23rd November 2010
Details on the bailout for Ireland are still being thrashed out and we will have to wait a good few days, if not weeks, before they become available.
The political fallout though is much in evidence already, with Ireland Prime Minister Brian Cowen, who at one stage appeared on the brink of quitting, being instead forced to announce a poll early next year after his Green Party coalition partners effectively pulled the plug on the government, as reported here by the Daily Mail.
In broad terms, the bailout for Ireland is widely expected to total €80 billion-€90 billion with the country in return being required to put in place additional measures for reducing its fiscal deficit on top of the aggressive belt-tightening it has already mapped out.
Jamie Stuttard, head of European fixed income at Schroders, says the new-look Irish austerity package will likely aim to achieve fiscal consolidation of €6 billion in 2011. That will form part of a strategy leading to a 3% of GDP deficit by 2014, which in turn indicates an overall consolidation of €15 billion over a four year period.
For those looking for an indication of the potential economic impact of the reformulated austerity measures for Ireland, Stuttard points to the Greek economy which is currently contracting at 4.5% of GDP.
While the market has not focused heavily on the UK's indebtness, having been assuaged by the coalition government's plans to heavily cut back on spending, it is by no means immune to fallout from Ireland's woes.
Stuttard grants that "the UK is not Ireland", noting that the UK gilt market has in fact been a "safe haven" government market since May 2010. Furthermore, the bail-outs of its banks – RBS, HBOS/Lloyds, not to mention the collapse of Northern Rock, dissolution of Bradford & Bingley – all occurred two years ago so markets have had plenty of time to digest the full implications of the shakeout of the UK banking system.
Also, the UK's AAA rating has been affirmed by S&P and the IMF have praised the approach of its new coalition government. Moreover, unlike Ireland, there is no 32% budget deficit in the UK this year given banking sector problems, and it is not having to contend with double digit public sector wage deflation either.
Still, Stuttard suggests the UK might want to look at developments in Ireland with more than just benevolence for the speculated £7 billion in bilateral contingency loans being mooted by the coalition government. With, for instance, UK VAT rises beginning in just six weeks time, Stuttard believes that it can be strongly argued that, in terms of fiscal policy, the UK is only nine-12 months or so behind Ireland and the impact it may have on its real economy.
The relative magnitudes of problems affecting the UK and Ireland are certainly very different but, as Stuttard points out, it is not as if the UK's 450% debt to GDP has been materially addressed yet. While the UK's imbalances are of a far smaller scale than Ireland, the direction of the patterns in the housing, consumer and banking sectors are similar: boom/bust, too much leverage and many banks that failed due to excessive participation in the boom years.
Indeed, Stuttard recalls that it was only 9-month ago, in January 2010, that the eminent and very experienced bond investor Bill Gross warned, as reported here by The Guardian, that the UK was a "must to avoid" for his investors as its debt was "resting on a bed of nitroglycerine".
Stuttard says those comments by Bill Gross might, with hindsight, appear a little melodramatic, especially when it is considered that 10-year gilt yields are below 3.5% at present and traded as low as 2.9% in the third quarter.
But he warns that the aftershocks of the colossal financial and consumer bubble that burst in so many countries in 2007 "are clearly not over" and urges investors to be alert to the next sign of funding problems in those countries that had the largest imbalances.
He adds: "Pre-judging nitroglycerine as "melodramatic" may be premature in terms of mark to market, fiscal risk premia or the inflationary consequences of easy monetary policy."
Turning to the broader outlook for the eurozone and fallout from Ireland, Stuttard warns that those who think that euroland's problems are resolved and that debt contagion fears in the region are now "contained" should expect markets to continue to press areas of uncertainty and ambiguity until these are resolved in reality.
Foremost among these is how to deal with the eurozone's debt problems after June 2013, following expiry of the European Financial Stability Facility, which aims to provide financial assistance to eurozone states in difficulty, and just ahead of the next German Federal elections in October 2013.
He adds: "With two countries now in the hands of the IMF and European Union aid, the eurozone still has multiple challenges to deal with in its maturation process and as it continues to face its first major test in its youthful history."
Worryingly, Stuttard also notes that as many countries both in the eurozone and beyond face large refinancing challenges in 2011, a creeping awareness that sovereign debt problems tend to follow banking crises may draw more countries into funding difficulty.
With over $5 trillion worth of government debt that requires issuance in 2011 to meet coupons, redemptions and anticipated budget, the primary government bond market calendar will once again be a major test for the more fundamentally challenged countries.
"As Ireland has shown, this has everything to do with fundamentals, and very little to do with Moodys' Aaa ratings, GDP per capita, corporation tax rates and such like. For instance Spain, rated Aaa as recently as September this year, will need to roll over nearly 20% of GDP in 2011 via bills and bonds, without even assuming further problems in the banking sector."
Stuttard says the policy response to Greece and Ireland has been "slow, full of mixed messages" and there remains "massive uncertainty" as to how problems in eurozone government debt will be addressed post-2013.
The choices for Stuttard seem clear: let individual countries restructure or share the burden more broadly among bondholders via inflationary policies such as further rounds of quantitative easing, more financial stability facilities, and European Central Bank bond purchases, and above all, another layer of debt and money creation below the current existing stock of indebtedness.