Will the IMF bailout help Ireland recover from the debt crisis?

How will the Irish economy recover from the debt crisis? Will the bailout plan work? And will the Irish economy bounce back quickly? How will the Irish people be affected by this situation? These are some of the questions one can ask after the events of the last few weeks. 

From 1995 to 2007, Ireland saw its economy grow substantially and was known as the “Celtic Tiger”. As Irish people tend to own their houses from a relatively young age, banks easily gave out cheap loans on houses and construction projects without asking many guarantees. House prices were continually rising and eventually in 2008, like in the United States, caused the housing price bubble to burst. In the wake of the ensuing crisis, the Irish government decided to bail out its banks, recapitalizing or nationalizing most in the process. The government guaranteed savings, checking accounts and bonds that they sold to investors on behalf of Irish banks that attracted foreign investment for a while, but as the situation worsened in other countries, this money inflow soon disappeared. At the same time, the government’s injection of money was not sufficient to re-launch the economy, and the country high budget deficit no longer permitted it to cover the banks’ liabilities.

In May 2010, as Greece accepted the International Monetary Fund’s bailout terms, Ireland’s prime minister stated that his country’s economy was not like that of Greece and didn’t need help. As described by Robert M. Dunn in his book “International Economics”, Countries are generally reluctant to ask for the IMF’s help as it imposes drastic measures that render it hard to “manage economic and financial affairs”. Even though the IMF ensures investors to see their money again, its intervention stigmatizes the government; its ability to maintain a stable economy is questioned, and is often seen as a political embarrassment. When budget deficits are maintained for long periods of time, and trade deficit widens, the constant depletion of foreign exchange reserves will bring the economy to a halt, to the point where the government will have to wait until it receives money from its exports to pay its bills.

Today, numerous European countries are owed important quantities of money by Irish banks. For example, as Simon Johnson, a former chief of the IMF and author of “13 banks”, has declared: “German banks are owed $139 billion (4.2 % of German GDP), British banks are owed $131 billion, (~5 % of Great Britain’s GDP), and the French ones are owed $43.5 billion, (~2 % of French GDP). 

It is clearly not in their interest for Irish banks to fail, as it is then more likely that given the present state of its finances, the Irish government would not be in a position to cover their debt. As the situation deteriorated, it was only a matter of months before the more important Euro zone countries would pressure Ireland into seeking their help and that of the IMF. 

At first, Ireland would not give in, but on Sunday November 28th 2010, a €85 billion package was imposed with the obligation for the government, like in Greece, to put in place an austerity plan with constraining fiscal policy to compliment the bailout. It consists of cutting Ireland’s social welfare budget by 15% in an effort to save 4 billion a year and widening the source of tax, to make money from low-income workers who pay no tax and public pensioners. As stated by Paul Mason, the economics editor for BBC’s Newsnight “each Irish family will pay an extra €3000 in tax.” In the process, 25,000 public sector jobs will be terminated, and the nation’s hourly minimum wage will be cut by 1 euro (-13%). Finally, the government spending on healthcare will be cut considerably. All will be done in the hope of stimulating job creation and reducing budget deficit from 32 to 3% of GDP within the next 4 years.

France and Germany also asked Ireland to increase its corporate tax, as did the EU Economic and Monetary Affairs Committee who wish to enforce a standard of 25% for all Euro zone members to level competition. But the Irish government resisted this, as this measure has allowed the country to attract foreign investment and create jobs and as David McKittrick reported in the Belfast Telegraph: It “is to remain unchanged at 12.5 %, Dublin having argued that it was one of the engines of its one-time prosperity and could be so again”.

Since the inception of the Euro currency on the 1st of January 1999, Euro zone advocates had highlighted its advantages, particularly the fact that it had eliminated exchange rates between the 16 countries, thus facilitating trade between them. However, with the debt crisis, we can see that the very ties implemented by the single currency which were bragged about during periods of growth, have facilitated the contagion throughout the Euro zone. As a result of the record high Irish debt combined with the depletion of their foreign exchange reserves, the Euro has depreciated substantially in the last few weeks (close to 8%), even though it only forms two or so percent of the Euro zone’s GDP. 

Investment confidence has vanished and speculators are now turning their attention to Portugal and Spain. In that context, European political leaders are trying to reassure investors, and Dominique Strauss-Kahn, the leader of the IMF, has stated that “the Irish economy will come back on track rather rapidly”.

But the reality is that investors are still skeptical, and in my opinion, rightly so as the margin for manoeuvre of the Irish government is limited. Yes they are introducing an austerity plan, and the IMF bailed them out, but there is little hope for the Irish economy to undergo a growth of 2.75% within the next 4 years as announced. Indeed, the single currency hinders Ireland’s ability to conduct an export-led growth whereby it cannot devalue its currency to increase net exports. For Paul Mason, “it is dependent on a more general recovery across the Euro zone and/or successfully competing for high value inward investment by, for example, speculative finance industries or high tech, high value global operations.”

Besides, there is continuous pressure from other countries to increase their corporate tax. This, if it were to be implemented would have a catastrophic impact on the recovery, as it would tremendously reduce foreign investments. At the end of the day, it seems to me that, no matter what they do, the Irish government cannot control their own destiny and very much depend on what will happen in the Euro zone and particularly in Iberia: only time will tell.