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Why are Irish Government bond spreads so high?

Well this might not seem like a mystery at all, given the ballooning budget deficit and the overhang of banking problems. But I do want to ask what others think about the potential role of the overfunding/prefunding of the government deficit.

The NTMA’s recent Preliminary Results highlights the fact that there was additional borrowing of 8 per cent of GDP in 2008 over and above what was needed to cover the Government’s borrowing requirement for 2008. This extra amount has been banked (safely I am sure).

Of course this should all be transparent to an efficient market, but could it be that such a large volume of gross borrowing might have contributed to market sentiment against Irish paper and increased the spread over bunds?

After all, this additional borrowing affects the General Government Debt to GDP ratio driving this to 41 per cent. (Though it does not affect the traditional National Debt ratio which is around 31 per cent of GDP).

14 replies on “Why are Irish Government bond spreads so high?”

Spreads were relatively tight up until Lehman’s bankruptcy, moved up a bit over the following two weeks, and then really exploded over the final three months of the year. That timing might suggest that the Government Guarantee and bad economic/fiscal news are primarily to blame.
It is striking that Net Debt was only 20 percent of GDP at end-2008. That should mean plenty of room to maneuver.

No doubt that fiscal/banking issues, and the prospect of heavy future borrowing are the main things.

And it is true that part of the overfunding partly dates to before end-September.

I guess the striking contrast is between the apparent “room to maneuver” indicated by net debt to GDP and the fact that spreads are higher than Italy at 150 basis points over ten year bunds. Future expected borrowing needs is the prime suspect, but I do wonder whether an optical illusion from such large gross borrowing in recent months has added to the market spreads.

On Patrick’s striking contrast, I assume that markets are implicitly viewing our current net debt as being a lot bigger than ithe official numbers show, given the state of the banks and the guarantee scheme. Could a clever person back out from the interest rate spread the additions to the national debt which markets are expecting as a result of the banks? (I guess one has to make assumptions about probabilities..)

I doubt that the widening of Irish-German yield spreads has much if anything to do with what Patrick describes as ‘additional borrowing’ by the NTMA. This overfunding of the 2008 budget deficit appears to be entirely attributable to issuance under the Agency’s Commercial Paper programme which is very short-term stuff with what I would imagine to be a typical maturity of 3 months or so. As such we’re talking about debt instruments with a very different market to that for 5- or 10-year bonds.
Two other points on this. The first is that Ireland is by no means an outlier in terms of spread widening vis-a-vis Bunds: other ‘peripheral’ euro-zone sovereigns have suffered a similar fate, amongst them Greece, Italy, Portugal and Spain. In other words there has been a generalised flight to quality.
Second, as the NTMA is keen to point out in its recent statement, Ireland continues to be ranked as a AAA issuer (and with a stable outlook to boot!) by all the rating agencies.

With the threat of deflation on the cards I am surprised that (given our AAA rating as mentioned by Jim) that we need to offer such high yields to attract investors, surely anything that has that rating would not need to offer so much more in order to attract investors given the deposit options and deflation risk?

the only other answer can be that Ireland is viewed as a country that is writing IOU’s but that we don’t really have a set way of paying them back the way the Germans might, not to say that we never will but my question is this – where does the money come from?

We can’t devalue our currency, and the EU stimulus package (coming in the form of rate cuts) isn’t making a difference, instead we are seeing the deficit widen by the month while tax takes fall, simply put the market is accurately reading the facts.

Well, Jim, you’re much closer to the market than I would be, but approaching €20 billion seems like a lot of borrowing, at whatever maturity, for the market to absorb.

I take it that your reference to other peripherals does not imply that you think our little local problems have nothing to do with the spread!

In response to Karl, Irish 10-year bonds are yielding 4.2 percent at present, which doesn’t look especiallly high to me. I take your point about deflation, but surely we are not looking at 10 years of deflation! Is it not reasonable to assume that inflation will average, say, 2 percent, over the next ten years? If so, an ex-ante real yield of just above 2 percent is not expensive. Of course, yields may well rise from present levels in response to bad news/policies/luck.

Of course €20bn is alot but some of it is apples and some oranges. My take on it is (and I’m nowhere near as close to the market as I used to be – Maynooth is in a different time zone from Dawson St!) that just as there has been a flight to quality names (like Germany) so also, for any given name, there has been a flight to the safe end of the maturity spectrum. Thus the Irish government’s attractiveness as a short-term issuer is not much diminished even if, for the reasons adverted to in other posts on this thread including those ‘little local problems’, long-dated Irish paper has to offer a much increased risk premium.

In response to Alan, what I meant by the bond spread if deflation is a genuine threat is this:- anything above German bond is a big plus if it is AAA rated in an environment where deflation may be likely (so even if Ireland only offered 10 basis points more then it should be attractive in this set of circumstances).

If interest rates go so low that deposits rates are near zero it would mean that bond yields are particularly attractive at the german pricing (I looked at the 5yr) which is currently 2.438 vs the Irish 5yr at 3.807.

So if deflation is such a threat and we are AAA rated then why do we need to offer 137 basis points more to attract offers?

Simply put we shouldn’t have to, so either the bond pricing is wrong or the AAA rating is, or (worst of all) our assumed ability to repay is not believed on some level by the market.

Regarding deflation/inflation, I think 2% inflation might be reasonable [perhaps even optimistic!] for 09′ and maybe early 10′ but after that I would wager on high single digit to low double digit inflation.

The NTMA has a track record of “overfunding” in the sense that it raises more funds on the bond markets than it needs and then holds the proceeds in liquid form till they are needed. This pattern developed in the 1980s when they were concerned that funds might dry up, given the very difficult circumstances then prevailing. Given that the some of the key personnel who managed the debt in the 1980s are still responsible for it today it would not be surprising if a similar pattern were followed now.
In 1986/7 the precursor of the NTMA carried out a “sting” on the market. They overfunded in 1986. However, instead of lodging the funds with the Central Bank, they were held in liquid form abroad. This meant that they were not netted off the debt (as is the normal practise with liquid funds held in the central bank) so that the national debt appeared to rise more rapidly than people expected. Coming into 1987 many banks expected that the Irish government would again have to raise a large amount on the market. However, at that point the liquid funds were repatriated and the markets found that the government would not be borrowing significant funds in Irish pounds for quite some time. The consequence was a significant fall in interest.
This experience highlights the major problems with the accounting conventions applied to the government’s balance sheet both in Ireland and elsewhere.
If the NTMA has raised more funds than are currently needed, the holding of liquid assets should be netted off the gross debt to arrive at the true national debt figure. However, if the funds are used to recapitalise the banks then the national debt will reflect the gross borrowing.
In Ireland as in all other countries, there is no national balance sheet published. This means that the cost of recapitalising the banks is probably grossly exaggerated. As the shares in most if not all the banks are worth approximately the amount subscribed by the government, a national balance sheet would paint a very different picture of the consequences of such a recapitalisation.
The rise in the gross debt, looked at on its own, looks pretty dramatic. However, the government has to provide for the recapitalisation of the banks as well as funding the deficit . If the government published a balance sheet it would provide additional information to the markets. While still showing a major deterioration in the strength of the economy, the picture which such a balance sheet would show would be rather different from that painted by the gross debt figure and it might warrant a lower risk premium. Of course this argument also applies to all other governments who are having to raise funds to recapitalise their banking systems.

Assuming that the NTMA’s surplus cash is on deposit with Irish banks, then the postion of the Irish banks surely is considerably worse than is beng admitted. This would suggest that the depositors are shunning the banks here.

Has this money been borrowed to fund deposits with the banks, because some of them cannot get access to cash themselves?

If the position is as John Fitzgerald suggests, and Anglo Irish are consistently on top of the FT’s list of rates offerred on deposit accounts, retail depositors have very little faith in the Irish Government guarantee. I

Shopping centres in Kiev and Ufa don’t strike me as worthwhile collateral, let alone commercial property in the UK!

In response to Jim – yes the ratings agencies still have us at AAA, but for how long? Plus, the ratings agencies are not exactly ‘ahead of the curve’ when it comes to such minor things as the solvency of corporations (Enron et al), never mind the solvency of sovereigns.

Constantin Gurdgiev recently posted a blog on S&P’s outlook downgrade for Ireland (http://trueeconomics.blogspot.com/2009/01/s-downgrade-for-ireland.html) and made the argument that our AAA rating does not hold water when one considers we are underwriting such institutions as Anglo Irish et al.

Patrick, I hope so, but do we know for sure? My point is that there is little or no trasparency in the Govt.’s actions or in the real state of the banks’ balance sheets. Some, none or all of the money may be on deposit with Irish Banks.

As effectively, by way of the guarantee scheme, the State has taken the banks’ liabilities on to the National Balance sheet, would you suggest to anyone to buy the bonds of a country with such a huge contigent liability?

By the way, Anglo Irish are at third place for fixed rate deposits giving 4.6% for a one year bond and top of the easy access table with 4.55% in the UK.

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