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November 16, 2012 5:27 pm
Investors looking for good eurozone news this week should have heeded Village People’s advice: “Go West.” Ireland became the first eurozone member, excluding tiny Estonia, to see a positive rating action by one of the big three US ratings agencies since the region’s debt crisis erupted in late 2009.
The shift was modest. Fitch changed its outlook from “negative” to “stable”, while keeping the north-west eurozone country’s rating at BBB+. Its action nevertheless took Ireland, which was forced into a European Union/International Monetary Fund bail-out in November 2010, closer to regaining full access to financial markets when its aid programme expires next year.
It was also a pop fantasy moment in another gloomy week for the 17-country bloc. The IMF and EU feuded publicly over tackling Greece’s still-growing debt mountain, anti-austerity protests re-erupted, and Spain’s government bond yields edged higher again on worries about its turnaround chances. IMF and eurozone leaders “want to make Ireland the poster child for success, and how official programmes can work”, says Julian Callow, international economist at Barclays.
The country is already testing financial market appetites. On Tuesday, the Bank of Ireland, the country’s biggest lender by assets and its only big bank not under government control, comfortably raised €1bn in covered bonds – the first bond issuance by an Irish bank since October 2010. German investor demand was particularly strong.
In the wake of Fitch’s report, the yield on Irish nine-year government bonds ended the week at 4.7 per cent, the lowest since June 2010. Dublin on Friday raised €500m in three-month bills at an average yield of just 0.55 per cent – compared with 4.2 per cent paid by Greece on three-month bills earlier this week. A next step, says Donal O’Mahony, global strategist at Davy stockbrokers, may be to issue longer-dated dollar bonds “as part of its efforts to broaden the available channels for Ireland’s return to market financing”.
Helping to drive Ireland’s official borrowing costs lower has been a bet taken by Franklin Templeton, the US fund manager, which has acquired a substantial holding of Irish bonds. Another factor was the European Central Bank’s promise to act as a backstop in eurozone bond markets – provided countries accept official reform programmes.
But Ireland is also gaining credit for its improved economic prospects, for efforts to rein in public debt, for revamping its bloated bank industry – which threw the country into crisis originally - and for meeting scrupulously the demands of its bail-out programme. “Every box is ticked 110 per cent,” says Gillian Edgeworth, economist at UniCredit. “Clearly the banking sector was not ‘lucky’ but the fact that Ireland completed proper bank stress tests a year or 18 months before Spain and then Italy became problematic meant it had a year to begin shedding assets. That was good in generating some momentum.”
Michael Hasenstab, a senior Franklin Templeton manager, wrote in a recent note to clients: “Hopefully even the US could look a little deeper into what the Irish have done and try to emulate some of those policies.”
A successful Irish turnaround would vindicate eurozone policymakers’ decision not to encourage the example set by Iceland, which ended up rebuilding its financial system from scratch. “Iceland and Ireland were a test of whether it was better to let your bank system collapse or bail it out,” says Jim Leaviss, head of retail fixed interest at M&G Investments. “So far it is not clear which was best. Irish bond yields have fallen a lot but that was skewed by the ECB’s actions.”
Irish exports – more important than in other eurozone “periphery” countries – have been boosted by competitiveness gains. The country returned to growth last year and is on course for a modest 0.9 per cent expansion in 2012 and 1.5 per cent growth in 2013, according to Irish government forecasts.
But Ireland’s public finances – and investor appetite for its debt – will still hinge crucially on what happens elsewhere in the eurozone. Much of the returning confidence assumed European leaders would help in restructuring the country’s €64bn in bank debt, using the continent’s new bail-out fund, the €500bn European Stability Mechanism. But that is looking less likely and would almost certainly require Spain to be given similar help first. Dublin is instead pinning its hopes on being allowed to restructure promissory notes issued to help the refinancing of Anglo Irish Bank, which was at the centre of the country’s financial crisis.
At the same time, Ireland’s debt levels – forecast to peak at 121 per cent of gross domestic product – and export dependence leaves it exposed to external shocks such as a slump in eurozone growth or a US recession triggered by Washington’s failure to secure fiscal reform. Next month, Dublin will unveil its sixth austerity budge since the crisis began and the Irish public is weary of spending cuts and tax hikes. Philip Lane, economics professor at Trinity College Dublin, warns: “Even if the budget deficit comes down, with such a high level of debt the economy will remain vulnerable in the longer term.”
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