Ireland's parliament approved a multi-billion euro EU/IMF bailout package on Wednesday in the face of opposition threats to renegotiate the deal to force losses on some senior bondholders in Irish banks.
Finance Minister Brian Lenihan pushed through the 85 billion euros package with the support of independent MPs and told the center-right Fine Gael party that its proposals to lean on senior bondholders would fail because of opposition from the European Central Bank.
Those who think we can unilaterally renege on senior bondholders against the wishes of the ECB are living in fantasy land, he said.
Under the EU/IMF deal, Irish people face years of cutbacks and tax increases in return for fresh capital to shore up the banks, preserving full repayment of their senior bonds -- those first in line to be repaid in the event of any default.
But Fine Gael, which will likely lead a coalition government following an election next year, said investors who hold bank senior debt not covered by a government guarantee, amounting to around 15 billion euros, should take a share of losses, so lessening the amount that Ireland had to borrow.
You have the obscene situation now where the poorest of the poor in Ireland, through their taxes and welfare cuts, are being asked to guarantee the speculation of investors in hedge funds, Michael Noonan, Fine Gael's finance spokesman, and a possible future finance minister, said.
Ireland has no moral or legal obligation to cover this debt. That's why it's a bad deal, that's one of the principal reasons we're going to vote against it, and that's why it has to be renegotiated.
EUROPE CALLS THE SHOTS
The government, the most unpopular in recent history, got the bailout approved by a margin of six votes, prompting an easing in spreads and paving the way for the IMF to approve its 22.5 billion euro portion of the bailout on Thursday.
The premium that investors demand to hold Irish 10-year debt over benchmark German bunds dropped to 538 basis points, reversing an earlier increase and 3 points narrower on the day.
Despite the bailout's easy passage in parliament, the humiliation of having to go cap in hand for funds is likely to ensure a record drubbing for the governing Fianna Fail party in an election, possibly in March.
Britain's announcement on Wednesday that it would earn 440 million euros in fees and interest from its loan to Ireland, its former colony, is particularly awkward. [nLAH006826]
The prospect of a change of administration is some comfort for disgruntled voters but the uncertainty unnerves investors.
The longer it drags on, the more of a negative it becomes, said Ken Darmody of Goodbody Stockbrokers.
Investors would prefer to have a new government in place because at the moment you don't know what the policies really are of the two (parties) that are possibly going into power.
Noonan's warnings about unguaranteed bank senior debt nudged the price of the debt slightly lower on the secondary market.
It's not a game-changer as of yet because ultimately Europe are calling the shots here, and they have said they don't want any pain for senior bondholders, said Gavin Curran, a bond trader at Dolmen Securities.
Opinion polls indicate Fine Gael will form a coalition government with center-left Labour after the next election.
Both parties are campaigning to renegotiate the bailout but, given Ireland's dependence on the rescue package to shore up its banks and finance its deficit, and having signed up to its tough fiscal targets, their room for manoeuvre may be lmaneuverimited.
Concerns about the euro zone's debt crisis escalated on Wednesday after the ratings agency Moody's said it had put Spain on review for a possible downgrade. [nL3E6NF0D8]
Ireland's bailout is designed to end a two-year banking crisis that has brought the Irish economy to its knees and sent shock waves through the euro zone.
In return for 50 billion euros in sovereign funding and 35 billion euros in capital top-ups for its banks, Ireland has promised to shrink and radically restructure its lenders and tackle the worst deficit in Europe by 2015 at the latest.
Dublin will squeeze 15 billion euros -- equivalent to around 10 percent of annual economic output -- from its deficit over four years, starting with the 2011 budget's record package of 6 billion euros in spending cuts and tax rises.
Some economists have warned that such aggressive austerity measures will tip the domestic economy into a prolonged downturn, jeopardizing its ability to meet its deficit targets and deal with the debt crisis.
(Additional reporting by Yara Bayoumy; Editing by Kevin Liffey)