EUR/USD had one of its occasional ‘it’s gonna blow’ days on Friday:
Here’s what could have spooked the market.
We don’t know what it is about IMF staff reports on the viability of country programmes when loans are negotiated — but they always read like thrillers.
The economic and financial pressures facing Ireland are intense. At the heart of the problem is Ireland’s banking sector, which is over-sized relative to the economy and holds sizeable vulnerable assets despite major support measures taken by the authorities…
If you want a single document on what went wrong in Ireland and what needs to happen now for the bailout to work, the IMF staff report is it.
The report also makes clear that the IMF’s financing of Ireland could well have to increase, requiring even more fiscal cuts as a condition. That’s worth watching.
Still, what’s likely to particularly upset markets is the report’s conclusions on Irish credit risk to the Fund itself.
The report concluded that ‘Ireland’s capacity to repay the Fund will remain satisfactory under an Extended Arrangement’. Otherwise the Fund’s share of the Irish bailout would never have been approved, of course.
However, while the IMF is senior to all other creditors, Irish public and private debtors have a lot of creditors, as made clear in the section of the IMF report dealing with credit risk:
Ireland’s external debt is the highest of recent exceptional access cases, with private sector debt accounting for the largest share. Ireland’s total external debt is projected at over 1000 percent of GDP at end-2010… While a substantial portion of gross debt is accounted for by the liabilities of International Financial Sector Center (IFSC) participants, which do not reflect Irish risk, excluding an estimate of the bank component of this IFSC debt would still leave total external debt at almost 800 percent of GDP, with banks’ external liabilities accounting for about half… At end-2010, Ireland’s total stock of private short-term external debt is projected at approximately 370 percent of GDP, of which about a fifth consists of banks’ repos with the ECB.
In the end, it comes down to this chart from the report, which details the Irish burden facing the IMF’s basic General Resources Account (click to enlarge):
Basically — the peak burden will not be as high as for Greece’s original programme, but it’s the way that Ireland’s repayments will remain elevated for a long period of time that might worry the IMF.
Now, remember that the IMF and the EU recently extended Greece’s loans to give it the same term (seven years) and interest rate as Ireland received. Makes sense — it would have been pretty dumb to watch Greece default on intense debt refinancing episodes that would have been likely in 2012 or 2014 because of the Hellenic Republic’s high rollover rates on its government bonds.
Then along comes the ESM.
The European Stabilisation Mechanism that comes into force in 2013 (you know, what the current EU summit just agreed to set up) will be capable of bailing-in Irish or Greek bondholders.
The IMF is always first in the queue for its losses on defaulted or restructured lending to be made whole. However, all creditors to Ireland and Greece face a difficult 2013 or 2014, with the ESM coming into operation.
For example, the Greek yield curve currently has a nasty lump around the three- to four-year sections, not helped by Moody’s noting that the fiscal reform effort there looks highly unclear around 2013 and 2014:
Rollover is all, the ESM will make it worse — and that’s a problem for IMF lending even excluding Ireland’s many other repayment pains related to deleveraging and deflation in the economy.
Which leads to prompt closing sentences like these in the report:
The impact of the proposed extended arrangement on the Fund’s liquidity and credit risk exposure is very substantial…
The proposed arrangement would reduce Fund liquidity significantly…
There are significant risks to the program that could affect Ireland’s capacity to repay the Fund…
…Overall, the proposed access would entail substantial risks to the Fund.
How to save the eurozone, by JPMorgan – FT Alphaville