Business

Q&A: Irish Republic bail-out

  • 29 November 2010
  • From the section Business

The Republic of Ireland and the EU have agreed an 85bn euro rescue package to help tackle a huge hole in the government's finances.

As part of the package, the Irish government has drawn up an austerity programme detailing four years of tax rises and spending cuts.

How did the country get into this mess?

Hailed as the "Celtic Tiger" for the rapid growth of its economy, in the space of three years the Irish Republic has gone from boom to almost bust.

Much of its growth was built around the property market. But, since 2008, this has suffered a dramatic collapse, with house values falling by 50-60%.

Bad debts have almost wrecked the country's banks, forcing the government to bail them out.

This opened a huge hole in the Irish government's finances - which will see it run a budget deficit equivalent to 32% of GDP this year.

Excluding the cost of bailing out the banks, the government's spending gap is still a substantial (and unsustainable) 12% of GDP.

A deep and painful recession has caused a sharp deterioration in tax revenues and a rise in unemployment benefit claims.

What's more, there are fears that the government's austerity measures could plunge it back into the recession it has started to climb out of.

Hadn't the Irish government been insisting it didn't need bailing out?

Yes, until 18 November, Dublin said it was fully funded until at least the middle of next year, meaning it could cover its outgoings without going to the markets to borrow more money.

They do this by issuing more bonds, which are effectively IOUs to investors.

People walk past a recruitment office in Ireland
Like many EU nations, the Irish Republic has seen higher unemployment and lower tax revenues

So why did the Irish Republic ask for a bail-out?

The government gave the Irish banks a blanket guarantee at the height of the 2008 financial crisis.

But this put Dublin on the hook for all the banks' debts, which are worth several times the annual output of the entire Irish economy.

As losses mounted at the banks, foreign investors began to question the Irish government's ability to meet the guarantee, so they withdrew more and more money from the banks.

This left the banks massively dependent on the European Central Bank for emergency funding - something that made the central bank and other European governments very uncomfortable.

Also, many of the banks' lenders - who benefit from the guarantee - are the major banks of other European countries, including the UK.

So, ultimately, it was the other European governments that pushed Ireland to accept a bail-out.

Already 10bn euros of the bail-out cash is being put into the capital reserves of its state-backed banks, with another 25bn in reserve, earmarked for their use.

The remaining 50bn will cover budget financing.

Where is the 85bn euros coming from?

The money will come from:

  • the Irish Republic itself will contribute 17.5bn euros to the overall fund from its cash reserves and, controversially, the National Pension Reserve Fund
  • 22.5bn euros from the International Monetary Fund (IMF)
  • a similar amount from the European Union's European Finance Stability Mechanism
  • 17.5bn from the European Financial Stability Facility, which is funded by eurozone governments
  • bilateral loans from the UK, Sweden and Denmark.

What are the potential impacts for the UK?

The UK has offered to make a direct bilateral loan to the Irish Republic. Its total contribution is expected to be about 8bn euros.

The UK is to initially contribute an estimated 3.8bn euros in a direct loan for the banks.

The rest will come from its contributions to the IMF and the European Union's Financial Stability Mechanism.

Chancellor George Osborne said: "It is in Britain's national interest. It is money we fully expect to get back, and we think it will help Ireland get on a fully stable path back to growth."

Tough times in the Irish Republic would mean less demand for UK goods and services from one of the UK's largest trading partners.

According to UK government figures, trade with the country exceeds total UK trade with Brazil, Russia, India and China.

Also, many of the UK's banks have large exposures to the Irish economy.

Dublin
The UK and the Republic are key trading partners

What is Dublin doing to sort out its finances?

The Irish government had already announced spending cuts and tax rises to the tune of 15bn euros since the 2008 financial crisis.

On top of that, the latest four-year austerity plan will cut another 15bn euros over four years.

This includes 6bn euros in 2011 alone.

The government had aimed to have its budget deficit down to about 3% of GDP by 2014, from 12% currently. As part of the EU bail-out they now have until 2015 to achieve this.

The government also plans to buy more shares in the banks, increasing their capital - the buffer against future losses - from 8% to 12% of their assets.

Will this plan actually get implemented?

The Taoiseach, Brian Cowen, gave in to demands from his junior coalition partner to hold elections in January, after the 2011 budget is passed. But there are fears the government may not even last that long.

All of the Republic's parties support the cuts in principle, but opposition parties disagree over the details of where the axe should fall.

Why is the situation in the Irish Republic a worry to other countries?

Other financially weaker members of the eurozone such as Spain and Portugal are concerned about the risk of financial contagion.

Having pushed Ireland into the arms of the IMF, panicky investors may also lose confidence in their public finances.

Yields on Spanish and Portuguese long-term debts - a measure of how much the market would charge to lend their governments money - are trading near their highest levels since joining the eurozone in 1999.

Like Ireland, Portugal has severely stretched public finances and a weak government.

Spain's government is in a stronger position. But its economy experienced a property boom and bust almost as bad as Ireland's, and there are big concerns about the health of some of its banks.

They will welcome the Republic taking an EU bail-out in the hope it will take some of the heat off them.

But so far that has not happened.

Map showing eurozone government deficits