Dublin, Ireland. Strong program implementation has helped restore confidence in the economy (photo: Cathal McNaughton/Reuters/Newsom)
Irish Economy
Ireland has pulled back from an exceptionally deep banking crisis, significantly improved its fiscal position, and regained its access to the international financial markets.
In an interview, former Ireland country reviewer Chopra and current Ireland mission chief Beaumont—who were involved with the program from start to finish—share their views on the main achievements and the road ahead. Ireland needs to persevere with steady fiscal consolidation and reforms to help an emerging economic recovery become strong and lasting, say Chopra and Beaumont, noting that the program’s success owes much to the full commitment by the Irish authorities and its people—who persisted despite challenges and uncertainty during their program.
IMF Survey: Jai, you oversaw the Fund’s work on Ireland—what do you see as major successes under the program and what is left to do?
Chopra: Ireland has achieved a tremendous amount in the three years since the EU/IMF-supported program began in December 2010. Remember that this period included threats to the very existence of the euro area, making Ireland’s achievements all the more impressive.
The crisis in Ireland was first and foremost a banking crisis. Hence the immediate priority was to recapitalize and stabilize the banking system, which was achieved early in the program, stemming the outflow of deposits. Progress has also been made in reducing the size of the banking system, which had assets of almost 500 percent of GDP when the program started.
On the fiscal side, budget consolidation started even before the program. Over 2009–13, the structural primary deficit has been reduced by about 10 percentage points of GDP. This consolidation has been achieved in a pragmatic way with a good balance of spending and revenue measures and with due regard to fairness. As a result of this adjustment, Ireland should be able to achieve a primary balance in 2014 and government debt should soon be on a declining path.
We are also beginning to see signs of growth emerging and unemployment has been falling. Back in 2011, I had said that employment growth, which has been accelerating in recent quarters, would be the real test of whether the program is working.
Ireland has also implemented a range of institutional reforms to address weaknesses that led to the crisis. The medium-term fiscal framework has been strengthened and a credible and well-functioning fiscal council has been established. And on the financial side, regulation and supervision, which were deficient in the run-up to the crisis, have also been revamped.
But all that said, there is still much that needs to be done. This is not unusual—when problems are as severe as what Ireland faced, it is not possible to fix matters in three short years. This was recognized at the outset, and it does not detract from what has already been achieved.
Importantly, there’s still a large overhang of debt that needs to be worked out. Households’ debts amount to almost 200 percent of disposable income. Sovereign debt is also still high—we project it to peak at about 124 percent of GDP in 2013. So private balance sheet repair and fiscal consolidation both need to continue. Inevitably, these processes take time.
Despite the progress in recapitalizing and stabilizing the banking system, banks are not yet supporting the economy with adequate lending. Nonperforming loans are still high and progress in dealing with these impaired assets has been slow. And bank profitability remains weak. Work needs to continue to address these impediments to sustained recovery.
Looking forward, the critical objective is to generate higher growth based not only on exports, but also a revival of domestic consumption and investment. Such balanced growth is essential to create more jobs and make a bigger dent on unemployment.
The Irish authorities recognize that continued sound policies are needed to support Ireland’s growth and they recently released a medium-term economic strategy to cover the period from 2014 to 2020. The determination to articulate and implement such a strategy is most encouraging.
IMF Survey: Thank you, Jai. And Craig, as mission chief, what do you think were the major steps that Ireland took to regain access to capital markets?
Beaumont: Ireland began to regain market access in the middle of 2012. It started by issuing Treasury bills, with the first issue happening to come immediately after the end-June Summit that called for banking union. Access continued to strengthen, especially after ECB President Draghi announced Outright Monetary Transactions.
Ireland was well placed to take advantage of improved market conditions in the euro area because its strong program implementation had addressed the acute uncertainties around public debt that prevailed at the end of 2010. The deficit target for 2011 was met and the budget for 2012 continued fiscal consolidation at a steady pace. As Jai mentioned, decisive actions on the banking sector during 2011 identified and met the banks’ capital needs in a credible way, at an overall cost below expectations. Perhaps most importantly, markets gained confidence in Ireland’s capacity to recover from the banking crisis as export-driven growth was quite strong in 2011 at 2.2 percent; investors we talked with considered that important.
So regaining market access reflected a combination of steadfast policy implementation, signals of Ireland’s potential to recover economically from its deep banking crisis, and the significant steps forward in addressing the euro area crisis. Market access was confirmed through well subscribed bond issues in January and March this year, including a 10-year issue at a 4.15 percent yield, which is now trading at about 3.5 percent.
IMF Survey: How did the Fund and its European partners collaborate in support of Ireland during this period of turmoil and crisis?
Beaumont: Working with our EU Commission and European Central Bank counterparts was a very collaborative process, seeking a common position on all the key policies. This collaboration helped produce better policy proposals which were then very intensively discussed with the Irish authorities.
In advance of the missions in Dublin, we would coordinate on what the main policy issues were and alert the Irish authorities to those. During the missions we would learn a great deal from our discussions with the authorities, and also with private sector and academic economists, and need to adjust our views.
Typically during the weekend the troika teams would work together on drafts of the policy agreements (the Memorandum of Understanding and Memorandum of Economic and Financial Policies), which often required lengthy discussions among the experts on each issue—we would sometimes bet on when the meetings would finish!
The Irish authorities were the key party in developing and implementing the policies for the program supported by the EU and the IMF. This reflected Ireland’s strong commitment to recover from the crisis, as seen in its significant contribution to program financing, with €17.5 billion of the total package of €85 billion coming from the Irish state.
IMF Survey: What was a broader social and political impact of the bailout?
Beaumont: The bailout was a dramatic shock for Irish society. The government that had negotiated the program soon resigned and elections were held in February 2011. The new coalition government formed in March had a strong mandate to implement its program for Ireland to recover from the crisis. It began by engaging with the troika on redesigning aspects of the program supported by the EU-IMF, including by revising the mix of budget measures to promote job creation.
The social impact of the bailout is hard to disentangle from the ongoing fallout from the banking crisis. Often the bailout is linked to difficult budget measures, though Ireland had been undertaking such measures for 2–3 years before the program, and in the absence of EU-IMF financing, even larger measures would have been required. There was also disappointment in Ireland that the program did not provide a more immediate turnaround in the economic situation. For example, unemployment kept on rising until it peaked in early 2012, though it has declined more recently. But the program did avert a sharper deterioration in the economy, which was likely given the deep loss of domestic and external confidence at the end of 2010, especially in the banking system.
Chopra: I would also add that the teams from the IMF, EC, and ECB made a concerted effort to have a dialogue with labor unions and with other organizations that had direct experience in dealing with vulnerable parts of society. This dialogue was very useful. No doubt, our counterparts will consider that not enough was done to address their concerns and I can understand that perspective. But we encouraged the government to design its fiscal consolidation measures with fairness and equity very much in mind.
IMF Survey: How do you see the prospects for Ireland’s economy going forward?
Beaumont: After relatively strong growth in 2011, growth was sluggish in 2012 and into this year owing to weak trading partner activity and a “patent cliff” shock to Ireland’s large pharmaceutical sector. But a range of indicators signal the economy is beginning to pick up in the second half of 2013.
We are projecting growth to rise to about 1¾ percent in 2014—a little below consensus estimates—and then to about 2½ percent in the medium term. Ireland’s economy is highly open so the main contributor to higher growth is the recovery expected in trading partners, especially the United States, the United Kingdom, and the euro area.
By contrast, we anticipate modest gains in domestic demand next year, with the revival of domestic demand expected to be a protracted process as strained private balance sheets gradually become more healthy and also as the pace of fiscal consolidation eases. Improving financial sector health will also help sustain recovery though renewed lending, although near-term contributions are not expected to be significant.
Chopra: Here I think it’s worthwhile to pick up on a point that Craig made, about the strength of trading partners. Ireland has grown faster than the eurozone average over the last three years. This is encouraging, but it should not obscure the fact that Ireland’s prospects are inextricably intertwined with those of the eurozone. Therefore, Ireland’s prospects will depend very much on the progress made to address demand and supply deficiencies in the eurozone, to achieve the ECB’s inflation target rather than undershoot it, to reduce fragmentation, and to make more meaningful progress in improving the architecture of the monetary union.
IMF Survey: What lessons does the Irish experience hold for global policymakers?
Chopra: IMF rules require an independent staff team to prepare an ex-post evaluation of the Ireland program before the end of 2014. That evaluation will provide a more definitive view, but for now I’ll offer five preliminary lessons.
The first is when the government is dealing with a systemic banking crisis it needs to come to grips with the situation quickly. It is essential to identify whether institutions are viable or not and then deal with them accordingly. Nonviable banks need to be resolved while viable ones need to be recapitalized, restructured and restored to healthy functionality.
Even though systemic banking problems in Ireland first blew up in 2008, confidence that these problems were being adequately tackled did not come till the publication of stress test results in March 2011, about three months into the program. These stress tests, together with the underlying asset quality diagnostics that were undertaken with the help of independent experts, have served as a model in other cases. The Irish also set a high bar for the transparency with which they communicated the results of the analysis underpinning banks’ capital needs.
But it is not just a matter of recapitalizing banks. The banks also need to improve their profitability and get back into the business of lending. And to do that they need to be forceful in dealing with the bad debts on their books. Ireland was quick to set up an asset management company, NAMA, to deal with the large problem loans, especially in the property sector. But it is also essential to deal with smaller distressed borrowers, a problem that became more acute with the rise in residential mortgages that are in arrears. On this front, it took some time to develop a political consensus and the necessary legal framework and banks’ operational capacity to deal with mortgage arrears. In retrospect, more rapid progress in dealing with mortgage arrears would have been worthwhile.
The second lesson is that it is unfair to impose the burden of supporting banks primarily on domestic taxpayers while senior unguaranteed bank bond holders get paid out. This not only adds to sovereign debt, but it also creates political problems, making it harder to sustain fiscal adjustment. Eurozone partners precluded the Irish from imposing haircuts on senior creditors of insolvent banks. But subsequent developments in the principles of orderly resolution of banks, after Ireland had paid off these creditors at great cost, have shown that imposing losses on senior bank bond holders is now becoming more accepted.
Third, on the fiscal front, steady but gradually phased fiscal consolidation that is designed within a well-specified medium-term plan, and that allows for the free play of automatic stabilizers, can be consistent with the return of confidence. There are some who wanted Ireland to move even faster with fiscal consolidation. This would have been a grave mistake. Investors also care about growth.
The fourth lesson from the Irish case is that it demonstrates how pernicious feedback loops can be. Weak balance sheets of banks, of the government, of households, and of companies all interact with each other. These interactions cause economic activity to stagnate and increase deflationary tendencies, further worsening all these sectors’ balance sheets all over again. These feedback loops need to be arrested.
Some of this requires a domestic effort, which the Irish have accomplished as has already been outlined, although much remains to be done to reduce over indebtedness. But in a monetary union support is also needed from partners in the union. No doubt eurozone and EU partners have been generous and supportive of Ireland’s efforts through various initiatives. Nevertheless, there remains an excellent case for even greater eurozone solidarity to break these adverse feedback loops, especially between banks and sovereigns. Such additional support would have a positive payoff, making it an investment that is worth undertaking.
Finally, and perhaps most importantly, the government’s design and ownership of the program is critical. The Irish authorities’ excellent record of policy implementation and compliance with conditionality under the program owes much to the fact that key components of the program were designed by the Irish themselves, and adopted only after they had been debated intensively both internally and with external partners. Social and political cohesion was maintained. Only then do you get full commitment to the measures as in Ireland. Moreover, the Irish persisted despite uncertainty and some dark moments. This makes me more confident that they will continue to persevere to get the economy growing again and to improve people’s lives.
IMF Survey: Finally, Jai, you are leaving the program and the Fund and many people in Ireland are interested to hear about your plans.
Chopra: My involvement with Ireland over the past few years has been the capstone of a three-decade career at the IMF. This experience, together with other stimulating work I've done over the years at the IMF, motivates me to stay engaged in economic policy analysis and advocacy, but in a different setting here in Washington, D.C. I am also interested in doing volunteer work on financial literacy with low-income families and students. The manipulation of borrowers leading up to the crisis demonstrates the need for improving such literacy.
