They never said it would be easy. Just when it looks that Ireland’s battered economy is turning the corner, a storm builds to crisis proportions on the Euro zone’s South Eastern periphery.

The crisis has unfolded in distinct phases.

The first consisted of German Government foot dragging over the go ahead for a €45bn rescue package that helped to spark panic in the bond markets, with resulting contagion effects for Portugal, Spain, and to a degree, Ireland.

It is fortunate that the National Treasury Management Agency has prefunded much of this year’s financial requirement, but the impact of the crisis on confidence, and on the cost of funds to the Irish banking sector, and by extension on borrowers, is real.

The cost of the bailout swelled as the Germans prevaricated during the run in to key elections in North Rhine Westphalia, all to no avail as a heavy defeat resulted in the loss of the Coalition Government’s majority in the Germany Upper House of Parliament.

This is expected to restrict the ability of the governing Christian Democrat/ Free Democrat coalition to implement measures opposed by the Left bloc. 

The defeat is also a further signal of the growing impatience on the part of the German public with the escalation in the cost of financing rescues in weaker economies across the Eurozone.

However, events elsewhere took on a momentum of their own, culminating in final agreement on the €750bn IMF/ EU rescue package.

As the access to the bond markets was being shot down for the weaker Euro States loosely referred to as the PIGs ( or PIIGS depending on one’s point of view ), for the first time, questioning of the very future of the Euro moved into the mainstream media and on to the front pages.

We were being asked to stare into the abyss. The view was not inspiring.

On the eve of the bailout, it was hard to see how the ECB, the IMF and the Euro zone member state Governments could quench the flames that were blowing out of control.

As I write, it is exactly one week on from conclusion of the bailout. 

We can now begin to assess the short term reaction.

A short lived rally in stock markets and rebound in the value of the Euro, one that has petered out quietly as real concerns remain.  

Where the markets are now

However, stability for now has returned to the sovereign debt / bond markets, with the cost of Irish ten year money back close to the 4.5% mark where it stood prior to the recent crisis.

So what are the concerns now?

It is clear that this rescue package does not come without strings attached.

The prospect of much stronger EU budgetary surveillance is now very real.  Indeed, it sparked an outbreak of acrimony on the home front when Fine Gael entered the debate by suggesting that Ireland’s low corporate tax rate could once again be under threat.

The Government retorted that such remarks were irresponsible, constituting a threat to foreign direct investment (as uncertainty over future tax rates could deter those considering long term investments here).

For now, a financial restructuring, or controlled default on its loans appears less likely in the case of Greece, reducing fears of ‘contagion’, which would have a major impact on the borrowing costs borne by heavily indebted peripheral Eurozone countries such as Ireland, Portugal, Spain and perhaps, Italy.

But such concerns remain below the surface. Let no one be under any illusion about this.

During 2008, we witnessed an international financial/banking crisis which spread to the wider economy, in turn, sparking the sovereign debt crisis that has become evident in much of the Eurozone in 2010.

Any Greek default, or debt restructuring, could create a new round of banking loan defaults, with French and German banks being particularly exposed, but with Irish banks, too, on the hazard.

Interdependence in the Eurozone

Those in countries like Germany, or Holland tempted to pull the plug on the ‘greedy Pigs’ would be well advised to note the points made in a recent article in the Economist magazine (dated May 1st 2010.)

The briefing on the Euro zone crisis highlights the exposure of banks to countries such as Greece and Portugal.

According to the Economist, around €213bn of Greek bonds is held abroad while foreign banks’ lending to Greece’s government, banks and private sector amounted to €164bn.

A Greek default could cost Euro zone banks in excess of €50bn yet Euro zone countries would still have to prop up the Greek economy.

Foreign banks’ holdings of Portuguese assets, at almost €200bn, are even greater.

French banks’ exposure to both countries amounts to €85bn, that of the German, almost €65bn.

If there were a meltdown in the markets and it to Spain – Spanish banks have an exposure of €60bn to neighbouring Portugal alone, and if Spain were to falter…?

And this is before we start considering an impact on the already shaky economies of Eastern Europe (Latvia’s economy shrank 18% last year.)

German and Austrian banks and wider economies have heavy exposures to Eastern Europe.  

All of this may explain why French President Sarkozy reportedly blew a gasket with Chancellor Merkel and why the US President, Barak Obama was so busy working the phones to Europe.   And also why the package finally agreed is €750 billion, a huge bulwark against a meltdown.

Ireland – Indicators of Recovery

The Athens eruption comes just as the mood music on the Irish economy has begun to change for the better. The latest figures out of Dublin port are encouraging. They point to growth in exports, validating those who argue that the economy here has been regaining much of its lost competitiveness.

Ireland is benefiting from the weakening in the euro, the great silver lining in the cloud.

The figures from the port – which accounts for one half of total Irish trade – point to an increase in exports of almost 15% in the first three months of 2010, admittedly when compared to exceptionally poor figures for January-March 2009.

This data is tangible evidence that Ireland’s open economy is benefiting from the international recovery, particularly that in the US, the largest recipient of Irish exports.

Exports rose 23% in March on March 2009, with imports also up 7.3% suggesting  that some recovery in consumer confidence is kicking in. This should assist the flow of VAT receipts into State coffers, in particular.

Export figures should be treated with some caution, as monthly figures often show lumpiness.

However, the latest data from the Small Firms Association point to a big drop in levels of pessimism among small firms. If exports will lead the economic recovery, then SMEs will account for a large part of any recovery in employment levels.

Another important straw in the wind is the uptick in hiring by multinationals.  The Sunday Times reports that Apple has hired five hundred contract staff in Cork.

Economists have begun to revise upwards their projections for activity in 2010.

Rossa White of Davys is now predicting growth of one per cent in each of the next quarter and Bank of Ireland also believes that the recession has ended. White’s recent predictions have been close to the mark. Exports of services are about to overhaul manufacturing exports helping to raise hopes that investments in the new economy are beginning to pay a dividend.

We will soon discover whether the European Central Bank has ditched its counter inflation strategy in favour of a sustained policy of quantitative easing and an acceptance of depreciation in the value of the currency as the price to be paid to avoid a downward deflationary spiral.

Spain has announced plans to cut public sector salaries by five per cent as part of the quid pro quo for the €750bn package. Against such a background, the need for an accommodative monetary policy appears pretty obvious.

A big question is whether the ECB, which is bankrolling our economy, will continue to view thing this way….

We can only wait and see.

Written by Kyran Fitzgerald