Irish head toward bailout; Portugal could follow

Friday, November 19, 2010

IRISH OFFICIAL said government welcomes "contingency fund"

DUBLIN -- Ireland edged toward taking a bailout loan from the European Union to bolster its debt-crippled banks -- but the prospect offered little reassurance that other corners of Europe could cope with their own crushing levels of government debt.

After Greece and likely Ireland, analysts say Portugal may be the next country in the 16-nation eurozone to need assistance. They suggest the crisis is now being driven less by irrational fears than by a growing realization that debts are too big for vulnerable nations to refinance, never mind pay back.

Experts from the European Commission, European Central Bank and International Monetary Fund met Thursday in Dublin to explore the scope and terms of a bailout. European officials agreed to send them at a summit Tuesday after weeks of Irish denials that they required any emergency aid. The talks were expected to run into next week.

Irish Finance Minister Brian Lenihan insisted his government needed no money itself because it's fully funded through mid-2011. But Lenihan said he would welcome a "contingency capital fund" -- a backstop for the country's troubled banks -- effectively an overdraft or credit line.

"The banks grew to such a size that they became too unmanageable for the state itself. That's the big difficulty here. ... And it's clear that we will need some form of external assistance to address the difficulties," Lenihan said at the conclusion of daylong talks at the Irish Central Bank.

The government appeared determined to defend its prerogatives in bailout talks, which typically involve the aid recipient agreeing to the creditors' conditions to improve its finances.

In Ireland's case, deputy prime minister Mary Coughlan declared that keeping Ireland's 12.5 percent rate of corporate tax "is nonnegotiable." It's a key attraction for businesses, but EU heavyweights such as Germany and France don't like the tax because theirs are higher.

Such inflexibility, while widely supported in Ireland, has been questioned elsewhere as unrealistic.

Government in denial?

"When does denial turn into delusion?" Joan Burton, finance spokeswoman of the opposition Labour Party, said to Lenihan and Coughlan during a parliamentary debate. She accused the government of lying to the public about the inevitability of a bailout.

All across the eurozone, analysts say, debt-burdened governments are living in denial about their weakening power to keep drumming up fresh finance from skeptical bond markets and foreign banks.

Weak growth means Greece remains vulnerable to eventual default, or a second rescue, when its current 110 billion EU-IMF loans come due for repayment in 2013. Portugal and Spain are hoping the interest rates on their bonds will fall once the EU and IMF cap concerns about Ireland.

And investors did trade positively on news of the IMF's arrival in Dublin. The euro gained nearly a cent to $1.3640, while the interest rate on Ireland's bonds fell, most markedly on shorter-term securities. But reflecting wider jitters, the yields on Spanish, Portuguese and Italian bonds rose.

The immediate focus is on Dublin because its banks have broken the patience of their major recent source for funding, the European Central Bank. Losses at five Irish banks, all of them nationalized or with major state stakeholdings, have required a $62 billion government bailout that has pushed the Irish deficit this year to an unprecedented 32 percent of GDP.

The Irish Central Bank, controversially, has also made its own ECB-authorized loans to the banks, taking total ECB exposure in Ireland up to a quarter of its book.

Irish Central Bank governor Patrick Honohan forecast that Ireland would negotiate a loan facility with the EU and IMF worth "tens of billions." He said the funds would be a financial "buffer" for Irish banks that would reassure markets the banks could pay and thus could be "shown but not used."

Lenihan said Honohan, who is independent of the government, "may well be right" that tens of billions will be required. "But figures have not even been discussed yet," he said.

Borrowing more

While Ireland two months ago quit the bond market, citing the punitive rates being demanded, Spain, Italy, Portugal and Greece haven't had the option of waiting it out and have been borrowing at increasing rates from jittery bond markets. Paying progressively higher rates can leave a country unable to roll over its debt, or borrow to pay off expiring bonds, as happened to Greece when it was rescued from bankruptcy in May.

Just like Ireland, Spain has been laid low by the 2008 collapse of a runaway property market. Its own exposure to ECB borrowing exceeds 70 billion. The Spanish have led eurozone calls for Ireland to accept an aid package soon, believing this will ease the yields on eurozone bonds as a whole.

Yet analysts caution that any announcement of an Irish aid deal won't stop a "contagion" effect -- because other corners of the eurozone are suffering from their own specific ailments, most immediately Portugal.

"The resolution of the Irish crisis is really irrelevant for Portugal," said Daniel Gros, a former IMF economist who directs the Center for European Policy Studies, a Brussels think tank.

"People always think that markets are irrational" and that panic will spread from one country to another, Gros said. "But after a while, markets look at the fundamentals, whether a country is vulnerable -- and on the fundamentals Portugal is very weak."

Portugal has the eurozone's worst current account deficit, which means its residents consume far more than they export. While the 16-nation bloc's current account deficits average just 1 percent, Portugal's is 12.3 percent.

As in Ireland, Portugal's treasury officials stress that everything is under control and they see no difficulties in borrowing on the open market, albeit at rates approaching 7 percent.

Portugal, Ireland, Greece and Spain all have accused the eurozone's primary bankroller, Germany, of needlessly driving up their immediate borrowing costs by raising the specter of bond defaults down the road.

Chancellor Angela Merkel insisted again Thursday that bondholders -- savvy investors who make loans knowing they have no guarantee of repayment -- must start taking losses when Europe's current ad-hoc system for providing emergency aid to eurozone members expires in 2013.

"For me, it is a question of principle to what extent politicians expect market participants to be responsible to some extent for their risks," she told a conference of German insurers.

Thursday's behind-closed-doors talks in Dublin involve Ireland's state-owned "bad bank," the National Asset Management Agency. It has been buying tens of billions of Irish banks' dud property-based loans at hefty discounts in an exercise to remove toxic debts from the banks' books.

Ireland's major trading partner, Britain, has already pledged it could contribute around 6 billion pounds $9.6 billion to an Irish aid effort.

Britain has exposure to Irish bank loans totaling $222 billion, while Germany has $206 billion and the United States $114 billion, according to the Bank for International Settlements.

AP Business Writer Gabriele Steinhauser in Brussels contributed to this report.

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