Wednesday 28 June 2017

History points to escape from bond cruzbond markets

Mike Dolan

IF Ireland is determined to avoid default in the face of bond market panics, history appears to be on our side.

The popular narrative around bond scares is that they become self-fulfilling prophecies and downward spirals that usually end in default, with bond traders acting like financial vigilantes.

But the experience since 1990 suggests most countries try and succeed to face the market down and avoid defaults.

International Monetary Fund studies of such creditor strikes in developing economies over the past 20 years show that bond markets systematically overreact.

Only one in five cases where sovereign borrowing premia rose to more than 10 percentage points above benchmarks actually ended in default.

We all know why the cost of borrowing is rising for Ireland, but given borrowing rates themselves are a key determinant of Irish debt sustainability, should the Government here simply accept that it is caught in some inevitable spiral?

In the paper published in September before the latest blowout, the IMF's Fiscal Affairs Department said default for developed economies, including the pressurised peripheral eurozone sovereigns, was "unnecessary, undesirable and unlikely".

Apart from citing the 20 years of false alarms on sovereign debt in emerging markets, it said default and haircuts would not solve the crux of the current problem facing "advanced" economies, including Ireland and Greece.

The IMF's main point was that the challenge facing advanced countries today, unlike emerging market crises in recent decades, is bloated primary budget deficits and not the excessive debt servicing costs of historical debt blowouts.

Crunching the numbers, the Fund said Ireland would require a not-unprecedented shift in its primary budget deficit of 10pc this year to a surplus of 0.4pc in order to stabilise its debt-to-gross domestic product ratio by 2012.

For many economists, however, the risk calculation is less to do with bond mathematics than the politics of long-term deflation, deep budget cuts and the demand of richer European countries such as Germany that their taxpayers do not become continuously liable for routine bailouts.

But an ultimately political calculation with such very definite advice from one of the multilateral agencies likely to be consulted means bond sellers and buyers alike need to beware.

(This is an abbreviated version of an analysis that first appeared on Reuters)

Irish Independent

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