The economy is slowly growing again and government revenues have stopped falling at an alarming rate. But the next big crisis facing the economy – a full-blown sovereign bond crisis – may be only a few weeks away.
Despite the seriousness of the situation, there is no debate in the Dáil or chatter on the airwaves. Senior politicians, who are aware of the threat, do not wish to comment lest they are blamed for sparking a market crisis. Politicians may no longer wish to discuss sovereign bonds because they know there is little they can do to influence the debt markets. Daily share movements on the stock exchange still attract expansive coverage, while significant moves on the sovereign debt markets go unreported.
The funding needs of the Irish banks in the coming months and the fate of Irish sovereign bond rates are intimately linked. The big interest rates that the markets demand from Ireland and Portugal are the surest sign that a crisis is still brewing. Other markets which determine the cost of insurance for people buying sovereign bond paper tell a more alarming story.
The so-called credit default swap prices place Ireland and Portugal respectively as the 16th and 13th most expensive countries in the world to insure against a potential default. Bond-holders of Iceland, Greece and Hungary are charged significantly more but Vietnam, Egypt and even Poland are seen as safer bets than Ireland. Both the secondary market for national debt paper and the credit default insurance market are suggesting that Portugal and Ireland will be the first to tap the €750bn that European taxpayers, led by Germany after the Greek bailout, have pledged to defend eurozone countries.
The National Treasury Management Agency (NTMA) is next due to tap the sovereign debt markets on 20 July – Tuesday fortnight. The last time the debt agency issued 10-year bonds it agreed to pay its lenders an annual interest rate of about 4.8%.
But the scale of the crisis is more clearly seen by comparing the interest rates the market suggests that other European countries should pay. Paying the same rate of about 2.5% that Germany pays is evidently a distant dream. But other more indebted countries such as Italy pay substantially less, about 4%, to borrow money for ten years, than the 5.5% Ireland pays.
Worse, Spain, which has attracted a lot of attention in recent weeks on fears that its banks are not telling the full truth about their property loan losses, pays only 4.5%. Holders of Spanish bonds also pay significantly less to insure the bonds they hold against the risk of the Spanish government failing to pay back interest payments on time. The sovereign bond and the credit default swaps markets suggest the eurozone debt crisis will pass Spain by. Unfortunately, they are also saying that Portugal and Ireland are facing a market crisis.
"If we can get through September and get a budget done, I feel that the sovereign rates will come down," said Karl Whelan, professor of economics at UCD. "But those are big ifs," he added.
There are quite a few potential triggers that would put Ireland in a full-blown market crisis this summer. Many market observers believe that if Portugal, because of its considerable refunding needs, were forced to tap the €750bn eurozone bailout then Ireland would be forced into using the funds too. It is a sequence of events that the sovereign bond markets may be signalling, because Portugal pays about a quarter of a point more to borrow money for ten years than the already expensive rate Ireland faces paying.
The crisis need not even be triggered in Lisbon or Dublin. Another bank in Spain, or more talk of spluttering European economic growth in the summer months, would raise more questions about the growing strain on government budgets.
Whelan believes a possible trigger for a summer sovereign bond crisis could be the funding needs of the banks. By trawling through the annual reports, he estimated the amounts the banks will need to raise before the end of September. His estimates – that the banks covered by the two state guarantees need to refinance through the summer months to the tune of €74bn, including €57.8bn in senior bonds and €16.4bn borrowed from other banks – were confirmed in a written reply by finance minister Lenihan to Labour's finance spokeswoman, Joan Burton.
Experts say the €74bn amounts to a formidable 'wall of money', almost half of GDP, that needs raising at a time when the private banking markets are once again frozen over. The funding needs of the banks affect Irish sovereign interest rates because the state has, since September 2008, guaranteed that bond investors who lent Irish banks money will be repaid in full. The government does not have €74bn to lessen the liquidity crisis facing the banks.
Irish banks will not be the only ones looking to tap the private banking markets: Spanish and British banks will also be seeking to refinance their banking debts this summer.
Some sources suggest that the European Central Bank could assist as lender of last resort in helping to refinance the Irish banks in the coming months. Others believe that the ECB, by buying Irish sovereign bonds, would indirectly help finance the Irish banks' 'wall of money'.
Even then there is no guarantee that the sovereign debt crisis, specifically the high market rates that Ireland faces, would ease anytime soon. Markets could choose to force the issue by sending Irish sovereign rates higher, forcing Ireland to tap the €750bn eurozone bailout.
The NTMA will be facing a familiar dilemma as 20 July draws closer. Borrowing money at high rates risks the state paying high interest rates when it has no huge immediate funding demands. The agency has already raised a big chunk of the €20bn the government needs this year to plug its budget deficit. But cancelling the July auction threatens to highlight the potentially much larger liquidity crisis, namely the €74bn the banks require in the next three months. That bill is also the responsibility of taxpayers.
Summer 2010 may be recalled as the time when the Ireland started out on the long road out of recession. Or, it may be remembered as the time when the sovereign debt crisis deepened.