Monday, November 29, 2010

Ireland bailout...

Ireland has successfully negotiated an 85 billion Euro bailout with Euro-area Governments, the EU and the IMF. The funds are made up from a contribution of 17.5 billion Euro from Ireland itself (from cash reserves and national pension fund), 22.5 billion from the European Financial Stability Mechanism, 22.5 billion from the European Financial Stability Fund and bilaterals from the UK, Sweden and Denmark, and 22.5 billion from the IMF.

The support is for a 7-year period. This is a far more realistic period than the original 3-years negotiated in the Greece package in May – which has now been extended by a further 4.5 years to match the Ireland term. This will reduce, although in our view not entirely eliminate, the risk that Greece eventually restructures its debt.

EU finance ministers have also approved the broad outline of a permanent crisis-resolution mechanism to be called the European Stability Mechanism. Private bondholders could be made to share the burden of restructuring of a euro zone country's sovereign debt bought after 2013, subject to a case-by case evaluation. This will also help market sentiment since it significantly waters down a proposal from Germany and France for investors to be forced to take losses to share the costs with taxpayers. More on this later.

The immediate question now is whether the Ireland deal is sufficient to stem the contagion. Only time will tell. The good news is that the likely next cabs off the rank are Portugal and Spain, where economic fundamentals are weak, but better than either Ireland or Greece. A Portugal bailout could be easily managed within the existing EU/IMF facilities in place, but possibly not enough to cover Spain, raising the prospect that the existing facilities need to be expanded.

Of course if Spain needs a bailout, it could also be the case that the issue becomes more than Europe can handle itself and that the bailout mechanism becomes a more global effort, with the likes of the US, China and other brought in, under IMF auspices.

For about two years now we have been arguing the importance of governments articulating credible plans for consolidating their fiscal positions back to some semblance of sustainability. That seemed a tad silly in the depths of the recession, but we also pointed out that the risk of not doing so would be that bond markets, which generally dislike uncertainty, would seek answers to tough fiscal questions.

Bond markets are looking for certainty, and will continue to pick off one country at a time until that certainty is resolved, or at least as best it can be. Governments all over the developed world need to get in front of the problem and articulate meaningful fiscal consolidation plans.