Moody’s cut Ireland’s credit rating on Monday, warning the country faces a slow climb out of recession as the cost of a rescue of its banking sector mounts, Reuters reports. Moody’s also changed Ireland’s outlook to stable from negative.
“The timing isn’t great, given the bond auction tomorrow and certainly this will add to the premium that will need to be paid to raise money.”
The one-notch downgrade to Aa2, which came a day ahead of a scheduled sale of up to 1.5 billion euros of Irish debt, put Moody’s on par with rival agency Standard and Poor’s AA rating and still one notch above Fitch. Moody’s also changed its outlook to stable from negative.
The downgrade, which a minister said provided no surprises but which weakened the euro versus the dollar and hit European stocks, prefaced a sale of six- and 10-year bonds worth between 1 billion and 1.5 billion euros at Ireland’s regular monthly auction.
“The timing isn’t great, given the bond auction tomorrow and certainly this will add to the premium that will need to be paid to raise money,” Alan McQuaid, chief economist at Bloxham, says.
“Today’s downgrade is primarily driven by the Irish government‘s gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability,” Dietmar Hornung, a Moody’s vice president and lead analyst for Ireland, says in a statement.
Some of the euro zone’s toughest spending cuts last year gave Ireland a brief respite from the market assault on peripheral euro members, but its fiscal rectitude has been all but overshadowed by fresh rounds of bad news on the banking front.
The cost of bailing out nationalized Anglo Irish Bank last year gave Ireland a budget deficit of 14 percent per gross domestic product, the highest in Europe, which could rise to 20 percent or more this year, the state-funded Economic and Social Research Institute (ESRI) said last week.
With Ireland have emerged from the euro zone’s longest running recession in the first quarter, Moody’s says it expects Irish medium-term economic growth of 2-3 percent per year, below the 4 percent projection built into the government’s fiscal program.
Moody’s says banking and real estate — engines of growth in the years preceding the country’s crisis – would not contribute meaningfully to overall growth in the coming years.
“It’s really not telling us anything that we don’t know already,” Martin Mansergh, Ireland’s minister of state for finance, says. “We all know that banking and real estate are not going to be sources of growth.”
The IMF last week said Dublin would not meet a European Union-agreed deadline to reduce its budget deficit to 3 percent of gross domestic product (GDP) by 2014, also citing threats to Ireland’s growth target.
While the Irish public has so far grudgingly accepted fiscal tightening, a senior official in Prime Minister Brian Cowen‘s governing coalition said on Sunday voters might not be ready to accept all the cuts still envisaged by the government.
On the positive side, Ireland does not face any major bond redemptions this year and it has raised enough bonds to see it through to the first quarter of 2011 regardless of the outcome of upcoming monthly auctions, officials says, according to Yahoo Finance.
Moody’s action also suggested the country was close to hitting its ratings floor, says David Schnautz, a Commerzbank strategist in London.
“They … stabilized the outlook, which might indicate that we’re much closer to a bottom in ratings. …This is something which in the end should turn out to be supportive for Irish bonds and (euro zone) peripherals as well.”
The spread of Irish 10-year bonds against their German equivalent widened on Monday to 300 basis points, their highest since July 2.
Here’s Moody’s Press Release:
Frankfurt, July 19, 2010 — Moody’s Investors Service has today downgraded Ireland’s government bond ratings to Aa2 from Aa1. The main drivers for the downgrade are:
1. The government’s gradual but significant loss of financial strength, as reflected by the substantial increase in the debt-to-GDP ratio and weakening debt affordability (as represented by interest payment to government revenue).
2. Ireland’s weakened growth prospects as a result of the severe downturn in the financial services and real estate sectors and an ongoing contraction in private sector credit.
3. The crystallization of contingent liabilities from the banking system, as represented by a series of recapitalization measures and the need to create the National Asset Management Agency (NAMA), a government-created special purpose vehicle that is acquiring impaired loans from banks.
Moody’s has changed the outlook on the ratings of the government of Ireland to stable from negative as the rating agency now views the upside and downside risks as being evenly balanced at the current rating level.
Moody’s has also affirmed Ireland’s short-term issuer rating of Prime-1 with a stable outlook. Ireland falls under the Eurozone’s Aaa regional ceilings for bonds and bank deposits, which are unaffected by the Irish government’s downgrade.
Moody’s has also downgraded to Aa2/stable outlook from Aa1/negative outlook the rating of Ireland’s National Asset Management Agency (NAMA), whose debt is fully and unconditionally guaranteed by the government of Ireland.
RATIONALE FOR DOWNGRADE
“Today’s downgrade is primarily driven by the Irish government’s gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability,” says Dietmar Hornung, a Moody’s Vice President — Senior Credit Officer and lead analyst for Ireland. The country has suffered a dramatic contraction in GDP since 2008, causing a sharp decline in tax revenue. The general government debt-to-GDP ratio rose from 25% before the crisis to 64% by the end of 2009, and is continuing to grow.
Moody’s also expects economic growth to be below historical trend over the next three to five years for two reasons. Firstly, banking and real estate — the engines of Ireland’s growth in the years preceding the crisis — will not contribute meaningfully to overall growth in the coming years. Secondly, the fall in private sector credit is dampening the growth outlook. The ongoing credit contraction reflects both (i) the tightening in credit supply, due to balance sheet constraints among lenders; as well as (ii) the weak demand for credit as a consequence of a broad de-leveraging process in which the household sector is seeking to repair its balance sheets through increased savings (or reduced dissavings).
The third key factor driving Moody’s rating action is the crystallization of contingent liabilities from the banking system as a result of the government taking on debt to provide support to the country’s ailing banks. Overall, the recapitalization measures announced to date could reach almost EUR25 billion (equivalent to15.3% of Ireland’s 2009 GDP) — and Moody’s expects that Anglo Irish Bank may need further support. In addition, the government created NAMA, a special purpose-vehicle that is acquiring loans from participating banks at a discount in exchange for government-guaranteed securities. While we do not expect the government — not even in a moderately stressed scenario — to incur permanent losses in excess of 25% of the country’s 2009 GDP as a result of these obligations, we believe that the uncertainty surrounding final losses would exert additional pressure on the government’s financial strength.
While Moody’s expects the near-term deterioration in the government’s debt metrics to be severe, the rating agency nevertheless expects the general government debt-to-GDP ratio to stabilize at 95% to 100% over the next two to three years. Given Ireland’s wealthy and flexible economy and its very high institutional strength, these debt levels are commensurate with a Aa2 rating. Ireland’s demonstrated adjustment capability and its economic vitality — reflected for instance in its ability to attract foreign direct investment — are important characteristics that support the rating.
RATIONALE FOR STABLE OUTLOOK
At the Aa2 rating level, the upside and downside risks are evenly balanced. “If the GDP growth trend were to exceed Moody’s expectations — with a quick resumption of domestic credit flow and a supportive global economic environment — then the government’s debt metrics could stabilize earlier than is currently being assumed,” says Mr. Hornung.
On the other hand, Moody’s notes that the country could experience downward rating pressure in the event of (i) a failure of the economy to rebound in a meaningful way; and/or (ii) a severe deterioration in the country’s debt metrics triggered by a further crystallization of bank contingent liabilities beyond Moody’s current expectations.
For further information, please refer to Moody’s Special Comment entitled “Key Drivers of Ireland’s Downgrade to Aa2,” which is available on http://www.moodys.com.
PREVIOUS RATING ACTION & METHODOLOGY
Moody’s last rating action affecting Ireland was implemented on 2 July 2009, when the rating agency downgraded Ireland’s government bond ratings to Aa1 and assigned a negative outlook. Prior to that, Moody’s last rating action on Ireland was taken on 17 April 2009 when the rating agency placed the government bond ratings on review for possible downgrade.
Moody’s last rating action affecting NAMA was implemented on 16 June 2010, when the rating agency assigned an initial rating of Aa1 with a negative outlook to the senior unsecured debt issued by NAMA, which is backed by a full guarantee from the Irish government.
The principal methodology used in rating the government of Ireland and NAMA is “Moody’s Sovereign Bond Methodology”, which was published in 2008 and can be found at http://www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody’s website.
After a sharp drop this morning, the Irish stock market have regained most of its losses, and the Overall Irish Index is down 0,55% at the moment.
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