Merkel Dents Irish Hopes Of Bank Debt Deal Then Backtracks

German Chancellor Angela Merkel sparked a mini-political crisis in Ireland after ruling out using the EU's new bailout fund, the ESM, to recapitalize banks for debts accrued in the past.

But within days she backtracked, following a telephone conversation with Taoiseach Enda Kenny after which they two leaders agreed that Ireland's was "a special case" that deserved a different approach.

At a press conference following an EU summit in Brussels on Friday, in response to a question about Spanish banks, Mrs Merkel said: "There will be no retroactive direct recapitalization".

This hardline approach was in direct conflict with expectations in Ireland following an EU summit in June, when a statement from EU leaders explicitly mentioned Ireland and pledged to enhance the sustainability of Ireland's debt program.

Ireland's bank debt is in two main parts - around €30 billion euro which was put into Anglo Irish Bank in the form of promissory notes, and another €34 billion which was pumped into the other pillar banks.

Ireland is due to pay €3.1 billion in March next year on the Anglo Promissory notes, although it deferred the payment earlier this year.

The government is hopeful of restructuring these repayments to spread the cost over a longer period of more than 30 years.

On the other €34 billion, Ireland is looking for the new bailout fund to take on a large proportion of that debt.

The government believes that the link between sovereign and bank debt must be broken, and the scale of the debt burden on the Irish State is unsustainable in the long term.

Yields on Irish bonds have fallen since the June summit, as expectations grew that Ireland was likely to get a deal.

Tanaiste Eamon Gilmore described it as a "game changer" and in subsequent media appearances, EU Comissioner Ollie Rehn repeatedly indicated he believed a deal was likely by October on Ireland's bank debt.

But in recent weeks the Finance Ministers of Germany, Finland and the Netherlands - the three donor countries to the bailout fund - said the money could only be used for capitalizing banks into the future once a common banking supervisory mechanism was introduced.

And on Friday, Mrs Merkel's comments backed up the position adopted by her finance minister.

Immediately, the Irish government found itself under serious pressure to explain to the Irish public whether the deal apparently struck in June had unravelled or been over-sold at the time.

Tánaiste Eamon Gilmore said he was concerned by Ms Merkel's comments but said a distinction needed to be made what one leader said at a press conference and what 27 had agreed to do at the formal European council meeting which included Ms Merkel.

Minister for Jobs Richard Bruton also said the June agreement "absolutely still stands".

But opposition parties jumped at the chance to criticise the government for failing to secure a deal.

Fianna Fail leader Michael Martin said he was "extremely concerned" at the remarks, and Sinn Fein accused the government of "blowing a lot of hot air about positivity when there is no progress at all".

There were high level contacts between the Irish and German governments on Friday night, resulting in a statement issued by a German government spokesman to RTE on Saturday.

"The Chancellor has used several opportunities to reiterate strong support for the efforts made by the government and the people of Ireland for a full return to the markets," it said.

"The European Council has just taken important decisions to advance the project of a Single Supervisory Mechanism, it is now our common task to complete the legal framework for it by the end of 2012 and to work on its operational implementation in the course of 2013.

"The later process of recapitalization of the banks will be a complex one with negotiations at each stage to address important issues.

"Ireland and Germany will continue to cooperate closely in order to improve the sustainability of the Irish program and ensure its successful outcome."

Meanwhile, as Enda Kenny faced into one of his toughest weeks as Taoiseach yet facing calls to explain to the Dail this week if his negotiation strategy on Ireland's bank debt has been a failure, a phone call was arranged between the two leaders late on Sunday night.

A joint communique was issued saying the pair had "discussed the unique circumstances behind Ireland's banking and sovereign debt crisis, and Ireland's plans for a full return to the markets. In this regard they reaffirmed the commitment from June 29th to task the Eurogroup to examine the situation of the Irish financial sector with a view to further improving the sustainability of the well performing adjustment program."

"They recognize in this context, that Ireland is a special case, and that the Eurogroup will take that into account."

The communique proved that Kenny enjoyed access to Mrs Merkel, the most powerful leader in Europe and he followed that up with a planned visit to Paris on Monday to meet French president Francoise Hollande, arguably the continent's second most powerful.

However, in the end it will be the shape and size of any eventual deal on Ireland's bank debt that will count.