Saturday, September 18, 2010

Economics 18/9/10: It's not just IMF

As argued in my earlier post (here), based on the IMF analysis, our sovereign bonds yields are still some distance away from those justified by fundamentals.

It turns out the IMF paper cited in the earlier post is not alone in the gloomy assessment of our realities. Another August 2010 study from German CESIfo (CESIfo Working Paper 3155), titled "Long-run Determinants of Sovereign Yields" and authored by António Afonso Christophe Rault throws some interesting light on the same topic, while using distinct econometric methodology and data from that deployed in IMF paper.

Here are some insights from the paper (available for free at SSRN-id1660368). "For the period 1973-2008 [the study] consider the following countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Sweden, Spain, UK, Canada, Japan, and U.S."

Take a look at table 2 of results from the paper estimation across listed countries. The model is based on 3 variables here - Inflation (P), Current Account (CA) and Debt Ratio (DR). All have predictable effect on the variable being explained. Per study authors: "Results in Table 2 show that real sovereign yields are statistically and positively affected by changes in the debt ratio in 12 countries. Inflation has a statistically significant negative effect on real long-term interest rates in ten cases. Since improvements in the external balance reduce real sovereign yields in ten countries, the deterioration of current account balances may signal a widening gap between savings and investment, pushing long-term interest rates upwards."

Ok, here are those results:
Ireland clearly shows relatively weak sensitivity in interest rates to debt.

But take a look on our sensitivity to deficits. Per study: "Moreover, when the budget balance ratio is used (Table 3) a better fiscal balance reduces the real sovereign yields in almost all countries"
Clearly, Ireland shows 3rd highest sensitivity of interest rates to Government deficits. We are in the PIIGS group, folks, based on 1973-2008 data!

Now, this firmly falls alongside the IMF results - further confirming my guesstimate in the post earlier.
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