VIEW FROM THE MARKET:Perceptions are divorced from reality regarding Ireland's stabilisation efforts

IF THE latest pricing signals from the sovereign bond markets are to be believed, the heavy burden of adjustment borne by the Irish economy, its public finances and its banking system over the past 18 months has all been in vain.

Irish spreads over benchmark Bunds have ballooned out to record wides since early August, while absolute yield levels have breached the 6 per cent watermark in 10-year maturities, exceeding the highs visited during the darkest days of early 2009.

Although some of this recent spread widening may be attributable to a renewed bout of risk aversion across the asset classes during August, the brunt of the move has a distinctly “Guaranteed Irish” look to it. Concerns over Irish solvency and liquidity risks have reignited in the financial media of late, encompassing both the sovereign and the banks.

Bearish commentary has focused on a number of prevailing event-risks, ranging from the restructuring of Anglo Irish Bank, recapitalisation of AIB, the ostensible “funding cliff” facing banks as a whole and, not least, the outlook for Ireland’s sovereign credit rating in the wake of a recent and controversial Standard Poor’s downgrade.

It is readily apparent that market perceptions surrounding Irish solvency and liquidity risk are now substantially divorced from the reality on the ground. Although the burden on Irish taxpayers arising from enforced banking sector interventions is a deeply unpalatable one, it is far from insurmountable, given the relatively low stock of public indebtedness and debt servicing costs that still pertains in the aftermath of the crisis.

Solvency concerns continue to be credibly addressed at both sovereign and bank levels, the former in the shape of the Government’s 2010-2014 fiscal consolidation plan, and the latter in the context of the Nama process and attendant recapitalisation of the Irish banks. Meanwhile, a fully funded exchequer borrowing requirement now extends to the second quarter of 2011, while the immediate refinancing needs of the Irish banks are being accommodated by substantial contingent liquidity.

Nonetheless, perception can trump reality for prolonged periods in financial markets, all the more so if media commentary is relentless and concerted in its persuasion. The inevitability of ultimate Irish sovereign default has suddenly become de rigueur in certain reputable external media, the nation’s “effective insolvency” (Financial Times, September 6th, 2011) being often asserted not on the basis of first principles research but rather on the received wisdom (sic) of others. Meanwhile, ongoing name-confusion of Anglo Irish Bank with Allied Irish Banks has done little to alleviate current market tensions.

In truth, foreign misrepresentation of the Irish story is being partly fuelled by domestic coverage. Given the clarion calls of many opposition politicians and academics for a default of Irish liabilities as a legitimate policy “solution”, the self-fuelling impression conveyed abroad is one of heightened insolvency risk.

The domestic mood is understandably angry in relation to the continued fallout from Ireland’s economic and banking catastrophe, but the quest for retribution (via default) from certain quarters is a hopelessly misguided signal to transmit abroad, given our continued reliance on external support to bridge the large “funding gap” for both exchequer and banks.

Lest anyone believe there is a “shoot the messenger” element to all of this, yesterday’s adverse feedback loop between the domestic and foreign media tells its own pitiful tale. On Thursday, a major overseas investment bank opined that Ireland did not require IMF aid assistance – “at least for now”. This morphed into “may yet need help” on the front page of a major Irish newspaper on Friday, and from there back to the newswires, only now with Ireland “perilously close” to an IMF intervention.

Irish bond yields and spreads spiked sharply higher, before official rebuttals from both Minister for Finance Brian Lenihan and the IMF itself stabilised matters, albeit with substantial damage from the day’s Chinese whispers already done.

At a current five-year sovereign CDS spread of 410bps, the market ascribes a 34 per cent probability of Irish sovereign default over the next five years.

This appears wholly at odds with the State’s relatively restrained debt- servicing profile which, at an estimated 4.2 per cent of GDP by 2014 (based on average funding costs of 5.5 per cent), is roundly half the levels of the early 1990s, a period during which the sovereign comfortably discharged all of its liabilities in full.

With the economy once again exhibiting impressive flexibility to hasten the recovery process, and the ultimate burden of banking stabilisation now increasingly quantifiable, Ireland’s creditworthiness is, for the moment at least, both underappreciated and undervalued. If a nation’s solvency is defined as “the ability to finance debt in a sustainable way”, then the combination of Ireland’s prospective stock of public indebtedness, debt-servicing costs and flexible market economy renders such financing eminently sustainable.

Donal O’Mahony is global strategist at Davy Capital Markets