Ireland says surge in borrowing costs "very serious"

Ireland warned on Thursday that a surge in its borrowing costs to record highs had become "very serious" and the EU said it was ready to act should the humbled former "Celtic Tiger" require a rescue from its euro partners.

European officials said they were monitoring developments in Ireland closely, but denied for a second day running that Dublin was seeking financial aid, in an ominous echo of the rhetoric that preceded an EU/IMF bailout of Greece six months ago.

"The bond spreads are very serious and there is international concern throughout the euro zone about that," Irish Finance Minister Brian Lenihan said in Dublin.

He blamed part of the surge on "unintended" comments from German officials about a new permanent rescue mechanism for the euro zone that would force private debt holders to help shoulder the costs of future rescues.

Lenihan said Ireland was seeking clarification of the plans.

Although Germany has made clear the new mechanism would not apply to existing debt, the plan has spooked markets, raising fears of a domino-effect on peripheral euro members that only weeks ago appeared to have weathered the worst crisis in the single currency's bloc's 11-year history.

"We have the capacity to put the state on a sustainable and credible basis," Lenihan said.

Deeply unpopular and clinging to a razor-thin majority in parliament, Ireland's government is battling to prove it does not need a Greek-style rescue to help it reduce the worst budget deficit in Europe.

Markets are skeptical however, worried the government will struggle to win passage of a draconian 2011 budget that foresees 6 billion euros in cuts.

Jitters have pushed the yields on 10-year Irish bonds up to 9 percent from 6 percent in just three weeks.

Speaking to reporters at a Group of 20 summit in Seoul on Thursday, European Commission President Jose Manuel Barroso said the EU was ready to move should Ireland need assistance.

"What is important to know is that we have all the essential instruments in place in the European Union and euro zone to act if necessary," Barroso said, in comments that Lenihan said highlighted the "solidarity" of the euro zone.

Bank Shares Hit

Irish bank shares fell sharply on Thursday, reflecting renewed jitters about their exposure to the country's wrecked property market, with Allied Irish Banks shedding 7 percent and Bank of Ireland off 8.4 percent.

Foreign banks with a large exposure to Ireland, including Royal Bank of Scotland, also fell.

The cost of insuring Irish, Portuguese and Spanish debt against default pushed up to record highs, and the spread between Irish 10-year bond yields and those of German benchmarks rose above 680 basis points, hitting a new high for the ninth straight session.

"It's the same trend we've been seeing," said Gavan Nolan, an analyst at Markit. "The market is very nervy."

Unlike Greece at the height of its woes back in April, the Irish government is fully funded until mid-2011, meaning a liquidity crisis is not imminent.

The IMF says markets are overestimating the risks of default in countries like Ireland. A recent report said that of the 36 instances in the last two decades where a country's spreads rose above 1,000 basis points, only seven resulted in default.

But most analysts agree Ireland will be forced to seek a rescue if its borrowing costs do not stabilize soon. With liquidity in the bond market drying up, some are now openly speculating the country may also have to restructure its debt, particularly if its banks suffer more losses.

In a blog post on Thursday, University College Dublin economist Karl Whelan said a surge at the short-end of the Irish yield curve suggested markets now believed there was a high probability of a default as early as 2012.

"(This) strikes me as unwarranted. But it illustrates the scale of the current negative sentiment toward Ireland in the bond market," he wrote.

Prime Minister Brian Cowen's government has pledged to outline a four-year plan later this month to bring the ballooning budget deficit under control and to push through the 2011 budget on December 7.

However, with a parliamentary by-election likely to cut the government's majority to just two seats later this month, some analysts now say only an early general election that produces a new government with a stronger popular mandate may convince investors that Ireland is able to overcome its debt crisis.

Should Ireland fall, concerns about Portugal and probably Spain could rise, creating a vicious spiral that could drag the euro zone into another deep crisis with global implications.

[Source: By Carmel Crimmins, Reuters, Dublin, 11Nov10]

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