts between 2011-2014, and €5bn in tax rises
• minimum wage to be cut by one euro to €7.65 per hour
• €3bn of cuts in public investment by 2014
• €2.8bn of welfare cuts by 2014, returning spending to 2007 levels
• reduction of public sector pay bill by €1.2bn by 2014
• the reform of public sector pensions for new entrants with pay cut by 10%
• corporation tax rate to remain unchanged at 12.5%
• 24,750 public sector jobs to be cut to save €1.2bn
• VAT to rise from 21% to 22% in 2013, then 23% in 2014
• raise an extra €1.9bn from income tax
• abolition of some tax reliefs worth €755m
• real GDP to grow by an average of 2.75% from 2011 to 2014
• unemployment to fall from 13.5% to below 10% in 2014
• the introduction of domestic water charges by 2014.