Irish Debt Woes Revive Concern About Europe
When interest rates soared last week on Irish government bonds, it served as a grim warning to other indebted nations of how difficult and even politically ruinous it could be to roll back decades of public sector largess.
An Irish bond market already in free fall plunged further after Ireland announced on Thursday that it planned to nearly double its package of spending cuts and tax increases to try to rein in its huge deficit.
Investors took it not as a sign of resolve but rather of Ireland’s desperation and uncertainty about the true extent of its problems.
The yield on Ireland’s 10-year bond climbed to 7.6 percent on Friday, expanding the gap with the 2.5 percent interest rate on comparable bonds issued by Germany, which is emerging most strongly from the European debt crisis.
Borrowing costs in Spain, Portugal and Greece also spiked upward again, as investor concern re-emerged that those countries would be hard-pressed to bring their deficits under control and avoid defaulting on their bonds.
Even as global stock markets rallied last week, those bond market jitters were a forceful reminder of how wary investors remained after Europe’s debt crisis last spring, despite the commitment of a combined 750 billion euros ($1.05 trillion) in bailout funds by the European Union and the International Monetary Fund.
“The scale of the deficits are just so big,” said Philip R. Lane, a professor of international economics at Trinity College in Dublin. “The issues are political as much as they are economic.”
Prime Minister Brian Cowen’s increasingly shaky political standing in Ireland may be threatened by the new deficit reduction measures, which will cut to the heart of the Irish welfare system, including health care.
In Greece, regional elections on Sunday were viewed as a test for the Socialist Party led by Prime Minister George Papandreou, whose government’s austerity measures have been wildly unpopular.
In a televised address, Mr. Papandreou claimed victory in the elections and viewed the results as support of his economic policies.
International concerns about the high budget deficit in the United States, and Washington’s seeming willingness to print money rather than tackle tough debt-cutting measures, help partly explain the recent anti-American criticism from countries as diverse as Brazil, China and Germany.
Countering those critics may be one of the biggest tasks for President Obama in Seoul, South Korea, this week at the Group of 20 meeting of the leaders of the world’s biggest economies.
Within Europe, though, the more immediate concerns involve Ireland. Its debt woes have stoked fear that it might even need to follow Greece and request a bailout from the European Union and the International Monetary Fund.
Such a move could do lasting damage to Ireland’s credit standing.
For the moment, at least, that outcome seems improbable. Unlike Greece earlier this year, Ireland has enough cash on hand to allow it to finance government operations through June 2011.
And it has, at least temporarily, withdrawn from the bond market instead of paying the new, higher interest rates, which Irish officials say do not adequately reflect the country’s true economic condition.
To a degree, Irish officials are correct. Market experts concur that the ever widening gap between the interest rates Germany pays on its debt and those of Ireland and other vulnerable euro zone economies is partly a reflection of technical factors, like the tiny number of bonds actually being traded.
Low trading volumes mean that every time even a single spooked investor decides to sell an Irish or Greek bond, it can be a market-moving event, causing the price to plummet and the yield to rise.
Still, there is no denying that the recent run-up in interest rates highlights a real concern throughout Europe: that the first round of spending cuts and economic changes put forward by countries that also include France and Britain may not be enough to bring deficits down to the target levels of 3 percent of gross domestic product by 2014.
In this respect, Ireland, where the deficit is currently 32 percent of its G.D.P., is exhibit A. A year ago, as cascading mortgage defaults brought down the biggest Irish banks, Ireland became the first major developed nation to impose an austerity program.
The country was hailed worldwide as an exemplar of probity and national consensus. But as the full extent of the banking and real estate bust became evident, it was clear that the government of Prime Minister Cowen, which has been in power since the onset of the crisis more than two years ago, had underestimated the cost of fiscal recovery.
Now the possibility that he will be forced from office or compelled to call a new election grows by the day. Last week, the Irish government conceded that it had previously miscalculated the scale of its debt challenge.
It announced that the task would require an additional 15 billion euros in savings over four years, bringing the total sum of tax increases and spending cuts to about 30 percent of Ireland’s total economic output.
And Ireland’s need for cuts and taxes is hardly unique. Whether in Spain, France or Italy, European nations remain saddled with heavy welfare obligations — ones that inevitably must be curtailed to meet ambitious deficit targets, even as their tax revenue is constrained by low economic growth.
And political pressures are building in Britain, where the government at least has a thin electoral mandate to cut the deficit, and where politically sensitive components of the welfare state, like health care and pensions, so far have largely been spared.
Last week, subway workers, firefighters and BBC journalists went on strike over proposed public sector cutbacks. The British chancellor, George Osborne, perhaps the keenest deficit hawk among policy makers in the developed nations, was taken to task last week by lawmakers.
They accused him of exaggerating the extent of the country’s fiscal problems to justify broad cuts in middle-class benefits like universal payments to parents with children.
“How many children will be forced to leave their homes?” demanded one furious member of Parliament. “Will the numbers of homeless increase or decrease under your government? Will there be a reduction in special needs education for children in our schools?”
The chancellor replied that he had no choice. Unless the root causes of the British deficit were addressed, he said, the country’s credit rating would be jeopardized.
In a report last week, the International Monetary Fund largely reinforced that view, arguing that the increasing debt ratios among advanced nations needed to be addressed. It highlighted the extent to which the debt ratios of all developed nations had exploded since the onset of the financial crisis.
The leader is Ireland, whose debt level has almost doubled, to nearly 100 percent of G.D.P. The monetary fund noted, too, how quickly markets could lose their confidence. It recalled that a year ago the interest rate spread between Greek and German bonds was 1 percentage point.
It is now nearly nine times as large — 11.3 percent for Greek bonds, versus 2.5 percent for those of Germany. Such signals matter.
It was a flare-up in bond yields, after all, that eventually pushed Greece into the arms of the International Monetary Fund in the spring, and sent the euro on a downward spiral against other major currencies from which it has only recently recovered.