Three years after the European Union’s debt crisis erupted, the bloc is preparing for its first success story — Ireland’s exit from its EU-International Monetary Fund bailout program. But they’re not exactly cracking open the bubbly on the streets of Dublin.
The Republic of Ireland is well placed to regain full access to the international capital markets after a successful start to its fundraising this year. On January 8 the government raised €2.5 billion ($3.4 billion) through a syndicated bond issue, a tap of an existing bond that matures in 2017. Overseas investors snapped up some 87 percent of the offering, and the yield of 3.316 percent was comparable to the level of rates the country was paying before it had to turn to the EU and the International Monetary Fund for a €67.5 billion bailout in 2010. The issue attracted orders totaling €7 billion.
Now the government is looking to capitalize on the success of that deal as well as the general improvement in the European sovereign debt market, which has rallied strongly ever since European Central Bank president Mario Draghi promised last July to “do whatever it takes” to preserve the euro. Bankers say the Treasury is aiming to issue a 10-year bond issue in the first quarter of this year, which would be its first such offering since January 2010. The Treasury made an initial dip into the markets last July, when it sold a total of €4.2 billion of five-year and eight-year debt, but a borrowing at 10 years — the benchmark of the long-term sovereign market — would represent a major step in Ireland’s return to normality.
“Given current demand conditions a 10-year issue will certainly be well received,” says Conall Mac Coille, chief economist at Davy stockbrokers in Dublin. “The real test is whether Ireland can achieve regular issuance as it moves closer to exiting formal EU-IMF funding support at the end of 2013.” John Corrigan, CEO of Ireland’s National Treasury Management Agency, said at a Dublin news conference in January that the agency wanted to issue a 10-year bond but that officials hadn’t made any decision about timing. The agency aims to resume monthly bond auctions at some point this year, he added. The NTMA plans to borrow €10 billion from the markets this year; the government will cover the rest of its borrowing needs by drawing the remaining €11.3 billion from the EU-IMF bailout facility. Prime Minister Enda Kenny told the European Parliament on January 16 that he believed Ireland could be free of EU-IMF support by the end of this year.
“The syndicated bond issued in January was relatively easy — they knew they could sell it,” says Philip Lane, an economist at Trinity College Dublin. “An auction will be more uncertain, and the real test is a 10-year bond.” Nick Gartside, chief investment officer of international fixed income at J.P. Morgan Asset Management in London agrees. “A 10-year issue would demonstrate full market access,” he says. J.P. Morgan currently has an overweight position in Irish sovereign debt.
Gaining full market access would be an important achievement for Ireland. Olli Rehn, the EU Economic and Monetary Affairs commissioner, said recently that the ECB might buy some Irish bonds under its new Outright Monetary Transactions program “as a way of smoothing, paving the way for a successful return to market financing.” The ECB hasn’t commented on that prospect, but Draghi said last October that the central bank would be prepared to use the OMT for countries that had “full market access.” Draghi has never defined that term, but the Irish finance minister, Michael Noonan, has said Dublin believes it would qualify for the OMT after making two 10-year bond issues.
The possibility of ECB support could help reduce Irish borrowing costs, a key aim of the government. Although rates have come down sharply since 2011, when 10-year Irish bond yields hit a peak of 14.07 percent, the authorities remain concerned about the cost of funds. They are especially indignant that one of the three main ratings agencies, Moody’s Investors Service, still rates Ireland as subinvestment grade, at Ba1 with a negative outlook.
Central Bank of Ireland governor Patrick Honohan said the yield on the country’s 10-year bond, which was running at 4.13 percent at the end of January, was still too high compared with Germany’s equivalent figure of 1.69 percent. “Irish sovereign spreads may no longer be bloated by redenomination risk, but at 300 basis points at the long end, they do seem to reflect a credit risk premium that is poor reward, so far, for what has been a sizable fiscal adjustment effort,” Honohan said in a speech on January 8 at the Bank for International Settlements in Basel, Switzerland. Ireland’s costs are lower than that of other peripheral European countries, though. The yield on 10-year Spanish bonds, for instance, stood at 5.08 percent on January 18.
Kathrin Muehlbronner, a senior analyst at Moody’s in London, said in a note on January 14 that “unimpeded market access is an important precursor for Ireland to regain an investment-grade rating.” Fitch Ratings’ analyst Douglas Renwick, who rates Ireland BBB+, said the firm could raise Ireland’s rating “back to the single-A range” if Dublin can negotiate “an element of risk sharing” on some of its obligations. The Irish government is trying to extend the maturity of some of the debt it took on to finance a €64 billion recapitalization of Irish banks, the source of Ireland’s debt crisis. The government borrowed €31 billion from Ireland’sCentral Bank in 2010 to cover the cost of bailing out Anglo Irish Bank; it is due to make repayments of €3.1 billion a year until 2022, and smaller amounts until 2031, when the debt will be extinguished. Noonan wants to convert the debt into longer-term bonds held by the Irish Central Bank, but to do so he needs the approval of the ECB in Frankfurt.
A successful renegotiation of the central bank debt would burnish the image of Ireland as a country on the mend, says J.P. Morgan’s Gartside. “Any upward trend in ratings would be a powerful signal to investors, and an upgrade from Moody’s in particular would be likely to widen the investor base,” he says.
Progress in reducing the budget deficit will be critical to regaining investor support, Gartside contends. Ireland has adopted a series of budget cuts and tax hikes — the latest being a new levy on property — under an austerity program designed to restore the budget to health. The government projects the final deficit figure for 2012 will be 8.2 percent of gross domestic product, below its program target of 8.6 percent and far below the peak of 30.9 percent of GDP in 2010, when bank bailouts swelled the government’s red ink. It projects a further decline to 7.5 percent of GDP this year and 2.9 percent in 2015. The national debt is projected to crest at a lofty 122.5 percent of GDP this year before declining slowly.
The government is counting on stronger growth to sustain the improvement in deficits and debt. The country’s gross domestic product fell by more than 8 percent between 2008 and 2010 and has grown only sluggishly since then. “Economic growth was around 1 percent in 2012 and there’s a consensus it will be about the same in 2013,” says Lane. Even such a modest performance looks attractive at a time when core euro zone countries such as France and Germany are struggling to achieve any growth at all. “Ireland is well positioned to benefit from the global economic cycle,” says Cosimo Marasciulo, head of government bonds and foreign exchange at Pioneer Investments in Dublin. “It has good net exports and there is great potential for outperformance given that unit labor costs have fallen 20 percent since 2007.”
Ireland’s improvement is real, but it will take years to overcome the costs of the crisis.