Recovery is on track but no guarantees

There will be a very clear yardstick next year to measure the performance of the economy — whether the country successfully exits the EU/IMF bailout programme and makesa full return to the markets.

The programme is scheduled to end in Nov 2013. The National Treasury Management Agency (NTMA) successfully tapped the markets during the summer for the first time in two years.

Through bond swaps and new issuances, the €11.9bn funding cliff that the Government faced in Jan 2014 has now been whittled down to a much more manageable €2.4bn.

Unless there is a major economic setback in 2013, such as Greece being forced out of the euro or a potentially destabilising war in the Middle East, then Ireland will regain some sort of economic sovereign.

The Department of Finance is in negotiations about securing support from the ECB through the outright monetary transaction programme as it re-enters the markets. This could include buying short-term bonds in return for adhering to certain conditions.

But whether the Government can stay in the markets over the medium term depends on the interest rate investors are willing to pay for Irish debt.

Debt-to- GDP is forecast to peak at 121%. The Government would need to secure an interest rate of 3%-4% to make a sustainable re-entry over the medium term. But this hinges on restructuring the €64bn in bank debt.

The Department of Finance is in talks with the ECB about wrapping up the €34bn plus interest of promissory notes — scheduled to be repaid every March in €3.1bn instalments until 2030 — into a 40-year bond. This would alleviate the funding pressure on the Government, but it would not reduce the overall stock of debt.

The second strand of negotiations is focused on getting the European Stability Mechanism (ESM) to take over the Government’s stake in the pillar banks. But its attempts are likely to meet implacable opposition from the eurozone’s creditor nations. The State may have pumped €30bn into shoring up AIB, Bank of Ireland and Permanent TSB, but the National Pension Reserve Fund values these stakes at €8bn.

The Government would have to persuade Brussels to pay way above current market value to take over its equity in the three banks. The chances of this strategy working appears remote. ESRI economist John FitzGerald recommends that the Government hold onto the banks until 2020 when they would be back to full profitability and could be worth up to 20% of GDP.

Returning the banking sector to profitability is dependent on overcoming a number of short-term barriers. There is still a huge quantum of mortgage and personal debt that the banks have to work through.

It remains to be seen whether the banks will use the personal insolvency legislation to tackle the massive level of mortgage arrears and write down unsustainable debt.

International investors are unlikely to look at the domestic banks until they can feel confident that the losses are manageable.

The resolution of the debt crisis also depends on growth returning to the economy and employment levels picking up.

There is a fragile, but uneven, recovery. The domestic economy is unlikely to recover until the banks are repaired and lending to the SME sector and the high debt levels are restructured.

Positive growth could see the start of a virtuous circle. However, negative growth could see the vicious circle of spiralling debt and stagnant growth take hold.

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