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Irish Bondholders in Pain Again as Cost Cuts Bite: Euro Credit
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Irlanda: La cura ammazzerá il cavallo? C'é chi pensa che il rischio sia molto alto

Oct. 27 (Bloomberg) -- Bond investors are losing faith in Ireland’s plan to lower the deficit as spending cuts threaten to undermine economic growth, reducing government revenue.

Irish 10-year bond yields climbed within 50 basis points of the 454 basis-point record spread, set Sept. 29, relative to similar-maturity German bunds. Portugal’s spread fell about 1 percentage point against the German benchmark in the past month, the Greek-German yield gap narrowed 102 basis points and the Spanish spread was close to the lowest level since Aug. 10.

Ireland was the first euro-region nation to announce budget reductions in 2008 in response to the sovereign debt crisis. The bond market responded with yields on 10-year Irish securities falling to a low of 4.43 percent in April. Investors now question whether austerity measures will push the economy back into recession. Yields have increased to 6.45 percent.

“If the Irish economy grows 1 percent less than forecast or the deficit is 1 percent higher than we forecast, then the debt trajectory becomes upward sloping,” said Mohit Kumar, a fixed-income strategist at Deutsche Bank AG in London. “The market doesn’t completely trust that Ireland has managed to draw a line underneath the banking sector.”

The Irish-German 10-year yield spread widened nine basis points to 402 basis points as of 11:42 a.m. in London.

Finance Minister Brian Lenihan said Oct. 20 that a “united effort” is required to fight the deficit as growth is weaker than originally estimated. He aims to narrow the budget gap to 3 percent of gross domestic product from about 12 percent this year, a figure that rises to 32 percent when costs of the banking rescue are included. Ministry officials are studying a budget-savings package of 3 billion euros ($4.2 billion) to 7 billion euros for 2011.

‘Smother the Patient’

“The danger is you smother the patient just as he is trying to get on his feet,” said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin. “I am not convinced the market just wants to see a slash-and-burn approach. It wants some sort of sign that the economy can grow.”

The government said yesterday it will have to reduce spending and raise taxes by as much as 15 billion euros to reach its targets by 2014, twice what it had projected in the 2010 budget. Lenihan will announce details of the plan next month.

The increase is due to “lower growth prospects both at home and abroad and higher debt interest costs,” the government said in a statement. While the measures “will have an impact on the living standards of citizens,” it is “neither credible nor realistic to delay them,” it said.

‘Danger’

Prime Minister Brian Cowen told lawmakers in the parliament today that the budget adjustment may be reduced only if economic growth and job creation are stronger than forecast.

Unemployment has doubled to 13.7 percent since 2008 to stand close to a 16-year high, while GDP shrank 1.2 percent in the second quarter from the first quarter. Further signs of economic deterioration emerged last week when Britvic Plc said bar sales fell 11 percent in Ireland.

“There is a danger for countries like Ireland that have huge deficits that cutting spending will not be enough and the situation will deteriorate,” said Ralf Ahrens, who helps manage about $20 billion as head of fixed income at Frankfurt Trust and holds Irish government bonds. “There is this central question of where does growth come from.”

Bank Bailout

The deficit is about 19 billion euros, equivalent to about 12 percent of GDP, according to government estimates. It’s the highest of the so-called euro peripherals, with Spain’s budget gap at about 9 percent, Greece’s at 10 percent, Italy’s at 5 percent, and Portugal’s at 8 percent.

Ireland’s fiscal deficit rises to 32 percent of GDP this year when including the 33 billion euros earmarked to bail out lenders such as Anglo Irish Bank Corp. Ltd., Allied Irish Banks Plc and Irish Nationwide Building Society. The final cost may be as much as 50 billion euros, the government said Sept. 30.

“The bottom line is Ireland suffered the most heated property and banking bubble,” said Brian Devine, an economist at NCB Stockbrokers in Dublin. “The aftermath of such bubbles has never been anything but painful.”

Credit-default swaps linked to Irish debt were at 422 basis points yesterday, falling from a record 485 on Sept. 28, according to CMA prices. The cost of insuring Greek debt for five years was 662 basis points, the most expensive in Europe.

Pimco’s View

Greece may default within three years because budget- cutting measures won’t be enough to reduce the nation’s debt burden, Pacific Investment Management Co. Chief Executive Officer Mohamed A. El-Erian said Oct. 25 at a conference sponsored by the Economist magazine in New York.

A default is possible as long as “it is done through orderly restructuring and repricing to retain competitiveness,” El-Erian said at the meeting.

Europe’s financial crisis erupted at the end of 2009 after Greece’s newly elected socialist government said the nation’s budget deficit was twice as big as the previous administration had disclosed. The European Union and International Monetary Fund approved an aid package on May 2 in exchange for the Greek government agreeing to cut public-sector wages and pensions and raise taxes on fuel, alcohol and cigarettes.

In Ireland, the austerity plan may push the economy into a “prolonged recession”, the country’s Economic and Social Research Institute said on Oct. 21, suggesting the government push back its targets by two years to 2016.

The risk is “the medicine is too severe so that, like chemotherapy, it puts the patient into decline,” said John Fitzgerald, an ESRI economist and a member of the country’s central bank board. “We have got to get that right.”

By Dara Doyle and Matthew Brown

--With assistance from Finbarr Flynn in Dublin. Editors: Tim Quinson, Fergal O’Brien

Source >  Bloomberg


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