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

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65

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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