Just weeks ago, the international debt markets were saying that Ireland was going bust. By late January, traders who trade existing sovereign debt paper, or bonds, were demanding a risk premium to insure against the possibility of an Irish default.
The international debt markets were signaling red alert for Ireland. The definition of a country going bust is when people abroad do not want to lend any more money to the state. Investors, foreign governments and financial institutions fear a so-called default when a country will fail to pay back some, or skip the whole of a debt repayment.
Their fears can become a self-fulfilling prophecy. At first, to cover their increased risks, the sovereign debt markets demand an increasingly larger interest rate. Then, a country can be excluded altogether from raising new borrowing.
For Ireland in the eurozone, failing to raise money would lead to Taoiseach Brian Cowen and finance minister Brian Lenihan phoning up the European Commission or Jean-Claude Trichet at the European Central Bank to seek money to bail out a eurozone country in need. This was the scenario facing Ireland just a few weeks ago.
The strains were enormous. Since the autumn, some of the largest government agencies had opted for the safety of the Central Bank, shying away from placing their money overnight in the local banks. Michael Somers, chief executive of the National Treasury Management Agency (NTMA) related last week how he took a phone call while on holiday from an official in Dublin asking why the agency had taken off €5bn-€10bn it would normally place overnight with a roster of banks.
International confidence was visibly seeping away. Despite September's bank guarantee, talk surfaced in January and February of billions of euro leaking from the interbank system, as companies and individuals withdrew deposits. Fearing they would not get their money back, bond holders of private bank and sovereign debt fretted that the government guarantee would snap. No matter how unlikely the outcome, hedge funds placed bets that the strains of small states like Ireland would lead to a crumpling of the eurozone. Perplexing calculations were being made. Despite Britain arguably facing larger budget deficits and greater banking liabilities, the focus of the international press remained focused on the crisis here.
The warnings were flashing red. The big numbers on the international debt markets were saying as much. The interest payments on some maturities on Irish debt paper were changing hands at almost double the rate that Germany had to pay. As Somers pointed out, German investors were none too pleased. The inverse of rising interest rates is that the value of the bonds held by existing holders of Irish debt plummets. These are the same investors in Germany and France whom Ireland will need to buy its huge levels of debt in future years.
If anything, it was a worse story on the credit default swaps (CDS) markets. Here, the insurance premia investors had to pay to hold Irish bond debt ballooned to levels that suggested a strong likelihood that Ireland was heading for a default.
Scare stories circulated that the liabilities of the Irish banks stretched out by nine times the annual value of the economy. These were perverse sums that could only be reached by lumping together the liabilities of non-Irish banks in the International Financial Services Centre.
In other parts of the eurozone, international events in January and February were conspiring to make matters worse again. Austrian banks were under focus for their purported high levels of lending across eastern Europe. It looked like a British euro sceptic's dream: the decade-long euro system would be broken by the irresponsible Irish.
Then fairly rapidly, from the middle of March to early his month the red alert level eased. The turning point was probably that the German and French governments realised that events could indeed unspool the eurozone.
Peer Steinbrueck, the German finance minister, spoke of Ireland not being a weak link in the eurozone. At the European Central Bank, Jean-Claude Trichet remarked that there was oodles of money in the ECB system. The cost of Irish sovereign debt fell. Interest rates still stand about one percentage point above the Italian level and over 1.5% more than that of Germany. Not many months ago, Irish debt was trading all of 20 basis points above Germany's.
By late last month, Capital Economics in London wrote that for the members of the euro club to fall out would need a greater slump than forecasters were predicting. Ben May, economist at Capital Economics, said the traditionally high-debt countries, Italy, Belgium and Portugal, had more risk of defaulting than anyone else.
"Next in the pecking order come Spain, Austria, Greece and Ireland," he said. "The CDS market actually ranks the last three of the countries in this group as the most likely to default… but all entered the downturn with relatively low levels of net debt, and are therefore well-positioned to withstand negative shocks."
So, the creditworthiness of Ireland fell from red alert to remain on amber. But the danger remains of another external crisis this year or next.
"The tail scenario – that things can go badly wrong – is quite strong," said Karl Whelan, professor of economics at UCD. Ireland could still be cut off from debt markets, he said.
The debt figures look gigantic but maybe we should be a bit more relaxed about the cost of bailing out the banks. John FitzGerald of the Economic and Social Research Institute, in new forecasts for 2015 and 2016, says that Ireland may still be facing levels which are smaller than most of the rest of Europe. "The costs of dealing with the banks is small compared with the loss of output we suffer," said FitzGerald. "Of course we have to deal with the banks first before we can get out of this. But Ireland will return to reasonable growth rates. There is life beyond this gloom."
FitzGerald's sums work out like this: leaving aside the banks, Ireland's gross debt rises to 82% of GDP at the end of 2015. Subtract from this the sum the value of the assets in the National Pension Reserve Fund, which the ESRI calculates are worth 10 percentage points, and debt will fall back to 72%. Adding back in – temporarily – the 40 percentage points of GDP to account for the costs of the assets bought by the National Asset Management Agency and debt rises in 2015 to 110%, estimates FitzGerald.
Britain will be in worse shape than here because the ESRI assumes that the annual deficits will stay higher than Ireland's. During the ESRI forecast period, Italian debt creeps up a bit in the forecast period from 110% to 115% of its annual GDP.
The end of 2015 is a key reference date because that is the eve of when the ESRI believes the government will sell the fully recapitalised banks back to private investors.