I move:
That Dáil Éireann
—supports the action of the Government in realigning the value of the Irish pound within the exchange rate mechanism of the European Monetary System and in remaining within the narrow band of the mechanism;
—calls on the Government to continue to press for reform of the EMS at ECOFIN and in other European Community bodies;
—supports the underpinning of the exchange rate policy by budgetary and other economic policies in order to provide a competitive trading environment for business, which is an essential basis for increasing employment.
I welcome this opportunity to put on record in Dáil Éireann the events of recent months and to outline the reasoning underlying Government policy throughout the currency crisis.
The upheaval in the European Monetary System last September was in retrospect not as sudden and unexpected as may have seemed at the time. It had been abundantly clear for a considerable time that there were serious tensions in the system that called for urgent attention. The persistent high interest rates in Germany and the underlying weakness of sterling and the lira created a very unstable situation. The tensions in the money markets were heightened by politcal uncertainty following the rejection in Denmark of the Maastricht Treaty. While a well-managed re-alignment within the system could have forestalled the subsequent chaos, the reality is that it did not take place.
Hindsight was not available in September, however, and the events of that month came as a huge shock. As a result, there was no co-ordinated response from Europe. The markets, and particularly the speculators, had a free run for a time. It was unprecedented that the foreign currency reserves of three of the most powerful industrialised countries in the world, and members of the G7 — France, Italy and the United Kingdom — should be seriously depleted in quick succession. The authorities did not have any plan to react to this demonstration of market power.
Even though the crisis was not of our making, it left us in a vulnerable position. Other currencies were caught in a similar dilemma and there had to be immediate responses. Our Government decided to hold the parity of the Irish pound and we were in no doubt about this. It was the proper course of action and there was a strong consensus at home, embracing employers and trade unions, in favour of this policy. It was also the considered view of our European partners that this was in the best interests of the Irish economy. We had one of the lowest inflation rates in the Community, a consistent balance of payments surplus and a good budget performance.
We were subjected to an immediate and severe attack by the markets but we demonstrated our capacity to resist and maintain our position. It was reported at the time that we introduced new exchange controls. This was not correct. We made more intensive use of existing controls and we acted in strict accord with our EC obligations. I am convinced that, if we had adopted a weaker currency line, we would have been subjected to a similar attack.
It is well to recall the mood in Europe at the time in relation to the crisis. After the initial shock, there was a confident expectation that the worst was definitely over and that the European Monetary System would quickly recover its equilibrium. After all, there were no good monetary reasons why other currencies should be subjected to further attack. It was expected that the lira would resume its place quickly in the exchange rate mechanism and that sterling would be in a position to return without undue delay. A Summit of Heads of State and Government was arranged for Birmingham to address the issue and there was a general belief that the German authorities would be in a position to reduce interest rates without delay. Following the initial attack the markets generally accepted that the Irish pound would hold its parity and the Irish market settled down. Unfortunately, higher bank retail rates and mortgage rates were unavoidable and increases of 2 per cent to 4 per cent were implemented. At the same time interest rates in some of the other member countries of the EMS also had to be increased.
The Government policy to maintain the parity of the Irish pound was based on a number of considerations. Since 1987 we had seen the benefit of a policy of stability built on low inflation. We have made substantial gains in competitiveness particularly against the United Kingdom. The disciplined approach to economic management has paid excellent dividends in terms of reduced budget deficits. Exchange rate stability within the narrow band of the exchange rate mechanism has been a key factor in this and we considered it vitally important to maintain our position, if this were possible. In any event we are committed to greater European integration. We believe that economic and monetary union can be achieved within a reasonable timetable and we want to be part of this.
Therefore, there was no good reason for us to change our position and, as I mentioned, there was a strong national consensus in favour of holding the line. It was necessary to provide some temporary relief for business badly affected by the sudden fall in the value of sterling and the Government introduced the market development scheme with a commitment of £50 million.
It is well to reflect on the options that were open to us in September. One commentator put it well when he said that we were caught between a rock and a hard place. If we had chosen not to hold the line the options were devaluation within the exchange rate mechanism, free-floating of the Irish pound, linking with sterling or linking to the ECU. Contrary to rumour, our European partners in all probability would have rejected a devaluation, if we sought their agreement, because at that stage it would not have been justified by reference to our economic position.
A variant of the devaluation option perhaps might have been to move on to the wider band of the exchange rate mechanism for a period. However, I see no real merit in this. It would probably be seen as evidence of weakness and would lead to greater volatility for our currency arising from a loss of confidence. It would bring no particular benefit. Certainly, it would not provide any protection against higher interest rates. I believe it would be interpreted by the markets as an effort by us to move closer to sterling.
Free-floating would effectively mean a fall in the value of the Irish pound because of the market perception of the influence of sterling. Therefore, free floating and linking with sterling in practice, are likely to amount to much the same thing, in the immediate future. Free-floating would be inadvisable for a number of reasons. As events have demonstrated, it would have meant great volatility for our currency. I do not believe that we could have followed the example of the United Kingdom in bringing down interest rates. On the contrary, there would have been a distinct risk of high interest rates on a long term basis to match the uncertainty about our currency policy. This approach would also result in strong inflationary tendencies. Inflation in Ireland would be likely to be stronger than in the United Kingdom because the Irish economy is operating at a higher capacity level than the United Kingdom economy, the Irish economy is much more open. The small size of its market means competition is less intense and increases in import prices are more likely to be passed quickly on to the consumer. Investors would become more wary of our position and the overall effect of free-floating would be that much of the achievement of the previous five years could be undone.
Linking to the ECU would not have eased our problems to any consequential extent. The fall in the ECU over the period of the crisis was 2.4 per cent only. The devaluation required to satisfy the markets obviously had to be much greater than this. Linking to the ECU outside the ERM would have reduced our ability to defend our position because of the absence of the ERM support mechanism. Therefore, our interest rates would have been higher rather than lower had we linked to the ECU. In short, we would have the problem of very high interest rates to protect us against speculative pressures, while not being in a position to avail of the ERM defence measures. I would remind the House that some Scandanavian countries followed this policy earlier and they discovered that it offered them no protection when they came under attack from the markets.
The Birmingham Summit was a disappointment and a signal that re-establishment of the EMS as a zone of stability could be a slow process. However, it did give a mandate to the monetary committee of the European Community and the Central Bank Governors to consider the lessons to be learned from the crisis and to report to the Council. This activity is still in progress. As I speak, the monetary committee is considering a report which, I understand, will soon be submitted to Ministers. I would hope that this will lead to substantial improvements in the working of the EMS. It is not evident that changes are required if the system is to be a force for stability in Europe and a staging post for economic and monetary union.
The continuing pressures in the EMS and on other European currencies throughout the autumn led to devaluation of the Portuguese escudo and a second devaluation of the Spanish peseta in November. I must repeat that there were no pressures from Europe for a change in the parity of the Irish pound. In retrospect, I believe that if our currency had been devalued in the early weeks, it is quite possible that we would have faced the same experience as the Spanish authorities. I say this because the clear market perception would have been that the Irish authorities were seeking to align their currency with sterling and also because at that stage our European partners would not have been willing to agree to anything approaching a 10 per cent devaluation.
The Irish pound was not the only currency under strain. There were also substantial pressures on the French franc and the Danish krone. I said on a number of occasions that we were ready to consider a realignment within the exchange rate mechanism and it did appear from time to time that such a realignment involving the Irish, French and Danes might take place. Despite widespread disappointment that the long awaited cut in German interest rates had not materialised, the French and Danes were unwilling to participate in a general realignment. A further disappointment was the failure of the Edinburgh Summit to address the continuing crisis adequately.
Our position deteriorated considerably in the new year. The removal of exchange controls on 31 December was not a significant factor in the context of defending the currency. Exchange controls had been useful for a short period when pressure emerged in September but, by November, it was necessary to push overnight interest rates up to 100 per cent despite the existence of controls. Similar interest rate levels were again required on two occasions in January. The main focus now was on wholesale interest rates which had risen to a point where further increases in retail rates generally and in mortgage rates were imminent. This was a reflection on intense market pressures and persistent rumour — sometimes originating from sources that had much to gain — that the Irish pound would be devalued.
The new Government launched an immediate and strong offensive to support the parity of the currency. The initial reaction from the markets was encouraging as they recognised the determination of the Irish authorities to hold the line. In a short time there was a significant improvement in our external reserves position and, while interest rates remained high, there were prospects that reductions might not be far off. In order to stave off immediate danger of an increase in retail rates the Government decided to provide exchange rate guarantees for borrowing in foreign currencies by industry, agriculture and the mortgage institutions.
A further and substantial fall in sterling, however, following a reduction in United Kingdom rates, put immediate pressure on a number of businesses and added to the pressures on Irish interest rates. The combination of these factors and the weakening of the national consensus created extraordinary difficulties and the Government decided reluctantly that the currency had to be devalued. There was no real prospect of reducing interest rates quickly even with the implemenation of the exchange rate guarantee schemes.
There has been much criticism in recent days of the poor response from our European partners to requests for assistance. I would like to put this in perspective. At all times the rules of the exchange rate mechanism on intervention have been applied rigidly in our case but it has become evident in recent months that these rules are no longer adequate. It is common knowledge that on two occasions last year the German authorities went beyond their obligations in providing assistance for the French franc. This led to the understandable perception that the dominant partner in the European Monetary System was differentiating between currencies. It was for this reason that we, and others, protested that it undermined the solidarity of the system. On the other hand, if special assistance for the franc had not been provided on the occasions in question, it is possible that the system might have collapsed altogether.
The Government did take strong diplomatic initiatives to generate support for its policy of maintaining the parity of our currency. Contrary to rumour, there was no question at any time of a special deal for the Irish pound. This would have made little sense and would hardly be accepted by the markets. Our efforts were directed towards improvements in the operation of the exchange rate mechanism, with multilateral intervention, to secure greater stability and to demonstrate effectively to the markets that further speculation against the currencies in the mechanism were unwarranted and would not succeed. I know that we were not alone in seeking change and we were not alone in pointing to the need for reductions in German interest rates quickly. We also stressed the need for some disciplines on currencies which participate in the EMS but have suspended their obligations within the exchange rate mechanism. As participants they have commitments to ensure that their economic and monetary policies are not inconsistent with the overall obligations of EMS members and it is vitally important that these commitments be honoured. This is an issue that will be pursued further at European level by the Government.
In the days immediately prior to the devaluation of the Irish pound there were indications from our European partners that they were willing to consider intervention on a co-operative basis to support our position. This would have been an extension of the support given to us during the crisis; as we have seen, this support was provided later for the Danish krone. It represents a change in the operation of the intervention arrangements, which has yet to prove itself, and hopefully it is a sign that improved arrangements will emerge in the future. In the circumstances it was the view of the Irish authorities that this would have been too little too late and that it would be insufficient to achieve an immediate reduction in Irish inter-bank interest rates. This view is supported by the fact that some Danish official rates are very high despite the cut in German rates. Besides, we had no reason to assume then that the reduction in German rates would be implemented within days. It is regrettable that an offer of multilateral intervention from our European partners should have come so late in the day. We had proposed this repeatedly at earlier stages but it had not been possible to get universal support.
Following the devaluation of the Irish pound, it became evident last week that the whole system was under imminent threat once again. While the Danish krone was in the front line, there were pressures on other currencies and a co-ordinated initiative was needed immediately. When it reduced interest rates it was, according to the Bundesbank, responding to changes in domestic and global economic conditions and to pressure on the EMS.
The Government decided on a devaluation of 10 per cent because this was the figure required to bring our effective market exchange rate back broadly to its level of the first half of last year and to provide the best prospect of getting early reductions in interest rates. Our partners agreed to support this figure while reaffirming their viewpoint that an adjustment was not warranted by reference to convergence criteria. They welcomed the assurance that the Irish pound will continue as one of the core currencies of the exchange rate mechanism in the movement towards economic and monetary union.
The change in the parity of our currency has provided immediate reliefs. The threat of increases in retail interest rates generally and mortgage rates has receded. Interest rates continue, however, to be high and I must warn against expectations that rates can be brought down further in the immediate future. I am optimistic, however, that there can be further reductions and that interest rates will be down significantly later this year. This will obviously depend on external as well as internal factors. In particular the timing of further reductions in European interest rates generally will be an important factor in determining the timing of reductions in Irish interest rates.
The competitiveness of Irish industry measured on a trade weighted basis has been restored. The position of exporters and of those competing with goods produced abroad has been improved. There are also increases in farming incomes. These are the immediate benefits and they may beg the question as to why there was such opposition over a long period to devaluation. There has been opposition because of the clear attendant risks over the medium and long term.
I have always accepted that there are some short term gains from devaluation. However, devaluation has imposed significant costs on the State. It has added about £800 million to the national debt and the additional cost of servicing this debt in the current year will be about £50 million. The debt of the State-sponsored bodies has increased by about £160 million and the servicing of this will impose an extra charge of about £15 million on these bodies this year. Of much more significance are the inflationary pressures on the economy. Experience has shown that devaluation rarely secure a permanent improvement in competitiveness and instead tend to leave enduring interest rate disadvantages. It has to be a priority of Government to address these problems in the forthcoming budget and with other policy initiatives to ensure that on this occasion we make devaluation work. Unless costs are contained and, through responsible policies, we manage to contain price increases, our competitiveness could suffer. We must continue to improve our competitiveness to create additional employment.
Some critics have suggested that the devaluation would not have been necessary if the Government had introduced measures to reduce domestic costs and so restore the competitive position of the economy. There is no doubt but that adjustment of domestic costs would have eased pressures on business, but these critics have not spelled out clearly the scale of the adjustments which would have been needed and the implications for incomes and for the public finances.
An example of what might have been necessary was given by the director general of IBEC when he said that a freeze in wages would not be adequate — what was needed was an actual reduction in nominal wages. Reducing other industrial costs on the lines requested by the director general of IBEC would have required significant tax reductions or subsidies. This would have increased the budget deficit at a time when it is already under strain from the effects of recession and rising unemployment.
There has been much misinformed comment about the costs of defending the parity of the Irish pound over several months. There appears to be an impression in some quarters that big expenditures were involved through loss of external reserves. It is true that the reserves were depleted but reserves are intended for use in an emergency and the standard procedure is to use them to minimise the worst effects of a difficult situation. As long as we continue to manage the economy in a prudent way, the reserves can recover very quickly. For example, overseas investors sold substantial amounts of Irish gilts. This repayment of debt to non-residents was refinanced by borrowing from other non-residents denominated in foreign currency. The additional foreign currency debt increased by about 8 per cent in response to devaluation. On the positive side, the interest rate on this debt is currently well below the interest rate on Irish pound debt. Besides, my information is that there would have been substantially more disinvestment from Irish gilts, both in the short term and the longer term, if we had not demonstrated a strong commitment to currency stability. Following the easing of tensions in the markets generally our reserves have already improved very substantially. I am not in a position to mention any figures, as is the tradition, but I can assure the House that the authorities are satisfied with the situation.
In any difficult situation where a major decision has to be made there are attendant costs and benefits on both sides and many elements cannot be reduced to arithmetic. There were figures mentioned about job losses and potential job losses as a consequence of policy on the exchange rate. These figures were grossly exaggerated and there was a growing tendency in some quarters to attribute every redundancy to the currency crisis. There were obvious costs associated with excessively high interest rates but there can be no assurance that interest rates would be lower if we had devalued in September. On the contrary, devaluation then would probably have built a long term premium into Irish interest rates because of market doubts about the strength of our commitment to maintaining a stable currency both now and in the future. This reputation for stability could prove to be a very important factor in the longer term. On the downside, it is well to bear in mind that the devaluation of the currency can have a damaging impact on employment in the longer term and we must be very careful to ensure that this does not happen.
The currency crisis has generated much debate about speculation. There has been quite intense speculation against all currencies in the EMS which came under threat. I would define speculation as short term borrowing of a currency solely for the purpose of making a large profit from a subsequent devaluation. It is an accepted practice in the marketplace — involving the corporate sector and banks located overseas — and we have no choice but to learn to live with it, within whatever rules apply internationally. However, the experience of recent months will open up the debate about market regulation. The markets have become huge and very sophisticated and, working at international level, the monetary authorities must ask themselves whether existing regulations should be strengthened to counter undue speculation and to put reasonable limits on the powers of the markets. Exchange controls are now seen as a sign of weakness but, internationally, the classic response of higher interest rates may not be enough in the future to maintain proper balances. I believe that significent changes are likely but these are probably down the road. As regards the speculation against the Irish pound. I can say that it proved costly for many of the speculators who used the mechanism over many months and who hoped we would quickly devalue in September, but this was not to be so.
The most important consideration now is to plan well for the future. The Irish pound will remain within the narrow band of the exchange rate mechanism of the EMS. This is seen as the best guarantee of future stability. While there are still residual fears, I believe that the worst of the EMS crisis is over and the system can recover its equilibrium quickly. The process towards economic and monetary union is continuing. It is well to bear in mind that stage II is due to commence on 1 January 1994. I have no reason to believe this deadline will not be met.
I have heard the case being made for alternative policies, particularly that the Irish pound be free-floated as a means of achieving a dramatic reduction in interest rates in the short term. I have referred to this already. Superficially this may seem attractive and getting interest rates down as quickly as we can must be a priority. I must warn, however, that this kind of approach would amount to a high risk and dangerous strategy that could do serious damage to the economy down the road; for a small open economy this is much too dangerous. As a small currency we cannot free-float; the markets would in all probability attach us to some larger currency and, as I have said already, in our situation, we would be linked to sterling. We must adjust to the new realities in regard to sterling and we will not return to the exchange rate that applied in the first half of 1992. We will not adjust our exchange rate in response to changes in sterling. Irish business must recognise this as a fact of life and plan for the future on this basis.
Over the past five years we have invested heavily in a disciplined approach to economic management and this has paid excellent dividends up to now in terms of low inflation and reduced budget deficits. The stability of our currency has been a very signficiant factor and we must do our best to ensure that devaluation does not undo in any way the achievements of recent years. I am disappointed that devaluation was inevitable and reject the viewpoint that an earlier devaluation would have avoided much of the difficulty. On the contrary, I believe we have gained much in credibility in consequence of our determined opposition. It is regrettable that the national consensus against devaluation could not be sustained. As demonstrated in other countries, this consensus is necessary in order to successfully defend the parity of a currency. We must now adopt to the stiuation in which we find ourselves. There will the short term advantages but some long term cost.
On the positive side, there will be a stronger level of economic activity this year compared wit what would have been the case if we had not devalued. On the budgetary front the effects this year will be only slightly negative. The extra costs in debt servicing will be balanced by positive gains in other areas. In the longer term our foreign debt has increased and we will probably suffer a premium on our interest rates in the medium term. We need to reduce this premium. Even in the short term inflation this year will be higher than if we had not devalued. There has been a downward trend and this has been reversed but only to a limited extent.
The new situation presents us with a challenge. We have been given a competitive advantage in certain markets and we must seek to get the benefits in terms of jobs from this. In countries which we have devalued against, for example, Germany, France, the Benelux countries and the US, we have now a major competitive advantage in terms of our exports prices. In other areas where we compete with UK or Italian products we reduced the degree of adjustment required for firms in those markets. This should help support our current market share. Indeed, given low wage inflation in recent years here we should be expanding markets. In other areas, for example, tourism, the devaluation increases the attractiveness of Ireland for visitors from both the US and Europe. It will also help boost the growth of holidays domestically for Irish people.
We must as a nation now work together to take advantage offered by the devaluation. All sectors must work together, as we have done in the past, to turn devaluation into concrete achievement in employment. We must not seek to compensate ourselves in personal income terms for anything lost by devaluation. Rather it must be through increased productiviely that we earn back any losses.
As a strategic consideration we have worked to lessen dependence on the UK market. We must continue this process. Otherwise, we may be over-affected, at a future date, by sterling volatility. We need to break in the markets' minds this perceived link. Our economic performance over recent years has been far better in terms of pay rises and inflation than the UK. This must be reflected in our exchange rate.
There should be no doubt in Deputies' minds about our exchange rate policy. The main aim of the Irish exchange rate policy is the preservation of the Irish pound at existing bilateral rates within the narrow band of the exchange rate mechanism of the EMS. Until last September, the system had provided a stable regime for our currency and we now hope that, following the recent crisis, the system will return to its former stability.
I would like to take this opportunity to acknowledge the widespread support throughout a difficult period for the policy adopted by the Government. This support came from many quarters, and not least from people who were immediately affected by increased competition in business or by mortgage increases. It says much for the maturity of the Irish people that there was a general recognition of the merit of resisting the easier short term option in the interests of the longer term benefit of the economy. While we could not sustain this policy in the face of intense pressures, it is encouraging that there is such a strong appreciation here of the merits of a stable currency based on a low inflation policy.