Saturday, August 25, 2012

Cautious Optimism As Irish Bonds Dip Below Pre-Bailout Levels

Irish bond yields: Bloomberg

It is of some welcome relief and a moment to celebrate with the news that this week saw the yield on the government’s bonds due to mature in 2020 fall below 6% for the first time since the bailout. This is in fact a fraction lower than Spanish bonds, a country that did not have to take a full sovereign bailout from the Troika and not far off Italian yields either. For some it would be seen as vindication for austerity, that the extreme cuts demanded by the bailout are working. However this is probably not the reason.

When one compares the countries that have requested a bailout from the Troika or are on the watch list for one, there is a slight difference between those nations and Ireland and Portugal, whose bonds also this week dropped to pre-bailout rates. The difference is that once Ireland and Portugal requested a bailout, those two countries have implemented with very little hesitation or procrastination the entire programme of austerity requested of them as terms for receiving the bailout money. The austerity has been exceptionally painful for both nations but they have been unwavering in their implementation. Neither country has called for more time in implementing austerity. Contrast this with Greece where virtually all trust has been lost due to their ducking and diving and this week’s request for two more years to fully implement austerity. One can also contrast Ireland and Portugal to a lesser extent with Spain, where the government of Prime Minister Mariano Rajoy consistently drags its’ feet in implementing structural reforms, tackling vested interests and coming to terms with the shocking debts of its local banks and strongly independent regions.

The reduction in bond yields should not be seen as austerity working. In fact the austerity has resulted in a depression in domestic demand in Ireland that Irish GNP, which is a measurement of the economy less the outflows from multinational entities has been almost consistently decreasing since 2007. The size of the economy is still significantly below pre-crash levels with austerity exacerbating the situation. Ireland has been fortunate in that its highly export orientated economy has held up in the past few years, albeit in very specific fields such as pharmaceuticals and to a much lesser extent agricultural produce. The fruits of this growth have not fed in to the domestic economy. This has continued the historical deviation between GDP and GNP, the former holding up well the past few years but there still seems to be no end in sight to this exceptionally long recession domestically in Ireland.

The reduction in bond yields should be seen as a large part due to the unwavering implementation of austerity even in the face of it causing a prolonging of the recession. It is a badge of confidence given to us by the markets, which have in the past shown extreme displeasure in half-baked proposals and shoddy implementation of reform and austerity in other countries. Markets do not like to be surprised and like us all, find comfort and satisfaction in sticking to the book. It is in essence an award for doing everything that had been asked of us even if it was not all for the best.

The government should not become complacent for without growth the austerity will become an uncontrollable death spiral for the Irish economy. Bond yields could easily shoot up if the economy continues to contract, thus making the level of debt larger in relation to the size of the economy thus necessitating more cuts. That is a real danger for Ireland, as the world economy seems to be heading for a slow down whose magnitude we have not fully grasped yet. Therefore one should be allowed to celebrate but with extreme caution. 

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