Davy Research |
|
Market Comment
Scope of EU agreement to help reduce Irish government debt unclear
02 July 2012
Conall Mac Coille
Irish nine-year bond yields fell sharply on Friday (June 29th), currently 6.436%, as markets digested the unexpected news from the EU summit meeting. Over the weekend, the government has appeared to play up the probability of securing a deal to significantly reduce Ireland's debt level. Media reports suggest that a reduction of Irish government debt to 100% of GDP is being mooted as the level required to ensure debt sustainability. This would entail a €34bn reduction in Irish debt levels, or approximately half the costs of recapitalising Ireland's banks.
What is the probability of Ireland securing such a favourable outcome? It seems clear from the EU summit statement that the ESM will consider injecting equity into Irish banks, in addition to Spain's. But the terms of such equity injections are not clear. A starting point would be that any direct recapitalisation of European banks, including Ireland's, will be on the basis that the ESM will not be expected to make a loss on its investment. What is being proposed is to break the link between government and bank balance sheets — not necessarily to use the ESM as a vehicle for large fiscal transfers to meet banks' loan losses. Perhaps any capital injections by the ESM might even be at a discount to current market prices to ensure that the ESM does not make an eventual loss.
If so, the ability of the ESM to reduce the costs (40% of GDP) of recapitalising Ireland’s banks will be much more limited than the ambitious plans reported over the weekend. It would certainly rule out large capital injections into IBRC where the equity has little value. Sales of existing government stakes in the Irish financial system to the ESM at market levels could yield 5-8% of GDP.
However, it is large leap, both financially and politically, to expect the ESM to inject capital at levels where it can have little expectation of a return. And it is not clear from last week's EU summit meeting that European politicians have agreed to the large fiscal transfers required (through the ESM) to reduce Ireland's debt level to 100% of GDP.