THE resolution of the eurozone crisis hit another bump on the road with the raft of soverign debt downgrades announced by ratings agency Standard & Poors last Friday. These downgrades were not a very well kept secret and really don’t tell us anything we don’t already know.

THE resolution of the eurozone crisis hit another bump on the road with the raft of soverign debt downgrades announced by ratings agency Standard & Poors last Friday. These downgrades were not a very well kept secret and really don’t tell us anything we don’t already know.

One of the purposes of ratings is to provide a snapshot guide to people who do not have the time to investigate the complete details behind a particular investment. This is useful for the myriad of funds and securities that are now in existence. No individual investor or fund manager would be in a position to analyse them all.

The top triple A ratings that the agencies gave to the collateralised debt obligations (CDOs) that were created by bundling together millions of residential mortgages in the US in the mid-2000s suggested that they were not doing a good job.

The sovereign bonds of European countries are not some offbeat investment that is rarely analysed. Developments in European sovereign bond markets have been front page news at times over the past year. We do not need to wait for a downgrade from a ratings agency to realise that there are huge problems affecting these investments.

The sovereign bond downgrades may not offer any new information but that does not mean they will have no effect. There are many fund managers and investors who have defined how they will allocate the money available to them across different investment classes. For example, a low-risk fund designed to protect capital may be promoted on the basis that it puts a certain portion of its money into triple-A rated investments.

In the current volatile environment where many people are looking for a return of their capital rather than a return on their capital such funds are attractive. If a country loses its triple-A rating it means it no longer has access to the money available from these funds.

The downgrade of France to one notch below triple A attracted significant attention but it had been expected since at least the downgrade of the United State last August that S&P would take this action. Markets had been there well before S&P made the announcement last Friday.

The day before the France downgrade, triple A rated 10-year French government bonds had a yield of 3.1pc. On the same day triple A rated 10-year German government bonds were yielding 1.8pc. Investors do not need to wait for a ratings downgrade to distinguish between securities.

In the week since the downgrade the yield on these French bonds has been largely unchanged and remains around 3.1pc.

The downgrade of France to AA+ led unsurprisingly to a similar downgrade for the European Financial Stability Facility (EFSF). This is a eurozone “bailout” fund that was established in May 2010 to provide a backstop for the turmoil in eurozone sovereign bond markets. The EFSF is providing €17.7 billion of the loans being made available to Ireland through the €67.5 billion EU/IMF rescue programme.

The money in the EFSF is guaranteed by the members of the eurozone. With only four of the 17 eurozone countries now having a triple A rating, Finland, Germany, Luxembourg and the Netherlands, the fund was not going to be able to maintain its triple-A rating with S&P unless these countries offered larger guarantees. These guarantees were not forthcoming so the EFSF was downgraded as, in eyes of S&P, it was not sufficiently backed by triple-A rated countries to warrant a triple-A rating.

Of course, the fact that huge numbers of the mortgages that comprised the CDOs mentioned above were provided to sub-prime borrowers in the US who were more likely to default did not prevent the agencies from giving these CDOs the top triple-A rating.

We have yet to see what impact this downgrade will have on the EFSF and whether there will be any knock-on effects for Ireland. On Tuesday the EFSF ran a very successful auction where demand was more than three times the amount the fund was seeking to raise. However, this was only for six-month Treasury Bills. Even bankrupt Greece manages to raise short-term debt such as this, albeit it far higher rates.

As Ireland has 10-year loans with the EFSF it will only be when the fund tries to raise long-term money that we will get a truer reflection of its performance and a possible impact from Ireland.

Ireland also formed part of the European sovereign debt review undertaken by S&P but the agency decided to leave the rating unchanged at BBB+. This is seven notches below the top triple-A rating and two notches above speculative or “junk” status. Ireland has had a BBB+ rating with S&P since November 2010.

The S&P statement on Ireland was reasonably positive given the difficult economic position we find ourselves in. They believe that Ireland is on track to get the budget deficit down to 3pc of GDP by the 2015 target. By 2015 S&P predict that government net debt will have fallen to 103pc of GDP after peaking at 109pc of GDP in 2013. These net debt projections account for government liabilities and assets, and are inclusive of NAMA’s debt obligations as well as the full cost of the bank bailout.

If by 2015 Ireland has brought the deficit to under 3pc and net debt is around 100pc of GDP then we will be in a far stronger position than many commentators are forecasting. Of course, S&P may not be the most reliable of sources but their views are not without support.

In secondary bond markets Irish government bonds maturing in eight years are trading with a yield of around 7.3pc. This is the lowest these have been since November 2010. The gap between the low interest rates on Ireland’s official funding and the interest rates required to borrow from markets is getting ever narrower.

The comments last week from Willem Buiter that Ireland will need continued official funding after 2013 attracted a lot of attention. Significantly less attention was given to his views that Ireland will not default. Buiter believes that Greece and Portugal will default but predicted that Ireland can avoid going down the same route.

Last July investing in Irish government bonds was seen as a high risk move and another ratings agency, Moody’s, downgraded Irish bonds to speculative or “junk” status. In the middle of July the yields on the eight-year bonds was above 15pc. The market perception of default was very high. Since then the yields have fallen almost continually and at 7.3% are only a couple of percentage points above what would be considered sustainable.

S&P have maintained Ireland’s investment grade rating; Willem Buiter does not think we will default; and the markets prices for Irish bonds are reflecting these views. There are many significant problems that remain, both domestic and external, but we should not allow them to cloud the progress that is being made.

Seamus Coffey is a lecturer in economics at UCC and a blogger at http://economic-incentives.blogspot.com