Taoiseach Enda Kenny’s second government is drawing the same kind of positive judgment in financial markets as his first. With 10-year sovereign borrowing costs still well below 1 per cent and close to a record low, Moody’s credit-rating agency delivered a fillip to the new administration by putting an A grade on Irish debt for the first time in years. But what’s behind the sentiment? And can it last?
Internal and external forces are at a work, say analysts. If the course of Government action and the evolution of risk and events will determine how things go in future, the Government’s opening position is viewed in positive light. In a volatile international situation and with pay and other pressures mounting on the domestic front, ensuring that continues will be a critical challenge in the months and years ahead.
One factor is a clear sense of confidence in markets that the minority Government – for all its political frailty, and for all the uncosted promises it has made – won’t do anything radical to swerve from the corrective course of fiscal policy. This is on top of steady improvement in the public finances, itself accompanied by rapid economic growth and the return of domestic demand as consumers gain in confidence.
Another factor is the continuation of big European Central Bank bond-market interventions, which keep a lid on the cost of servicing the State’s abundant debts. Still another is a sense of anticipation in markets that Britain’s looming Brexit referendum will not lead the country out of the European Union.
Bond ‘A’
rate In spite of bitter political inf
ighting this week over variable mortgage rates and yet another Garda controversy, this is the rather benign backdrop against which Moody’s followed rivals Standard & Poor’s and Fitch last Saturday to assign an A rate on Irish bonds.
The first driver was Moody’s assessment that key credit metrics were improving at a faster pace than foreseen even a few months ago. The second was the perception that the risk of fiscal policy reversal was limited. This was the case even after a dubious political U-turn on water charges and in advance of a further U-turn on waste charges.
The manoeuvre by Moody’s was significant, as the first rating action after any government takes offices marks a test of its credibility and clout. Although Moody’s expects the growth rate to moderate, the upgrade can be seen as a vote of confidence in the Taoiseach’s new government. While Moody’s was simply doing the same as rivals did earlier, market observers had expected it to wait until after the British referendum in June.
“The timing of the Moody’s upgrade is a positive surprise to the market, despite being way overdue, in our view,” wrote Anders Møller Lumholtz, chief analyst in the fixed-income research division of Danish bank Danske.
“In line with eight out [of] 11 analysts, we expected that Moody’s would wait until after the Brexit vote, although we first called for an upgrade to A level back in 2014.”
Impressed with declining deficits and a marked reduction in the debt-to-GDP ratio, Moody’s said the political agreement between Fine Gael and Fianna Fáil “gave comfort that the budget deficit will be reduced further in coming years”. This is crucial, say analysts.
“Fianna Fáil and Fine Gael are clearly now in a working relationship of some sort,” said Bill O’Neill, head of the UK investment office at UBS Wealth Management in London. This form of alignment between the two big Irish parties was in contrast to the schism between the major Spanish parties, he added.
“That is a comfort to the markets. They may argue over the means but the objective is the same,” said O’Neill.
This is in keeping with the Moody’s assessment. “Even during the election campaign, there has been little disagreement between the two parties on the direction of fiscal policy and the need to reduce the budget deficit and public debt further,” the agency said.
Moody’s blessing came in spite of concern about the narrowing tax base and weaknesses, underlined in forceful terms by the European Commission, and despite anxiety about the low rate of public investment, set out by business lobby Ibec.
On top of all that are market worries about political interference in banks’ mortgage rate-setting, which could constrain competition and hamper the investment case whenever nationalised banks are being privatised. What is more, the 160-page programme for government included dozens of political promises and not much by way of costings.
Budget deficit
One answer to all that is that the new Fine Gael-led administration has pledged in unambiguous terms to maintain its commitment “to meeting in full the domestic and EU fiscal rules as enshrined in law”. Thus did the Government promise to eliminate the remaining budget deficit by 2018 and keep the public finances “broadly in balance” thereafter.
Such pledges were certainly cast as a solemn declaration of intent not to return to wayward ways in the public finances. Still, analysts warn that deeds and not words are the real test of any government’s promise uphold high fiscal ideals.
“It is an important commitment,” said Jean-Michel Six, the Paris-based chief economist at S&P for Europe, the Middle East and Africa. “I’ve heard similar commitments time and again and in many different places, which explains my reservation, my caution. It is welcome. It’s a pretty good statement. It’s good to have in there. But I would not bet the ranch on it. Let’s see what happens specifically.”
Six, who was in Dublin yesterday for a conference, said the “political stability” seen in the formation of the Government was a plus. “We don’t have that in many countries,” he said.
“When I say I am cautious, that’s not derogatory in any way. It’s just that, over the years, I’ve learned that there’s a distance between the words and facts and the action. There seems to be a will to do certain things to improve the situation.
“What we’ve learned through this crisis is that when the times are good or better, reducing deficits and reducing public debt is difficult to do because what you fear is that that will reduce the rate of growth.
“And when times are bad, of course, you’ll have all the arguments you need to say: ‘Well, it’s not the right time to do this.’ So it’s never the right time. In that sense it really takes some political grit to say: ‘Okay, now the rates of growth we’ve seen allow us to be a bit more focused on the fiscal side because we are back on sustainable growth.’”
Even though Ireland continues to derive big benefits from low borrowing costs, UBS’s O’Neill suggested the rapid decline in the debt-to-GDP ratio raised questions.
“From our perspective, Ireland has low debts at relatively high cost in terms of debt affordability.”
The prime question for markets centres on the sustainability of the Government, he added. However, the common commitment of mainstream parties to a programme of fiscal stability provided a comfort blanket for international markets.
Then there is the Brexit riddle, which presents clear potential for disruption on several fronts within Ireland, within the crucial British market and in the setting of the wider EU.
The poll present a downside risk for Ireland given close trading ties with Britain, Moody’s said. The impact would be greatest on “indigenous” Irish sectors such as agriculture, food and tourism, it added. Still, Ireland could benefit from additional foreign direct investment inflows.
“On a net basis, the impact would most likely be negative for Ireland, albeit manageable overall,” the ratings agency said.
This particular matter is in the hands of British voters. It is, however, but one of many moving parts on the landscape.
