Economics 25/8/10: S&P & the horrific cost of banks bailouts

As you all know, Standard & Poor (S&P) downgraded Irish sovereign debt to AA- from AA with a negative outlook. The downgrade was mainly motivated by the fact that the cost of the Irish banking bailout has increased significantly over previous expectations. S&P now estimate the cost of recapitalising the Irish financial system at €45-50bn, up from €30-35bn.

In my view, this is still behind the news curve in terms of estimated total costs.

My projections for total losses are as follows:

• Nama - net loss of (mid-range) €12bn, rising to €19bn in the worst case scenario (although I have not redone estimates for this scenario for some time and they reflect 55% haircut applied on Tranche 1);
  
• Anglo - €33bn in mid-range case, rising to €38.6bn in the worst case scenario (another update is due once the bank reports its results in the next few weeks);
  
• INBS - €6bn, no range as we have little clarity as to their balance sheets details;
• AIB - €7bn mid-range, assuming successful disposal of M&T and BZBWK, worst case scenario €9bn;
  
• BofI - €2bn.

So the total expected banks losses are €50-55.6bn in my estimates.

Importantly, S&P's negative outlook allows for the possibility that the rating could be cut
further if the Government fails to deliver on promised fiscal stabilization. This can occur either due to significant continued deterioration in underlying economic conditions or due to the failure of the Government to actually implement planned cuts, or both.

S&P's current position rates Ireland at the same level as Fitch and one notch below Moody’s, but both of these are keeping Ireland on a stable outlook.

S&P latest estimate is for Ireland net government debt / gross GDP ratio reaching 113% in 2012. Forever cheerful folks at DofF projected this ratio to be 83.9% in 2012 in their Budget 2010 figures. This shows just how much can change in 8 months time. S&P's estimate for debt implies Ireland is facing greater debt mountain than similar rated Belgium and Spain.

But here comes a tricky part. Remember that our debt is currently yielding in excess of 5.5% for 10 year notes. This implies that in 2012, we can expect to pay out 6.215% of our GDP in interest payments alone, or 7.52% of our domestic economy total income. The bill will be €10,241 million - using DofF forecasts - or 20.5% of the total current expenditure planned by the Government. All in, even by rosy projections from DofF for tax revenue, our interest bill alone will be swallowing every third euro revenue will bring in.

This puts into perspective recent ECB research that concluded that debt levels above 90-100% of GDP are, "on average, harmful for growth" and that porblems could arise at the debt levels of as low as 70% of GDP. ECB currently projects that euroarea-wide average debt levels will reach 88.5% in 2011. Does anyone believe anymore that Ireland can run 2.5-3% annual growth rate in the current conditions as projected by the IMF? Or 4.5-4.3% (2012-2013) real GDP growth as projected by DofF?