Sticking with austerity is Ireland’s only hope of a viable future

Some Irish politicians seem to be buying the hype that Ireland is Europe’s success story, suggesting that the country ease off on austerity given how well it has done in achieving the fiscal targets set out in its bailout programme.

The State has enjoyed several successes and its exit from the bailout at the end of this year has never looked more likely. But the challenges it still faces to regain debt sustainability are huge. There is no room for backtracking on progress made thus far and Ireland should get ready for several more years of fiscal consolidation before it is out of the woods.

Calls from Government figures to relax austerity began last February when the State negotiated a restructuring of promissory notes. Savings from this deal could plug any budget gap that might arise from slowing consolidation without any backlash from the private or official sector creditors, it has been argued.

Anti-austerians were emboldened further this week when the European Commission announced that Ireland's budget deficit in 2012 was 7.6 per cent of gross domestic product, well below the target of 8.6 per cent of GDP stipulated in the memorandum of understanding with the EU-IMF troika.

Those insisting Ireland should ease austerity argue that the extra money saved as a result of its target-beating belt-tightening should be used to encourage Government, company and individual spending, thereby stimulating growth.

Irish politicians are not the only ones suggesting harsh austerity is no longer an appropriate policy to pursue in Europe. Last week, a seminal academic study concluding that public debt above a certain threshold significantly undermines economic performance was debunked (http://iti.ms/11JASwM).

This study was regularly quoted by the European commissioner for economic and monetary affairs Olli Rehn as a justification for the commission's approach to the euro area crisis but has now lost much of its credibility. Furthermore, in a speech this week European Commission president José Manuel Barroso said austerity had reached its limits of political and social support.

Debt burdens
Easing austerity to stimulate growth in a recession makes sense unless you are dealing with a

state that has unsustainable public finances, such as Ireland. While the budget deficit came in under the bailout target last year, it was the third highest in the European Union behind Spain (10.6 per cent of GDP, owing partly to bank recapitalisations in 2012) and Greece (10 per cent of GDP).

The Government has a lot of savings to generate if it is to reduce its budget deficit to 3 per cent of GDP by 2015 as demanded by the commission. Furthermore, the public debt burden soared to 117.6 per cent of GDP in 2012, behind only Greece (156.9 per cent), Italy (127 per cent) and Portugal (123.6 per cent) in the EU.

Such high government deficit and debt burdens can be sustained over the medium to long term as long as a country’s growth model works. While Ireland has stood out among the bailout countries for having posted a few quarters of growth since the beginning of the crisis, the State slipped back into a technical recession (two consecutive quarters of contraction) in the final quarter of last year. For all the talk of Ireland being a poster child, its growth model faces considerable challenges.

The State has long been heavily reliant on exports for growth, with services exports, food/live animals and high-tech sectors such as pharmachemicals proving to be resilient industries despite the crisis. Services exports continue to perform relatively well, but are concentrated in multinational firms that have established headquarters in Ireland to gain entry to the greater European markets and therefore contribute more to gross national product than GDP.

High-tech industries are not particularly labour-intensive, and so their contribution to job creation in Ireland is limited. Furthermore, exports of pharmachemicals and food/livestock have slowed over the past six months. This is unsurprising, given that most of the State’s exports are going to the ailing euro area, the UK and the US, none of which is posting impressive growth figures.

Domestic demand here is an even greater worry than exports, as it continues to drag on growth and shows no signs of turning around. Unemployment remains high at 14 per cent in March.

In the final quarter of last year, about 12 per cent of mortgages for private principal dwellings were in arrears over 90 days (http://iti.ms/Y1N8cy). If so many people are still stuck with negative equity private consumptions will not rebound. The new personal insolvency regime will help Irish banks to address this problem, but only for the completely insolvent, a small subset of those who are having difficulty paying their mortgages.

Bad loans are also severely hampering investment in Ireland. The banks will not begin lending again until they have addressed some of their non-performing loans. Many of these relate to property and must be resolved in a sustainable way over the next few years as stipulated by the Central Bank (http://iti.ms/11JEChQ).

Worryingly, in a recent speech Fiona Muldoon of the Central Bank said roughly half of all small and medium enterprise loans were also non-performing.

Important concessions

Sure, some of these loans are property-related, but even so this is a staggeringly high figure. It will take years for the banks to clean up their balance sheets, and may require further bank recapitalisations.

But it is not all bad news. The State has secured concessions on repayment of its loans to international creditors and has succeeded in re-entering the bond markets for short- and long-dated paper. The markets seem to have regained confidence in Ireland, with 10-year bond yields falling to about 3.6 per cent.

I expect we will manage to exit the bailout programme later this year. But the more important question is whether the State will retain market access over the medium to long term once it has exited its bailout. Given the fiscal trajectory it is on, the answer to that question is probably no. If Ireland wants to return to debt sustainability, it will not only need to hold the course on fiscal consolidation now, it will need to do so for several years to come.

Megan Greene is chief economist at Maverick Intelligence ( maverickintelligence.com), a senior fellow with the Atlantic Council and a senior visiting research fellow at Trinity College Dublin. She is on Twitter @economistmeg