FOUR MONTHS ago the most pressing question in some quarters was whether Ireland could continue to borrow to finance a soaring budget deficit that was slipping further out of control. The answer was that it could do so with increased difficulty and at a higher financial cost. Foreign lenders sought ever-higher returns to compensate for the greater risks associated with a shrinking Irish economy – which may contract by 2 per cent in the three years to 2010.
In March, the yield difference – or spread – between Irish and German ten-year bonds had touched a record high. Ireland, as a sovereign borrower, was paying far more than Germany to issue government debt – almost 3 percentage points more – even though both countries share a common currency, the euro.
That yield gap has since narrowed, and the differential is now closer to 2 percentage points. As Ireland’s borrowing premium has declined, so too has the annual cost of servicing the national debt, which represents some welcome news for taxpayers.
What is the reason for the sharp turnaround? Certainly, international investor sentiment towards Ireland has improved greatly in recent months, despite the loss of the country’s triple-A credit rating in March. Michael Somers, chief executive of the National Treasury Management Agency (NTMA), which borrows for the government and manages the national debt, has detected a noticeable shift in attitude by international investors, plainly impressed by the Government’s plan to stabilise the public finances by 2013. In financial markets, however, sentiment is notoriously fickle.
Fears of debt default, and suggestions that Ireland might be forced to seek sanctuary with the International Monetary Fund (IMF) may well have seemed greatly exaggerated, given Ireland’s low level of government debt. Nevertheless, at times of great financial and economic uncertainty, markets may be moved as much by sentiment as by more fundamental concerns. The success in changing a negative international perception of the Irish economy into a much more positive one, as measured by a reduction in borrowing costs, does represent a considerable achievement. It helps achieve stabilisation of the public finances, which is the foundation for economic recovery. The Government can take some credit for what Dr Somers has described as the “huge change in general sentiment towards Ireland”. Finance Minister Brian Lenihan impressed international investors needing further reassurance about Ireland’s creditworthiness during his recent tour of major financial centres.
That said, as Dr Somers has warned, international investor sentiment could also quickly change for the worse. A second rejection by voters of the Lisbon Treaty would prove greatly damaging in international markers. So too would any sign the Government lacks the political will to meet the tough budget targets required to stabilise the public finances. Much of the renewed confidence of international investors in the Irish economy is now based on the Government being able to keep its word, and deliver the tough medicine it has promised – regardless of the political consequences.