Concerns over EU ‘game changer’ deal

Concerns have been raised over the potential of the latest EU agreement to reduce Ireland’s debt to manageable levels and pave the way for a return to sovereign bond markets in 2013.

At the EU Council summit which concluded last Friday, heads of states agreed that the European Stability Mechanism (ESM) would be allowed directly recapitalise banks.

The move was hailed as a game changer, particularly here, as it was seen as the most effective way of breaking the link between sovereign debt and the banking system.

However, Davy Stockbroker economist Conall McCoille is sceptical that what is eventually agreed will have a significant impact on Ireland’s debt position.

The EU summit statement did not clarify how the ESM would be used to recapitalise banks or what criteria would be used. Roughly €63bn of total Irish Government debt relates to the bailout of the banking system. Of this, €34bn was pumped into the former Anglo Irish Bank, the Irish Bank Resolution Corp.

It is believed the ESM will take equity in banks, which limits the potential of doing a significant deal on Irish debt, argues Mr McCoille, because the ESM has to protect taxpayers’ interests and, in the case of Ireland, there is no equity in the main component of bank debt because IBRC is in the process of being wound down.

“What is being proposed is to break the link between government and bank balance sheets — not necessarily to use the ESM as a vehicle for large fiscal transfers to meet banks’ loan losses. Perhaps any capital injections by the ESM might even be at a discount to current market prices to ensure that the ESM does not make an eventual loss.

“If so, the ability of the ESM to reduce the costs of recapitalising Ireland’s banks will be limited. It would certainly rule out large capital injections into IBRC where the equity has little value. Sales of existing government stakes in the Irish financial system to the ESM at market levels could yield 5% to 8% of GDP,” says Mr McCoille.

“However, it is a large leap, both financially and politically, to expect the ESM to inject capital at levels where it can have little expectation of a return. And it is not clear from last week’s EU summit meeting that European politicians have agreed to the large fiscal transfers required (through the ESM) to reduce Ireland’s debt level to 100% of GDP”.

In an apparent about-turn on the agreement, Finnish and Dutch government officials say they would block the ESM from buying up sovereign debt on secondary markets. Both countries want sovereign debt purchases done on a case by case basis.

Finance Minister Michael Noonan said he would like a deal on Irish bank debt to be concluded by October. A finance spokesman says the IMF would form a view in the final quarter of this year about Ireland’s chances of regaining market access in 2013.

But the German chancellor Angela Merkel wants a single European banking supervisory agency in place before the ESM will be allowed proceed with bank recapitalisations. A European Commission source says that it is highly unlikely a bank supervisory agency will be up and running before October.

* Additional reporting Reuters