ANALYSIS:The Opposition parties want to renegotiate the bailout. It is possible?

RENEGOTIATING THE terms of the EU-IMF bailout is fast emerging as a general election issue. Last week Fine Gael leader Enda Kenny and f inance spokesman Michael Noonan went to Brussels to signal their intention that, if elected, they would fight to cut the interest rate applied on EU bailout money and to lessen the costs of propping up the banks for Irish taxpayers.

On Sunday, Labour Party leader Eamon Gilmore matched Fine Gael and upped the stakes, promising to open a third renegotiating front. In government he would seek a package of spending cuts and tax increases smaller than set out under the terms of the bailout. He would also look to spread the adjustment over a longer period.

Both parties have stated that seeking to change the terms will be the first thing on their agendas upon taking office. But what scope exists to achieve a better deal? How should the three issues raised for renegotiation thus far be prioritised? And what positions are the three members of the bailout troika and the other euro zone member states likely to adopt on altering the terms of Ireland’s rescue?

Answering the last question first is essential before answering the other two.

Despite having the highest profile (and the most active spin doctors) during the November bailout talks, the International Monetary Fund (IMF) is the least powerful of the troika of institutions, which also includes the European Central Bank (ECB) and the European Commission. This time last year, as it was becoming obvious that Greece would need a bailout to avoid default, many senior European figures rejected the notion of any IMF involvement in euro zone affairs, both because they feared a loss of control and because it could be interpreted as the sign that the euro zone was as badly run as countries that usually require IMF assistance.

Although the IMF was, ultimately, invited to participate, its weakness vis-a-vis the European institutions was amply demonstrated by its losing the arguments on the issues that emerged as points of difference between it and the other pair in the troika on Ireland’s bailout – these were: the extent to which bank bondholders should take losses for their bad investment decisions; and the magnitude and timeframe of the budgetary adjustment.

The ECB is the most powerful of the three institutions and has taken the hardest line on many issues, in part because it has most to lose from this situation, in terms both of its inflation-fighting credentials and its perceived independence. It is very unlikely that the ECB will allow a tiny corner of the euro zone economy, which accounts for little more than 1 per cent of the total, to undermine its credibility as guardian of euro zone price stability.

The ECB’s massive exposure to the rotten Irish banking system threatens not only its credibility, but its solvency, and hence its independence. The bank will require recapitalisation if its exposure to Ireland results in losses (central banks can go bust, just like any other bank). This would result in it having to go cap in hand to the member states of the euro zone for an injection of fresh capital.

Among the member states, those with sound budgetary positions are supporting Ireland and Greece with bailouts. Economically and politically Germany is the dominant actor. Its population is strongly opposed to bailouts, its policymakers viscerally hostile to the running of deficits and its politicians in denial over the losses made by the country’s banks.

With these issues, interests and relative power positions of the main players in mind, considering Irish prospects for reopening the terms of the bailout becomes clearer.

The issue of most material importance for Ireland is how to fix the banking system. The current deal, which envisages the State picking up the tab for all bank losses, is clearly not working. Given speculation that the State is already insolvent, some sort of Europeanisation of its exposure to the banks appears unavoidable if default is to be avoided, the banking system put on a stable foundation and the ECB’s exposure to that system normalised. A new government could certainly appeal to others’ sense of justice on the issue, but there are limits to this.

On the cutting of the interest rate, the possibility of a new government convincing others to do this is very low. Unlike the banking issue, on which there is scope for bilateral deal-making because of the uniqueness and awfulness of the problem, the interest rate will be changed only in a multilateral context. As one of 17 euro zone countries and one of just two being bailed out, Ireland’s influence on interest rate issues is negligible. Expending precious negotiating capital on trying to have it cut would appear futile. What happens will happen regardless of the position Ireland takes

The new front opened by Eamon Gilmore at the weekend is to seek a dilution of the budgetary adjustment programme. This was misguided. Having watched the ECB professionally since its foundation, and observed its consistent advocacy of fiscal rectitude, I cannot believe it will countenance any reduction in the size of the package or an extension of its implementation timeframe. Rollback at this early stage in the three-year bailout programme would undermine market confidence in Europe’s ability to get its house in order. It would, too, incentivise other countries being bailed out, now or in the future, to push for the easing of budgetary adjustment commitments. The ECB is very likely to have the strong backing of Germany on this given Berlin’s views on deficits.

Raising this matter risks not only lessening the chances of concessions on the central issue of banking costs, but also of antagonising key actors. This is to be avoided if at all possible.

In international relations relative power matters more than anything else. Ireland is among the smallest EU member states and has depleted much of its goodwill. It is now in a position of extreme weakness.

How weak and powerless states can fare in the current financial crisis is exemplified by Iceland’s treatment at the hands of Britain and the Netherlands. One of Iceland’s banks collapsed in 2008 owing British and Dutch citizens a sum roughly equivalent in size relative to Iceland’s economy as Anglo Irish Bank’s losses relative to this one. In a gross abuse of its anti-terrorist laws, Britain froze Icelandic assets in its jurisdiction and, along with the Netherlands, used its veto at the IMF to prevent bailout funds being made available to Iceland.

Hardball happens within the EU too. “The ECB f***** us,” said an Irish official privately in November, referring to the sudden and ill-flagged decision of the Frankfurt bank to launch the pre-emptive bailout. A new government should not underestimate the risks of those on the other side of the table acting as aggressively in the future.

Overplaying a weak hand also poses risks domestically. Promising too much during the election campaign could expose any new government to an early humiliation if little is conceded, both by demonstrating its impotence vis-a-vis Europe and by exposing it to the accusation of miscalculation. For a new government to have its authority undermined so early would be demoralising for it – and everyone else too.

A serious failure of political leadership after such a long period of weak and failing political leadership would serve to deepen the mood of despondency.

Dan O’Brien is Economics Editor