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Research Ireland: A costly affair

By: Danske Bank
  • The market appears alarmed by the rising cost of restructuring in the Irish banking sector and in particular the Anglo Irish bank. As a result Irish 10-year government bond spreads to Germany hit a new euro lifetime high of 4.12% on Monday. On Tuesday the mood improved as two Irish bond auctions went well.
  • The total cost of restructuring the banking sector depends among other things on developments in the housing market and the construction sector. In our main scenario house prices will stabilise in 2011 after a total decline of 40-45%. Estimates of the total cost of the banking crisis range from EUR38bn to EUR50bn, or 23-32% of GDP.
  • The one-off expenditure will primarily affect the government budget in 2010-11. The deficit excluding the cost of bank restructuring is projected to be 11.6% of GDP in 2010 and decline to 10% of GDP in 2011. The government debt excluding bank restructuring costs is likely to peak at around 107% of GDP in 2014.
  • Due to the high costs of restructuring banks and a somewhat downbeat growth outlook (the outlook for exports is promising, but the recovery in domestic demand is set to be slow) the government may have to do more fiscal tightening than previously planned in order to reach the target of 3% of GDP deficit in 2014.
  • At current market rates, going to the EU/IMF for help could make financing the debt cheaper, but since the Irish government is well aware that a rescue package comes with strings attached and funding is in place well into Q1 11 the government is liable to take a wait and see approach for now.
  • The government has much credibility tied to solving the current crisis without IMF/EU help, so we believe it would only ask for international help if all other options fail. We thus find that unless spreads become prohibitive the likelihood that Ireland will ask for IMF/EU help is small.
  • We believe that it is feasible to bring public finances on a sustainable path, but that declining support for austerity measures is a risk to watch. Other risks include rating downgrades (Irish government bonds are on negative outlook from S&P) and more negative news about the housing market and banking sector.
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