Ireland rescue is not a game changer

By Mohamed El-Erian


Published: November 29 2010 11:26

Europe tried to strike a delicate balance this weekend. It granted emergency loans to boost liquidity, an approach that has visibly lost traction in containing the dislocations in the continent’s periphery. But it also moved towards a more durable approach to tackles solvency problems, although one that involves greater risk of collateral damage.


The new liquidity package does little to deal with Ireland’s debt overhang, or to reduce the embedded cost of its debt.
Instead it aims to introduce stability into market conditions, which in turn should allow the Irish government to implement its recently announced austerity package.


Ireland will get €67.5bn to recapitalise its banks, and fund the state’s balance sheet. The financing carries an average interest charge of 5.8% - not cheap but considerably better than market terms.


The package, therefore, is not a “game changer”. It will reduce the risk of contagion to other peripheral countries, until a regional resolution framework is put in place. But it will not significantly improve Ireland’s medium-term growth and employment prospects.


That this package delays rather than solves the European Union’s problems is not lost on Ireland’s European neighbours. They know that time is being bought to formulate a sovereign debt reduction mechanism, to be made operational in 2013.


Such a mechanism would expand the range of alternatives to deal with future debt crises, while also providing for politically more acceptable burden sharing. But a number of conditions must be met even if this weekend’s package is to work.


Ireland itself must be able to implement its new, ambitious adjustment program – and do so with taxpayers carrying a considerable burden, while no haircut is being imposed on creditors.


Ireland’s creditors and depositors must also quickly signal their reassurance at the new package, and also their confidence that Europe’s timeline for imposing any loses on creditors will not be accelerated.


Finally the same (repeatedly challenged) liquidity approach from the EU and the International Monetary Fund must stop contagion to other peripheral European countries.


It took time for Europe to recognise the severity of the peripheral debt crisis. Now it is also recognizing that liquidity support (while necessary) may not be enough. Instead Europe is embarking on a gradual transition to a medium-term mix of liquidity and solvency solutions.


Understandably, Europe wants this transition to be orderly, and relatively long. But it is walking a difficult line. Any slippage on this most recent deal will quickly see European officials facing a transition that is quicker and less orderly than they would like.


The writer is chief executive and co-chief investment officer of PIMCO


Copyright The Financial Times Limited 2010