Summary:
– Ireland has officially exited the Troika (European Commission, IMF, ECB) aid program (Memorandum of Understanding) following the disbursement of the final tranche of financial aid worth €648 million from the IMF.
– Ireland’s successful return to market financing will depend on its ability to meet its fiscal adjustment commitments and continue to clean up its banks’ balance sheets, particularly in terms of managing non-performing loans.
– Finally, a significant part of its success will depend on investors’ risk aversion as the US Federal Reserve’s asset purchases slow down.
This weekend, Ireland officially exited the Troika (European Commission, IMF, ECB) aid program (Memorandum of Understanding) after receiving the final tranche of financial aid worth €648 million from the IMF. Of the four eurozone countries (Greece, Portugal, Spain, and Ireland) benefiting from the Troika program, Ireland is the first to be released from international supervision. During the three years of the program, the Irish government received EUR 85 billion, including EUR 67.5 billion from international creditors. However, Ireland will remain under close supervision by the Troika until 75% of the loans granted since it entered the program in November 2010 have been repaid.
The return to market financing suggests that Ireland is entering the repayment phase, which logically follows the consolidation of its public finances and, above all, its banking system. However, while Ireland has been « an example in terms of structural reforms » for all eurozone countries, particularly in terms of fiscal adjustments, Christine Lagarde pointed out that the banking system remains fragile: the rate of non-performing loans held by banks is still high (24.8% of total loans) and lending to the economy remains weak. Furthermore, the Irish non-performing loan ratio excludes transfers to the National Asset Management Agency (NAMA), which acquired 12,000 toxic mortgages that it resold in May at a discount of 75.3%.
Last November, Irish Prime Minister Enda Kenny surprised observers by declaring that Ireland would return to market financing without resorting to a precautionary credit line, insisting on his desire to make a « clean exit. » According to the Irish Treasury (NTMA), debt refinancing and the Ministry of Finance’s financing needs would reach €16.6 billion in 2014 and €10 billion in 2015, and the NTMA would plan to auction €6 to €10 billion in 2014. In addition, Enda Kenny explained that Ireland had been preparing for its return to the market over the last three years, referring to the fact that of the €35 billion allocated to recapitalizing the banks, only half was needed, leaving a significant amount of liquidity to cover approximately one year of financing needs.
Furthermore, Ireland’s decision to exit the program without a precautionary credit line is a positive signal to investors. This confidence is supported by a recent improvement in the economic outlook, although economic indicators remain subject to high volatility. In 2013, GDP grew by 0.4% q/q in the second quarter after contracting by 0.6% q/q in the first quarter. However, the unemployment rate remains high at 12.5% in November, even though it has fallen from its peak in early 2012 (15.1%). Surveys showed an improvement in economic sentiment in November, close to pre-crisis levels. PMI indices in the manufacturing and services sectors returned to expansionary territory, and industrial production rebounded in November 2013 (11.7% compared with November 2012) despite the negative impact of the loss of exclusivity of numerous patents in the pharmaceutical industry.
Ireland has managed to reduce its public deficit by nearly 6 points in one year, from 13.4% of GDP in 2011 to 7.6% of GDP in 2013. However, it remains the highest in the eurozone. Irish growth is mainly driven by net exports, mostly to the eurozone. The strength of Ireland’s foreign trade is due in particular to a very attractive tax regime for international companies (12.5% compared to an average of 23.5% in the European Union), the strategic location of American companies for the European market, and a skilled, English-speaking and relatively inexpensive workforce. The main weakness of the Irish economy remains, of course, its still fragile banking system: the country’s two main banks,Allied Irish Banks and Bank of Ireland, still have the lowest capital ratios of any banks in the eurozone.
The risk of renewed stress on the Irish sovereign debt market could therefore arise after the publication in November 2014 of the results of the stress tests and the assessment of the quality of bank assets (AQR) to be conducted by the ECB early next year. In this case, Ireland may once again need financial assistance. However, by refusing to sign up to a precautionary credit line with a purchase mandate (ECCL1) and no longer being under the Troika program, Ireland is no longer directly eligible for the ECB’s massive asset purchase program (OMT) on the secondary market. To benefit from this, the government would have to apply to the ECB, which would slow down the intervention process.
However, other forms of EU assistance could be considered, such as direct retroactive recapitalization of banks via the European Stability Mechanism (ESM). Last June, the Eurogroup gave its approval on a case-by-case basis, despite opposition from German Chancellor Angela Merkel. Ireland could thus recover some of the funds used to recapitalizeAllied Irish Banks and Bank of Ireland during the 2008 financial crisis. However, the legal provisions surrounding direct recapitalization via the ESM are currently being drafted and, in the context of the AQR and stress tests organized with a view to banking union, it is likely that no decision will be taken before fall 2014.
However, this would not involve the ESM acquiring a stake in Irish banks, but rather structured financing whereby the ESM would guarantee the non-performing loans (NPLs) held by Irish banks. The main concern is the management of mortgage arrears held mainly by AIG and Permanent TSB banks. However, according to the Irish Ministry of Finance, 90-day doubtful residential mortgage arrears fell for the first time since the start of the crisis in the third quarter of 2013, and Moody’s rating agency noted a stabilization of the Irish real estate market.
Ireland’s exit from the Troika’s assistance program is a powerful symbol for the peripheral countries of the eurozone and could inspire others to exit « cleanly, » i.e., without a precautionary credit line. In this regard, Portugal is preparing to return to market financing in early 2014, according to an announcement by Prime Minister Pedro Passos Coelho. Furthermore, Ireland’s imminent return to the financial markets comes at a time when investors are preparing for the Federal Reserve to slow down its asset purchases (tapering), which could potentially destabilize European sovereign debt markets. Tapering could trigger a resurgence of risk aversion, putting upward pressure on the cost of financing Irish sovereign debt. Consequently, Ireland’s successful return to market financing will depend on investor confidence in the country’s commitments to structural and fiscal adjustments, and on the resilience of Irish banks to the stress tests conducted by the ECB next year. On this last point, the IMF issued a final recommendation in the Troika’s11th reviewof Ireland that « direct recapitalization of banks via the ESM prior to the 2014 stress tests would be desirable to protect market confidence and financial stability. »
