Citigroup Warns Irish Investors to Plan for Losses
As Irish bonds extend their rally, the gains for investors may be disguising a different story.
The yield on Ireland’s benchmark 2020 bond fell below 5 percent today for the first time since the country’s international rescue in November 2010. The debt is the second- best performing in the euro region this year, trailing only fellow bailout recipient Portugal.
All of the optimism that Ireland can raise money in the markets and avoid a debt restructuring is premature as the nation struggles to emerge from its worst recession in modern history, said Michael Saunders, Citigroup Inc.’s head of European economics in London.
“Ireland faces an almost impossible task to get back to fiscal balance,” Saunders said. Visits to the country showed “life is tough, very tough and not getting that much better anytime soon,” he said.
Saunders said a slower economic revival may eventually make Ireland’s debt, which more than tripled during the past five years, unsustainable. Gross domestic product was unchanged in the second quarter from the previous three months of the year, the Central Statistics Office in Dublin said today. Analysts had expected an increase of 0.7 percent. The economy contracted 1.1 percent from the second quarter last year.
Irish government bonds with a maturity of at least 10 years returned 31 percent in the past year, including reinvested interest, according to indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies.
After reducing its budget deficit, the country sold bonds in July, returning to longer-term credit markets for the first time in almost two years. Benchmark 2020 bonds rose for a third day, pushing the yield to 4.99 percent at 11:20 a.m. in London.
“Ireland is still the good student,” said Alberto Gallo, head of European credit research a Royal Bank of Scotland Group Plc in London. “Ireland is making good progress on reform and fiscal measures.”
Since 2008, the Irish have made about 25 billion euros, equal to 16 percent of GDP, of austerity measures, with another 8.6 billion euros to come.
Sustaining the rally depends in part on reigniting growth after the economy shrank 15 percent since 2008 in the wake of a collapse of the real-estate market. With the European debt crisis, Saunders forecasts gross domestic product will contract 0.6 percent this year and grow by the same amount next year.
“The key risk is the economy,” Saunders said by telephone on Sept. 17. “If it doesn’t come right, and I don’t believe it will, then the math becomes difficult.”
With growth muted, the government is pushing for European help to lower the cost of its legacy banking debt. Ireland has pledged or injected 64 billion euros ($83 billion) into the financial system, making it the world’s costliest banking rescue since the Great Depression.
“A lot depends on what kind of deal they get on the banks,” said Saunders, who has been in his post since 2003. “Will it significantly reduce the debt level? I’m not sure it will. If they don’t get relief, they are going to find it hard to fund themselves on a sustained basis at a tolerable yield and will be looking at some sort of second bailout program.”
Ireland’s debt may peak at 119 percent of GDP in 2013, the European Commission said on Sept. 18. That’s up from 25 percent of GDP in 2007.
While the Irish government has said the country won’t default on any debts, it may be that investors have losses, in a process known as Private Sector Involvement, or PSI, Saunders said. Prime Minister Enda Kenny told lawmakers in June that defaulting even on bank bonds would be a “disaster and catastrophe” for the country.
“It would be wrong to see debt restructuring as a failure of the current government,” Saunders said. “It’s a reflection of the difficult debt situation it inherited.”
Investors involved in Greece’s debt exchange earlier this year lost 53.5 percent of the face value of their bond holdings, reducing the country’s debt by about 100 billion euros.
The cost to insure against Ireland reneging on debt payments using five-year credit-default swaps dropped to 275 basis points yesterday from 580 in June. That implies about a 21 percent probability of the nation failing to meet its obligations within five years. Spanish debt has a 26 percent chance of default and Italy 24 percent, swaps indicate.
“The PSI view is out there because people are looking at the debt dynamics in Europe and wondering how do you grow out of this,” said Alan McQuaid, an economist at Merrion Stockbrokers in Dublin. “But Ireland wants the name of being a good European. It doesn’t want to be seen as not paying back its debts. The only way I could see it happening would be as a part of a wider European restructuring of debt, including countries like Italy, and I don’t see that happening anytime soon.”
Saunders remains skeptical as the government implements additional spending cuts and tax increases in a bid to narrow its budget deficit.
“I stress that’s it’s not by lack of effort,” Saunders said. “It’s just the scale of the overhang and the fact that Ireland has little ability to stabilize its debt because it’s so vulnerable to global shocks.”
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