Irish Funding, Insurance Costs Hit Record

By Emese Bartha

The cost of insuring Irish debt against default hit a fresh record Friday with investors fearing that Ireland’s draconian budget cuts will slow economic growth and further weaken public finances.

Spreads on Irish five-year sovereign credit default swaps topped 6.10 percentage points Friday, according to data provider Markit, after having briefly touched 600 basis points Thursday. This means that investors will have to pay €610,000 annually to ensure €10 million Irish debt against default. Some market watchers note that CDS trading starts to dry up at these levels as investors worry about being caught on the wrong side of the trade.

CDS are tradable, over-the-counter derivatives that function like an insurance contract for defaulting on debt. If a borrower defaults, the protection buyer is paid compensation by the protection seller. The Irish 10-year yield spread over German bunds, which show how large a premium investors demand to hold Irish bonds versus more-stable German debt, also hit a record of 5.31 percentage points Friday.

“We doubt that next year’s €6 billion fiscal squeeze will be enough to ensure that the Irish government’s 2011 budget deficit goal will be met,” Ben May, European economist at Capital Economics, said in a note.
“This, combined with rising political uncertainty and surging bond yields, implies that Ireland may struggle to solve its fiscal problems unaided,” he said. But he noted that Ireland’s decision to front-load its austerity measures is “clearly encouraging.”

The Irish government said late last month that it would need to make budget cuts of €15 billion over the next four years in order to reduce the country’s budget deficit to 3% of gross domestic product by 2014, as previously agreed with the EU.

Ireland’s budget deficit is expected to reach a euro-area record of 32% of gross domestic product by the end of 2010, largely because of costs related to recapitalizing the banking sector.

The government expects its budget deficit to be between 9.25% and 9.5% of GDP in 2011. It also forecasts little economic growth this year but expansion by 1.75% in 2011, 3.25% in 2012, 3% in 2013 and 2.75% in 2014. Ireland’s government had previously forecast growth of 3.3% next year and 4.5% in 2012.

JP Morgan economist David Mackie said that gauging the impact of fiscal consolidation on economic growth isn’t easy but the growth projections in the new plans “still look ambitious.”

“The cumulative fiscal adjustment may still need to be greater, either if the equilibrium primary position is more positive than the government is currently assuming or if growth fails short of the new projections,” he said.

Details of Ireland’s economic and budgetary outlook from 2011 through 2014 will be given Dec. 7.

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