Irish Bail-out Doubts Unnerve Investors

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Financial Times:

Only a few months ago, Ireland appeared to have escaped the wrath of the markets as its austere public sector reforms convinced investors that the country was prepared to take tough medicine to turn round its ailing economy.Standard & Poor’s decision to downgrade Ireland’s credit ratings highlights the fact that the country’s economic prospects are still in the balance.
 Although the decision was largely expected by the markets, investors are still nervous about whether Ireland’s fiscal adjustments will see the country turn the corner. This is largely because of fears about its weak banking sector.
Ireland’s change of fortunes has been dramatic. The once buoyant Celtic Tiger economy, which for 15 years outperformed the rest of the eurozone and boasted budget surpluses in every year bar one in the decade to 2007, has been laid low by a property and banking crash largely of its own making.
To set things right, Ireland is now attempting one of the most far-reaching fiscal adjustment programmes in the eurozone at the same time as bailing out the banks, which even ministers see as responsible for the economic mess.

In a different political context, Brian Cowen, the prime minister, coming under pressure from anxious backbenchers in his populist Fianna Fáil party, might have been tempted to put off the painful fiscal measures. A general election has to be called before May 2012.
But with the government seemingly heading for certain defeat – the latest poll put Fianna Fáil third behind Fine Gael, the right of centre opposition party and Labour – most analysts believe Mr Cowen and Brian Lenihan, the finance minister, will stick to the plan on the grounds the party has little to lose.

However the economic news is getting worse. The markets were clearly taken by surprise when the European Commission in early July gave approval for a further €10bn ($13bn, £8bn) injection into Anglo Irish, the specialist property lender nationalised in January last year after a spate of governance scandals.
It was announced on Monday that the National Asset Management Agency was paying just 38 per cent of the face value of the property loans it was acquiring from Anglo Irish, reflecting the poor state of the bank’s collateral and a fall in property values.

“Initially we applauded when they owned up to the scale of the problems at Anglo. But they said the haircuts taken by the banks would be around a third, now we’re told it’s 62 per cent,” says Paddy Digan, a commercial property investor.
It is uncertainty over the cost of the bank bail-out that has unnerved international investors. S&P says the final bill to the Irish taxpayer could be up to €90bn, including the amounts eventually realised on the Nama loans. This would be equivalent to 50 per cent of gross domestic product, three times more than the Nordic banks rescue of the early 1990s.
“The whole reason for Nama’s existence is that it is hard to value these assets and it’s a significant uncertainty whether the government will be able to realise any value in the long term,” Trevor Cullinan, credit analyst with S&P, told Irish radio.
The bigger the haircuts imposed on the banks, the bigger the capital hole that will need to be filled. But the more money that has to be found to recapitalise the banks, the bigger the challenge to stabilise the public finances, with the deficit currently at about 14 per cent of GDP – after two of the toughest budgets in the country’s history.
The government plan envisages that by 2014 the budget deficit will be less than the 3 per cent fiscal guideline used by the European Commission for eurozone members.
The International Monetary Fund in its annual report on the Irish economy calculates that a further consolidation equivalent to 4.5 per cent of GDP will be needed to meet the target. But it warns that “if growth outcomes are weaker than those currently foreseen by the authorities – a clear possibility within the current range of scenarios – the additional effort needed may be even greater.”
The government in July raised its GDP forecasts for this year from a 1.3 per cent contraction to 1 per cent growth. But the IMF forecasts a contraction of 0.6 per cent, returning to 2.3 per cent growth in 2011.
In an open economy much depends on global conditions, particularly the performance of the US, where forecasts have been revised downwards.
“Last year the only source of growth was the US multinationals,” says Alan McQuaid, chief economist at Bloxham stockbrokers. “I’m not sure we can count on that again this year.”

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