Ruth Lea: The euro party is over as Celtic Tiger licks its wounds

DESPITE Irish resistance to an EU bail-out, it will almost inevitably happen. Ireland's eurozone partners will surely insist. The bond markets have been panicking about Ireland's ability to repay its government debt. In other words, they doubt its solvency.

Moreover, the panic is spreading to other vulnerable eurozone countries – to Portugal in particular and, much more seriously though not yet acutely, to Spain. Ireland's eurozone partners are rightly concerned that this contagion undermines the euro. Ireland will probably have to agree to a bail-out, whether it likes it or not. Ireland is in the euro and its troubles are the euro's troubles.

Ireland is in deep financial and economic difficulties. In the early days of the euro, the situation seemed so different, but potential problems were already stacking up.

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In the early 2000s, the European Central Bank (ECB) kept interest rates low in order to support Germany, where the economy was in recession. These rates were right for Germany, but far too low for Ireland, which experienced buoyant economic growth and a booming property market, accompanied by soaring bank lending.

The Celtic Tiger was growing healthily and the party, while it lasted, was terrific.

But, as the global recession hit Europe's economies in 2008 and 2009, Ireland's property market collapsed – house prices have roughly halved since the peak and bad debts began to escalate.

Moreover, overly-generous Irish government guarantees given to the creditors of Ireland's commercial banks have left Irish taxpayers with a truly vast bill.

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Some estimates suggest the bill could amount to 50bn euros which, given a population of about 4.5 million, amounts to more than 10,000 euros for every man, woman and child. Other estimates suggest even higher costs.

Partly reflecting these huge guarantee costs, the Irish public sector deficit is expected to be 32 per cent of GDP this year – the deficit without these costs is about 12 per cent of GDP.

Public sector debt is rising rapidly. It is not surprising the bond markets are taking fright about Ireland's solvency. Moreover, fuel has recently been poured on the flames by German Chancellor Merkel's insistence that future "crisis resolution mechanisms" (in other words bail-outs and/or defaults beyond mid-2013) would force government bond-holders to share any losses with taxpayers. However reasonable this sounds, she was warned that such comments would panic the bond markets. On cue the markets were duly spooked.

The Irish government is due to announce its next budget on December 7, when there will be yet more belt-tightening in an attempt to restore confidence. This comes on top of austerity measures including public pay and pension cuts that have already been very tough – significantly tougher than the ones proposed in Britain.

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Moreover, whereas our cuts are against a backdrop of an economy already partly recovering, Ireland's economy is still depressed. GDP fell back in the second quarter by over 1 per cent, after contracting 8 per cent in 2009, and unemployment is little short of 14 per cent.

There are few signs of growth. Yet, without growth, Ireland will struggle to restore its public sector finances as revenues will remain depressed and the chance that Ireland will meet its public deficit target of 3 per cent of GDP by 2014 is slim.

But where can the growth come from? Well, there can be no competitive boost from a falling exchange rate, unless the euro itself weakens, as Ireland is locked inside the eurozone. And Ireland's super-competitive 12.5 per cent corporation tax rate, which has attracted so much inward investment, is under attack from Germany on the grounds that it gives Ireland an "unfair competitive advantage".

If Ireland is obliged to accept the bail-out, almost a dead cert, Ireland's corporation tax rate will probably have to rise to 20-30 per cent. Businesses will leave. Growth will be anaemic at best, high unemployment will persist and the public sector finances will remain burdensome.

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The eurozone is clearly dysfunctional. The current mix of countries cannot live with the same monetary policy. The economic recession tested the notion they could to destruction. At some point it surely must be agreed that stressed countries should exit the eurozone in an orderly fashion.

They could then let their currencies depreciate and, along with rescheduling of their government debts (or even default), inject some growth back into their economies. Ireland, along with Greece and Portugal, are obvious contenders.

This would be a more attractive option for Britain than bail-outs. The proposed Irish bail-out may cost British taxpayers a minimum of 7bn. And an Irish economy with no growth will continue to damage our exports.

On a final note, there is concern that, if the Irish government reneges on the generous guarantees given to Irish banks' creditors, British banks will experience big losses. But this could happen whether Ireland stays in the eurozone or leaves. And the consequences will have to be tackled if or when it happens.

Ruth Lea is economic adviser to the Arbuthnot Banking Group.