The Story Behind The Irish Meltdown

The Story Behind The Irish Meltdown

The Irish Miracle

Ireland does not have a long history of economic success. Economists and historians still argue about the reasons why, but Ireland never really participated in the industrial revolution, and the well-known famine in the 1800s began a pace of mass migration that lasted more than 100 years. Simply put, Ireland spent much of the 20th century as a relatively poor (at least by Western European standards), largely agricultural country with a large public sector and heavy state involvement in the economy.

All of that started to change in the 1990s. The national government reduced its direct involvement in the economy, brokered social partnerships between business, unions and itself, significantly cut corporate taxes, and actively encouraged export-focused industry. The result was nothing short of remarkable - Ireland produced GDP growth on par with Asian growth stars like South Korea, Taiwan and Hong Kong, unemployment fell, and the government found itself able to invest in social services like education and infrastructure.

Too Much Too Soon

Unfortunately, it would seem that Ireland sowed the seeds for its own economic destruction during the boom times. The government consistently increased its spending and borrowed to do so, apparently forgetting the lessons of the pre-boom times. What's more, Ireland developed a reputation for rather loose banking laws and turned a blind eye towards rising inflation and a property bubble.

When the credit crunch hit in 2008, it hit Ireland hard. Rising wages were already making Ireland a less desirable offshoring location relative to places like Slovakia and Turkey. Couple that with an overall decline in import demand across Europe and North America and a sudden realization that the loan books of Irish banks were loaded with bad debt, and things went badly very quickly.

Where They Are Today

Where Ireland once came to expect GDP growth in excess of 8% as nothing out of the ordinary, it now appears that Ireland is in for more hard times. GDP seems likely to contract for some time, housing prices are falling, and the company faces large budget deficits and considerably more foreign debt than even Greece or Portugal. Although Ireland's public debt is not nearly so large as its total external debt, it is still large enough to be problematic.

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Seeing the same sort of systemic risk that emerged during Greece's debt crisis earlier in 2010, the European Union is taking more or less the same approach - a large bailout to help the country weather the storm. More specifically, the EU announced a bailout package worth about 85 billion-euro designed to help tide the country over for about four years. For whatever it says about the respective countries, Ireland's deal is a bit different from the bailout given to Greece - Ireland will have longer to pay the loans back, but will be required to kick in more of its own capital (tapping its own pension reserves).

Not surprisingly, this mess has wreaked havoc among Irish businesses, particularly those in the financial sector. Anglo Irish is nearly done for, while Allied Irish Banks (NYSE:AIB) is in deep trouble - so much so that it has had to dispose of valuable assets like its stake in a Polish bank that was acquired by Spain's Santander (NYSE:STD) and its sizable stake in American bank M&T Bank (NYSE:MTB) (which Santander also reportedly wanted to buy). While AIB trades at a price that suggests nationalization (whether formally or informally) is all but a given, Bank Of Ireland (NYSE:IRE) seems to trade with more of a glimmer of hope - but hardly anything close to optimism.

Not Just About Ireland

As Ireland wobbles, familiar fears have come back into the market. Numerous large European banks and insurance companies own large amounts of debt from the so-called PIGS countries (Portugal, Ireland, Greece and Spain), and fears and rumors are once again circulating about what this latest crisis will mean to the solvency and liquidity of these banks. In other words, a second credit crunch (and the resulting economic spillovers) is the fear in many investors' minds, and the spreads on credit default swaps (a measure of investors' risk appetite and fear) have been moving higher again. Now, the fear is if Spain or Portugal will follow the path of Greece and Ireland and further strain the system.

The Bottom Line

Unfortunately for Ireland, there is no easy road back to prosperity. The entanglements of membership in the European Union limit the government's options, and competition from other countries has eroded Ireland's competitive advantage as an export factory of choice. Ultimately, property values will have to fall to whatever constitutes a new "normal," and wages will likely follow as well. Ongoing efforts to pull back government spending and encourage business formation are good starts, but there is no quick fix here. Ireland is looking at a stretch of hard times and tough decisions before it can think of how to bring the good times back to life.

Source: www.investopedia.com

Thanks,
Gaurav Agarwal
Head Dealer
DENIP Consultants Pvt Ltd