Fitch on Ireland

In a brief assessment the ratings agency Fitch have affirmed the BBB+ view of Irish government bonds with a stable outlook. 

Back in January Moody’s moved Ireland from Ba1 (“junk” status) to Baa3 (lowest grade of investment status).  Standard and Poor’s have Ireland and the same level as Fitch, BBB+, but assign a positive outlook to their rating.  Today’s statement from Fitch is below the fold.

Fitch Affirms Ireland at 'BBB+'; Outlook Stable
21 Feb 2014

Fitch Ratings has affirmed the Republic of Ireland's Long-term foreign and local currency IDRs at 'BBB+' with Stable Outlooks. The issue ratings on Ireland's senior unsecured foreign and local currency bonds have also been affirmed at 'BBB+'. The Country Ceiling has been affirmed at 'AA+' and the Short-term foreign currency IDR at 'F2'.

The rating of National Asset Management Ltd's (NAMA) guaranteed issuance has been affirmed at 'F2', in line with the sovereign rating.

KEY RATING DRIVERS
The affirmation reflects the following factors:

Ireland successfully completed its three-year adjustment programme in December 2013. All quarterly fiscal targets of the Troika (EU, ECB, IMF) programme have been met, underpinned by strong policy commitment. Parallel with fiscal consolidation, Ireland has returned to market financing and has built up cash buffers equivalent of 13% of GDP by end-January 2014, including EUR3.75bn from a 10-year bond sale in January 2014.

Fitch forecasts a budget deficit of 4.8% of GDP in 2014, implying a balanced primary position, compared with a primary deficit of more than 9% of GDP in 2009 excluding bank recapitalisation. Nevertheless a further EUR2.0 bn of consolidation will be needed next year to reach a budget deficit below 3% of GDP, the precondition to exit the EU's Excessive Deficit Procedure (EDP).

Ireland's gross general government debt/GDP ratio may have reached around 124% in 2013, one of the highest among Fitch-rated sovereigns. The combination of high debt and modest medium-term growth potential implies that keeping debt on a declining path will require large primary surpluses for an extended period.

The acceleration of economic growth and larger than expected fall in unemployment in 2H13 are signs of a broad-based recovery. GDP growth could reach 1.6% in 2014 and 2.2% in 2015 as growth contribution from domestic demand will turn positive after five years of balance-sheet recession in the private sector. Fitch expects the current account surplus to remain around 4% of GDP in 2014-15, similar to 2013.

Post-crisis vulnerabilities remain in the banking sector, notwithstanding the improvement in economic conditions and the authorities' efforts to accelerate mortgage resolution.

Ireland has retained many of its structural strengths throughout the crisis. It is a wealthy, flexible economy and its per capita gross national income was USD35,100 in 2013, more than twice the 'BBB' median.

RATING SENSITIVITIES
The Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could individually or collectively, result in a upgrade include:
- Greater confidence that the GGGD/GDP ratio will be on a firm downward trend over the medium term.
- Sustained, balanced economic recovery.
- Reduction in financial sector vulnerabilities, notably an improvement in banks' asset quality and profitability.

The main factors that could lead to negative rating action are:
- Material divergence from the fiscal targets leading to GGGD/GDP ratio peaking higher and later.
- Additional recapitalisation needs of the financial sector by the Irish sovereign, for example in the context of the ECB's Comprehensive Assessment.
- Weaker economic performance resulting in a substantial deterioration of banks' existing loan portfolio.

KEY ASSUMPTIONS
Fitch assumes that fiscal consolidation efforts will continue to ensure the exit from the EDP by 2015 in line with the government's stability programme and substantial primary surpluses will be maintained over the medium term, consistent with Ireland's medium-term objective.

High public ownership in the banking sector implies a close bank-sovereign link, amidst the eurozone level progress towards banking union. Nevertheless Fitch assumes no further recapitalisation of the financial sector by the sovereign.

Fitch assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term. It also assumes that the risk of fragmentation of the eurozone remains low.

Core inflation at 0.9%

Today’s CPI release from the CSO shows that overall consumer price annual inflation remained at 0.2% in January.  The monthly drop of 0.5% matched the 0.5% drop recorded in January last year.

If we strip out energy products and mortgage interest (equal to around 15 per cent of the overall index) we get a measure of ‘core’ inflation.  This rose slightly in January but remains below 1%.

Upward pressure on Irish inflation is coming from services.  Services excluding mortgage interest are up 3.0% in the year.  Services are:

Electricity, gas, telecommunications, alcoholic beverages consumed on licensed premises, meals out, housing, rent, mortgage interest repayments, insurance, public transport, entertainment and recreation, education, household services and miscellaneous services including childcare, social protection, package holidays and other services.

As we examined before most of the price increases in these sectors can be explained by excise duty increases (alcohol), regulated price increases (electricity, gas, public transport), property taxes (housing), lower tax relief and higher charges (health insurance) and higher fees (education).

Why can’t we repay the IMF early?

A recent PQ set for Michael Noonan provided some interesting details on Ireland’s official loans.

Ireland has borrowed €22.5 billion from the IMF in 12 loan tranches and these will be amortised (paid back in instalments) in varying amounts from July 2015 to December 2023 when the final payment on the last tranche drawn down will be made.  Here are the individual loans from the IMF.

The weighted average life across all the loans is 7.3 years. 

The response also tells us that the average interest rate on the loans is 4.16 percent (with an additional surcharge of 100 basis points applied to around one-fifth of the total amount due to the excessive size of Ireland’s loans relative to our IMF quota). 

The indicative seven-year yield on Irish government bonds is probably around 2.50 percent.  Here is an extract from the daily bond report for Tuesday 4th February published by the Irish Stock Exchange.

One problem the NTMA face as they plot an exit from the official funding phase of the programme is that we have very little need to borrow money.  A cash reserve of around €25 billion has been accumulated and over the next two years there is only one government bond due to mature (a €3.6 billion bond in February 2015).  Ireland’s near-term funding need for maturing debt are very low.

Maybe we should consider borrowing some money at the yields shown in the previous table to further cement the view that we have exited the EU/IMF programme and use that money to repay the IMF loans.  We could borrow for seven years at 2.50 percent to pay back loans with an average life of seven years and an average interest rate of 4.16 percent.  The potential interest savings would be around €350 million per annum.

In a second PQ Michael Noonan was asked about this possibility.  He replied:

The question of early repayment of any one lender cannot therefore be treated in isolation from other lenders and market expectations for when programme loans are due to be repaid.

The early repayment of, for example, IMF funds would trigger automatic mandatory proportional early repayments to the EFSF, EFSM, United Kingdom, Kingdom of Sweden and Kingdom of Denmark. This would apply in respect of each of the programme funding partners.

So early repayment of the shorter-duration, higher-interest IMF loans would automatically trigger proportionate repayments of the longer-duration, lower-interest EU loans.  One issue is that it is not clear where the requirement for this mandatory repayments comes from.  It does not appear to be in the Memorandum of Understanding. 

The Minister has stated that these mandatory repayments are in place but it would be useful to know where this comes from.  I would guess that the IMF would be more than happy to see their loans made to Ireland repaid early.  So that leaves…

Debt relief for Ireland?

In yesterday’s Irish Times, Chris Johns concluded an article on central banks with:

The Holy Grail of central banking, credibility, depends mostly on hitting pre-set targets. But credibility also requires honesty. And I think it is legitimate to ask whether or not the ECB has been honest with us. It clearly made a mistake when it came to the bond holders. It may well have been an error of judgement, made in the heat of battle when things were less clear than they are now. But it was a mistake. Serious people said so at the time.

For its own sake, the ECB should come clean about all of this. If it is to become the kind of institution that commands the respect it needs, honesty about mistakes is, as Haldane has persuasively argued, essential. The ECB should fess up and figure out a neat way of giving us some debt relief. It’s the right thing to do and would enhance the ECB’s standing.

Over time more details have emerged about the discussions surrounding the €6 billion of unsecured, and by that stage unguaranteed, senior bonds that remained in Anglo and INBS in November 2010.  It is well known that the IMF were in favour of burden sharing.  In an interview with the same paper last week, current Bundesbank president, Jens Weidmann, said in relation to the November 2010 discussions that:

The Governing Council then was weighing bail-in versus financial stability risks, and its majority concluded that the latter were more relevant under the concrete circumstances. In that debate the Bundesbank has always considered it important to make investors bear the risks of their investment decisions and already then favoured contributions of investors in the event of solvency problems, especially for banks that are to be wound down.

Weidmann (who was not working for the Bundesbank at the time) talks in generalities rather than the specifics of the Irish case but the interpretation easily lends itself that way.  One specific Weidmann did cover last week was whether Ireland should get some debt relief for the forced repayment of the €6 billion of senior unsecured bonds in Anglo/INBS as argued by Chris Johns.  Weidmann hints that we already got it through the Promissory Note swap engineered last February.

Some might consider the transaction as a kind of a compensation for the Irish support to its banking system, but in my view such transfers should not be the business of central banks.

I doubt this was the type of debt relief Chris Johns was calling for.  A 66% haircut on the €6 billion of senior bonds left in Anglo/INBS in November 2010 would have netted €4 billion – a massive amount of money.  Under certain assumptions, the NPV of the gains from the Promissory Note swap can be put at €4 billion.  Perhaps Weidmann’s suggestion has some merit.

Of course, the biggest black hole Ireland poured money into in “support” of the banking system was the repayment of deposits in Anglo and INBS.  There is still no sign of a smoking gun to indicate that the repayment of deposits was forced on Ireland by external forces or that Ireland was prevented from putting the banks into resolution earlier.  All indications are that these decisions were made domestically and internally there were close to no calls for depositor haircuts as the banking crisis emerged.

If a smoking gun for the deposits is found (and it needs to be from well before November 2010) then maybe a case for further debt relief can be made.  However, the indications to date suggest that it does not exist.  Then the argument is based on little more than solidarity.  There wasn’t much solidarity shown to holders of Greek government bonds or large depositors in Cypriot banks.  They made decisions and had to live with the consequences of them when they couldn’t be repaid. 

In Ireland, we made the decision to repay depositors and there are consequences that followed from that.  It is easy to look back and say decisions were wrong.  It is much more difficult to look back and find someone else to blame.  It might not be palatable but it is likely that the arrangement put in place last February is as good as it gets.