Mission Concluding Statement 

Dublin, May 31, 2010

Retaining Credibility

1. Through assertive steps to deal with the most potent sources of vulnerability, Irish policymakers have gained significant credibility. Measures to stabilize the banking sector and achieve substantial fiscal consolidation have demonstrated the authorities’ resolve to alleviate short-term risks while beginning to tackle their considerable long-term challenges. These actions have reassured the global policy community and international financial markets. Over the past months, Irish sovereign bond spreads have tended to rise significantly on the days of intensely adverse international market sentiment but otherwise Ireland has been accorded the space to pursue its planned policy trajectory.

2. Along the complex and long-haul path to normalcy, retaining policy credibility will require active risk management. The appropriately ambitious fiscal consolidation plan demands years of tight budgetary control. Likewise, the weaning of the banking sector from public support and its eventual return to good health will proceed at only a measured pace. In the interim, unforeseen fiscal demands may occur. In this context, at times heavily bunched banks’ funding needs and episodes of market volatility could generate unwelcome pressures and disruption. With limited fiscal resources for dealing with contingencies, maintaining a steady policy course will require mechanisms for oversight and transparency, and high-quality communication to minimize risks and sustain the political consensus and market confidence.

A Modestly-Paced Recovery

3. Ireland is likely to emerge from its output contraction into a period of relatively modest growth potential and high unemployment. Current Irish and global conditions make forecasts subject to much uncertainty. Various indicators point to a return to economic growth during this year, but following its earlier steep fall, GDP in 2010 is projected to be about ½ percent lower than in 2009. As the post-crisis dislocations are undone, annual growth rates should rise gradually to about 3½ percent by 2015. After peaking around 13½ percent this year and, absent additional policy measures, a sizeable structural component will likely keep unemployment at around 9 percent in 2015.

4. The improved global outlook will help, but to a limited extent. With some reversal in the earlier loss of competitiveness and improvements in the global economy, exports will lead the recovery. But spillovers to the domestic economy will be limited because of exports’ heavy reliance on imports, their tendency to employ capital-intensive processes, and the sizeable repatriation of profits generated by multinational exporters.

5. Moreover, home-grown imbalances from the boom years will act as a drag on growth. The unwinding of these imbalances—arising from rapid credit growth, inflated property prices, and high wage and price levels—will limit the upside potential.

• Financial sector weakness, fall in real estate prices, and high unemployment could continue to reinforce each other. For this reason, current policy efforts to boost banks’ capital-ratios are important and will help counter these tendencies.
• But deleveraging to reduce the loan-to-deposit ratio and banks’ risk aversion will constrain lending and the pace of economic recovery, at least in 2010–11. Higher than expected losses, uncertainties in global regulatory trends, and renewed financial market tensions—that may restrict access to funding—create downside risks. In this environment, the targets for SME lending need to be combined with strong prudential safeguards as the non-performing loans of this sector have grown rapidly.
• Prices and wages are declining, with beneficial long-term effects. But deflationary tendencies would raise the real debt burden of highly-leveraged businesses and households, impeding growth.

Restoring the Financial Sector to Healthy Functionality

6. Following recent measures to strengthen the banking sector, a sizeable agenda remains. The transfer of banks’ property development and commercial real estate assets to the National Asset Management Agency (NAMA) and the complementary decision to raise the targets for core Tier-1 capital of banks by year-end takes the banks closer toward normalcy. The further policy agenda includes restructuring—to continue dealing with the after effects of the crisis—and creating a stronger framework for financial stability. Together, these measures should help the phasing out of the guarantees of bank liabilities.

7. Three restructuring priorities deserve attention:

• NAMA should schedule an orderly disposal of the property assets acquired aimed to reduce the large overhang of property in state hands, restart market transactions and, thus, help normalize the property market. Oversight of NAMA operations, which is provided for in the legislation, is desirable.
• Mindful of the moral hazard risks, narrowly-targeted support measures for vulnerable homeowners would limit the economic and social fallout of the crisis. With their bolstered capital, banks could absorb the initial costs, perhaps basing themselves on the welfare system to identify eligible beneficiaries. This process will be aided by an overdue shift to a more efficient and balanced personal insolvency regime.
• From the current focus on bank-by-bank restructuring, the authorities’ intent to proactively reshape the system is appropriate. A strategic, but market-oriented, approach should be used to achieve a future viable and competitive banking system.

8. With much progress achieved in creating a framework for future stability, more immediate attention is needed to establish a special bank resolution framework. The de facto consolidation of the Central Bank and the Financial Regulator, the proposed bill to formalize this arrangement (including more accountability of the Regulator), and the new risk-based supervisory approach being proposed are all steps in the right direction. The key challenge is to ensure implementation of these plans through adequate resources and enforcement powers. This should be complemented by early action to introduce a special bank resolution mechanism which would strengthen the stability framework. The powers under such a regime would be an important addition to the set of tools available to the authorities to meet contingencies. Provision for bank levies of the sort being discussed internationally also needs to be considered.

Staying on the Fiscal Consolidation Path

9. The authorities moved early to establish a balanced consolidation plan and have stayed on course. As the fiscal situation deteriorated, the authorities acted repeatedly to take measures and raise the ambition of their fiscal consolidation goals. This was achieved in a remarkably socially-cohesive manner and represented a balance of economic and social considerations. With their 2010 budget, the authorities have adhered to the consolidation track leading towards reducing the budget deficit to below 3 percent in 2014.

10. Looking ahead, substantial challenges remain. Following the already sizeable consolidation in 2009 and 2010, further consolidation measures, although not as large as that already achieved, of at least 4½ percent of GDP are required to reach the 2014 target. If GDP growth outcomes are weaker than those currently foreseen by the authorities—a clear possibility within the current range of scenarios—the additional effort needed may even be greater. Staying on target is critical to retain the hard-earned credibility. But the risk of “consolidation fatigue” and, hence, a fraying of the necessary social cohesion cannot be ruled out. For this reason, greater specificity on further proposed measures is necessary. Sustainable expenditure savings will be central, including through efficiencies in public services. Broadening the tax base for revenue enhancement will also be necessary.

11. Now is also a good moment to establish an institutional process to reinforce the collective commitment to stable public finances. The authorities have indicated the possibility of further developments in the move to a medium-term budget framework. Adoption of such a framework would provide the structure to reduce the uncertainties associated with the consolidation process; in good times ahead, it would constrain excesses. The authorities should also seriously consider adopting a fiscal rule that creates a public metric for sound public finances and a technocratic fiscal council to advise on risks underlying public finances. Such mechanisms, despite their known limitations, would enhance policy credibility now and in the future.