Exiting the bailout: the factors at play

The Government and its sponsors must soon decide whether Ireland makes its return to private debt markets in December with or without the benefit of an emergency credit line.

This would be a special overdraft facility for use only if the State suddenly loses the confidence of private investors in the wake of the bailout.

At issue are two major questions. The first centres on the merits or otherwise of taking out such a safety net. Opinion is divided within the troika and elsewhere.

The second centres on the terms on which such aid is granted, the main element of contention being the force of fiscal policy conditions tied to the programme.

This is highly political for the Government and is already the subject of hard bargaining with both EU powers and the International Monetary Fund.

If there is to be a scheme, it is likely there would be separate credit lines from the European Stability Mechanism fund and the IMF. Yet there is still no certainty this course will be taken.

While the result of an ongoing stress test on Ireland's banks will be critical, the reality is that there are
nuanced differences between the three troika bodies.

It is well established at this point that the IMF would prefer a programme. So too would the European Central Bank. Frankfurt fears a weakness in the banking system could come back to haunt it and so has adopted a maximum-safety approach.

They are not so convinced in the European Commission, which argues that there is no “obvious” need for precautionary aid. With Ireland providing the only evidence that Europe’s strategy on the crisis has worked, the concern is that a credit line would undermine that narrative of success.

There is further anxiety about the need for parliamentary approval in Germany, and other countries, for such a scheme, and this might prompt Angela Merkel to be reluctant about it. In addition, her likely Social Democratic coalition partners are agitating over Ireland's corporate tax regime.

Safest option
Still, Taoiseach Enda Kenny might determine that the safest option is to take out a precautionary loan programme. Given the fragility of the economic recovery, this could give comfort to markets and international benefactors that the exit will not be blown off course by any unexpected shock.

There would be a price, however, and this is where it gets tricky for Kenny.

To avail of a credit line Dublin would have to commit to a new series of fiscal policy conditions. How would that be measured against the rhetoric on a return of Ireland’s economic sovereignty in December?

The obvious play for the Government is to minimise the scope of any conditions to demonstrate to the Irish people that the Coalition is in command of policy. For Fine Gael and Labour, this is something of a glittering prize. In this context, the nightmare scenario would be for precautionary credit to be dressed up as some kind of a second bailout.

This helps explain the claim for minimum conditions. It is also the backdrop to Kenny’s pre-summit letter to EU leaders in which he urged them to make good on their unfulfilled promise in June 2012 to break the link between bank and sovereign debt. Germany and its allies still oppose retrospective compensation from the ESM for historic banking debts.

Thus the implicit message seems to be this: don't break my back on precautionary loan conditions; you're already breaking my heart on retrospective aid. This is no small thing. Whatever hope surrounded the original solemn pledge has long since dissipated. Kenny can therefore be seen to be using broken promises as a lever in talks on precautionary loans. In addition, Dublin makes the case that the tamer the conditions, the greater the show of confidence in the exit plan to market investors. Europe accepts Ireland's bona fides, so should bond-buyers.

But will it wash? The view in troika circles is that a “conditions-light” programme is not really a runner. While it is acknowledged they would not be as heavy as in the formal bailout programme, it is argued that they should be substantial nonetheless.

In troika circles it is said that heavier conditions would provide a greater level of reassurance to the IMF and euro zone countries that the money they have lent Ireland will be repaid. There is no suggestion such debts will be repudiated, but the attraction of conditions is that they would keep the Government on a sensible path.

For all the fanfare about the end of the bailout, the case is made that Ireland’s economic salvation is not secure yet. The sky-high level of the national debt and unresolved troubles in the banking system are still a major risk.

Conditionality is also in the institutional culture of bodies such as the IMF and ESM. Furthermore, any precautionary scheme for Ireland would be a first for the ESM.

Its chiefs would be loath to set a “conditions light” precedent for any countries seeking similar aid.

Tough terms
The paradox in the Government's position is that the strength of the exit story weakens the Irish case
for further aid on favourable terms. For one thing, the argument can be made that tough terms in the bailout proper have been shown
to work.

A continuation of that strategy is therefore merited, or so the argument goes.

The Irish argument can also be thrown back in the Government’s face in that the exit proves there is no need at all for precautionary aid, which might not be used anyway.

We will know within weeks how this all plays out.