What is the extent of Ireland’s crisis?
- Kathleen Brooks is research director at forex.com. The opinions expressed are her own. -
The euro’s resilience in the third quarter has been astonishing. Since reaching a low against the dollar in June, the single currency has appreciated by an impressive 14 percent. This has coincided with the Irish financial crisis reaching boiling point, culminating in the announcement on Thursday by the Irish authorities of the final bill for winding down Anglo Irish Bank.
The euro didn’t flinch, even though the sums are enormous. The Irish government estimates that it will cost 29.3 billion euros to rescue Anglo. And it doesn’t stop there. Allied Irish Bank requires more capital as does building society Irish Nationwide, which may bring the total bill for rescuing the financial sector to 50 billion euros, pushing the debt-to-GDP ratio up to 32 percent. The Irish government doesn’t even anticipate making a return on any of this money.
Ireland has so far funded itself on the open market and has not had to follow Greece to the European Financial Stability Facility (EFSF). But the final bill will fall on the Irish taxpayer.
Tax receipts for 2010 are expected to be 31 billion euros, according to a forecast from the Department of Finance. That is less than the final cost of winding up Anglo. With growth weak and the possibility of another recession on the horizon, it wouldn’t take much for the markets to force Ireland to the EFSF like they did to Greece.
Is there a way out for Ireland?
Ireland does have one of the lowest tax takes in the European Union at less than 30 percent of GDP. It also has one of the lowest corporation tax rates in the world at 12.5 percent, compared with Germany where federal and national corporate taxes equate to company tax rates of more than 30 percent. So Ireland could boost tax take to help remedy its huge deficit, but at the expense of losing its reputation as a low-tax destination for global corporations.
What does it mean for the euro?
The euro has taken problems in Ireland in its stride. But why has it remained so strong? There are three factors. Firstly, the interest rate differential, especially versus the US and the UK. The European Central Bank (ECB) has not hinted at using monetary policy to boost the euro-zone economy, unlike the Federal Reserve or the Bank of England. The spread on the interest rate paid on European and US three-month money is currently 58 basis points. In an environment where investors are on a hunt for yield, the euro looks attractive compared to the other major currencies.
Secondly, the euro has been one of the worst performers in FX over the past year. But in recent weeks it looks like investors have had enough of going short the euro, and the single currency has experienced broad-based strength even against some of the commodity currencies like the Aussie dollar and the Kiwi dollar. And there could be more upside to come. According to Commodity Futures Trading Commission (CFTC) data, net long euro positions are not at stretched levels.
The last reason is the simplest. The euro zone is split into core and non-core economies. As long as the core economies continue to do relatively well then peripheral concerns won’t overshadow the single currency.