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Home  » Business » New challenge for the euro and the EU

New challenge for the euro and the EU

By Business Standard
November 29, 2010 11:36 IST
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Ireland is a relatively small economy, contributing roughly a quarter of percent of global GDP and 2 per cent of eurozone. The exposure of global financial institutions to both Irish sovereign and bank debt is somewhat small and the Irish government seems to be all set to be bailed out by Europe's stability fund and the IMF.

Market estimates put the bailout package at roughly ¤100 billion, a sum that is by no means hefty by the standards of rescue packages offered over the last couple of years.

Despite this, financial markets remain edgy and the pressure on the euro, and indeed on risky assets on the whole, doesn't seem to be showing any signs of abating. Thus, the significance of the crisis in Ireland seems to be potentially much wider than either Ireland's size or its fiscal dent would suggest.

The reason could be that the crisis has forced the markets to turn their attention back to the bigger picture in Europe. That picture doesn't look too pretty.

For one, Europe's so-called peripheral economies continue to bleed and no amount of austerity and fiscal surgery has been able to stanch this. The fiscal situation in Greece hasn't improved a jot. Other fiscally challenged economies like Spain and Portugal are just about hobbling along with a rising risk of their reneging on their obligations.

The impact of a default by a eurozone heavyweight like Spain, both on the region's growth prospects and bond portfolios, is likely to be significant. Ironically enough, Ireland was the more proactive of European governments in trying to put its house in order after the global financial crisis of 2008.

After suffering one of Europe's worst property busts, it moved aggressively to avoid Greece's crisis of confidence by cutting government spending and raising taxes. Irish authorities also injected fresh capital into ailing banks, set up a so-called "bad" bank, to warehouse dud property loans, and forced lenders to raise even more capital.

None of that seems to have paid off. The bottom line seems to be that Europe's periphery will need a steady infusion of assistance from the core for the foreseeable future.

The problem is that the Germans, who bear the largest share of bailout expenses (roughly about a quarter), seem reluctant to play ball.

Thus, assistance to distressed economies in future might either come at a heavy price or not come at all. This has brought the very survival of "Project Euro" into question.

If the Germans remain stubborn, weaker European economies might find it in their interest to exit the union and regain control of their monetary policy. They would also unshackle themselves from the rigid fiscal template that under-girds the union.

There are, of course, those who claim that the incentives to continue within the union far outweigh the gains from quitting. They also point out that it is in the interest of Germany and other core economies to ensure the union's survival.

Thus, Germany's apparent reluctance to reach into its pocket might be a little more than a bit of posturing after which it is likely to stump up the cash to bail its neighbours out.

That is certainly possible, but at this stage it might be dangerous to ignore the risk of the currency's demise.

If the union does break up, it is likely to entail massive costs as bond portfolios erode and trading arrangements based on the single currency are wound up. Ireland has put this risk back on the table.

 

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Business Standard
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Related News: Ireland, Europe, IMF, Irish, Spain
 

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