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Ireland: Some Form of Default Likely By 2013, But No Panacea
By James Mason
Determining the sustainability of Irish debt is a judgement call based on projections. Our opinion is that the balance of risks suggests the costs of bailing out Irish banks will make Irish government debt unsustainable in the medium term, although the risks are more finely balanced than is the case for Greece. Despite Ireland’s success in bringing down high government debt in the 1990s, the economic environment is much tougher now (Figure 1). Ireland already has a competitive and dynamic economy and, with extreme fiscal austerity ahead, the risks to growth forecasts are on the downside in the medium term.
Figure 1: Ireland: General Government Gross Debt (percentage of GDP)
Source: IMF World Economic Outlook and RGE calculations
With the recently released results of the stress test and promises to inject further capital into the banks, the opportunity to bail-in the majority of bank debt has passed. However, there will be further burden sharing with sub debt( less than €7 billion outstanding), and maybe also unsecured, unguaranteed senior debt in Anglo and Irish Nationwide Building Society (less than €4 billion outstanding).
Limited public understanding of these complex issues means that there is no popular consensus on what the Irish policy response should be, so unilateral default (bank or sovereign) is too hard a choice for the Irish government to make alone and the troika (IMF/EU/ECB) are unlikely to agree to it soon. Thus, we expect external support to be maintained until mid-2013 and then Ireland to need to borrow from the European Stability Mechanism (ESM). However, many risks, such as a Greek debt restructuring this year, could force the troika to formally evaluate Irish and Portuguese debt sustainably earlier than 2013. At that point we judge the troika more likely than not to decide that the sovereign debt is unsustainable, leading to a large haircut on sovereign debt. A pre-condition for being allowed to restructure sovereign debt will be significant progress in cutting the primary fiscal deficit down toward zero. (See related Critical Issue on Irish restructuring.)