And this time, we seriously doubt that the National Treasury Management Agency will complain about S&P’s unfair estimates.
Earlier on Tuesday, RTÉ had reported the €85bn size of the facility offered by the EU and IMF to the Irish government, and the FT noted that Dublin was taking over Bank of Ireland, which had been the last remaining big independent lender in the country.
At pixel time, the Euro had declined to 1.3393 USD after falling on consecutive days, and is now its lowest level in nearly two months:
In light of all this, the downgrade is somewhat anticlimactic, but we’ve highlighted a few of the interesting points below:
LONDON (Standard & Poor’s) Nov. 23, 2010–Standard & Poor’s Ratings Services said today that it lowered its long-term sovereign credit rating on the Republic of Ireland to ‘A’ from ‘AA-’ and its short-term rating to ‘A-1′ from ‘A-1+’. At the same time, Standard & Poor’s said that it placed both the short- and long-term ratings on CreditWatch with negative implications. The transfer and convertibility assessment remains ‘AAA’, as it is for all members of the European Economic and Monetary Union.
Conversely, the ratings could be removed from CreditWatch if the conclusion of the program and passage of the budget eases external pressure. Standard & Poor’s expects to resolve its CreditWatch placement by early in the first quarter of 2011.
The downgrade to ‘A’ and the CreditWatch action applies to other ratings that depend on Ireland’s sovereign credit rating, including the issuer credit rating on the National Asset Management Agency (NAMA), and the senior unsecured debt ratings on government-guaranteed securities of Irish banks.
“The lower ratings reflect our view that the Irish government will have to shoulder additional costs associated with further capital injections into Ireland’s troubled banking system,” explained Standard & Poor’s credit analyst Frank Gill. “We expect the government to be given access to a joint loan program extended by the EU and the International Monetary Fund (IMF).” Were it not for this support, the sovereign rating would be under even greater pressure due to our view of the liquidity challenges posed by Ireland’s banking system. At over three times GDP, Ireland’s stock of domestic credit is among the highest in the eurozone, and will likely weigh on the timing and trajectory of a recovery of domestic demand over the medium term.
“We think it reasonable to expect that the EU-IMF program currently being negotiated should help Ireland manage its downsizing of the commercial banks’ balance sheets,” Mr. Gill added. However, accelerated asset disposal could in our view hasten the need for additional capital requirements as some assets could be liquidated at prices below carrying values.” Depending upon the extent to which contingent liabilities become current, public debt could rise still further. Under its Eligible Liabilities Guarantee Scheme, the Irish government guarantees banking institutions’ deposits and senior debt equivalent to 75% of GDP and 20% of GDP respectively. These guarantees are in addition to those extended under the government’s Deposit Guarantee Scheme.
While a multiyear external support program may instill greater market confidence in the ability of Irish banks to rollover external debt, it will not reduce levels of private and public debt. Indeed, with domestic demand unlikely in our view to recover until 2012, net general government debt to GDP at end 2012 looks set to exceed our previous projections of 113% of GDP. This is more than 1.5x the median for the average of eurozone sovereigns, and well above the debt burdens we project for eurozone sovereigns such as the Kingdom of Belgium (98%; AA+/Stable/A-1+) and the Kingdom of Spain (65%; AA/Negative/A-1+). Irish private external debt levels also remain among the highest in the eurozone. At the end of 2009, these reached 325% of GDP, excluding Ireland’s international financial services sector.
Our gross general government debt figure for Ireland includes NAMA issuance to date, as well as a 6.5% of GDP estimate of new borrowings to create additional capital buffers for Ireland’s financial system. Under Standard & Poor’s methodology, only highly liquid arms-length assets are netted out of gross general government debt assets. As a result, we do not net out NAMA’s distressed property assets when assessing net debt levels in Ireland, although we acknowledge that future recoveries should provide supplemental funding for the government’s borrowing needs. In addition, Irish government liquid assets appear substantial, consisting of 16% of GDP in government deposits and the 8% of GDP portion of the national pension fund that is not already invested in strategic commercial banking stakes.
“The outlook for future costs to the government from financial retrenchment remains uncertain,” Mr. Gill said. “In our view, Ireland’s banking system will take several years to downsize.” Until then, the banking system is unlikely to be in a position to support the country’s economic growth. As a consequence of the high overhang of private debt, fiscal austerity, and the uneven outlook for external demand in Europe, Standard & Poor’s now expects close to zero nominal GDP growth for 2011 and 2012. We do not envisage GDP exceeding 2% a year in real terms before 2013.
In our view, downside risks of deflation remain. These depend partly on the external environment and the speed with which the financial sector can recover sufficiently to contribute to the economy again. Meanwhile, uncertainties surrounding the timing and extent of imposed burden sharing by EU institutions have raised refinancing costs. In our opinion, these refinancing costs are likely to remain high until investors perceive the forecasts for primary fiscal balances as much improved.
Our baseline expectation is that Ireland’s general government budgetary position improves by €15 billion (just under 10% of GDP) over 2011-2014 exclusive of any additional capital needs of the banking system. Nevertheless, reform fatigue could set in should the global economic environment weigh on the pace of the recovery.
The CreditWatch placement reflects the possibility of another downgrade if the negotiations over the terms of the IMF-EU program or over Ireland’s 2011 budget fail to staunch wholesale funding outflows. The ratings could also come under renewed pressure in the short term should the domestic policy consensus weaken, jeopardizing the successful implementation of a multiyear adjustment program. The emergence of a European sovereign debt restructuring framework that could reduce the perceived adverse political and financial cost of a sovereign debt restructuring could also lead us to reconsider our view of Ireland’s creditworthiness. However, we expect that resolution of this CreditWatch listing will likely leave the government’s ratings in an investment-grade category.