A year ago Ireland could finance its State borrowing on global capital markets by selling government debt at very close to the German rate for 10-year bonds. A year of great volatility in financial markets has changed all that. And today Ireland must pay investors more than that German benchmark rate. The differential, or yield spread, between Irish and German bonds has widened significantly in the past 12 months – by some one and a half percentage points.
Michael Somers, chief executive of the National Treasury Management Agency, last week warned that difficult trading conditions in global bond markets will be a feature of 2009. And that presents the NTMA with a formidable challenge in financing a high level of government borrowing this year. For Ireland will be in competition with other sovereign borrowers on global financial markets, where US and European governments will also raise huge sums to finance their national debt.
Irish Government debt is still regarded as among the safest in the world by credit rating agencies. Ireland’s debt ratio is still well below the EU average. Nevertheless, the national debt has risen sharply within a short time period. In 2007 the figure stood at some €37 billion. It now stands at € 51 billion and by year-end it may well exceed € 70 billion. That prospect – the doubling of the debt in two years, albeit from a low base – presents the NTMA with a much harder task in selling Irish bonds to international investors in 2009.
That task will, of course, be helped by Ireland’s membership of the euro, which on New Year’s day celebrated its 10th birthday with the arrival of the sixteenth eurozone member, Slovakia. The euro has proven a remarkable success, despite the many grim warnings from sceptics that the currency union was doomed. The European single currency would fail “economically, socially and politically”, Mrs Thatcher insisted: she has been wrong on all counts. Indeed the strength and stability of the euro has never been more in evidence than in recent months, as global financial turmoil intensified following the collapse of Lehman Brothers. In contrast the difficulties this presented for some countries outside the eurozone, like Denmark, are readily apparent. To defend the exchange rate and to prevent capital flight, they have to keep interest rates high. Not surprisingly, public opinion in many of these countries (for example, Denmark and Poland) has moved in favour of joining the euro.
For Ireland, the benefits of eurozone membership – most notably, exchange rate stability and low interest rates – have greatly outweighed the costs. One hazard of membership has been that Britain, Ireland’s largest trading partner, has remained outside the euro. When sterling was strong that hardly mattered. In the past year sterling has slumped in value, dropping by more than one quarter against the euro, and Irish exporters face a huge challenge. But with devaluation no longer an option, recovering lost competitiveness offers the only solution. However, with unit labour costs rising far faster in Ireland than elsewhere that is going to mean a necessary, but very painful, adjustment.