Irish woes may spread to other PIIGS

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The Irish Parliament in Dublin

Market fears over the solvency of Ireland’s troubled banks and the potential threat they pose to both government finances and to the country’s growth prospects may yet bring contagion to other peripheral European markets, investors fear.

Ireland is one of the countries included in the PIIGS bracket, an acronym for the peripheral economies of Portugal, Ireland, Italy, Greece and Spain, which are generally viewed as having the most threatening debt problems of any countries in the Eurozone.

Some investors and analysts fear that the recent focus by markets on Ireland’s debt troubles – debts largely concentrated in the country’s banking and property sectors – could quickly shift to other overly indebted countries in peripheral Europe. The first of these countries could be Portugal, where government measures to address the public debt and fiscal deficit have been remiss relative to other heavily indebted European countries.

“There is a risk of contagion and it is likely Portugal will have to seek some kind of funds too as a result of this,” says John Kinahan, head of portfolio management at Lee Overlay Partners, an asset management company with offices in Dublin and London. “When it comes to your investment strategy, you just have to be aware this could happen to any one of a number of Eurozone countries, and so there is a good bit of volatility in the markets.”

Until this week, the Irish government had dismissed EU talk of an Irish bailout package as inappropriate and unnecessary, pointing to the fact that Ireland would not need to go to the market before mid-2011.

But on November 18 Patrick Honohan, governor of Ireland’s central bank, told RTE Radio that the country would accept “tens of billions” of euros in loans from the International Monetary Fund (IMF) in order to reassure the markets that the country’s bank debts would not bring down the whole economy.

Delegates from the European Commission, European Central Bank and International Monetary Fund arrived in Dublin this week to iron out what such a package might look like, and to allay Irish fears that the funds would be dubbed a sovereign bailout rather than a bank collateral facility.

But some investors argue that Ireland’s bank debt troubles are by no means the most pressing. They believe the market's focus could quickly shift to other countries as investors follow debt problems across the currency union even more closely.

“I think the recent calendar of events in Ireland is the reason the market is focused on it just now,” says Daragh Maher, deputy head of foreign exchange strategy at Crédit Agricole in London. “The Irish budget needs to be passed from December 7 and there was the increased banking bailout bill too, so a lot of the recent skeletons in the closet have been related to Ireland. And it was not helped by Germany announcing in late October that future bailouts would require some kind of private sector burden sharing.”

Compared with other PIIGS countries, says Maher, the Irish sovereign does not need to come to the market very soon and is not suffering from especially high debts; the IMF projects Irish national debt to rise to 55.2% of GDP by the end of 2010, below even its forecasts for German and French national debt. Rather, it is Ireland’s bank debts and the cost they pose to the Irish government which have spooked investors. But, as a member of the PIIGS grouping, Ireland is not viewed in isolation by the market.

“The risk of contagion [to the PIIGS] is substantial,” says Maher. “Linkages between the behaviour of the peripheral debt markets seem to be very strong. The European Union and European Central Bank hope they can ring-fence Ireland and thus get stabilisation in Portugal and Spain. But the more likely outcome is that the market decides it has exhausted the Ireland story and starts looking for the next weakest link in the chain. Portugal would then be in the limelight.”

But the uniqueness of Ireland’s problems may cause investors to pause before they punish Portugal too.

“If the EU and IMF come to some agreement and Ireland is bailed out and taken out of the markets for the next two or three years, then arguably the contagion can be ring-fenced and it will not spread to other peripheral countries,” says Chris Iggo, chief investment officer at Axa Investment Managers in London.

“Spain worries me more than Portugal actually, not because it is fundamentally weaker than the others but just because it is big and does have some problems related to the property market and to banks, particularly the smaller savings banks which were overly exposed to property lending,” says Iggo. “But at the moment the market does not seem to be extending the concerns about Ireland to Spain.”

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