Monday, March 30, 2009

The cost of Ministerial chatter: Irish credit ratings

After a week of incomprehensible gibberish coming out of the Government statements on:
  • borrowing restraints (here);
  • receipts shortfalls (here and here);
  • 'painful' solutions (aka destruction of private sector economy via fiscal policy - here);
and months of policy wobbles, two things came to their logical conclusion today.

The first one - reported (for now in very oblique terms - I will put more flesh on it when the embargo on the documents I received expires) here.

The second one - the S&P downgrade of Irish sovereign credit ratings.

Now, S&P is not known for being the quickest or the sharpest analysis provider on the block (I wrote about the need for a downgrade for some three months now), but at last they have moved, if only a notch, lowering Ireland's ratings from AAA to AA+ and retaining negative watch outlook (meaning more downgrades await).

I was neither surprised nor impressed by the S&P statement:

"March 30 - Standard & Poor's Ratings Services today said it had lowered its long-term sovereign credit rating on the Republic of Ireland to 'AA+' from 'AAA.' At the same time, the 'A-1+' short-term rating on the Republic was affirmed. The rating outlook is negative"

So far so good. Except in my view, a combination of the depth of our crisis, the severity of our economic policy failures and the lack of realism on behalf of this Government, pooled together with Cowen's unwavering determination to 'soak the rich' (middle and upper classes) to protect his cronies in the public sector - all warrant at the very least a downgrade to an A level. Given the structural nature of our deficits and Cowen's willingness to flip-flop on policy - an A- rating will be also justifiable.

Ok, back to S&P statement: "The downgrade reflects our view that the deterioration of Ireland's public finances will likely require a number of years of sustained effort to repair, on a scale greater than factored into the government's current plans," Standard & Poor's credit analyst David Beers said. As I said - lack of realism on behalf of the Government is costly. I have mentioned some recent evidence I got from the Partnership Talks (here). Telling... But what is also telling is the shade of realism that is being brought to the policy discussion table by the S&P, which is completely missed by the quasi-state ESRI (see here) who expect swift (2-3 year time horizon) action on closing structural deficits by increasing taxes.

The S&P is also referencing their belief that there will be further need for additional support for banking sector. I agree. And the Government has been boasting to the Partnership folks that it has resolved the banking crisis...

But here is a really good piece - bang on in line with what I've been warning about for a long time now. Despite our Government's senile belief that soon - a year or two from now - we are going to return to strong growth, S&P clearly states: "We expect that the Irish economy will materially under perform the Eurozone economy as a whole over the next five years, recording minimal growth in real and nominal GDP, on average, during the period. As a result, we believe that Ireland's net general government debt burden could peak at over 70% of GDP by 2013, a level we view as inconsistent with the prospective debt burdens of other small Eurozone sovereigns in the 'AAA' category."For comparison, here is the table from the DofF Junior Nostradamus's' January 2009 Update (below). This shows that our boffins are thinking we will be churning out 2.3% GDP growth in 2011, with 3.4% in 2012 and 3.0% in 2013...

Yeah, may be if we get Michael O'Leary to run this country...

"The medium-term prospects for the Irish economy are constrained by three interrelated factors: first, the impact on domestic demand as the private sector reduces its high debt burden, which stood at 280% of GDP in 2008; second, the scale of the deterioration of asset quality in the banking sector and possible need for additional capital; and, third, the support from external demand Ireland can expect as global economic conditions improve."

Ont the first point, I am again delighted that S&P decided to look beyond their naive insistence on focusing on public debt alone. Private debt mountains choking Ireland Inc (and soon to be added public taxation concrete weighing the economy down as we sink deeper into a recession) have been something I warned about for some time now.

On the second point, it is important to recognise that this Government has done virtually nothing to help repair the banks balance sheets and is not forcing households deeper into financial mess. Banking sector and real economy are linked.

  • When a bank gets capital injection, but sees more mortgage holders defaulting because the Government has sucked their cash dry, what happens to banks assets?
  • When a bank gets a deposits guarantee scheme at a cost to the system of €226mln since inception, but it costs the Exchequer twice as much due to higher cost of borrowing, what happens to the financial system's ability to provide credit finance?
  • When a bank gets a promise to be rescued in some time in the future, but sees corporate deposits dry out today because the Government actually taxes companies (and sole traders) in advance of their receiving payments on overdue invoices, what happens to bank's capital?
Has Mr Lenihan bothered to take Level I CFA exams, he would have probably understood these brutal A-B-Cs of macrofinance. Alas, he didn't.

Now, next, the S&P avoids falling back into its comfort zone: "The government has already taken steps to contain the budgetary impact of these pressures, and further adjustments in taxation and spending, amounting to 2%-2.5% of GDP, are expected to be announced in next month's supplementary budget. At best, however, these measures will contain this year's general budget deficit to around 10% of GDP and lay the basis for a slow reduction in nominal budget deficits in future years. We are concerned, however, that a credible multi-year fiscal consolidation strategy will not emerge until after the next general elections, due by 2012. Accordingly, on current trends, we believe Irish net general government debt will likely exceed 70% of GDP by 2013 before beginning to trend downwards."

True that, as they say in the USofA. True that. Can you close your eyes and imagine Brian Cowen telling public sector unions that he is going to cut numbers of paper pushers employed in the public sector? or to trim their pay? or to eliminate our overseas aid budget? or to cut our defense spending by half to reflect the real might of our armed forces? or to privatize health care delivery (not access to services - delivery)? or to introduce efficient system of education fees? or that he will switch all public sector employees of age 45 and less into defined contribution private pension schemes? or that he will no longer automatically index pensions to already retired public sector workers to future wage increases in the sector? or that the corporatist model of centralized wage bargaining is done and over for ever? or that he will impose restrictions on striking activities in the public sector and will end job-for-life conditions of employment in the sector?

No? Neither do I. And neither does the S&P - at last.

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