IRELAND DEBT

CRISIS

Introduction

• The economy of Ireland has transformed in recent years from an agricultural focus to a modern knowledge economy, focusing on services and high-tech industries and dependent on trade, industry and investment.

• In terms of GDP per capita Ireland is ranked as one of the wealthiest countries in the OECD-28 rankings as of 2008 and the EU-27 at 5th.

• Unemployment plummeted from 16 per cent (on the ILO basis) in 1994 to 4 per cent in 2000 – essentially full employment for the first time in modern history.

Non-agricultural employment jumped from 33 % of the population in 1993 to 41 per cent in 2000 and 46 % by

2007 . 

The 1995 to 2000 period of high economic growth, Ireland was called the "Celtic Tiger", a reference to the "tiger

economies" of East Asia .

GDP growth continued to be relatively robust, with a rate of about 6% in 2001, over 4% in 2004, and 4.7% in 2005 .

• Up to 2000 the true ―Celtic Tiger‖ period involved exceptional export-led growth with moderate wage and price inflation maintaining cost competitiveness and healthy public finances.

• This period began in the late 1980s when the Government finally tackled the public debt problem with tough spending restraint and managed to negotiate a series of social partnership agreements which seems to have brought wage rate moderation (and industrial peace) in return for income tax concessions.

• EU structural funds amounting to as much as 3 per cent of GDP per annum also helped fund an expanded public infrastructural program.

By about 2000, as the economy approached full employment, and technological constraints began to bite, the potential for continued per capita growth at rates experienced earlier no

longer existed .

Further national growth above the industrial country average could only be achieved with continued large scale immigration and capital investment. (The Beginning)

The Emergence of a Property Bubble

• The preconditions for increasing housing demand emerged gradually with the sustained export-led real economic expansion from 1988 and especially from 1994 onwards.

• But the sharp fall in nominal and real interest rates in the months running-up to EMU entry really triggered the housing price surge?

Why it triggered housing price surge?.The combination of higher population, higher income and lower actual

and especially prospective mortgage interest rates provided a straightforward upward shift in the willingness and ability to pay for housing. But property prices developed their own momentum and overshot equilibrium levels.

In effect, purchasers increasingly built in an expected continuation in the increase of the relative price of housing.

• The current difficulties of the Irish banks – whether in terms of liquidity or solvency – are directly attributable to their over-lending for land and property investment, much of it through heavy short-term wholesale foreign borrowing.

( Making National banks vulnerable to World Wide Liquidity Crisis 2008, and over exposed to collapsing property market).

In short, although international pressures contributed to the timing, intensity and depth of the Irish banking crisis, the essential characteristic of the problem was domestic and classic.

Monetary and Fiscal Causes

Generally and Briefly

While the global financial crisis exacerbated matters, the banking crisis in Ireland was largely a home-grown phenomenon. The crisis stemmed from the collapse of the domestic property sector and subsequent contraction in national output. Its root cause can be found in the inadequate risk management practices of the Irish banks and the failure of the financial regulator to supervise these practices effectively.

The Monetary Miscalculations

Banks had not been central to the financing of the export-led Celtic Tiger period and do not appear to have played a leading role in the early phase of the property bubble.

However, the four last years of the boom, from late

2003 onwards, were clearly bank-led, as new entrants and incumbents competed aggressively, stimulating demand with innovation. ( Good Banking Incentives For Household Borrowing).

Lending to property developers also soared and much of it turned out to be unrecoverable thus

proving to be the major weakness of the banks .

And although some of the property collaterals were located in several foreign locations vulnerability to a correlated downturn in the different markets meant that banks would have needed a greater capital buffer to protect against a possible property crash.

EMUIreland’s monetary and public policy has to be viewed in the context of its membershipof the European Monetary Union (EMU) and the argument that the single currency could generate forces for greater economic integration.

The European Central Bank (ECB) engaged in a policy of low interest rates designed to stimulate demand. the increase in mortgage credit in Ireland was influenced by its membership of the EMU and the subsequent removal of interest rate control.

this low ECB driven interest rate environment contributedsignificantly to a construction-led boom and resulted in the Irish

economy suffering a severe loss in labour competitiveness. It also led to an over-dependence on the property sector for employment and the once-off, largely transactional-based, taxation revenues that it generated

Fiscal ReasonsThe emergence of macroeconomic vulnerabilities during the bubble period was reflected in a deterioration of wage competitiveness and underlying fiscal revenue and expenditure policies.

Although Ireland‘s public debt level immediately prior to the crisis was low 25 % in 2007, the fiscal deficit and public sector borrowing surged quickly with the onset of the crisis .

This was partly attributable to a rise in Government spending in GDP (after 2004) which became embedded in the system.

However, in light of soaring tax revenues at the time, Government decided to increase autonomous spending particularly on public sector pay .

In additionMuch of the reason for the revenue collapse lies in the systematic shift over the previous two decades away from stable and reliable sources such as personal income tax, VAT and excises towards

cyclically sensitive taxes. (facilitated systematic tax evasion)

Revenue became increasingly dependent on corporation tax, stamp duties and capital gains tax (in that order); the contribution of these taxes to total tax revenues rose steadily from about 8 per cent in 1987 to 30 per cent in 2006 before falling to 27 per cent in 2007 and just 20 per cent in 2008.

Moreover, Irish budget deficit was below EU (SGP level of 3%) at 1.6%. SO the Irish Fiscal Situation was satisfying.

features

Rise in Bond Yields

An indication of the debt crisis is a rise in bond yields. Higher bond yields are an indicator that private investors are unwilling to hold those bonds. If you don’t trust a country to repay you, then you don’t want to buy the bonds unless you get a higher bond yield to compensate for the higher risk

High Cost debt Financing

The cost of bailing out the country’s banks pushed this year’s Irish budget into the red by at least £16billion as borrowing rose to 32 per cent of GDP, a record for post-war Europe.

It could cost them more than 50% of GDP. That is an enormous number that is having to be plugged into a banking system.”

The taxpayers of Ireland who are having to go through a tremendous austerity, and the IMF and the EU that are putting in money.

Recession

It was the first country in the EU to officially enter a recession as declared by the Central Statistics Office 

Ireland now has the second-highest level of household debt in the world (190% of household income).

Downgrading Of Credit Rating

The country's credit rating was downgraded to "AA-" by Standard & Poor's ratings agency in August 2010 due to the cost of supporting the banks, which would weaken the Government's financial flexibility over the medium term

It transpired that the cost of recapitalising the banks was greater than expected at that time, and, in response to the mounting costs, the country's credit rating was again downgraded by Standard & Poor's to "A"

Down Sloping Economic Growth

• Economic growth was 4.7% in 2007, but -1.7% in 2008 and -7.1% in 2009.

• In mid 2010, Ireland looked like it was about to exit recession in 2010 following growth of 0.3% in Q4 of 2009 and 2.7% in Q1 of 2010. The government forecast a 0.3% expansion. 

• But, the economy experienced Q2 negative growth of -1.2%, and in the fourth quarter, the GDP shrunk by 1.6%. Overall, the GDP was reduced by 1% in 2010, making it the third consecutive year of negative growth .

• collapse in tax receipts due to a reduction in economic activity.

Unemployment

These property developers are currently suffering from substantial over-supply of property, much still unsold, while demand has evaporated.

The employment growth of the past that attracted many immigrants from Eastern Europe and propped up demand for property has been replaced by rapidly rising unemployment

Bailout

In november 2010 reland has formally asked for a bailout of up to £80billion (€90bn), with £40billion for banks, after a deal was agreed in principle by the EU. A team of European Commission, Central Bank and IMF officials have been in Dublin over the weekend checking Ireland’s figures and making an assessment of the costs of rescuing Irish banking.

Nationalization of Banks

This was followed by the nationalization of Ireland’s third largest bank, recapitalization of its two main financial institutions and the creation of a type of “bad bank” (National Asset Management Agency (NAMA)) to manage the billions of non-performing or toxic loans in the banking system.

however

Tens of billions have now been poured in Banks with little or no benefit to either the banks or the real economy. The banks' damaged balance sheets haven't been healed by any measures - NAMA, nationalization, partial recapitalization– the Irish government has taken to date.

Ireland has guaranteed the liabilities of the banks. The fact that banks' past liabilities are hinged to the sovereign's ability to raise funds on the open market means that the fiscal plan is itself hinged to the performance, or lack thereof, in the banking system.

Fiscal Remedies

AusterityIreland's 140-page National Recovery Plan

• More than 24,000 jobs will be cut, taxes raised and welfare payments to be reduced.

• Irish government published its four-year economic plan intended to save the country €15bn (£12.7bn) and ruthlessly drive down its national debt.

• It  introduced a range of cuts and tax rises aimed at cutting the republic's debt and restoring international confidence.

•  By 2014 the Irish will cut €10bn from public spending and raise an extra €5bn in taxes. These measures will also include a new property tax, water charges, cuts to the minimum wage and rises in student fees.

Restructure of some Budget items

The main points include:• Social welfare, which accounts for one third of day-to-day

spending, will be cut by €3bn with changes to unemployment benefit and reform of child benefit.

• Changes in the income tax bands will raise €1.9bn. The threshold for tax will be lowered to €15,300 and single people on higher incomes will have to pay more.

• Public sector pay will be cut by €1.2bn and staff numbers reduced by nearly 25,000.

• The minimum wage cut by €1 to €7.65.• VAT will increase by 1% to 22% next year and to 23% in

2014.• A new tax on more than 2m households and properties of

€200 a year — called the site value tax — will raise €530m.

THANKS VERY