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August 19, 2012

Is Ireland The Next To Collapse in the Euro Zone?

By Mindful Money via QFinance

The Emerald Isle has had a rough few years to say the least as it has begun to digest the consequences of the boom and then bust which took place in her housing industry. One direct consequence was the collapse of most of her banking industry which via the too big to fail strategy of her political leadership has saddled her with large debts. A population of some 4.59 million ended up having to provide some 64 billion euros of bailout money to her banks or just under 14,000 euros each.

How did this happen?

There is a lot of competition for this title but on the 30th of September 2008 the Irish Finance Minister Brian Lenihan took what is perhaps the worst decision of the credit crunch era. This was recorded by the Financial Times thus.
Ireland’s government on Tuesday unveiled a wide-ranging guarantee arrangement to safeguard the deposits and debts at six financial institutions in response to turmoil in the financial markets.

The scheme, which guarantees an estimated €400bn (£315bn, $567bn) of liabilities, covers retail, commercial and inter-bank deposits as well as covered bonds, senior debt and dated subordinated debt.
This was supposed to last for two years only but once on such a feed-line the Irish banks were converted into junkies and were always unlikely to be able to wean themselves off it. The poor Irish taxpayer found him/herself supporting junkie zombie banks. Even worse the banks drip fed out more and more bad news until the bailout numbers listed above were reached.

The warped logic of the times even had the Irish government stating that this would protect the taxpayer when it in fact turned out to be the worst decision ever to be taken on their behalf.

The real problem is the debt

Adding the excess financial liabilities of the Irish banking system to the Irish state led to her central government debt ballooning from 47.4 billion euros in 2007 to an estimated 186.7 billion at the end of 2012. So the direct effect of the bailout was some 46% of the increase and of course there would have been indirect effects too. Put another way without it Ireland would have a central government debt of 122.7 billion euros at the end of 2012 which would be 77% of her Gross Domestic Product rather than 117.5% of it. Quite a difference to say the least.

Her economy has shrunk

In 2007 Ireland had a GDP of 170.4 billion euros and in 2011 she had one of 158.7 billion euros. So just as she found debt piling up she was less and less able to support it. If we look at the latest figures we see this.
Preliminary estimates for the first quarter of 2012 show seasonally adjusted volume declines for both GDP (-1.1%) and GNP (-1.3%) compared with the fourth quarter of 2011. However, compared with the same quarter one year ago there were constant price increases in both measures: GDP (+1.2%) and GNP (+0.2%). 
Gross National Product

If you wish to see references to GNP you will find them in my past updates on Ireland. Why? Because Ireland has a lot of multinational businesses there who are the equivalent of non-domiciled for a person. Examples are Google and Microsoft and this brought her an estimated 32 billion euros last year. So GNP is GDP minus this amount which is “net factor income from the rest of the world”. If you wonder why this matters then imagine trying to tax a company which is in Ireland due to its low tax rate. What is likely to happen next? Accordingly when looking at Ireland’s ability to finance its public sector deficit GNP does matter and her central government deficit suddenly looks a lot more unsupportable as it is 147% of it.


The unemployment rate has risen from 4.4% in 2007 to 14.8% in July of this year. The last twelve months have seen a slowing and maybe a stop to the rise but so far we have no signs of any reductions.

Retail Sales
The volume of retail sales (i.e. excluding price effects) decreased by 0.7% in June 2012 when compared with May 2012 and there was an annual decrease of 5.5%. 

Are you Portugal in disguise?

There are similarities here between Ireland and Portugal in terms of national debt to GDP ratio,retail sales and unemployment rate. However other aspects of the Irish situation look more positive.

Balance of payments

Ireland has had a persistent balance of payments surplus and the latest report from her Central Statistics Office shows it going back to 1990. Indeed her surplus has increased through the credit crunch era and is now 15 billion euros a year higher. However care is needed with taking this number too far as it is virtually entirely been driven by falling import levels due to the weakness in Ireland’s own economy. However the surplus seems set to remain with Ireland and she faces an entirely different situation here to her colleagues in the euro periphery. She has the ability to finance debt from foreign creditors and if she went to a new Punt we face the possibility that it would rally and not fall. Certainly her trade surplus would create a demand for Punts although paying interest on foreign debts would be a drain.

Industrial Production

Here too we see quite a difference between Ireland and Portugal.
Production for Manufacturing Industries for June 2012 was 3.3% higher than in May 2012. On an annual basis production for June 2012 increased by 10.5% when compared with June 2011.
If we look for some perspective we see that the underlying index was 109 in 2007 and is 117.8 now so Ireland has seen since genuine growth over the credit crunch era. This is rare to say the least! Looking forwards the Irish manufacturing purchasing managers index for July was positive too at 53.9 (50=unchanged) so for now anyway the improvement goes on.

Public deficits are a continuing problem Whilst the two categories above show Ireland in a good light this one remains a problem rather like its near neighbour the UK. The European Commission forecasts a public-sector deficit in 2012 of 8.3% of GDP and one in 2013 of 7.5%.
Whilst this represents a considerable improvement of the 13.1% of 2011 and the bailout driven 31% of 2010 this poses a problem too. How will Ireland get to the euro area target of 3% of GDP? The treatment is of course austerity but again we face the question of whether the treatment will kill the patient like the blood-letting undertaken by doctors in the past. Compared to this year she has to find the equivalent of just over 5% of her GDP which will not be easy. Also I note that the European Commission forecasts rely on a return to growth in 2013 based on this. 
trading partner growth increases 
House prices and the banking sector

After a rise in May of 0.2% Irish property prices resumed their fall in June and dropped by 0.9% according to the Central Statistical Office. This means that they have halved since the peak and there is no real sign of any stop or halt. In a country of Ireland’s size that has an estimated 300,000 vacant properties that may be no great surprise. But it does pose a question as to how far prices will fall? And what about her bailed out banks?

Moody’s ratings agency thinks that Irish property prices may fall another 20%. If that is so at least some of the Irish banks will be in trouble again.

There is some scope for hope in Ireland’s performance in the credit crunch era. After it’s initial drop her economy has so far avoided the type of continuing downwards spiral that hit Greece so hard and is currently afflicting the Iberian peninsular.However she is balanced on something of a knife edge for two reasons.

Firstly the way that bank problems were switched to state supported debt has left her with a burden that may yet prove insurmountable. And if we review her housing and banking sectors it remains possible that further burdens may arise. Secondly whilst her reliance on multinational companies has brought Ireland many advantages in terms of economic output and exports it also brings vulnerabilities such as the risk of them leaving. It also means that the “taxable capacity” of Ireland is less than you might immediately assume.

In a way this pattern is repeated by Ireland’s recent government bond issue. As she was the first of the periphery to resume bond issuance her government puffed out its shirt with pride. And whilst this was symbolic and a sign of her relative status there was here too a catch as she will pay round 6% per annum on this debt rather than the 3% she would have paid to the IMF/EU/ECB troika.

Is there a way out? Potentially yes as any substantial form of debt restructuring or what was called PSI in Greece would transform Ireland and her prospects… Or some sustained economic growth but as I type this there seems little prospect of that on the horizon anywhere.

Courtesy Mindful Money via QFINANCE (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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