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Source: Reuters

UPDATE 1-ANALYSIS-High Irish pain threshold begins to impress

Published: 03 Feb 2010 06:30:56 PST

* Cross-party agreement could ensure continuity

* Risks include mortgage defaults, killing nascent growth

* Irish stock market up since budget, CDS spreads steadier

* Social protest limited

DUBLIN, Feb 3 - Ireland has begun to convince investors it has the public and political will to sustain financial pain long enough to heal its economy, providing a blueprint for other highly-indebted nations to ponder.

By moving fast on fiscal action and explaining the need for it early on, Ireland's government may have more, if still grudging, public support than other struggling nations, notably Greece where investors worry about union reaction to reforms.

The former Celtic Tiger lost its bounce spectacularly as its gross domestic product fell by nearly 11 percent from a 2007 high, more than double the average euro zone peak-to-trough decline.

The economic situation remains grim. In January, the jobless rate hit a 15-year high of 12.7 percent.. Ireland's services sector shrank and the manufacturing sector also deteriorated at a faster pace, partly because of bad weather, according to the NCB Purchasing Managers' Index.

But after two emergency budgets plus deep public spending cuts in last December's regular budget, Ireland's stock market has risen, confidence has grown in government bonds and economists have begun to predict a return to very modest growth some time this year. (For analysts poll, click on)

The public's response to the government's fiscal medicine has been one of reluctant acceptance. Political parties broadly speaking agree on the need for cuts, making it feasible austerity measures could continue if needed beyond the current political cycle, scheduled to end with elections in 2012.

"The road to recovery has started, and forward-looking investors are happier that such spending and cost-base cuts can be achieved," said Richard Batty of Standard Life Investments.

"This gives a salutary lesson for other nations," he added and was not just referring to euro zone countries.

"A form of medicine for the UK economy is due to be taken soon," he said, although the dose might not be administered until after a general election, to be held by early June.

As evidence of rising confidence in the Irish approach, Batty cited stabilising credit default swaps.

Used to insure against default, these financial instruments are viewed as a direct measure of investor nervousness.

Irish credit default swaps (CDS) have steadied to around 150 basis points, which is still high but far from an all-time peak of nearly 400 bps in February last year.

CDS for Greece -- which is this year expected to become the EU's most indebted country, with a debt to GDP ratio estimated to be more than 120 percent -- are still approaching 400 bps. The Irish government has forecast a debt to GDP ratio of 77.9 percent for 2010.

Investment bank Goldman Sachs is among those to see value in Irish assets, especially relative to other struggling euro zone economies, known collectively as the PIIGS (Portugal, Ireland, Italy, Greece and Spain).

"We are constructive on Irish assets versus Spain, Portugal and Greece," it said in a note.


No one denies there are downside risks, including unemployment (already around 13 percent), mortgage defaults and the risk too much pain will kill nascent growth.

"The danger is that you can be too virtuous on the fiscal front and the Irish government will be mindful of tightening policy whilst not killing growth too much," said Peter Dixon of Commerzbank.

In contrast to say Britain, Ireland does not have the luxury of a floating currency. Its cost-cutting therefore has to be more draconian, potentially draining spending power and curbing growth as it cannot weaken its currency to spur competitiveness.

Public sector pay cuts of between 5 percent, for lower earners, and 15 percent, for the highest earners, have contributed to falling retail sales figures.

It is accepted that Ireland's efforts to navigate out of recession while tied by euro zone rules are largely untested.

"It's a big experiment. It's never been done before," said Philip Lane, professor of economics at Trinity College Dublin.

But he thought drastic measures appropriate.

"The gradualistic approach is a long, drawn-out process. It's better to have a fairly sharp correction and hopefully a resumption of growth thereafter," he said. "All the political parties have more or less the same approach. No party is saying we should do something differently."

The question is how long will the austerity have to last?

When it announced cuts of 4 billion euros in December, the Irish government said that was part of an overall plan to make savings of 15 billion euros within four years.

That might not be necessary.

"Some good news is that the economy may grow faster in 2010 than the government currently expects, which will improve the starting point for the austerity measures to have an effect," said Commerzbank's Dixon.

Last year's measures were too extreme to be repeated, but they were significant as an expression of will, he said.

"There is a trade-off between what is needed and what is possible. The reforms do go a long way towards tackling the problems -- but more than that, they are a signal of intent."

In response, Irish public servants have embarked on work-to-rule protests against pay cuts, but their cause has excited little sympathy from the general public.

In contrast to the serious threat of unrest in Greece, in Ireland few expect a repeat of last year's national strike and opinion polls have shown the government's tough approach has earned it a very modest increase in popularity.

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