Not everyone is buying the Irish bailout success story

Barring an accident Ireland looks set to exit the bailout on a tailwind of positive sentiment. The Government has hit every fiscal target asked of it, bond yields are at record lows, and while concerns persist about the strength of recovery elsewhere, growth forecasts for Ireland are positive across the board.

To cushion its return to the markets, the NTMA has built up a war chest of some €21 billion in reserves – enough to last us until the first quarter of 2015 they say.

The muted market response to the backstop announcement will also be viewed by Government as further proof of its convalescence, and a thumbs up to its “go it alone” stratagem. However, if the crash has taught us anything, it is how quickly such sentiment can evaporate.

For Jeremy O'Friel, managing director of Belmont Investments – a New York-based hedge fund – there are still too many "what ifs" in the equation.

"What if the banks need more money? What if tapering [a cooling of the Fed bond-buying programme] starts and interest rates rise as the global economy recovers? What if Greece falls over?"

O’Friel bases his analysis on debt sustainability metrics that suggest Ireland – with a public sector debt of 125 per cent of GDP and rising – will need more than a modest growth rate just to cover the interest payments.

“So even with the following – European support, IMF support, record low global rates due to Quantitative Easing (QE), political stability – even with all of that, we are only just below the bubble.

“Yes, there is a possibility of growth, but just feed the numbers into the parameters and you will see that we need something extraordinary, to improve the tax take to a point where the situation starts to look safe again.”

Several European-based investors said the flood of central bank money was “aiding risk appetite” across the euro zone and prompting a surge in bond issuance from the periphery. Irish companies are taking advantage of what one observer labelled a “yield grab”, raising over €6 billion in debt in the year to date.

On Wednesday, AIB comfortably raised €500 million in its first "unguaranteed" bond issuance in nearly five years. Nonethless, there have been widespread reports of some investors in Irish bonds jumping ship and taking profits ahead of the bailout exit.

“Profit taking is likely the biggest motivating factor in these reported sales,” said Niall Quinn, head of international business at Eaton Vance, a $270 billion US money manager. “It may also be that, on a risk/reward basis, these investors believe that there are more attractive investment opportunities in other markets.”

Lee Cumbes, head of sovereign origination at Barclays, said, however, this was part of a natural maturing of the investor base whereby the initial wave of "credit investors" is replaced by more traditional "rate investors".

On the outlook for Irish bond yields, he said: “I don’t think they’ll come back as peripheral yields for a variety of reasons, but mainly because of the country’s positive growth outlook and its moderate borrowing requirements.” He reckons Irish bonds will form part of a semi-core in the future, rather than on the periphery of the market.

Juliet Tennant, economist at Goodbody capital markets, said: "There's nothing really happening with Irish yields specifically. They are moving in line with other bond markets in terms of whatever is buffeting bonds in general."

Fear around tapering in the US was probably a bigger issue for Irish bonds than the bailout exit, she said. “A lot of it is already priced in, but the other thing is that Irish bonds are held very tightly with a couple of very large holders so there’s a technical floor on the yields.” She said opting for a backstop would have been preferable.

While the Government is in a comfortable funding position, there were certain parts of the bailout programme that "haven't been completed in relation to the legal system, labour market activation measures and water meters". "The surveillance without a precautionary credit line is going to be less and the danger is the Government relaxes," she said.

Stable outlook
Two months ago, rating agency Moody's changed its outlook on Ireland's Ba1 rating from "negative" to "stable". Despite the upward adjustment, the low rating still prohibits certain pension, insurance and investment funds from holding Irish debt.

Kristin Lindow, the agency's lead analyst on Ireland, said future upgrades would require Ireland to keep hitting its fiscal consolidation targets. Another key element, however, would be sustaining a trajectory of modest growth so "that the debt metrics would improve on an ongoing basis".

She said Ireland remained one of the most indebted countries “in the rating universe” and that posed risks. At the outset of the crisis, she said, the troika insisted that a debt level of 120 per cent of GDP was unsustainable – Ireland’s is currently 125 per cent – but they’ve since rowed back on this assertion. “If the average interest rate paid on the debt continues to fall, and it will fall incrementally, that will help, and that is dependent on the maintenance of the kind of confidence that we’ve seen build over the last 18 months or so.”

She said Ireland’s recovery had been slow by the standards of most recession recoveries, but this was because of global and European circumstances.

“Although Ireland has been growing, the impetus coming from net exports has been slower, particularly in the last year, as a result of the external environment being sluggish and because of patent expiries in the pharmaceutical sector.”

She said while Moody’s had grown “less sceptical” about Europe’s sovereign debt crisis, another “flare up” would pose a serious risk to Irish debt spreads.

According to one Irish banking source, the biggest risk factor for heavily indebted countries like Ireland was the prospect of deflation, which could upend the debt/GDP trajectory. With deflation, the size of your economy, in price terms, shrinks while your debt remains the same, making debt a bigger percentage of GDP.

Ireland’s inflation rate was recorded at an anaemic 0.1 per cent in October, compared with 0.7 per cent across the euro zone. When it comes to deflation, Japan’s experience is instructive. The country’s inflation rate fell below zero in the mid-1990s as a result of a fairly spectacular property market crash. As the economy dragged along the bottom for the next decade, prices barely increased.

The country’s recent bout of quantitative easing – conducted under the banner of Abenomics – is aimed at finally shifting inflation into positive territory.

Gillian Edgeworth, economist at London's UniCredit bank, said Ireland's bailout programme had been more successful than most analysts would have thought when it was being launched. However, she said if there was one disappointment with the programme it was with the banks.

“The banks were overcapitalised for good reason because they knew a chunk of their loans and their loan books had to be written down. Until this is worked out in full it is difficult for banks to know exactly what’s available to lend. It’s difficult for banks to understand their capital position in full. There is still uncertainty hanging over the sector and that’s something that was the focus of the last couple of troika reviews.”

The point was illustrated last week when the Government proclaimed the bailout era all but over on the same day as KBC bank set aside a further €671 million for impaired loans, on top of the €104 million previously indicated.

One Irish banker, who wished to remain anonymous, said the exit of ACC and Danske and the probable downsizing of Ulster Bank's operation here showed the sector was still reeling from the crash.

Private debt levels
A factor in the decision to exit would have been the high levels of private debt which, he said, limited the prospects of future loan growth for lenders.

The prospect of the NTMA meeting serious headwinds on the international debt markets in the short term would appear limited. Of course, all this could change if there was further slippage in the euro zone recovery and/or another sovereign debt event.

According to Eaton Vance’s Niall Quinn: “The biggest risk factors for Ireland in a post-bailout world are two-fold: weakening global growth which would hurt the important export sector, in turn hurting the economic recovery and, or, a loss in investor confidence that the country will continue its austerity and reform policies, thereby prompting an increase in borrowing costs.”

For all the positive notes and choreographed political events in the coming weeks and months, particularly with talk of Ireland regaining “economic sovereignty”, it’s apparent that the data-driven market players are less concerned with the messages emanating from Dublin than with hard evidence of improvement in growth and debt sustainability.