For a taoiseach whose party had just suffered its worst ever electoral drubbing, it was an unusual speech for Brian Cowen to make. But he told the Dáil last week that the government was set on inflicting more economic pain. Clearly, his comments were not for a domestic audience. After all, why would an unpopular politician court greater unpopularity by promising sharp spending cuts and more tax rises?
It was as if a hidden audience lurked in the Dáil gallery – a gathering of nervy international lenders whom the government needs to convince to keep lending us money. Seen in this light, Cowen's speech was pitch perfect: despite an electoral disaster, the government was not turning back on a commitment to start paring the enormous deficit in the next budget. It would suck out €4bn from the economy next year and another €4bn in 2011, he said.
It was troubling stuff for domestic ears but soothing for people who have already lent us money – overseas central banks, governments and investors. The investors, who have suffered losses on the capital value of the Irish debt paper they hold, are the people the government will need to convince to lend the state about €20bn every year for the next several years.
Something of the nervousness in government circles about the sovereign debt markets returned last week. Increasing talk of an early general election, and, possibly the trickiest of them all, a re-run of the Lisbon treaty vote this autumn, will influence international perceptions on Ireland's capacity to pay back its debts. The international debt folk dislike political uncertainty the most.
"We always said that it was in the second half of the year that was going to be the difficult period to borrow," a senior government source said last week. "If the trend continues it is a worry. But we have seen an improvement since March in the Irish government's ability to raise funds."
Despite the touch of optimism about the world economy, it was indeed a difficult week for Ireland and the sovereign debt markets. Long-term interest rates had started to move up again since early May because the worst may be over for the re-inflated American and British economies – and central banks may jack up short-term interest rates soon too.
Good news you may think for an export-focused economy like Ireland. But the rise in Irish debt interest costs – up to 5.75% last week from only 5% in early May – comes at an unfortunate time when Irish debt levels will balloon. Using the kindest measure – that excludes the banking property-related bonds to be issued by Nama – Ireland's debt pile will climb soon to €150bn from about €100bn at present.
More significantly, the interest rate on Irish debt last week gapped to its widest margin for a month to over two percentage points above the 3.7% interest rate that Germany need pay. The Irish cost, or risk premium, over Germany is once again approaching levels reached earlier this year, when international commentators were questioning Ireland's capacity to pay back its debts.
There was also the matter of rating agency Standards & Poors delivering its second credit downgrade, to 'AA'. S&P analyst David Beers said taxpayers here face a growing exposure from Anglo Irish Bank. With bank shareholders wiped out, and the subordinated debt-holders nursing losses, the Irish taxpayer is the only one left to pay the bill.
Last week too, the spectre of a default somewhere in eastern European late this year or in 2010 again raised its head, as Latvia struggled to maintain its currency peg with the euro. A devalued currency has implications for the vale of its sovereign debt. The Financial Times, never slow to wade in with unhelpful comparisons, replaced Iceland to bracket Latvia with Ireland in its commentary.
Domestic politics will increasingly weigh on international perceptions of Irish debt this year. "I think a number of issues have come together regarding Ireland's funding," said Dan McLaughlin, chief economist at Bank of Ireland. "The broader one is that a small peripheral eurozone economy faces difficulties. But Nama and the price that the debt will be bought for has affected the perception of the state's ability going forward. And the Lisbon treaty – if they lose that – it is likely to pass, but who knows?
Any perception that an incoming administration will follow significantly different policies will likely lead to a deteriorating credit rating here, say experts. However, from Italy, a country well versed in political turmoil, Luca Cazzulani, a senior sovereign debt expert at Unicredit in Milan, plays down the risk of political turmoil here roiling the debt markets. "My experience in Italy, and Europe in general, is that elections do not have a big effect on bond yield spreads. And I think that is the case this time too," said Cazzulani, adding that euro bond spreads would likely be unchanged in the next month or so.
Government sources said its policy options to influence the bond markets are limited. "Our spread should go down – we can't control that," said a senior source. "But there is a very tough €4bn to come out in 2010 and another in 2011. Markets would respond very negatively if that did not go through. Markets will have to decide if Ireland is such a great risk to deserve a 2% premium."