Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
December 16, 2010
The IMF’s Executive Board approved December 16 a three-year lending arrangement for Ireland, totaling €22.5 billion. The loan is part of an international rescue package worth €85 billion that also involves the European Union, European bilateral lenders, and financing from Ireland’s own cash reserves. Continued liquidity support for Ireland’s banks from the European Central Bank is an essential component of the program.
Market in Dublin, Ireland, where problems in the banking sector and weak growth have necessitated an international rescue package (photo: Newscom)
IRELAND PROGRAM
The main goal of the EU/IMF-supported package is to restore confidence and financial stability. The package includes plans to fundamentally restructure Ireland’s banking system and safeguard public finances. Reforms to restore the long-term growth potential of Ireland’s economy are also part of the program.
“The Irish authorities have designed an ambitious package to address the economic crisis facing the nation,” IMF Managing Director Dominique Strauss-Kahn said.
In recent months, the economic and financial pressures facing Ireland have been intense, leaving the country with little choice but to turn to the international community for help. A preliminary agreement with the European Union and the IMF was announced November 28.
Repairing the banking system
Ireland’s banks are at the heart of the current crisis. Massive lending during the boom years left banks heavily exposed to the Irish property market, which has yet to stabilize despite a steep fall in housing prices of 36 percent since the peak in 2008. At the height of the boom, the assets of domestic banks amounted to five times Ireland’s gross domestic product, with real estate loans making up close to 30 percent of all loans in 2006.
Such an oversized banking system is no longer sustainable, not least because of the ongoing weakness of the property market in Ireland. The problems have resulted in a loss of deposits and market funding, and have made Irish banks overly dependent on financing from the European Central Bank. The banking sector therefore needs to be restructured and recapitalized.
“Swift and sustained implementation of this program will create a smaller banking sector that is robust and well capitalized, and able to serve the needs of Ireland’s economy,” EU Commissioner Olli Rehn and Strauss-Kahn said in their joint statement on November 28.
The EU/IMF-supported package has three key objectives:
•Identify those banks that remain viable and return them to health through downsizing and reorganization.
•Recapitalize banks and encourage them to rely on deposit inflows and market-based funding.
•Strengthen bank supervision and introduce a comprehensive bank resolution framework.
The joint financing will provide the funds necessary for the recapitalization. Under the program, the government will have a notional buffer of about €35 billion to support the banking system, although the actual amount that will be needed is expected to be less than that.
Restoring the health of public finances
The Irish government was among the first in Europe to consolidate fiscal policy in the wake of the global economic crisis. But because of the ongoing problems in the banking system and weak growth, much more is needed.
The Irish government’s National Recovery Plan aims for savings worth €15 billion―amounting to 9 percent of GDP―over the period 2011-14. Savings worth €6 billion are planned for 2011 alone.
Two-thirds of the savings will be achieved by reducing public expenditure. The size of the public sector will be reduced, and universal social welfare benefits will also be cut. The measures are designed to be socially fair and aim to protect the most vulnerable groups in society.
To raise revenue, the tax base will be broadened, and tax rates will increase. 45 percent of Irish households have not paid income taxes until now. The reforms will increase the number of tax payers, and will also make income tax more progressive, for instance by reducing tax relief for private pensions.
Public debt will remain high for the next few years but is projected to decline thereafter.
Raising the economy’s potential
A healthy banking sector and reduced fiscal uncertainty is a prerequisite to economic recovery. After a sharp contraction in 2008-09 amounting to 11 percent of GDP, Ireland’s economy is expected to stabilize in 2010, with moderate growth resuming in 2011.
As domestic imbalances from the boom years are repaired, the recovery will, at least initially, be export-driven. With its business-friendly legislation and highly educated labor force, Ireland has in recent years been a global leader in attracting foreign direct investment.
Unemployment is high at more than 13 percent of the labor force. To encourage new investment and job creation, the government plans further measures to remove restrictions on trade and competition. The unemployment benefits system will also be reformed to improve incentives to take up employment.
Return to growth
With support from the international community, Ireland should be able to restore confidence in its economy, allowing for a return to growth in 2011. But it will take years to repair the damage done to its economy by the bursting of the bubble. The IMF loan, provided under the Extended Fund Facility (EFF), will give Ireland the breathing space it needs to rebuild its economy.
