ireland’s eu-imf program: a safe harbor in a perfect storm
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Presentation by Craig Beaumont, Assistant Director of the European Department, International Monetary Fund at the Conference "Have We Learnt Anything from the Crisis?" in Riga, Latvia. 17.10.2014TRANSCRIPT
Ireland’s EU-IMF Program
A Safe Harbor in a Perfect Storm
Craig Beaumont
Bank of Latvia Economic Conference
“Have We Learnt Anything from the Crisis?”
Riga
October 17, 2014
Outline
I. Severe Challenges
II. Program Strategy
III. Euro Area Policies
IV. Results of Program and Euro Area Policies
V. Some Lessons
I. Severe Challenges
Major Credit Boom and
Property Bubble 2004-07
Confidence: underpinned by strong FDI-led growth in 1990s
Lax bank supervision: high exposures to commercial and
residential property, declining lending standards
Intense banking competition: entry from UK and EU banks,
battle for market shares
Wholesale funding availability: 55% of assets by end 2008
→ Irish Banks highly vulnerable to Subprime
& Lehman’s shock, intensifying bust
Severe Bust 3 Years Before Program (Deflation of 8% in 2009-10, 60% fall in Construction Jobs)
75
80
85
90
95
100
105
75
80
85
90
95
100
105
2007 2008 2009 2010 2011
Real GDP
Nominal GDP
Employment
GDP and Employment (2007Q1=100)
Source: IMF WEO; IMF staff calculations and estimates.
Program
starts
Δ2007-10
-9.4%
-16.7%
-12.2%
Revenue Collapse Pushes Fiscal Deficit
Over 10% of GDP (before bank costs)
35
40
45
50
55
60
65
70
75
80
35
40
45
50
55
60
65
70
75
80
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Revenue
Primary expenditure
Boom Period Bust Period EU-IMF Program
Fiscal Aggregates (Euro billions)
RevenuesFall 19.6%in 2 years
Averageprimary surplus 2.3% GDP
Major Irish Policy Efforts Before
the EU-IMF Program…
Banking measures (initially assume liquidity crisis)
Near-Blanket Bank Guarantees in Sept. 2008 (after Lehman)
Capital injections of €46.3 bn (30% of GDP) by end 2010
Nationalize 2 failed banks (Anglo Irish & INBS)
Large risky property loans to NAMA (€74 bn @ 57% discount)
But market concerns rise as banking costs grow
Fiscal efforts large (though partly reverse loose Budget 2008)
6.2% of GDP measures in 2008-10 (4.3 spend and 2.0 revenue),
includes 14% cut in public wages in 2009
But deficit still 11½% of GDP in 2010 and
Public Debt near 100% of GDP (from 25% in 2007!)
8
…but from 2010 Ireland
Faced a “Perfect Storm”
Irish Crisis Banks insolvent and illiquid
High private debt, weak demand Large fiscal deficits
Uncertain bank support costs
Euro Crisis Greece, Portugal, …? Bank Fragmentation
and Deleveraging Euro itself ???
...Culminating in Massive Runs of
Bank Funding in late 2010
0
20
40
60
80
0
20
40
60
80
Aug-10 Sep-10 Oct-10 Nov-10 Dec-10
Debt securities, net repayment
Deposits, private sector (net outflows)
ECB liquidity support
Sources: Irish Authorities; and IMF staff calculations.
Maturing bank bonds and deposit outflows (corporate
and wholesale) required large new ECB funding
in Sept.-Nov. 2010 (€65 billion, 40% of GDP)
Irish Government Lost Market Access as
Sovereign-Bank Loop Amplified by
Market Uncertainties about EA Policy
Sovereign Market Access
Public Debt Sustainability
Risks
Uncertain Cost of Bank
Support
Bank Market Access
ECB Funding
of Irish Banks?
(High ECB exposure,
solvency of banks)
Sovereign
PSI?
(Deauville)
Extent of
Bank
Creditor
Bail in?
II. Program Strategy
Objectives
1. Immediate Need: Restore Financial Stability
Recovery and debt sustainability not feasible otherwise
2. Ultimate Goal: Regain Market Access
by reducing uncertainties around:
Public Debt Sustainability
Financial System Soundness
Sustained Economic Recovery
1. Package of Upfront Actions in
first quarter of 2011…
Program financing (€85 billion, frontloaded)
Reduce market concerns about near-term default or PSI
Avoid resource constraints on bank support
Evaluate Bank Balance Sheets Credibly (PCAR 2011)
Asset Quality Review by third party (BlackRock Solutions)
Stress scenario conservative, 3-years, high floor (6% CT1)
Explicitly includes bank deleveraging cost (€13.2 bn)
Financial market analysts note transparency and credibility
Clear Plan for Banks (March 31, same day as PCAR 2011)
BoI and AIB to be “pillar banks” (though PTSB less definite)
Anglo Irish and INBS in wind down, transfer of deposits
…Helped Restore Financial
Stability in First Half of 2011
Capital need of €24 billion identified (15% of GDP)
Funds deposited in banks by April
→ Remove Doubts on ECB Funding (helpful ECB statements)
Deposit (mostly corporate) outflows slowed after Q1
ECB funding peaks at €150 billion in Feb. 2011
Public cost limited to €16.5 billion (10% of GDP), with
subordinated debt operations saving €4.9 billion. Savings
could have been larger with senior bank debt included.
But Irish yields only briefly fell 120 bps in April 2011, as
impact overwhelmed by Euro Crisis
Political stability also critical:
Election Feb. 2011: Coalition broadly supports program goals.
2. Address Public & Private Debt
Issues While Protecting Growth
A. Fiscal consolidation: large, frontloaded, phased
B. Banking sector repair: Deleveraging over time
Rebuild profitability
Resolve many NPLs
C. Other structural reforms: not important in Ireland
Business environment positive, employment protection modest
Competitiveness gap not large (5-10% in mid-2012), addressed
by flat nominal wages over time
2011 2012 2013 2014 2015
EDP ceiling (%GDP) 10.6 8.6 7.5 5.1 2.9
Consolidation Effort (€bn) 6.0 3.8 3.5 3.1 2.0
Debt Sustainability Fragile → Carefully
Balanced Policy Targets and Safeguards
Trade-offs to be balanced include:
Fiscal Consolidation Speed vs. Demand Recovery
Bank Deleveraging Pace vs. Disposal Cost & Credit Growth
Loan Resolution Pace vs. Restructuring Cost & Durability
Policy Target Safeguards
Fiscal
consolidation
Phased over 5 years
(3% by 2015)
Avoid pro-cyclical measures
for growth deviations
Bank
deleveraging
Phased over 3 years to 2013
Loan to Deposit < 122.5%
Mostly offshore assets
No fire sales
NPL
resolution
Mortgage arrears targets
phased during 2013-14
Awaited legal reforms
(insolvency and repossession)
Privatization Up to 2% GDP Sale depends on market
conditions
III. Euro Area Policies
Euro Area Support and Policies
Essential to Program Success
EU financing terms improved → Debt more Sustainable
Mid-2011: Margins on EU loans eliminated
June 2013: Maturity extension on EFSF/EFSM loans
ECB funding stabilized → Market Confidence Improved
Mar. 2011: Waiver of rating requirement for Irish collateral
Dec. 2011: 3-year LTRO stabilized bank funding
Feb. 2013: Promissory note collateral for ELA (7-8 year
maturity) replaced by government bonds (25-40 years)
Mid-2012 Commitments → Uncertainties Reduced
June 29, 2012: Banking Union adopted by EA Summit
July 26, 2012: “…, the ECB is ready to do whatever it takes
to preserve the euro. And believe me, it will be enough.”
IV. Results of Program
and Euro Area Policies
Irish Recovery Begins After mid-2012
led by Hiring and Investment
60
65
70
75
80
85
90
95
100
30
40
50
60
70
80
90
100
2007Q4 2008Q4 2009Q4 2010Q4 2011Q4 2012Q4 2013Q4
Employment, rhsTrough: 2012'Q3
House prices, Trough: 2013'Q1
Investmentex. AircraftTrough: 2012'Q3
Banking Union: June 29, 2012
"Whatever it Takes": July 26, 2012EU-IMF
Program
Euro CrisisIntense
Sources: CSO; and IMF staff calculations.
Fiscal deficit consistently
within EDP ceilings Effort greater in 2012 and less
in 2014 (by 0.3% of GDP)
-12
-10
-8
-6
-4
-2
0
2009 2010 2011 2012 2013 2014 2015
Actual EDP ceiling
General Government Deficit(Percent of GDP)
Sources: National authorities; and IMF staff estimates.
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2009 2010 2011 2012 2013 2014 2015
Actual Planned 1/ Change in structural primary balance
Consolidation Effort(Percent of GDP)
Sources: National authorities; and IMF staff estimates.
1/ National Recovery Plan 2011-14 for 2011 and Nov. 2011 MTFS for 2012-15.
Fiscal Policy Kept on Track Despite Growth
Shortfalls with Limited Adjustments in Effort
Banking—Much Progress but
Work Remains Capitalization and provisioning more robust
Provisioning guidelines tightened in 2011 and 2013
AQR (by CBI) in 2013 found additional provisioning needed
Capital still strong, with 13.3 percent CT1 ratio (end-2013)
Liquidity much improved
LDR reduced to 111% by end-2013, down from 190%
ECB support to open banks €90 billion → €12 billion recently
Restructuring progress but work remains
Cost cutting progress in 2012 and two larger banks show
improving profitability
But smaller bank profit recovery too slow
NPL resolution rather slow (still 26% of loans), but resolution
frameworks now in place
Market Re-entry Step-by-Step Process
Starting from mid-2012
July 2012: First T-bill issuance, in week after EA summit
Sequence of well subscribed syndicated bond issues:
Moody’s last to upgrade to investment grade (Jan. 2014)
March 2014: First bond auction 10-year, €1 bn, yield 2.967%
October 2014: 10-year, €1 bn, yield 1.63%
Early repayment of IMF planned (€18.3 bn of €22.5 total)
Date Maturity Amount Yield
Aug. 2012 5-year
8-year
€3.9 billion
€1.3 billion
5.9%
6.1%
Jan. 2013 5-year €2.5 billion 3.3%
Mar. 2013 10-year €5 billion 4.15%
Jan. 2014 10-year €3.75 billion 3.5%
V. Some Lessons
IMF: Program Effectiveness
Ex Post Evaluation due in coming months will
provide formal IMF assessment of the program
Authorities’ ownership of design and
implementation of policies is key to success
Currency union policies also key, as program
success hinged on calming euro crisis
Reviews are critical to fixing problems, e.g., adverse
side effects of loan to deposit targets
25
Initial Deleveraging Targets Led to
Unintended Pressure on Deposit
Rates—Revised in first half of 2012
26
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13
Deposits, households
Deposits, NFCs
Loans to NFCs (below 1 mln), right scale
Pressure on deposit rates from targets onLoan to Deposit ratio
Interest Rates on New Business(Percent)
IMF: Reduce Deficits in Sustainable
Manner while Protecting Growth
Growth as well as deficits matter for debt sustainability
Comment repeatedly made by investors
Phasing of consolidation should recognize:
Capacity and credibility of authorities
Protecting growth by spreading fiscal drag
Financing availability
Anchor amount of fiscal effort/measures, let automatic
stabilizers work, review medium-term path if shocks persist
Authorities’ development of budgetary measures is key for
ownership, social cohesion, sustainability of consolidation
IMF: Careful Phasing of Financial
Repairs if Debt Sustainability Fragile
Well functioning banks involves more than restoring solvency.
Deeper repairs (e.g. deleveraging, loan resolution, operating cost
cuts) take time and involve market transactions and negotiations.
Bank repair design, including phasing, must contain fiscal costs.
Sovereign market access is a precondition for banks to regain
access. Bank solvency must be maintained, but full repair of loan
books or liquidity is not required for recovery or for banks to
regain market access.
Phasing of loan resolution depends on the type of loan:
Corporate loans: resolve quickly to protect business value and
facilitate new investment
Property loan: quick resolution may crystallize unduly large loss
in illiquid market, can outweigh benefits of reduced NPLs
28
Ireland: Has Strengthened its’ Fiscal
Policy Framework
Fiscal Council established. It independently:
Assesses soundness of fiscal stance
Endorses budget macroeconomic forecasts for Budget
Fiscal Responsibility Act approved by referendum:
General government: budget balance rule, debt rule
Expenditure ceilings at both aggregate and ministerial
level, with three year horizon
But new fiscal institutions face major challenges:
Is the strong bias to procyclical budgets addressed?
Can large primary surpluses be sustained to reduce debt?
29
Ireland: Financial Sector Should
Support Sustainable Growth
Supervision strengthened:
Increased CBI resources and new risk-based approach
Legal powers of CBI strengthened in July 2013
SSM from November
Liquidity: new Basel standards on NSFR and LCR
Lending standards: CBI proposed new LTV limits
Nonbanks for more diverse and robust financing:
REITs are bringing more equity to commercial property
Loan Origination Funds alternative for SME financing
Macro prudential tools being developed: will they be
effective against procyclicality in borrower confidence,
collateral values, credit ratings, wholesale funding availability?
30
EU/Euro Area: Many Issues Addressed
but Work Agenda Remains
OMT: avoid instabilities in sovereign debt markets
Banking Union: unified and strengthened supervision & resolution
Bank Recovery and Resolution Directive: enables bail in to protect
fiscal position with financial stability safeguards
Comprehensive assessment: remedial measures should be swift
and transparent
Macroeconomic imbalances procedure: support appropriate policy
response to imbalances including credit booms
Banking Union issues to be addressed:
Common fiscal backstop for banking union: help sever sovereign-
bank links
Liquidity support for distressed banks: if banks are to remain open,
arrangements need to limit uncertainties to avoid funding runs 31
Questions?
In Ireland, Other Structural Reforms
Were Not Key to Program Goals
Labor market
Minimum wage to be reduced by €1 to €7.65 for new entrants.
Sectoral wage agreements. Wage floors above minimum wage for 23% of
employment, mostly low skill, inc. construction. Reform aims to make
wage-setting more responsive to economic conditions.
Activation of long-term unemployed through stronger employment
services and training better linked to market needs.
Goods and services markets
Competition Act enforcement provisions strengthened, supported by
25% increase in resources of Competition Authority.
Legal services reform to make legal costs transparent & improve oversight.
Medical reforms reduce pharmaceutical margins & increase competition.
State asset disposals
Target of proceeds of up to €3 bn (2% of GDP), mostly power generation.
Other Structural Reforms—Mixed Gains
Minimum wage cut reversed: by new government as
election pledge, as population considered cut unfair
Employment services strengthened but rather slowly:
Offices for integrated employment services (Intreo) being
established. Modest redeployment of staff (300) to front-
line case officers, but ratio to unemployed remains low.
Tendering for private providers underway (late 2013)
Report on strategic priorities for Further Education and
Training, but implementation needed
State Assets: completed sale of Bord Gais for €1.1 bn
Goods and services: Legal Services Bill not yet enacted