Moody’s Rating Irish at Junk Threatens Kenny’s Goal: Euro Credit

Irish Prime Minister Enda Kenny
Enda Kenny, Ireland's prime minister. Photographer: Jock Fistick/Bloomberg

Irish Prime Minister Enda Kenny has said he wants to wave goodbye next year to the international creditors who bailed out his country. That ambition rests in part with a credit analyst poring over figures 675 miles away.

Dietmar Hornung at Moody’s Investors Service in Frankfurt said in an interview last week that Ireland’s rating is “rightfully positioned” at junk, signalling no immediate plan to restore the investment grade following the nation’s return last month to the long-term bond markets. Standard & Poor’s and Fitch Ratings rank Ireland three levels higher than Moody’s.

“For a minority of investors, ratings can be all or nothing,” said Ciaran O’Hagan, head of European rates strategy at Societe Generale SA in Paris. “While a junk rating isn’t an insurmountable obstacle for Ireland, it would be much better to lose that rating at Moody’s.”

Irish bonds delivered the best returns in the 17-nation euro region during the past 12 months as optimism grew that the country will refinance its banking debt and the European Central Bank signalled that it may resume buying government securities. Benchmark yields on Irish debt remain above 4 percent, a level that analysts say makes for an easier return to the fixed-income markets when the rescue program ends at the end of 2013.

The rate on Ireland’s 2020 bond was at 6.06 percent today, down 24 basis points in the past month.

Ireland was downgraded by Moody’s to Ba1, one level below investment grade, in July 2011. That’s below the rating of countries including Costa Rica and Iceland, making it difficult to attract investors.

‘Off Limits’

“Ireland remains off limits from much of the money-market fund sector and other similar ratings sensitive investors,” said Owen Callan, a Dublin-based fixed-income analyst at Danske Bank A/S. “We view further outperformance as difficult to justify, in the short term at least.”

The country had stopped selling bonds almost two years ago on concerns that losses in the banking sector may tip the nation into bankruptcy. The government secured a 67.5 billion-euro ($82.8 billion) package of emergency aid from the International Monetary Fund, European Union and ECB in November 2010.

As a first step toward self-funding again, Ireland’s National Treasury Management Agency last month sold 4.2 billion euros of bonds due for repayment in 2017 and 2020, returning to the market for the first time since September 2010. The securities sold for a weighted-average yield of 5.95 percent. Officials at the debt agency in Dublin declined to comment for this story.

Budget Warning

Investors made a return of 39 percent on Irish debt repayable in more than 10 years during the past 12 months and a gain of 32 percent for bonds with maturities of seven to 10 years. The advance was the biggest among indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies.

While the debt sale was “reassuring,” the country’s economic outlook has deteriorated since the last rating action, Hornung said during the Aug. 7 interview. The former head of emerging markets research at Dekabank in Frankfurt said he sees challenges ahead for Ireland, which faces a budget deficit equal to 8.6 percent of gross domestic product this year.

“That is a high deficit even compared to European peers and that implies that still significant consolidation is to be delivered,” said Hornung. “That could have a negative feedback loop on economic activity.”

Investment Grade

Padhraic Garvey, head of developed markets debt at Amsterdam-based ING Groep NV, is more optimistic.

“While Moody’s is the weakest link, I’d still classify Ireland as investment grade,” given that S&P and Fitch rate the nation above junk, Garvey said. “The real problem is that all three agencies have a negative outlook on Ireland. If any of the three could be persuaded to improve the outlook, that would be a massive positive.”

S&P said as recently as Aug. 2 that it was keeping its negative outlook for Ireland, meaning there’s a one-in-three chance that the nation would be lowered again this year or next. Fitch said this week that it’s keeping its negative outlook because of risks to growth and fiscal consolidation.

“Although Ireland’s has largely regained external competitiveness, it remains at risk from a further intensification of the euro-zone crisis,” Fitch said in an e-mailed response to requests for comment.

Three developments would prompt a reappraisal by the ratings companies, said Callan at Danske Bank.

Irish Options

First, there needs to be an improvement in the economy as Kenny’s government narrows the budget deficit, he said. Since 2008, the Irish have made about 25 billion euros -- equal to 16 percent of gross domestic product -- of combined spending cuts and revenue increases, with another 8.6 billion euros to come, S&P said.

Second, the government may have to win European help to refinance at least part of the 64 billion euros that the state used to rescue the banking system, Callan said. Third, the debt agency may have to demonstrate that it can continue to persuade investors to buy Irish securities, he said.

Failure to persuade the ratings companies to improve their view on Ireland would heighten Kenny’s difficulties in fully regaining the nation’s economic sovereignty, he said.

“A rating upgrade would be a complete game changer,” Callan said. “Ireland would probably be able to regain full access and be hailed as the success story.”

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