Ireland: The giant sucking sound heard in the past week must have been confidence exiting Ireland. Even for those who have long been pessimistic on the euro zone periphery, the speed of the rise in government debt yields to around 9 per cent for 10-year paper and over 6 per cent for two year has been astonishing.
Ireland has two big things against it. First, its finances do not look viable; it needs financial assistance. Secondly, European talk of a "crisis resolution mechanism" has been singularly ill-timed. EU leaders have sought to retract that talk by saying debt will not be restructured. But Ireland's position remains parlous. The government needs financial help. How investors will fare over time if support is given remains uncertain.
Ireland's economic crisis, in the first place, is serious. One of solvency, not liquidity. Ireland has cash now but does not look financially viable -- without help. The government's current four-year budget plan, released just eight days ago, looks implausible as soon as 2011. It envisages an undoubtedly big fiscal "consolidation" of 6 billion euros in 2011, close to 4 per cent of GDP, without specifying the cuts, and yet still sees a fiscal deficit in excess of 9 per cent of GDP and a rise in the debt-to-GDP ratio to 106 per cent.
Just how hard it would be to improve on those numbers shows the extent of Ireland's solvency problem. An additional 5 billion euro fiscal consolidation would be enormous and yet, on the implausible assumption that even more cuts do not kill growth, the fiscal deficit would still amount to 6 per cent of GDP and the debt to GDP ratio would climb to 102 per cent. On top of all this, there is the question of whether Ireland can effect still more austerity without provoking further mortgage defaults and another wave of crisis in its banks.
The problem may in part be one of political will but Ireland looks ill-placed to carry out its fiscal adjustment. The unhappy reality is that the bail out of Ireland's banks and the fiscal deficit of one-third of GDP in 2009 has sent Ireland's fiscal accounts and debt on an unsustainable trajectory.
The question then is how to help the country. The problem with the European Financial Stability Facility and the current talk of debt resolution mechanisms is that investors do not know where they stand. The EU is struggling to handle the Irish crisis and needs a range of options for helping periphery economies in troubles. A traditional IMF stand-by facility, combined with a major Irish budgetary effort and reassurances for creditors might have been enough. The EU's mixed messages have made Ireland still more vulnerable.