Presenting the Irish/German 10-year government bond spread…
… which has widened more than other peripheral spreads this Monday morning.
Traders are pinning the move on comments made by University Colleage Dublin’s influential economist Colm McCarthy over the weekend. In an article for the Irish Independent he outlined a scary (and probably realistic) scenario under which the Irish government is unable to fund itself and has to call in the IMF.
Now, McCarthy is not a completely objective observer. As the Indy notes, the economist wrote a report for the government that recommended budget cuts to generate cost savings of up to €5.3bn. His recommendations were largely ignored.
Even so, his comments are certainly sobering and likely to be taken seriously:
In what he calls a “scary scenario”, outlined in the Sunday Independent today, Mr McCarthy says “the game is up” if the Government flunks the Budget on December 7.
The sense of impending doom is also evident in the latest Sunday Independent/Quantum Research poll, which found that a massive 64 per cent believe it to be “inevitable” that Ireland will need the help of the IMF in the new year.
Mr McCarthy has said that if the Budget does “too little” to convince the financial markets, the Government will be unable to finance itself — “which means an IMF/European bail-out and economic policy dictated from outside the country for the first time since the State was founded”.
He warns that the country’s cash reserves will run low by next spring, unless Ireland re-enters the bond market with a “pretty big issue” of up to €5bn.
“Realistically, the Government needs to do this in January or February at the latest,” he says.
For now, the Irish government seems confident it will get the budget through, according to the Indy:
Government sources were yesterday confident that the Budget would be passed on December 7 and that there would be no defections from Fianna Fail, the Greens or by independent TDs who support the Government.
But McCarthy warns there really is no alternative to a tough budget:
“Those who object to a tough Budget on the grounds that it will weaken an already weak economy are whistling in the wind unless they can identify a less deflationary option. “It is not that we are living beyond our means: we are living beyond the willingness of lenders to lend,” he said.
Quite.
Update: 12.24 (GMT)
As reader Acme notes, McCarthy took to the airwaves on Sunday to explain what he really meant in his article.
Here are a few snippets from his piece so you can decide for yourself.
In the spirit of Halloween, here’s a scary scenario. What if the re-entry to the bond market doesn’t work? Not working takes two possible forms. The amount required is not offered or the rate of interest demanded is just too high to be affordable. In either case early resort to a bailout would be unavoidable. In the current condition of the markets, and even with decisive action in the four-year plan and 2011 Budget, this bad outcome is a possibility.
…….
The only factor the Government can do anything about at this stage is the budget deficit. If they do too little to convince the markets, the game is up and the Irish Government will be unable to finance itself, which means an IMF/European bailout and economic policy dictated from outside the country. How bad would that be?
Both Government and the main opposition parties are committed to avoiding this outcome and there are solid reasons for supporting their stance. Some commentators seem to believe that a bailout would be a soft option. But there is no good reason to expect that this would be the case. The EU and the IMF would agree to lend to Ireland for a period of years, subject to an exit strategy and a timetable. The rate of interest would be expensive; the total amount would not necessarily be generous; and the exit strategy would require that Ireland restore its creditworthiness on a tight timetable.
…..
The first mover is the Government and the four-year plan will be critical. But the Budget measures will matter even more.
The priority is to reduce sharply the projected amount of fresh borrowing for 2011 and hope that the bond market re-entry goes well. Those who object to a tough Budget on the grounds that it will weaken an already weak economy are whistling in the wind unless they can identify a less deflationary option. It is not that we are living beyond our means: we are living beyond the willingness of lenders to lend.
If the strategy succeeds and we can borrow successfully in the New Year, attention needs to focus again on the condition of the banking system. The reliance of Irish banks on credit from the ECB is unsustainable and they can derive limited support from guarantees issued by a Government which is itself struggling to borrow. The task of re-capitalising the two main banks — Allied Irish and Bank of Ireland — will be completed shortly, at substantial cost to the taxpayer. But that task is not really completed until the banks can finance themselves.
Related link:
Eek, Ireland! – FT Alphaville
So why is Ireland taking a break from selling bonds? – FT Alphaville
