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Saturday, December 26, 2009

Ireland and Greece

WSJ compares the two weakest links in the European economy:

Greece and Ireland face the biggest fiscal problems in Europe. But their responses couldn't be more different. Greece's lack of credibility has cost it dearly in the eyes of ratings companies, the European Commission and the bond market. That means it will have to go even further than Ireland if it is to win back confidence.

Both countries face double-digit deficits this year: 12.7% of gross domestic product in Greece and around 12% in Ireland. Greece's debt-to-GDP ratio is forecast to hit 120% next year; Ireland's headline ratio of 64% would also rise to more than 100% if the bad debt taken on by the government under its bank bailouts is included. The European Commission is demanding both cut their deficits to below 3% of GDP and reduce debt-to-GDP to less than 60%.

Yet both the commission and the rating companies are taking a notably more lenient attitude toward Ireland than Greece. Ireland proposes only to cut its deficit to 10.8% of GDP in 2010, compared to 9.1% in Greece. But Ireland has been given until 2014 to meet the commission's demands, while Greece must achieve its targets by 2013. And Ireland is still rated AA, while Greece has just been downgraded to BBB+, raising fears its bonds may not qualify as European Central Bank collateral in the future. That would push up Greek borrowing costs, making it even harder to restore its fiscal position.

Ireland has won this breathing space partly because it has shown far greater political courage. Its 2010 budget includes clear tangible spending cuts. Public-sector wages are to fall by between 5% and 15%, with the prime minister taking a 20% pay cut. Even child-benefit payments are under the ax. In contrast, Greece's budget relies heavily on one-time policies such as measures aimed at reducing tax evasion. Athens has shown a lack of will to embrace spending cuts beyond a partial freeze in public-sector wages and pensions.

But Ireland's past record earns it a degree of forbearance. Between 1994 and 2006, Dublin cut debt to 24% of GDP from 94%, according to Barclays Capital. Compare that to Greece, which has very little credibility when it comes to making tough political decisions: it cut debt only to 94% of GDP in 1999 from 108% in 1994 ahead of euro entry, before it started rising again. Even now, Dublin enjoys broad public acceptance of its austerity plans. But Greece faced riots last year and renewed clashes this past week.

Still, Athens has little choice but to bite the bullet. The credit default swap market is pricing in an appreciable chance of a Greek default. Most likely, the European Union would provide a rescue package, but this would come with strict fiscal conditions attached. The Irish lesson may be a hard one, but Greece needs to learn it fast.