Sovereign debt: Irish reforms rewarded with blowout return
Deal attracts 400 bids; deficit remains a concern.
At the beginning of January, Ireland made a triumphant return to the international bond markets, drawing some €14 billion of demand for its €3.75 billion 2024 bond, as investors rewarded the country for its exit from a three-year €67.5 billion EU/IMF funding programme.
January’s bond sale resulted in Ireland funding itself for 10 years at 3.4%, some 50 basis points lower than a similar bond issued a year previously and 11 percentage points below the intraday trading high in the first week of 2011.
In completing the deal, Ireland’s National Treasury Management Agency pocketed a sizeable proportion of its funding needs for the year, which it forecasts at between €6 billion and €10 billion. Further, the 400 investors that put in orders were a strong indication that appetite for issuance is likely to remain robust, say bankers who worked on the deal. "They planned to do a €3 billion benchmark and in the end did €3.75 billion, which shows that among the peripherals Ireland may be in the lead in terms of the perception of how far they have come and what has been achieved so far," says Lee Cumbes, head of SSAR origination EMEA at Barclays, one of the lead managers. "The international investor base is broadening and structural reforms in Ireland are starting to take hold, so now they are getting their reward."
Certainly over the recent period investor perception of Ireland in particular and peripheral sovereigns in general has improved, with yields declining sharply across the board. The Spanish 10-year yield was 3.75% in recent trade, after tightening nearly 40bp in a month, while Portugal was at 4.98%, 102bp tighter than in mid-December.
In the days following the Ireland deal Portugal attracted €11.2 billion of orders for a €3.25 billion five-year bond, with lead managers reporting that 88% of the issue went to real-money buyers, a sign of confidence among the mainstream investor base.
The biggest beneficiary of the upswing in sentiment has been Greece, whose 10-year bonds tightened by 1.08 percentage points to 7.59% over the month to mid-January, and almost 4 percentage points over the past year.
To some extent the decline in peripheral borrowing costs reflects the facts on the ground. Irish GDP expanded 1.5% in the third quarter of 2013 from the previous quarter, helped by construction, while the unemployment rate fell to 12.5%, compared with 15.1% a year earlier. Many economists are forecasting stronger growth in 2014.
"Ireland is highly dependent on the external environment and there are signs of a pick-up in the US and UK that will feed through," says Alan McQuaid, chief economist at Dublin-based Merrion Economics. "Manufacturing is expanding and consumer confidence is rising so we may see growth of 2% this year." Some 18% of Irish exports go to the US and 17% to the UK.
On the face of it the outlook for the Irish economy looks rosy. However, beneath the surface lurk some less impressive statistics and worrying long-term trends, which might give investors pause for thought.
Of particular note is the budget deficit, which is expected by Ireland’s Department of Finance to come in slightly below 7.5% of GDP in 2013, more than Portugal’s 5.9% and still far in excess of the EU limit of 3%. The national debt hit 124% of GDP last year, compared with 93% in Spain. Greece’s national debt is 176% of GDP.
"The key question for Ireland is whether its debt trajectory is sustainable," says Ciaran O’Hagan, head of European rates strategy at Société Générale in Paris. "If we remain in a low-growth and low-inflation environment you are going to need extraordinarily low rates for that to be the case. The alternative is to think about cutting debt or at least stopping the rise in debt." The annual average rate of inflation for 2013 in Ireland was 0.5%, compared with 1.7% in 2012.
|Ciaran O’Hagan, head of European rates strategy at Société Générale in Paris|
Ireland’s budgetary situation might be even worse than the debt-to-GDP figures suggest, says O’Hagan, because of the large slice of the GDP figures accounted for by multinational transfers that are largely ring-fenced from the tax take. "Both the IMF and the OECD have been saying that in a low-growth, low-inflation environment, debt is going to continue to be a serious concern, not just in Ireland but in all of the high-debt countries," O’Hagan says. "While there may be a big supporting argument in favour of Irish debt in the short term, and the growth outlook is definitely looking healthier, borrowing per person remains high and there is a lack of awareness of these problems."
In showing their willingness to accept a 3.4% yield on Irish 10-year debt, investors might be looking through the current low-growth outlook to an improved performance further down the road, some analysts say.
"The real question is: as the economy begins to grow do they stabilize debt levels?" says Luca Jellinek, head of European rates strategy at Crédit Agricole Corporate and Investment Bank in London. "It won’t weigh on people’s minds this quarter, but if Ireland doesn’t get control of debt they will be storing up problems for the long term."