Ireland is set to come under renewed scrutiny in financial markets whenever Taoiseach Enda Kenny calls the general election. At issue for international investors is whether the next administration maintains the thrust of policies which have finally spurred growth after years of turmoil.
This is no small question. Ireland’s high national debt and high dependence on foreign direct investment mean external confidence is crucial.
The eyes of the financial markets are not trained on Dublin right now, that is clear. But the inevitability of the election – early in the new year, most likely – means attention will turn to Ireland soon enough.
“Generally speaking the market dislikes elections. The mere fact that there is an election is like opening the Pandora’s box for investors, and smaller countries are particularly more susceptible,” says Michael Michaelides, European rates strategist at Royal Bank of Scotland in London.
Still, the backdrop for the election is perceived in markets to be a good deal more benign than was the case even a few months ago.
For one thing, reluctant acceptance of the third Greek bailout package by the radical-left Syriza government has blunted the force of anti-establishment rhetoric from its would-be bedfellows in Ireland and other crisis-struck countries such as Spain.
For another, the expectation of a new round of quantitative easing from the European Central Bank underpins confidence that funding conditions in euro zone sovereign bond markets will remain positive for some time to come.
This is crucial. Market participants note with some caution that €1.5 billion in supplementary spending this year meant the budget for 2016 is a lot larger than foreseen.
However, they say the expectation of more quantitative easing from the ECB means there is less market focus on the the “looser” stance in the budget.
“People paid the Italian government to take their money last week. The pricing of these risks has been significantly muted,” says a US-based investor in Irish debt.
All of this comes on top of speedy economic growth in Ireland, a big rise in tax revenues, solid progress to rein in the budget deficit and a declining debt ratio vis-a-vis gross domestic product. That is for the good, no doubt, but will it continue after the election? In summary, investors believe it will.
Semi-core market segment
Notwithstanding big ECB interventions, low Irish borrowing costs indicate that the State’s bonds are increasingly priced in the “semi-core” segment of the euro zone market alongside the likes of Belgium. That hardly suggests investor disquiet over the outlook for the election.
But market chatter persists around the rise of Sinn Féin, the hard left and Independents.
The perception of Sinn Féin is that it is not investor friendly, likewise the hard left. Neither is likely to be in government after the election, but questions are raised in the international setting as to whether the advance of such parties would lead to a hung Dáil.
“I don’t know if there’s a huge amount of focus on it right how but I’ve heard sporadic debate that Sinn Féin is extremely popular,” says the US-based investor, echoing the observations of other market participants.
“I don’t think a Fine Gael/Fianna Fáil government or the return of Fine Gael/ Labour would be news. It’s something that would keep the sovereign on the same road map it’s been on for the last four or five years. I don’t know if the market would differentiate between a FG/FF coalition or a FG/Lab coalition.”
Given that the Irish election is preceded by votes this year in Greece, Portugal and a looming poll in Spain, other observers concur that Ireland is not in immediate focus. But the outcome of the Portuguese election is seen to be salutary. Centre-right prime minister Pedro Passos Coelho won the most seats but not a majority, prompting ongoing efforts by opposition Socialists to form unlikely alliance with communists and another leftist party to topple his minority government.
“There were more interesting elections beforehand,” says Michaelides of RBS.
“For that reason Ireland is less in focus – funding needs are coming down, it’s converting to semi-core – it doesn’t seem interesting. The reason it might be slightly more interesting is what happened in Portugal.
“After Portugal there’s heightened awareness. No one has really asked who could combine with who in the Irish setting, and who are these Independents.
“I expect that sort of question to come more into focus, particularly when the election is called. No one is focused on it right now.”
Political concerns
But the election countdown is on. Citing the evolution this year of borrowing costs in Greece, Spain and Portugal, a Dublin- based trader says “political concerns” have been a major driver of relative government bond yields.
“Ahead of the Spanish regional elections held on September 27th, Spanish bonds underperformed their peers on fears of a pro-independence Catalan support,” the trader says.
“There was less concern from investors leading into the Portuguese elections on October 4th as polls suggested a centrist coalition would be the result. However, since the three parties making up the left alliance attempted to form a rival government in the aftermath, risk premium has increased.”
This person notes that Irish bonds have performed “weakly” in recent times, with the yield on 10-year paper widening by eight basis points versus equivalent French bonds in the past two months.
Although European Central Bank president Mario Draghi set off a rally in euro zone debt when he signalled an expansion of the quantitative easing programme a fortnight ago, the impact on Irish bond yields was negligible.
The trader attributes this to uncertainty over the election.
Michaelides of RBS is not inclined to agree with that assessment. “I would say it’s premature to say Ireland is not holding up because of the election,” he says.
But he also argues that the timing of the election in the first quarter of next year may not be helpful, particularly if the ECB actually moves ahead with another dose of quantitative easing.
“Ireland may not benefit as strongly from early-year flows as it would have done if the election had already passed, particularly given that quarter one tends to be most active period for most asset managers.”
Further questions surround the stance of credit rating agencies in relation to Irish debt, although market participants say that is less important these days than in the past.
At issue here is the stance of Moody’s, which stands apart from rivals Standard & Poor’s and Fitch by not having an A rating on Irish debt.
Thus the fiscal policy of the next administration will be crucial. “From our perspective we want to form a view on fiscal policy further, what that means for public debt and debt trends and how the economy performs,” says Kathrin Muehlbronner, senior vice-president at Moody’s.
“Anything that gives comfort that rapid fiscal consolidation will continue would be welcome. We don’t give recommendations but our view is that the faster you reduce the deficit, the faster the debt ratio comes down.”
Uncertainty
Muehlbronner notes inevitable uncertainty around the election. “Clearly we have seen in a number of European or euro zone countries that elections this time around have produced some surprises. I wouldn’t say it’s a huge uncertainty or huge risk factor, but there’s bigger uncertainty than in the past. That doesn’t only apply to Ireland.”
This brings us to the question of political stability, a mantra for Coalition parties as they gear up for the election. “Political stability is always better than political instability, that’s nothing peculiar to Ireland,” says Muehlbronner.
“It’s probably more a question of having a majority government, having a stable majority, that the next government can settle on whatever the policies are, and you don’t have a long period of forming the next government.”
Gergely Kiss, a London-based director in the sovereign group at Fitch ratings agency, says Europe’s new fiscal rules present a key test to the next administration.
“Any new Irish government will really need to remain compliant with the fiscal rules. Our baseline assumption is they remain compliant. The higher transparency built into the fiscal rules means that we will see early if a government is not compliant with fiscal rules,” he says.
“There is really a credibility earned through the consolidation period. Ireland really stands out a country which always delivered, or overachieved its fiscal targets. It makes a comfortable starting position that you have this credibility.”
