ECONOMICS:Substantial contagion has spread into the bond markets of other indebted euro states
THE GREEK bailout arose because the Athens government could no longer borrow at interest rates which permitted it to service its growing debt. If the interest rate moves sufficiently against you, and both the debt pile and future borrowing intentions are large enough, there is an interest rate above which you can no longer make the sums add up.
The Greeks ran out of road, and the result is loss of effective control over their economic policy. For the next three years Greece will be borrowing, at a subsidised interest rate, from the other 15 euro zone members and the International Monetary Fund.
It must pursue a programme of fiscal austerity dictated by the EU Commission and the IMF.
There has already been substantial contagion into the bond markets of other indebted euro zone members. Bond market spreads against Portugal, Ireland and Spain have worsened appreciably – Ireland’s debt management office, the NTMA, is now facing a “penalty” interest rate on 10-year bonds almost three percentage points on top of what Germany, the euro zone benchmark issuer, must pay. This is partly due to a decline in German rates, but mainly to an increase for the peripheral indebted countries.
While Ireland has no immediate need to borrow again, it must return to the markets in due course, and there is now a risk that it will face higher borrowing costs. This is unambiguously bad news, and a piece of bad luck since the decline in Irish spreads, a recognition of the early and sustained efforts to rein in the budget deficit, has now been reversed.
The European Central Bank’s governing council, which met in Lisbon yesterday, must now contemplate a resumption of liquidity support to the countries under fire, and there may be a programme of renewed provision of funds to their banks, as well as direct purchases of official debt.
There is a silver lining for Ireland. The turmoil in the bond markets has been accompanied by a further bout of weakness in the exchange rate of the euro against sterling and the dollar. Of all euro zone members, Ireland has the greatest exposure to trade in those currencies, and has accordingly suffered a greater handicap from euro strength.
There has been some cheerleading from European politicians about “defending the stability of the euro” and so forth, but there is no target rate for the euro exchange rate, and (whisper it) some further weakness would suit us just fine.
EU Commission president Jose Manuel Barroso is the latest European politician to lay the blame for the euro zone’s travails at the feet of “speculators”. These, you are to understand, are not those worthy fund managers who buy “safe” European government bonds, and have incurred sizeable losses for their investors by believing what European politicians have been saying these last few months.
When a country has large external liabilities, either as public or private debt, it is highly vulnerable in an international liquidity squeeze. Ireland, as a result of the credit-fuelled bubble, has enormous external private sector liabilities as well as public debt largely held abroad.
Ireland’s vulnerability has, through no particular fault of ours, increased substantially these last few weeks. If the measures finally agreed to tackle the Greek crisis and future ECB actions are successful in stabilising the markets, and specifically in getting the bond spread down for the euro periphery, well and good. If not, the margin for manoeuvre is reduced and it is necessary to consider whether there are unilateral actions open to Ireland which would reduce the risk of an adverse outcome in the form of an inability to fund and the need for EU or IMF assistance.
Next December’s budget is planned to reduce the deficit in line with the 2014 target, which is to borrow no more than 3 per cent of GDP. A sustained adverse level of borrowing costs could require that the budget come earlier than December, and there is no downside to indicating a willingness to contemplate such acceleration now. The Government could also give some more advance detail of the components of the medium-term fiscal consolidation programme.
The benefits of firm budgetary action through 2009 are evident – Ireland has had to pay less interest abroad because of these actions. The Greek government delayed and faces the same budgetary task under duress.
The recapitalisation of the banks is finally under way, but there remains a lack of clarity, to some degree unavoidable, about the likely Exchequer costs of rescuing the Irish banking system. These costs need to be minimised through ensuring that Exchequer exposure to junior bank creditors is removed when the guarantee runs out in September.
The Government must, of course, honour its legal and contractual obligations, but is in a weaker position than a few weeks ago to do any more than that.
In the meantime, a moratorium on suggestions for new public expenditure programmes, of which there has been an epidemic in recent weeks, would help a lot. It would be unfortunate to celebrate the centenary of 1916 with macro-policy dictated from Brussels and Washington.
The lesson of the Greek tragedy is that small, heavily-indebted euro zone countries must use their economic sovereignty or lose it.
Colm McCarthy lectures in economics at University College Dublin
