Ireland's debt rating cut over fears on bailout costs

THE COST of Government borrowing is set to rise after credit rating agency Standard & Poor’s cut Ireland’s sovereign debt rating for the second time in three months yesterday and warned that the soaring cost of bailing out the banking sector could lead to further downgrades.

Ireland is now rated “AA” with a negative outlook, S&P said. The agency removed Ireland’s “AAA” rating, the highest possible, in March, downgrading it to “AA+”.

S&P said it believed the cost to the Government of propping up the banking sector was now “significantly higher”. It estimates that recapitalising the banks will now cost taxpayers €20-€25 billion, up from its previous estimate of €15-€20 billion.

S&P analyst David Beers said the proposed National Asset Management Agency (Nama) was “uncertain” to work because of the risk that the bank assets would deteriorate in value by more than the Government expects at the time that they purchase the assets.

Losses announced at Anglo Irish Bank also “highlight both the continued fragility of the Irish banking sector and its reliance on the government for ongoing financial support”, S&P added.

As a result, Ireland could see its net general government debt climb to more than 120 per cent of gross domestic product (GDP) – a level that is higher than for other “AA” rated euro-zone countries.

Mr Beers said a further downgrade was not “inevitable”, but that a negative outlook meant there was a one in three chance the Republic’s credit rating would be taken down a further notch.

In a statement, the Department of Finance said the ratings downgrade “reflects developments which have taken place over the last while” and that there was “full recognition” that the transfer of assets to Nama would have to be “carefully implemented”.

However, Fine Gael finance spokesman Richard Burton said the move, coming just days after the Government suffered a severe drubbing in the local and European elections, was “more evidence that Fianna Fáil is unable to save the economy”. The decision to establish Nama had to be reversed and Anglo Irish Bank must be wound down, he said.

“The electorate has given the Government a massive vote of no confidence about the economy. Now Standard & Poor’s has done the same,” he said.

“This downgrade of our public finances, together with the sharp rise in the share price of the banks in recent weeks, suggests a growing market consensus that Nama involves a massive transfer of wealth and resources from the taxpayer to bank investors, because the State is going to overpay for the banks’ toxic loans,” he said.

NCB economics analyst Brian Devine said further downgrades were likely. “Ireland will likely be further downgraded in the future to bring it into line with where it is trading in the bond and credit-default swaps markets,” he said.

Despite the setback posed by the lower credit rating, Ireland is unlikely to default on its debt obligations or turn to the International Monetary Fund for help, according to Royal Bank of Scotland (RBS). “Ireland has many, many problems and we continue to view it as the weakest fiscal risk in the European Monetary Union, but investors should not leap to the view that this is an Iceland in disguise,” said Harvinder Sian, a bond strategist at RBS in London.

Investors demanded higher returns to hold Irish bonds after the downgrade. The spread between Irish bonds to the 10-year benchmark German Bunds widened by four basis points to 203 basis points.

The cost of protecting investors against a default on Government debt through credit default swaps, a proxy measure of financial risks, increased yesterday morning from 214 basis points to 226 basis points, according to figures from Deutsche Bank AG. This means it now costs €226,000 per year to insure an exposure of €10 million of Irish government bonds.

Rival rating agency Fitch cut Ireland’s “AAA” rating to “AA+” in April. Moody’s has retained its “AAA” rating to date, but has placed it on a negative outlook.

Last week, the Government said it would inject €4 billion into Anglo Irish Bank, in addition to the €7 billion already injected into AIB and Bank of Ireland. Anglo Irish is likely to need a further €3.5 billion if the quality of its underperforming loans continues to deteriorate. – (Additional reporting: Bloomberg, Reuters)