The Dublin government appears to be almost powerless to prevent a severe downturn. Ambrose Evans-Pritchard reports
The Irish banking system faces acute strains and may require a phase of temporary nationalisation as the property slump leads to a wave of defaults, according to a leading Irish economist.
Morgan Kelly, of University College Dublin, said the government is almost powerless to stop the downturn becoming a severe slump. "We're in a classic post-bubble recession, yet we can't do anything that a country would normally do in this situation because we're inside the eurozone," Prof Kelly said. "We can't cut interest rates, we can't devalue, and there is a lot less room for fiscal stimulus than people think. We're stuck.
"We have a domestic recession now colliding with a global recession. It is the state of the banking system that will determine how terrible this will be, and frankly that is looking very shaky."
Irish house prices fell 7pc last year. The pace of decline has accelerated so far this year. The damage is spreading to the broader economy. Unemployment jumped to an eight-year high of 5.2pc in February, from 5pc in January.
"We are going to see banks on life-support with very big bail-outs. The precedent for this is what happened in the Nordic countries in the early 1990s when they had to take over the banks. We may have to do something similar," he said.
Two of Sweden's largest banks were nationalised before being nursed back to health and refloated. The Nordic rescue is seen as a model of how to tackle a banking crisis. However, Sweden succeeded only after it left the ERM's fixed exchange system and regained control of its monetary instruments.
The Bank for International Settlements said in its latest report that there had been a surge in euro bond and note issuance in Ireland in the third quarter to $35bn (£17.4bn), up from $10bn. This is a huge sum for a country of 4.2m people.
It appears to reflect a distress move by banks to raise money for use as collateral at the European Central Bank after the credit crunch hit. "The increase in net issuance came mostly from financial institutions, whose borrowing in securities markets had largely dried up," said the BIS. Irish borrowers built up $123bn in cross-border liabilities.
Ireland has been a star performer over the past 20 years, transforming itself from a high-tax backwater in the early 1980s to a free-market tiger. However, the country is the most exposed in the EU to both the dollar and sterling blocs, leaving it more vulnerable to trade and investment effects of the soaring euro.
Prof Kelly said Ireland had lost 20pc competitiveness against its trade partners since the launch of EMU.
Eurozone rates of 2pc in the early part of this decade fuelled a credit bubble that has gravely distorted the economy. Household debt has reached 190pc of disposable income, the highest in the developed world. Bank lending rose by 30pc annually. Construction reached 15pc of national income, with 280,000 employed there,
Matthew Taylor, a credit expert at Fitch Ratings, said 27pc of all outstanding loans by late last year were to property and construction, leaving banks heavily exposed. Irish Nationwide Building Society has been downgraded from A to A-.
"If the downturn proves more severe than expected, a wider range of rating actions on Irish banks may be required," he said. For now, the problem looks "manageable".
Over 55pc of all mortgage loans are at floating rates, with several banks offering 100pc mortgages at the top of boom. Interest-only loans made up 16pc of the total borrowing in the third quarter of 2007. Anglo-Irish Bank, Allied Irish Banks, Bank of Ireland and EBS, all have a big stake in the property sector.
The establishment has pretended it's business as usual. But the mood is now changing. The Irish Independent warned this week that the country is sliding into a serious slump.
"Look at all the signs: every single one is screaming that the economy is in big, big trouble. Housing market dead, new car sales dead, consumer confidence is dead, record job losses, exporters being killed off by a strong euro, fuel prices spike, housing repossessions increase," it said.
Ireland is the only country to hold a referendum on the EU's revamped constitution, now called the Lisbon Treaty. The darkening economic picture may greatly queer the pitch.