18th November 2011
The UK started the crisis with a debt burden equal – or even exceeding – that of many Eurozone countries. Yet it has retained its AAA-rating and it costs it just 2.22% to borrow for 10 years (source: FT). Italy had a small primary surplus of around 0.5% of GDP. Certainly, its public debt to GDP ratio was extremely high, but it was no debt basket case. Yet has seen downgrades from all the major rating agencies and its 10-year bonds now have a yield of 6.79%.
When S&P downgraded Italy, it admitted that the maturity profile of Italian debt had been well-managed and there were still plenty of buyers for it. However, it specifically said that part of the reason for the downgrade was:
"Scepticism that the current government could deliver the internal reforms that would render credible the accelerated fiscal consolidation announced in August. More certainty on that front, said S&P, and it would confirm the current ratings."
The UK, on the other hand was quick to adopt austerity measures and markets had faith that they would be implemented in time.
This partly explains the difference between Portuguese and Irish government debt yields. Portugal is trading at 11.42%, Ireland at 8.38%. As this piece shows, austerity measures are already well under way in Ireland, while in Portugal, they are still going through parliament.
Many originally thought Spain would be the most vulnerable of the larger Eurozone economies, but its debt is trading below that of Italy. Partly this is because its austerity measures have already been passed through parliament and are already being implemented.
Jan Randolph, head of sovereign risk analysis at IHS Global Insight in London, is quoted in this article saying: "Italy will not be out of the heat … until a solid and stable government actually implements austerity and undertakes reforms – "It will also take time to reassure the markets over Italy because they will want to evaluate the new government's credibility and watch what it does," said Fabio Fois, an analyst at Barclays in the same piece.
Pilar Tellez, head of fixed income research at Allfunds Bank in Spain, says: "The safest countries are not necessarily those with the lowest debt. Governments need the authority to be able to implement their austerity measures." She says that this, more than anything else, is now determining how government bonds are priced.
This has an impact for investors, who now need to perform the type of credit analysis previously done on companies to sovereign debt. This may prompt a sea-change in the way government bonds are managed in future with credit analysis becoming as important as duration analysis in bond selection.
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