Tags: Bailout, Euro Debt

Irish Bailout Threatens to Reignite Euro Debt Crisis

By , Contributing Writer, Money Morning •

Ireland's reeling banking system, and the government's reluctance to accept outside help, is threatening to reignite the European debt crisis that nearly led to the demise of the European Union (EU) and its currency last spring.

EU officials are trying to persuade Irish officials to shore up the country's devastated banking sector with a possible $100 billion (73.5 billion euros) aid package as Irish policymakers continue to insist that the financially troubled nation doesn't require a bailout.

Just six months after EU governments established a $1.02 trillion (750 billion euros) rescue fund with the International Monetary Fund (IMF) to backstop Greece and other troubled members of the 16-nation euro currency area, cracks are once again emerging in the group's financial infrastructure.


While the government says it has sufficient capital to fund its obligations until the middle of 2011 without accessing the bond market, Ireland's banks have experienced a drawdown on collateral, threatening a liquidity crisis.

Corporate clients have pulled deposits from lenders, including the country's biggest, Bank of Ireland PLC. Allied Irish Banks PLC (NYSE ADR: AIB) has had similar withdrawals since June, the Sunday Times reported yesterday (Monday), without saying where it got the information.

The five-member ISEQ Financial Index has fallen 98% from its peak in February 2007. Bank of Ireland and Allied Irish account for about 80% of the benchmark by weighting, according to Bloomberg News.

If "evidence of a deposit flight in Ireland" accelerates, "then the prospect of additional support to the banking system could swamp the government's comfortable cash position," Paul Mortimer-Lee, London-based global head of market economics at BNP Paribas SA (PINK: BNPQY), wrote yesterday in a note.

"Equally, if the losses on the banks were to be revised up again, then with banks in a poor position to raise private capital, the government may be forced to appeal to the European Commission for support," he said.

With its lenders frozen out of Europe's money markets and with their deposits shrinking, German Chancellor Angela Merkel's government is pushing Ireland to accept EU funds to prevent a bond market crash and stop the spread of financial-market turbulence to other euro members.

Investors have been dumping Irish bonds in recent weeks, and Merkel and other officials view bolstering Ireland's banks as essential to keeping the lack of confidence from spreading to other debt-mired economies in Western Europe such as Portugal and Spain.  

Failing to subvert the crisis could destabilize the euro and threaten the global economic recovery.

Many European officials believe that taking action soon on Ireland would be better than waiting until markets force the country to seek more financing, after repeated delays in bailing out Greece this spring led to a near-collapse of investor confidence in the entire Eurozone.

European Central Bank (ECB) Vice President Vitor Constancio told Bloomberg that Ireland could use the European Financial Stability Facility to help prop up its banking system.

"It's totally clear that they absolutely must accept external support sooner or later," Christoph Weil, an economist at Commerzbank AG (PINK: CRZBY) in Frankfurt told Bloomberg. Confidence in "the banking system is collapsing, and they can't stop it by themselves." 

But officials in Ireland - where accepting international aid is being seen as a national embarrassment - again denied that they needed a rescue.

Irish officials maintain they can contain the problems with a new round of austerity measures designed to cut Ireland's record budget deficit back down to manageable levels.  Without the austerity plan, Ireland's deficit will be worse than that of Greece, which was bailed out by the EU and the IMF last spring, The Washington Post reported.

Other European officials told The Post no consensus had been reached yet on whether, or when, to bail Ireland out. Some critics argued that rescuing Ireland might send a message to the markets that the EU is willing to bail out any member that gets into trouble.

"There is still uncertainty over whether helping Ireland, as opposed to letting them stick to their guns, would really calm down the markets," a European diplomat familiar with the talks told The Post.  The markets "might then expect the same for Portugal, and maybe even Spain."

Meanwhile, Eurostat, the EU's Luxembourg-based statistics agency, reported yesterday that Greece's budget deficit was significantly worse than originally thought, putting pressure on the government in Athens to adopt even more austerity measures to meet requirements in the bailout package that kept the country solvent.

Greece's deficit for last year was revised to 15.4% of gross domestic product (GDP), up from 13.6%, surpassing Ireland's 14.4%, Eurostat said. The shortfall this year will be 9.4% of GDP, more than the 8.1% the government announced in May, the Greek Finance Ministry said in a separate statement.

"The target for next year should be kept," ECB's Constancio told Bloomberg in Vienna yesterday. "The necessary policies should be adjusted to maintain that target."

Eurostat also revised Greece's 2009 debt to 126.8% of GDP, surpassing Italy as the region's most-indebted country. The debt will jump to 144% this year, the Finance Ministry said. That would be the highest for any country since the start of the euro, Bloomberg reported.

The Greek deficit figures have been the subject of heavy scrutiny from EU officials since Prime Minister George Papandreou revealed last year that the gap was twice as high as forecast, fueling a surge in borrowing costs that pushed the country to the brink of default and spawning the EU debt crisis.

Eurostat revised the figures higher again in April, sparking a downgrade of Greece's credit rating by Moody's Investors Service. Papandreou announced the next day the country would formally seek the EU-IMF emergency loans to avoid default.

  • Eurostat said yesterday that its concerns about the country's economic statistics have been resolved and that it was confident the numbers are now accurate.

    • Speculation about the future of the EU increased over the weekend when a Portuguese government minister openly speculated that his country's economic difficulties could lead to its expulsion from the Eurozone.

    Foreign Affairs Minister Luis Amado told Portuguese weekly Expresso that Portugal faces "a scenario of exit from the euro zone" if it fails to tackle its economic challenges.

    "There has to be an effort by all political groups, by the institutions, to understand the gravity of the situation we're facing," he said.

    Unlike Greece and Ireland, however, Portugal doesn't face a debt crisis brought on by years of mismanagement and shoddy statistics.  Instead, slow economic growth combined with escalating wages have made Portugal's labor-intensive exports, such as textiles, vulnerable to competition from lower-cost producers in Eastern Europe and China.

    Despite expanding solidly for three straight quarters, its bonds have been targeted by investors.  Its 10-year government-bond yield is around 7%, making it hard for the government to reduce a near double-digit deficit as a share of its economy.

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