January 8, 2013 5:39 pm

Irish issue shows way for the periphery

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Over two years after Greece, Ireland and Portugal were rescued to prevent the eurozone from disintegrating, their bond yields – or borrowing costs – have tumbled to levels last seen before the eurozone debt crisis erupted.

The result has been striking profits for investors. Irish and Portuguese debt returned 29 per cent and 56 per cent respectively last year, according to Bloomberg-Effas indices. Greek bonds yielded a huge 112 per cent, thanks largely to a eurozone-sponsored buyback and official sector debt relief.

Although Athens is still far from regaining market access, both Ireland and Portugal can now potentially extricate themselves from their bailout programmes on schedule this year.

Ireland is the most likely candidate. On Tuesday Dublin successfully sold €2.5bn of bonds through a tap of its 2017 security. Although Ireland was able to raise about €1bn of fresh money through a debt exchange last summer, this week’s deal has been hailed as a landmark in Ireland’s recovery.

“This is a milestone in the route towards full market access for Ireland,” says Nicholas Gartside, chief investment officer for international fixed income at JPMorgan Asset Management.

Leaving the bailout programme requires repeated issuance, however. Ireland’s National Treasury Management Agency hopes to raise €10bn this year to pre-fund all its financing requirements in 2014, when the country is due to emerge from the programme.

Not so long ago that would have been considered difficult. Implied borrowing costs have dipped sharply – the benchmark 2020 bond yield has almost halved over the past 12 months to 4.26 per cent – but Dublin still faces daunting challenges.

Ireland’s debt-to-gross domestic product ratio is set to reach 122 per cent this year, the budget deficit is still gaping, and its heavy reliance on its export economy means the country is vulnerable to economic shocks.

Bond yields, moreover, reflect investor expectation of some sort of eurozone debt relief on Dublin’s €64bn banking debts, but this is uncertain.

The Irish government still hopes that some debt relief will be agreed by March 31, when it is scheduled to make an €3.1bn payment towards €31bn in promissory notes, effectively IOUs agreed at the height of the country’s financial crisis.

However, Germany and other northern eurozone states have refused to allow the European Stability Mechanism, the continent’s rescue fund, to take over responsibility for “legacy” bank debts, and the European Central Bank has so far balked at Dublin’s demand to extend the maturity of the IOUs over a much longer period, possibly 40 years.

A failure to achieve at least some debt relief could undermine investor confidence in Ireland’s spectacular recovery and make the €10bn fundraising target for this year tricky to achieve.

Nonetheless, the success of Tuesday’s bond sale makes exiting the programme much more feasible, analysts and asset managers say. Bond yields dipped further on Tuesday, near the lowest since early 2008 in some cases.

“Ireland’s orderly exit from its current troika [of international lenders] programme looks increasingly assured,” says Donal O’Mahony, global strategist at Davy, a Dublin stockbroker that was one of the dealers working on the bond sale.

The next step towards Ireland’s full rehabilitation will be broadening the investor base buying its bonds. Last year the dominant buyer was Franklin Templeton, a California-based asset manager, supplemented by a smattering of other US funds.

More recently, European pension funds and insurance companies have also emerged as buyers, but large Asian and Middle East investors in the Far East and Middle East have so far shied away from Irish debt.

This is mainly because Moody’s, the rating agency, continues to rate Irish debt as “junk”, which keeps the country’s bonds out of influential investment grade indices that many investors track.

If Dublin succeeds in getting Moody’s to restore its investment grade status, Irish debt would be readmitted to these indices and make it purchasable by many conservative investors.

Ireland’s bond sale is also good news for the wider eurozone periphery. Tuesday’s tap was arguably the first “proper” new bond sale by a bailed-out eurozone country, and reinforces the improving investor attitude towards the periphery.

“It’s cumulatively showing Ireland is getting back on track,” says Lucinda Creighton, Ireland’s EU minister. “It’s hugely significant and it’s not just significant for us, it’s significant for the eurozone.”

Portugal will certainly take heart at Ireland’s return to bond markets. Although the Portuguese 10-year bond yield has edged up marginally this week, it had dipped to 6.24 per cent last Friday, the lowest since November 2011 and down from a peak of more than 17 per cent in early 2012.

“Ireland is charting the way for Portugal to follow,” Mr Gartside argues.

Additional reporting by Peter Spiegel

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