Europe is lurching into a fresh phase of its crisis, as Greece again warns it will miss its cost-cutting targets and Italy scares investors with its wavering commitment to austerity. Many euro zone banks are so weak they may soon need to be recapitalized.
Against this backdrop, the performance of Irish sovereign bonds is remarkable. The former Celtic Tiger was one of the first economies to hit the wall after the global financial crisis. Along with Greece and Portugal, it needed bailouts by the European Union and the International Monetary Fund to stay current on its debt payments. Yet Irish government bonds handed investors a 14 percent gain over the past three months, the highest returns among 26 major government debt markets, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.
As investors have bought more Irish debt, the yield on Irish 10-year bonds has dropped from 13.8 percent in July to a recent 8.5 percent, the biggest recovery among the countries that have received aid. Greek yields, at 19 percent, are more than four percentage points higher than their recent low in July. Yields on Portuguese debt are two percentage points higher than those on Irish bonds. The difference in yields between German government bonds, the gold standard for Europe, and Irish debt has narrowed considerably.
Although Ireland’s general government debt was €148 billion ($209 billion) at the end of last year, the country has caught several breaks. An export-fueled recovery led by pharmaceuticals, medical, and dairy products propelled its economy in the first quarter to its fastest growth in more than three years. As a result, Irish gross domestic product will probably expand by 0.5 percent this year, Bloomberg surveys of economists show. That’s not Olympic class, to be sure, yet such growth is far above expectations.
Irish Prime Minister Enda Kenny has also obtained an interest rate cut from the EU and the IMF on their bailout loans: The drop in rates should save the government €1 billion annually. After some wrangling with the French, the Irish also got to keep the attractively low 12.5 percent income tax rate they charge companies. “My perception is, and always has been, that the situation in Ireland is more manageable than in all the other tricky countries,” says Kornelius Purps, a strategist at UniCredit in Munich. “The economy has growth potential while the other economies don’t.”
Right now much of the Irish economy barely has a pulse. The banking industry is essentially in receivership, construction and real estate activity have ground to a halt, and consumers are not consuming, because the level of household debt averages out to be one of the highest in the world. Yet the industrial infrastructure the Irish started to build in the 1970s is essentially intact—a low-tax, export-focused economy where the universities train young people in the skills multinationals need. Microsoft (MSFT), Hewlett-Packard (HPQ), and Pfizer (PFE), among many other U.S. corporations, still rely on Ireland to do research and development and make high-level products for EU customers.
The survival of that model is helping fuel optimism that Ireland will one day resume the sort of growth that doubled the size of its economy in the decade through 2007, before the real estate bubble burst. Economic expansion in Portugal has averaged less than 1 percent a year in the past decade. “We’ve met a number of international investors over the past few months, and they seem to view Ireland as being different from Portugal,” says David Owen, chief European economist at Jefferies International in London.
Ireland’s trade surplus widened in June to a record €4.08 billion from €3.8 billion in May as exports rose, Ireland’s Central Statistics Office reported in late August. The government predicts that the budget deficit will fall to 10 percent of GDP this year from 32 percent last year. The central bank forecasts that the economy will grow 2.1 percent in 2012, while exports will rise 6.4 percent.
In contrast, Portugal’s government doesn’t see significant recovery until 2013, Finance Minister Vitor Gaspar said on July 14. The Greek economy may shrink by 4.5 percent to 5.3 percent in 2011, Finance Minister Evangelos Venizelos said on Aug. 22. Fresh concerns are arising that the Greeks may never be able to get their sovereign debt to a manageable level.
“Ireland is not out of the woods yet, and there are still a lot of negatives on the domestic front,” says Padhraic Garvey, head of developed debt-market strategy at ING Groep in Amsterdam. “But the country may stand the best chance to outperform.”