WHATEVER THE outcome of negotiations between the Government and the social partners on reducing exchequer spending and irrespective of how the public react to the austerity measures that follow, the most critical judgment will be passed outside Ireland. Credit rating agencies and bond markets will make up their own minds on the effectiveness of what is being proposed and they will do so against a sharply deteriorating economic backdrop.
Exchequer returns for January published today are likely to show tax receipts weaker than forecast. And live register figures out tomorrow will confirm the inexorable rise in numbers out of work. All of which frames the task facing the Government. Time is not on its side.
The response of the rating agencies to the outcome of these talks will determine whether Ireland’s sovereign debt rating is maintained or downgraded. Foreign investors will decide whether the Government’s borrowing costs rise or fall. Bond markets set the price that sovereign states pay to finance their huge borrowing requirements. In this regard, our reputation for sound management of the public finances has been damaged by undue delay in addressing the fiscal challenges facing the State. The result has been a decline in international investor confidence in Ireland.
Assuming the Government succeeds in its objective of securing a real €2 billion in spending cuts, the general government deficit in 2009 will be close to 10 per cent of Gross Domestic Product. That is over three times the borrowing limit set by the EU. But without these proposed cutbacks, the deficit would rise to 12 per cent in subsequent years. And that is simply unsustainable.
Over recent months, sovereign bond markets have taken an increasingly negative view of the state of Ireland’s public finances and the State’s borrowing costs have soared. Eighteen months ago, there was little difference between what Ireland and Germany paid investors for borrowed money. By December, Ireland was paying 1 percentage point over the German benchmark rate to finance its borrowing. By last week, the yield differential had widened to more than 2 percentage points as investors worried about the deterioration in the public finances and the contingent liability associated with the Government guarantee scheme for the banks. Indeed, for a brief period, Ireland dropped below Greece as the euro-zone country with the largest differential, or yield spread, vis-à-vis Germany.
Credit rating agency Moody’s warned on Friday that Ireland could lose its prized AAA sovereign debt rating because of its concerns over the public finances. That echoed an earlier and similar warning from another agency, Standard Poor’s. A downgrading of Ireland’s high sovereign debt rating would be a huge setback, resulting in even higher future borrowing costs.
The best and only way of avoiding that prospect is by making a bold and convincing start to the Government’s budgetary strategy of restoring stability to the public finances over the next five years.