State must pay €11bn into bailout fund

IN two years time, Ireland will have to find up to €11 billion to contribute to the EU’s new bailout fund, the European Stability Mechanism.

EU leaders last night came close to finalising the details of the new fund that will replace the one from which Ireland borrowed last year when borrowing on the open market became too expensive.

The fund will be worth €700bn, contributed by eurozone countries, and €80bn of this will have to be cash up front over four years.

The balance of €620bn will be a combination of committed callable capital and guarantees from euro area member states.

Ireland will have to contribute its share and like most, if not all member states, will have to borrow its contribution.

The payments won’t be reflected in the EU member states’ deficit and debt statistics as the fund is being set up as an international financial institution, based in Luxembourg.

But if we set up a fiscal council with commitments to reduce debt and a cap on deficits and debt, it will affect it.

The mechanism has been devised as an important implement to help solve the eurozone’s debt crisis and to keep countries out of the hands of market speculators in the future.

Like the European Financial Stability Fund, set up in the wake of the Greek bailout, the emphasis is on making it as unattractive as possible to ensure countries access it only as a last resort.

The result is a penal interest rate of 3% on top of the rate the fund borrowed the money on the open market plus a handling fee. In Ireland’s case, this amounted to 5.8% over seven and a half years.

The second element is a tough austerity package, with German Chancellor Angela Merkel insisting that the experts on bailouts, the IMF, be involved in drawing up the measures to ensure there is no slacking.

The ink was hardly dry when economists and analysts pointed out its many shortcomings, not least that it didn’t appear to convince markets that the euro would not be allowed to fail.

There is disappointment that the new fund is not more flexible, such as providing money to countries whose economies are keeping to the EU budget rules but are being charged too much on the open market, and that it will not lend to governments to buy back their debt at a lower rate on secondary markets.

There is a clause, however, saying that changes can be made by the ESM’s board of governors in the future.

Some of its provisions are causing markets to fret and push up borrowing costs at the moment. This includes the fact that it will have preferred creditor status — meaning if a government goes bust, the ESM will be first in line to be paid.

The other issue worrying the markets is that private investors could find that they lose some of their money as part of an ESM deal. The decision on this will be made on a case by case basis and will depend on the outcome of a debt sustainability analysis.

The interest rate will be the borrowing rate plus 2%, rising to 3% after three years. This will be applied to the current stability fund also, the leaders agreed.

Greece has already managed to collect on this by agreeing to sell some of their substantial state assets.

Ireland has been told it too can benefit from the lower rate when they offer something over and above the current austerity plan.

The new fund will not come into force until July 2013 and the EFSM will remain in force until to administer outstanding bonds, currently this means from Ireland.