FEW PEOPLE in financial markets can be greatly surprised by Standard & Poor’s (S&) decision to downgrade Ireland’s credit rating. The rating agency warned in January that it might cut Ireland’s triple A status for its sovereign debt due to the sharp deterioration in the public finances. Since then the outlook for the economy has not improved. Tax revenues have declined more rapidly than forecast, forcing the Government to introduce an emergencybudget next week.
If the Government cannot be too surprised by SP’s rerating move, it will be dismayed by the timing of the agency’s announcement and its accompanying commentary. The Government will question why a lower rating comes with a “negative” outlook attached. This suggests that SP is more likely to reduce than raise Ireland’s credit status in the future. Above all, the Government will be disappointed by the agency’s reasons for lowering Ireland’s rating.
The downgrade could not have come at a worse time, a week before the emergency budget where the Government will attempt to save some €4.5 billion through spending cuts and tax increases. The agency believes that something greater than what is “factored into the Government’s current plans” is required to repair the deterioration in the public finances. SP has expressed concern that a credible strategy to consolidate the public finances may not emerge until after the next general election. Its comments are almost as damaging as the rating downgrade.
For the Government, this setback is another embarrassing public rebuff of its management of the public finances. In January also, the European Commission was highly critical of the revised stability programme that the Government had submitted. The commission found the Government’s recovery plan lacked clarity. It doubted that its proposals for a broadly balanced budget by 2013 could be achieved. It found that some of the plan’s key assumptions were either over-optimistic, or lacked sufficient detail to prove convincing.
When S&P awarded Ireland its triple A credit rating in October 2001, the character and composition of the economy had begun the process of change, shifting from export-led growth to a construction-led boom that has burst with devastating economic consequences. Then, the rating agency may have been too optimistic and failed to spot an emerging weakness.
Now it may be too pessimistic about the prospects for economic recovery. A credible and detailed plan to bring the public finances back under control is the first step on the road to economic recovery. Unless the Government makes a convincing start on that long and difficult five year journey of adjustment, S&P’s current pessimism will prove fully justified. The price paid will be further credit downgrades, a higher cost of borrowing, and an increased risk of default. The stakes could not be higher for the Government, the challenge could not be greater.