By Emma Charlton

BRUSSELS (MNI) – Crunch time is nearing for Ireland as the
country’s stricken banks try to roll over billions of euros worth of
debt amid investor fears about just how big the final bill for bailing
them out might be.

Worries about the ability of the Irish government to manage the
country’s deficit, along with the dire state of the country’s banking
system, have pushed Irish bond yields sharply higher. Irish spreads over
the benchmark German Bund hit a record high level of 371 basis points on
August 31. By Friday morning, the spreads had narrowed only slightly to
+356bps and remained the second widest in the Eurozone, after Greece.

Ireland’s banking system all but collapsed in 2008 and through much
of 2009 as its property boom imploded and the economy plunged into a
deep recession. Lenders who had given out billions of euros in cheap
credit were left with thousands of “bad loans” or “toxic assets” that
will never be repaid.

The country’s largest lenders are currently surviving on government
nationalisation programmes and generous liquidity provisions from the
European Central Bank. Economists say most of the government money will
never be recouped.

“Unlike in the UK, where the government looks pretty well placed to
make a profit on its financial support measures, the Irish government
will make a loss. The big question is how big it will be,” said Colin
Ellis, a London-based economist.

“Clearly the recent revelations that the banking sector will need
even more public money than previously thought will worry investors, and
the outlook over the near term is bleak,” Ellis added.

A lack of detail about the exact figures involved has led to
intense speculation and has spooked markets.

According to analysts at the Royal Bank of Scotland, Irish banks
need to refinance E26 billion in September.

“September will be a crucial month for Irish bonds,” economists at
BNP Paribas said in a note to investors. “Even though funding needs have
been covered, the expected news flow on the banks’ side could keep
volatility at high levels,” they said.

But overcoming the near-term challenge of debt refinancing is just
the first hurdle. The government still faces a bill for banks whose
total is unknown, a sky-high unemployment rate of 13.8%, and an economy
that looks likely to underperform government forecasts, throwing the
country’s austerity plans off track.

Ratings agency Standard and Poors recently estimated that the total
bailout bill for Ireland’s banks could be as high as E50 billion, with
as much as E35 billion going to one bank alone: Anglo Irish.

Ireland’s National Treasury Management Agency refuted the rating’s
agency’s claims. “In terms of the specific analysis by S&P, this is
largely predicated upon an extreme estimate of bank recapitalization
costs of up to E50 billion,” NTMA said in a statement. “We believe this
approach is flawed.”

But with the bill for Anglo Irish already at E25 billion and
officials reluctant to commit to what they think the final figure will
be, spectators have been left wondering how the country, which is
emerging from a deep recession, will be able to foot the bill.

In the near-term those fears could send Irish bond spreads even
wider, Citigroup economists say.

Over the medium term, Ireland’s government has committed to cutting
its budget deficit — currently around 11% of GDP — to below the EU’s
3% limit – by 2014. But some economists say the strict austerity plan is
based on projected growth of 1% this year and 3.3% next year, which they
argue is too optimistic. The European Commmission forecasts a
contraction of 0.9% this year and growth of 3.0% next year.

And the International Monetary Fund has warned that Ireland —
having already made E4 billion worth of spending cuts — runs the risk
of “consolidation fatigue” as it tries to push through more efforts to
bring its deficit down.

In Frankfurt Thursday, European Central Bank President Jean-Claude
Trichet said he wouldn’t comment on Irish bond spreads or individual
Irish banks, calling on Ireland’s government to take “appropriate”
decision.

“It is the responsibility of the Irish government and the Irish
authorities to deal with their banks,” Trichet told reporters after the
central bank’s September meeting. “I have confidence that they will
manage these difficulties, as they have done in the past,” he added.

EU diplomats said they don’t think Ireland will go the same way as
Greece, which took a E110 billion lifeline from the IMF and the Eurozone
in May in exchange for the implementation of a strict austerity plan.

They point out that Ireland has moved swiftly to cut its budget
deficit, is more flexible and dynamic than Greece, and has been running
a trade surplus for many years, which makes adjustment relatively less
painful.

“Even in the worst case scenario where the markets turn on Ireland
and a bailout is required, the European Financial Stability Fund can
easily meet Ireland’s financing needs because Ireland is a small
economy,” one EU source said.

Goldman Sachs economist Erik Nielsen said the European Financial
Stability Fund, set up in May to fund emergency cases, “easily” has
enough cash to take both Ireland and Portugal out of the commercial
funding market for a couple of years.

Others are less optimistic.

Writing in the New York Time, Peter Boon of the London School of
Economics and Simon Johnson, the IMF’s former chief economist, said
Ireland “appears insolvent under plausible scenarios with current
policies.”

“The government is gambling that growth will recover to more than
4% a year starting in 2012, in order to make all this spending and debt
affordable,” they wrote.

“If current policies continue, the calamity of the Irish banking
system will lead to a much deeper recession and the consequences will be
felt for decades,” they added.

–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com

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