The government of Ireland released its 4 year plan for fiscal consolidation and structural reform earlier today.Â Finance Minister Brian Lenihan gives the optimistic version in the Financial Times.Â Speaking of optimism, here’s an interesting bit of the underlying economic analysis (page 28) —
This combination of current account surpluses and substantial (though declining) budget deficits implies the continuation of a large private sector financial surplus throughout the period of the Plan.Â Â Much of this accumulation of financial surplus by the private sector will take the form of increased deposits with and reduced borrowing from domestic banks. The result will be a very substantial fall in the loan-to-deposit ratio of the domestic banking system and a corresponding reduction in the domestic banksâ€™ reliance on external sources of funding.
So the expenditure compression coming from continued austerity will form part of a slow-motion solution to Ireland’s banking crisis, because deposits will go up and loans go down.Â With Bank of Ireland and Allied Irish Banks currently on loan-to-deposit ratios of about 160 percent, this effect certainly goes in the right direction.Â But it takes a long time to work relative to the speed with which wholesale funding can disappear.Â And it’s a very fine balancing act.Â In the section on risks, the same 4 year plan says —
… domestic risks are tilted towards the downside. The most significant of these risks is that households maintain savings rates at current very high levels which would represent a continued constraint on personal consumption.
So the same saving that might help the banks could undermine expenditure growth in the economy.Â Â But most of all, the optimistic scenario regarding banks’ funding needs assumes that these Irish household savings flow into Irish banks.Â Â Whether the traditional home bias of Irish savers — as is true for savers in most EU countries — can be assumed to continue is an open question.Â Without confidence in domestic banks, the assumptions in the four year plan look heroic.