Irish Budget and Bailout: Will These Work?

Earlier this week, Fitch downgraded Ireland’s sovereign debt by three notches from A+ to BBB+, as they weighed the possible impact of restructuring the Irish banking system.

To be honest, I wouldn’t say the downgrade came as a surprise. Besides, other credit rating agencies such as S&P and Moody’s are probably getting ready to slap a few more downgrades on Ireland. Word on the forex grapevine is that S&P might take its A rating a couple of levels down while Moody’s could cut Ireland’s debt rating by a whopping five notches.

And who could blame them? Ireland has a long list of problems, from banking sector risks to limited access to funds for financing its debt. You don’t need to be a rocket scientist to see that Ireland needs drastic measures to get out of its rut.

To end its financial problems and qualify for a much-needed bailout, some Ireland officials have proposed tough austerity plans. The belt-tightening measures would involve 6 billion EUR worth of cuts in its 2011 budget and a total of 15 billion EUR in cutbacks over the next four years. Because of the severe cost-saving measures and painful tax hikes involved, the plans have been described as the harshest in Irish history.

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As expected, the plans received mixed reviews, so the Irish parliament decided that the democratic thing to do was to put the plan to a vote. So far, the ayes have had it. The austerity budget passed its first hurdle with the first voting earlier this week, and just yesterday, received another thumbs up with the second voting.

Investors seem to find relief in all of this. The markets have reacted positively to the news as bond spreads have narrowed and Europeans stocks have climbed following the break of the news.

The question is, will it work?

In truth, the EU needs to find a more concrete solution to the current debt crisis. Taking a case-by-case approach may prove detrimental down the line. The number of countries who may need a bailout is growing by the day (ahem, Hungary). As I’ve said in the past, by bailing out Greece and Ireland, what’s to stop other countries from knocking on the EU’s doors asking for some moolah?

No matter how tough it is, it’s time to face the music. Let’s take for example the stress tests done earlier this year. Clearly, those tests were not firm enough. Let’s not forget that the financial crisis started with just a few banks in the U.S. Later on, it became clear that many banks, and not just a few, were financially distressed.

These problems need to be nipped on the bud, and it starts with enforcing stricter guidelines. Perhaps the EU’s insistence on Ireland having tough austerity measures is the first step towards this process. In any case, the EU needs to remain firm in its resolve and ensure that everybody plays by the same rules.