Friday, May 28, 2010

Economics 28/05/2010: Spain's downgrade is a warning for Ireland

In a significant development today, Fitch cut Spain’s credit ratings to AA+ from AAA. This was expected.

What was unexpected and new in this development is the expressed reason for the cut.

Per reports, "Fitch said Spain’s deleveraging of record-high levels of household and corporate debt and growing levels of government debt would drag on economic growth." (Globe & Mail)

This puts pressure not only on the euro and European equities, but also on the rest of the PIIGS' sovereign bonds. Ireland clearly stands out in this crowd.

As I have shown here and more importantly - here, Ireland is by far the most indebted economy in the developed world. While it is true that a large proportion of our total external debt accrues to IFSC, even adjusting for that

  • Our General Government Debt held externally is the fifth highest in the developed world;
  • Our External Banks Debt is the highest in the world;
  • Our Private Sector Debt (Total Debt ex Banks & Government) is the highest in the world; and
  • Our Total External Debt is the highest in the world.

In addition, per IMF (see here) our budgetary position is one of the weakest in the world, including for the horizon through 2015 (here).

“The downgrade reflects Fitch’s assessment that the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term,” Fitch’s analyst Brian Coulton said in a statement.

Fitch said "Spain’s current government debt would likely reach 78 per cent of gross domestic product by 2013 from under 40 per cent before the start of the global financial crisis in 2007." Irish debt is projected to reach 94% of GDP by 2015 (IMF) or 122% of GNP - the real measure of our income. If we factor in the cost of Nama and banks, Irish Government debt will reach 122% of GDP by 2015.

This puts into perspective the real scope for public spending cuts we must enact in this and next year's Budgets. The Government aim to reduce spending by a miserly €3 billion in each year through 2012 will not do the job here. We will have to do at least 2.5 times that much to get our house in order.


Anonymous said...

Dear blogger,
Where is these rating agencies when ninja mortgages?
Where is theses rating agencies when selling and buying houses are treated sustainable economic models?
If the market rating agencies are so "Intelligent" why didnt they screamed when there sub-prime is the biggest economic activity?


TrueEconomics said...

@Anonymous. Thanks for commenting and reading.

Your points are correct - rating agencies did miss a host of risks in their assessments of the relatively new and high risk products. And they missed that badly. Rating agencies also had some clear-cut conflicts of interest relating to the products you named and more.

Not to defend them, however, one must recognize that rating agencies have a relatively good historic track record in rating long established products, especially sovereign bonds. There are many (some technical) reasons as to why they are more successful in rating some products, while simultaneously are unable to see the obvious truth about other.

To actually further strengthen your own case, rating agencies are virtually never able to lead the markets. They usually are lagging indicators - acting as a reflection of what is already known to professional and institutional investors and as signal bearers for some mandate-driven investors.

As I always suggest, one should tackle not messenger, but the message. Being wrong before does not preclude one from being right in the future.

What rating agencies are doing in the current case of the PIIGS is giving public exposure to the cancer that is debt overload afflicting European (and also other) economies, as well as to the unsustainable model of expanding fiscal deficits. In doing this, for all their apparent falls and errors, they are providing a useful service to societies and economies at large.

People like myself have only a limited power to bring facts (and our views on these facts) to the public. Rating agencies, following in our footsteps have much greater power to expose the fallacy of the economic systems based on Governments (and with Governments' gentle 'guidance', incentives and occasionally outright blessing, economies at large) borrowing unsustainable, economically unjustifiable, reckless amounts of funds to finance day-today life style choices for their public servants, privileged elites - private and public alike - and narrow interest groups.

You can elect to ignore rating agencies because they get things wrong from time to time or even often. You are free to ignore the facts. But don't say you have not been warned when your Government comes to you to take away your own and your children's future, because it was mortgaged (often by someone else) up to afford unearned pensions and wage increases for the few, the many, or even for your self...

Hope this explains.

Best regards and keep on reading and commenting.

TrueEconomics said...

Oh, PS: I have been critical of rating agencies work on a number of occasions before. Here are some examples:

and so on...

jpc said...

Would anyone like to ponder the state of the nation 5 years from now? Given these horrific realities.