Less than a week after the Irish Finance Ministry unveiled its plans for the banking system, doth Moody’s strike. The credit rating agency says it will undertake a review of the country’s Aa2 rating — and that of its National Asset Management Agency — which could lead to a downgrade, most likely by one notch. Standard & Poor’s and Fitch already have Ireland on Aa-.
Here’s the Moody’s statement:
Moody’s places Ireland’s Aa2 rating on review for possible downgrade
NAMA’s Aa2 rating also on review for possible downgrade Frankfurt am Main,
October 05, 2010 — Moody’s Investors Service has today placed Ireland’s Aa2 local currency and foreign currency government bond ratings on review for possible downgrade. In a related rating action, Ireland’s short-term rating was affirmed at Prime-1.
Moody’s decision to initiate this review was prompted by (1) increased uncertainty regarding Ireland’s ability to preserve government financial strength after additional bank recapitalisation measures announced on 30 September; (2) the clouded outlook for the recovery of domestic demand in light of recently published data; and (3) a further rise in borrowing costs since our last rating action in July that would — if sustained — negatively affect debt dynamics.
Moody’s has also placed on review for possible downgrade the Aa2 rating of Ireland’s National Asset Management Agency (NAMA), whose debt is fully and unconditionally guaranteed by the government of Ireland. Ireland’s Aaa country ceilings for bonds and bank deposits fall under the eurozone’s regional Aaa ceilings and are not affected by the rating review.
For a more detailed analysis of the review, please refer to Moody’s Special Comment entitled “Key Drivers of Decision to Review Ireland’s Aa2 for Possible Downgrade,” which is available on www.moodys.com
RATIONALE FOR REVIEW
“Ireland’s ability to preserve government financial strength faces increased uncertainty as a result of three main drivers, which together would further increase its debt and aggravate its debt affordability,” says Dietmar Hornung, a Moody’s Vice President-Senior Credit Officer and lead sovereign analyst for Ireland.
These key drivers are:
1.) Crystallisation of additional bank contingent liabilities. The Irish government has announced a series of additional recapitalisation measures that are likely to raise the government’s total cost for bank support by EUR 10-15 billion. These measures will lead to a substantial rise in Ireland’s general government deficit to around 32% of GDP this year.
2.) Increased uncertainty regarding the economic outlook. Recently published data highlight Ireland’s weak growth prospects, which are a result of the severe downturn in the financial services and real estate sectors as well as an ongoing contraction in private sector credit. Moody’s regards Ireland’s supply-side characteristics — i.e. its competitive tax system, flexible labour market, business-friendly environment — as sources of economic strength. However, fresh uncertainty arises from demand-side weaknesses, particularly the impact of new austerity measures on domestic demand. According to Moody’s, these weaknesses raise concerns about a much longer period of recovery and the implication for weaker government revenue.
3.) Elevated borrowing costs. Ireland’s borrowing costs have increased considerably since July. In light of these elevated borrowing costs, the interest burden stemming from Ireland’s growing debt stock is set to increase significantly in the coming years should interest rates remain at current levels. Moody’s measures debt affordability by using the ratio of interest payments on public debt as a share of government revenues.
“Taking these three factors into account, Ireland is on a trajectory toward lower debt affordability over the next three to five years,” says Mr. Hornung.
FOCUS OF THE REVIEW
Moody’s rating review will focus on Ireland’s ability to preserve government financial strength in a difficult economic environment.
“A key element of the review is Ireland’s revised four-year fiscal plan, which the government will present in early November. The plan will identify measures to stabilise public finances and bring the deficit below 3% of GDP by 2014,” says Mr. Hornung. The analyst noted that banking system developments and any additional transfer of assets to NAMA will also be monitored, in particular as they affect economic activity, the availability of and demand for credit and the government’s balance sheet.
In Moody’s view, the forthcoming fiscal consolidation programme will be challenging given that (1) GDP growth forecasts used in the government’s own debt projections now look overly optimistic, and (2) the interest rates at which Ireland borrows have increased significantly.
If Moody’s decides to downgrade Ireland’s ratings at the conclusion of the review, it would most likely be by one notch. A downgrade to the high single-A rating range could occur if Moody’s decides that a stabilization of the debt to GDP ratio in the next three to five years appears unlikely. Moody’s intends to conclude its review within a three-month period.