Will Ireland Default? Ask Belgium
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By Simon Johnson
On the face of it, Ireland seems poised on the brink of default. Its debts are very large relative to the size of its economy, most of this money is owed to foreigners and – unless there is an unexpected growth miracle – the country will struggle to pay its debts in full for many years to come.
Yet all the indications are that, as part of the historic rescue package to be introduced this week by the European Union and the International Monetary Fund, Ireland will not default on or otherwise restructure its most substantial debts. Why not?
To be clear, Ireland owes a huge amount of money to the outside world. In the best scenario, Ireland’s government debt is likely to stabilize at more than 100 percent of gross national product (G. N. P.); in the worst scenario, with greater real estate losses and a deeper recession, this level could reach 150 percent.
That’s a higher number than you see in many news reports, in part because officials are still focused on gross domestic product, a misleading statistic in the Irish case, as Peter Boone and I have been arguing in this space for some time. (Update: some news reports are currently using a higher number for Ireland’s debt, implying that the country owes 10 times its GDP; this is based on misreading the statistics regarding off-shore financial transactions that are run through Ireland. This misunderstanding will be cleared up when the Ireland-IMF-EU package is announced.)
At least 20 percent of Ireland’s G.D.P. is from “ghost corporations” that have little or no real activity in Ireland. Corporate taxes are set at 12.5 percent, but leading global corporations are able to construct complicated schemes involving other offshore tax havens that reduce their effective tax rates to the low single digits.
The Irish insist that raising the corporate tax rate would not generate additional revenue – effectively acknowledging the point that this part of the economy cannot be taxed as part of the anti-crisis policy mix. You will know that reality has finally set in when all the relevant numbers are presented relative to G.N.P., not G.D.P.
After the I.M.F. finishes going through the Irish books, we will all need to redo our projections (remember the data revisions that came to light in Greece under similar circumstances). But for now we stand by our previous assessment regarding the likely trajectory of Irish budget deficits – in the region of 10 to 15 percent of G.N.P. for this year and next.
So why not restructure some of this debt, particularly as much of what the government will owe is actually debt taken on by overgrown and careless Irish banks?
The government has indicated that it will force a restructuring of some subordinated, relatively junior debt – for at least for one prominent bank, Anglo Irish, this may amount to paying 20 cents in the euro. This debt by itself is too small to make a difference, but why not apply the same principle to other categories of borrowings?
The most obvious answer is: Ireland’s European partners do not want this to happen, because it would expose the really bad decisions made by pan-European banks and their regulators over the last decade and create potential fiscal risks in other euro-zone countries.
Jacob Kirkegaard, my colleague at the Peterson Institute for International Economics, points out that the claims of foreign banks (in the 24 countries reporting to the Bank for International Settlements) on Ireland “are at over $500 billion — three times the scale of total claims against Greece.” (The underlying BIS data he uses can be seen here:
http://www.bis.org/statistics/provbstats.pdf#page=90; start on p.90.)
German banks in particular lost their composure with regard to lending to Ireland – although British, American, French and Belgian banks were not so far behind. Hypo Real Estate – now taken over by the German government – has what is likely to be the highest exposure to Irish debt.
But look at loans outstanding relative to the size of their domestic economies (using the BIS data on what they call an “ultimate risk basis”).
German banks are owed $139 billion, which is 4.2 percent of German G.D.P. British banks are owed $131 billion, or about 5 percent of Britain’s G.D.P. French banks are owed $43.5 billion, which is approaching 2 percent of French G.D.P. But the eye-catching numbers are for Belgium, which is owed $29 billion – in the relatively small Belgian economy, this accounts for around 5 percent of G.D.P.
Given the prevalence of off-shore banking in Ireland, these numbers may overstate the true liabilities. But still, Belgium is already on the hook, according to the Bank for International Settlements, for 18.3 percent of G.D.P. as a result of “general government contingent liabilities arising from ‘crisis assistance’ to financial institutions” (again, see Jacob’s note.) The last thing it – or the rest of the euro-zone – needs is a fiscal crisis arising from commitments to support its banks after an Irish default.
Belgium’s overall fiscal picture is not good, its political stability is far from assured and its underlying social fissures would surely not be helped by a further dose of severe austerity. (According to Eurostat’s latest numbers, the Belgian budget deficit was 6 percent of G.D.P. in 2009 and its debt was 96.2 percent of G.D.P. at the end of last year; to be fair, Belgium has an established tradition of being able to survive with high debt levels.)
In addition, Ireland’s European creditors reckon, if they can just hold on for a few years, perhaps there will be a recovery in asset values. But real estate prices rose dramatically in Ireland over the last decade – quadrupling by some measures. And fiscal contraction – either higher taxes or lower government spending or both, as negotiated with the I.M.F. and E.U. – is unlikely to help the residential real estate market (so far most of the damage has been in commercial real estate.)
It is true that Irish mortgages are “recourse” — that is, you can’t just turn in the keys and walk away from a property as you can in many parts of the United States. On the other hand, Irish residents can leave the country – moving to Britain or the United States is a well-established tradition for many families. And how can an Irish lender enforce debts when someone has emigrated?
Eventually, Ireland will need to restructure its debts. How soon and how completely it does this will have major implications for the rest of Europe.
Many countries were exposed to the potato blight of the 1840s – it was a global affliction — but Ireland was unusually dependent on this one crop (a phenomenon known as monoculture). The result was famine and emigration; the population never returned to its pre-1840s level.
Many countries experienced debt-based property booms over the last decade fueled, in part, by reckless cross-border lending. Ireland again proved to have something of a monoculture; this is the origin of its extreme vulnerability and an awful decade to come.
This time, will the global disease continue to spread as banks elsewhere get bailouts that allow them to become even bigger and more dangerous? Will we see immediate ramifications in other euro-zone countries, such as Belgium or others?
And will the same underlying problem continue to grow in such a way that it can ultimately bring down the United States – as Peter Boone and I suggested here in March?
