Irish debt restructure hangs in the balance
The assault on the Irish bond market by bond investors has continued with a vengeance this week with 10-year bond yields hovering close to nine percent at 8.91 percent. Since August yields have been trending higher, but they accelerated sharply in mid-October, when they were at six percent. At this rate, yields could be in double figures by next week.
Investors are concerned that Ireland will not be able to meet its financial obligations due to the costs associated with bailing out its beleaguered banking sector. The government has estimated that these costs may top 50 billion euro (£42.7 million), however this sum remains a guess and the true bail-out cost is unknown.
Since the Irish debt crisis was precipitated by the bursting of a mega property bubble, the final cost of writing down the bad debt will not be known until there are some stabilization in house prices. As Irish house prices declined seven percent last year and the fall in prices has accelerated in 2010, this could be some way off.
The risk of a default in the near-term is reflected in rising shorter-term bond yields. The two-year yield has nearly doubled since the start of November and currently stands at just over 6.5 percent.
The Irish government has already reduced public spending sharply and is planning further cuts next year to bring down its deficit of 14.4 percent of GDP, prompting fears that the Irish will have to follow Greece and use the EU/IMF debt stabilization fund.
Some argue that the government could actually borrow at much lower rates from the fund – five percent or above to borrow money for three to five-year periods. This is much lower than borrowing from the markets, so it might be worth the reputational damage to withdraw from the financial markets altogether.
However, Central Bank governor Patrick Honohan has reasserted that the government will be able to go back to the financial markets next year when 10 billion euro of re-financing is due.
Investors should not forget that there are a couple of compelling reasons for Ireland to avoid a Greek-style fate.
Ireland’s debt repayment schedule is fairly evenly spread out with big redemptions due in 2011, 2014 (11.8 billion euro), 2016 (10 billion euro), 2019 (15 billion euro) and 2020 (20 billion euro). This buys the government time to try and persuade the markets it can cope with its debt burden.
Even if the prospect of cheaper debt financing is tempting, Ireland might want to stay away from the debt stabilisation fund until Europe has agreed what, if any, “haircut” investors will need to take in the event of a default by one of the peripheral European nations.
Right now investors are dumping Irish debt as the size of a potential “haircut” – in the event of restructuring – remains uncertain. If Ireland was to turn to the stabilisation fund, it may want to wait until the authorities have reached a formal agreement on an orderly default mechanism for euro zone nations to avoid as much disruption as possible.
Turning to the EU’s stabilization fund could actually be detrimental for growth in Ireland. One could imagine that a condition for Ireland to use the fund would probably include increasing its 12 percent corporate tax rate. Some Irish economists have pointed out, that although this might raise revenue in the short term, it would be a negative shock to the financial services sector and the multi-national export sector in the long term. Harming exports could push the Irish economy to breaking point as they are considered key to the Irish economic recovery.
While Irish bond spreads blow out to levels experienced by Greece prior to its debt crisis back in May, the Irish government has to consider its options carefully. Turning to the EU stabilisation fund too early might have long term detrimental consequences.