CREDIBILITY, TRUST and confidence are required when a government seeks to raise money on international bond markets, particularly to finance a soaring budget deficit. Above all, lenders need assurance that a sovereign borrower will not default on a loan repayment. Bond investors must trust the country’s economic data, regard a government’s deficit reduction plan as credible and remain confident that the government can meet its policy promises. The Greek government has already failed two of these three critical tests.
Greece’s economic statistics, as the European Commission has discovered and as its government has acknowledged, are not to be trusted. The Greek government’s plan to cut the budget deficit from 12.7 per cent of GDP to below 3 per cent by 2012 lacks credibility and has been met with scepticism by investors. And confidence remains low that the government will take further austerity measures should budget targets not be met.
The European Commission was dismissive this week of Greece’s budgetary efforts, feeling it had not done enough to reduce the deficit. Last month, the country’s credit rating was downgraded by rating agencies. All this has taken its toll on Greece’s financial reputation as a result of which the country finds it harder to finance its borrowing needs. Its borrowing costs have soared as nervous investors demand a higher risk premium to lend to a country in danger of defaulting on its debt.
A year ago, Ireland’s cost of borrowing, as measured by the yield spread or risk premium over the benchmark rate set by German bonds, was higher than that of Greece. Since then the position has been dramatically reversed: now the yield spread for Irish bonds is some two percentage points below Greece, while Greece’s cost of borrowing is double that of Germany.
Over the past year, the Irish Government has displayed many of the qualities the Greek government has lacked: the veracity of its economic data has never been in doubt, while an austerity budget which relied more on spending cuts than tax rises to stabilise the deficit has enhanced the Government’s credibility with the bond markets. At a time when sovereign risk has begun to haunt investors, Greece’s botched attempts to finance its deficit have depressed the value of the euro and focused far more attention on other peripheral eurozone economies. However, Ireland – as the bond markets clearly show – finds itself better placed than a year ago to withstand any adverse fallout that may arise from Greece’s ongoing fiscal difficulties.