Why the ECB must share the pain

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The Central Bank's move to slash its 2011 economic growth forecast demonstrates once again that the government’s four-year economic plan can’t work.



11 February 2011

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ECB1Less than three months after the government unveiled its four-year economic and budgetary plan, under which a combined €15bn would be taken out of the Irish economy in spending cuts and tax increases in the four years to the end of 2014, the strategy is quickly unravelling.  

In its most recent quarterly bulletin the Central Bank revealed that it was now expecting economic growth as measured by GDP, which includes repatriated multinational profits, to be just 1% in 2011. As recently as last October, the Central Bank had been predicting 2011 GDP growth of 2.4%.

Of even greater significance is the revelation that the Central Bank now expects GNP, a far more relevant measure of Irish economic performance that excludes repatriated multinational profits, will fall again this year. This will be the fourth consecutive year that Irish GNP has fallen, something which will surprise no-one operating in the domestic Irish economy. 

Growth? Not a snowball’s chance in hell

The Central Bank’s latest forecasts make a nonsense of the growth projections contained in the four year plan, which pencilled in average GDP growth of 2.75% for the four years to the end of 2014. Based on current trends there is now not a snowball’s chance in hell of these growth targets being fulfilled.  

This in turn renders absurd the planned increase in tax revenues from €31bn in 2010 to €42bn in 2014, which is the centrepiece of the four-year plan. With the outgoing government predicting that the €15bn to be taken out of the economy under the four-year plan would be split 2:1 between spending cuts and tax increases, i.e €10bn of spending cuts and €5bn of tax increases; it is relying on economic growth to deliver €6bn of the hoped-for €11bn increase in tax revenues, more than half.      

If economic growth falls as far short of target as the latest Central Bank forecasts are now indicating, then the government would be forced to squeeze even further tax increases and spending cuts out of an already chronically depressed economy in order to meet the budget numbers we agreed with our EU “partners” under the terms of last November’s EU/IMF “bailout”.  
Stop! These are the economics of the madhouse. By pursuing such deflationary policies we would be condemning the Irish economy to a decade or more of 1930s-style depression. With the Irish political, economic and social fabric already stretched close to breaking point the likely consequences of such policies don’t even bear thinking about.

Taxpayer can’t bear the burden of debt

With the January exchequer returns having shown a 6% fall in income tax revenue – the 3.5% increase in VAT receipts was almost certainly driven exclusively by the car scrappage scheme – it should now be clear to anyone with eyes in their head that the central premise of both the four-year plan and the associated “bailout”, that the Irish taxpayer can somehow shoulder the entire burden of the losses of the Irish banking system, is inherently flawed.

Already the markets and many bank depositors have delivered their verdict. Between them the ECB and our own Central Bank have lent banks operating in Ireland a combined €180bn. Even when one excludes the approximate €30bn which the ECB has lent to the Irish arms of foreign-owned banks operating in this country, that still leaves almost €150bn, the equivalent of at least half of the remaining loan books of the Irish-owned banks once transfers to NAMA and other loan write-downs are taken into account.

Enda Kenny has already promised to renegotiate the penal 5.8% interest rate the EU is charging Ireland for the €45bn it is lending this country as part of the “bailout” package.  

Unfortunately the usurious interest rate is in reality merely a symptom of a much more fundamental flaw with the “bailout”. It is based on the completely lunatic assumption that the Irish taxpayer can somehow repay the losses of the Irish-owned banks in full. 

ECB should take some responsibility

Indeed the Irish financial crisis only came to a head last November after the ECB had first lent the Irish-owned banks sufficient funds to repay €70bn of senior bonds, most of which were held by British, German and French banks, in full. It was only when most of the senior bonds, with only about €20bn now remaining to be redeemed, had been paid off in full that the ECB cut off the tap to the Irish-owned banks. Did the ECB not even have a teeny-weeny suspicion that the Irish banks were effectively bust when it was lending the money to pay off their senior bondholders?   

Now the EU and ECB expect the Irish taxpayer to pick up the full cost of this sweetheart deal for the senior bank bondholders. While it is now clear that the unilateral bank bond and deposit guarantee introduced by the outgoing government in September 2008 was a catastrophic mistake, almost certainly the worst economic policy decision taken by any government in the history of the independent Irish state, the EU and the ECB, by insisting that there be no Eurozone bank failures and that the senior bondholders be repaid in full, are also partially culpable.  

Now that the vast majority of the senior bondholders have been repaid in full courtesy of the ECB, Frankfurt, whether it likes it or not, is on the hook for a hefty share of the losses of the Irish banks. With the bond markets and credit default swaps, where investors insure against the risk of bond default, now indicating that the market is pricing in at least a 40% “haircut” on Irish government bonds some time over the next five years, the ECB had better get ready to take a hit.          

When the new Taoiseach and Finance Minister travel to Brussels after the election they must make it crystal clear that, after having allowed most of the senior bondholders to escape unscathed, the ECB will now have to share the pain of the losses of the Irish banks rather than leave Irish taxpayers to foot the entire bill.



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