Ireland downgraded by Moody's
One of the rationales behind the downgrade is the bailout that the government is providing to prop up failing Irish banks. We should fear the same downgrade in the United States. It is inevitable given that we have followed the same foolhardy path.
Moody's Investors Service has today downgraded Ireland's government bond ratings to Aa2 from Aa1. The main drivers for the downgrade are:
1. The government's gradual but significant loss of financial strength, as reflected by the substantial increase in the debt-to-GDP ratio and weakening debt affordability (as represented by interest payment to government revenue).
2. Ireland's weakened growth prospects as a result of the severe downturn in the financial services and real estate sectors and an ongoing contraction in private sector credit.
3. The crystallization of contingent liabilities from the banking system, as represented by a series of recapitalization measures and the need to create the National Asset Management Agency (NAMA), a government-created special purpose vehicle that is acquiring impaired loans from banks.
Moody's has changed the outlook on the ratings of the government of Ireland to stable from negative as the rating agency now views the upside and downside risks as being evenly balanced at the current rating level.
Moody's has also affirmed Ireland's short-term issuer rating of Prime-1 with a stable outlook. Ireland falls under the Eurozone's Aaa regional ceilings for bonds and bank deposits, which are unaffected by the Irish government's downgrade.
Moody's has also downgraded to Aa2/stable outlook from Aa1/negative outlook the rating of Ireland's National Asset Management Agency (NAMA), whose debt is fully and unconditionally guaranteed by the government of Ireland.
RATIONALE FOR DOWNGRADE
"Today's downgrade is primarily driven by the Irish government's gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability," says Dietmar Hornung, a Moody's Vice President -- Senior Credit Officer and lead analyst for Ireland. The country has suffered a dramatic contraction in GDP since 2008, causing a sharp decline in tax revenue. The general government debt-to-GDP ratio rose from 25% before the crisis to 64% by the end of 2009, and is continuing to grow.
Moody's also expects economic growth to be below historical trend over the next three to five years for two reasons. Firstly, banking and real estate -- the engines of Ireland's growth in the years preceding the crisis -- will not contribute meaningfully to overall growth in the coming years. Secondly, the fall in private sector credit is dampening the growth outlook. The ongoing credit contraction reflects both (i) the tightening in credit supply, due to balance sheet constraints among lenders; as well as (ii) the weak demand for credit as a consequence of a broad de-leveraging process in which the household sector is seeking to repair its balance sheets through increased savings (or reduced dissavings).
The third key factor driving Moody's rating action is the crystallization of contingent liabilities from the banking system as a result of the government taking on debt to provide support to the country's ailing banks. Overall, the recapitalization measures announced to date could reach almost EUR25 billion (equivalent to15.3% of Ireland's 2009 GDP) -- and Moody's expects that Anglo Irish Bank may need further support. In addition, the government created NAMA, a special purpose-vehicle that is acquiring loans from participating banks at a discount in exchange for government-guaranteed securities. While we do not expect the government -- not even in a moderately stressed scenario -- to incur permanent losses in excess of 25% of the country's 2009 GDP as a result of these obligations, we believe that the uncertainty surrounding final losses would exert additional pressure on the government's financial strength.
While Moody's expects the near-term deterioration in the government's debt metrics to be severe, the rating agency nevertheless expects the general government debt-to-GDP ratio to stabilize at 95% to 100% over the next two to three years. Given Ireland's wealthy and flexible economy and its very high institutional strength, these debt levels are commensurate with a Aa2 rating. Ireland's demonstrated adjustment capability and its economic vitality -- reflected for instance in its ability to attract foreign direct investment -- are important characteristics that support the rating.
RATIONALE FOR STABLE OUTLOOK
At the Aa2 rating level, the upside and downside risks are evenly balanced. "If the GDP growth trend were to exceed Moody's expectations -- with a quick resumption of domestic credit flow and a supportive global economic environment -- then the government's debt metrics could stabilize earlier than is currently being assumed," says Mr. Hornung.
On the other hand, Moody's notes that the country could experience downward rating pressure in the event of (i) a failure of the economy to rebound in a meaningful way; and/or (ii) a severe deterioration in the country's debt metrics triggered by a further crystallization of bank contingent liabilities beyond Moody's current expectations.