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Kranty – the end of the road? Updated

Posted by Dr. Constantin Gurdgiev @ True Economics
Wednesday, February 25, 2009
Updated below

Krantyis a Russian slang for German “Kaput“, ItalianFinita la Comedia“, or in plain English “The end of the road”. You get the wind… So is the latest 3-year Irish bond issue of €4bn at 170bp over mid-swaps the end of the road for Irish Exchequer borrowing? The FT’s Alphaville blog seems rather pessimistic (here). FT’s blog musings aside, for a country which has seen CDS levels in excess of those paid on the senior debt of an embattled English retailer just a couple of weeks ago, the question is no longer of the extent of markets pessimism, but of fiscal survival.

And the latest bond offer is puzzling.

Borrow short to lend long?
First the 3-year term. It is equivalent to borrowing short to lend long, for even the DofF forecasts (rosy as they may be) imply that in 2012 – the bond will mature in the environment of a deficit of 4.75% of GDP and a General Gov Balance absent serial €16.5bn savings between now and then) of 12.25% of GDP. In other words, no one can seriously expect the Government to pay down the bond.

So why is this 3-year term? Is it because the NTMA could not place any new bonds on these terms with a longer maturity? Is it because the market pricing for a new 5-year bond would have implied an admission of a junk-level risk on Irish Government debt? The indications that an answer to these questions might be, sadly, a ‘Yes’ is in the details of the bond offer itself.

Costly, but small
This time around we are raising only 2/3rds of the volume of funds raised in January’s €6bn placement. Given that the Government, post January issue, was in the need to somehow raise ca €19bn of new funds to plug its deficit this year alone, €4bn today is peanuts. Why not go to the markets early and raise, say €10bn? We know we’ll have to do this at some time later in the year, by when many other countries would have gone to the markets and the spreads would have widened for all, including the Germans? In short, a miniscule placement today also suggests that quite possibly, NTMA could not place a sizable issue into the market.

Lastly, there are questions about the pricing of the bond. The FT blog outlines this problem perfectly: the latest bond “spread is almost five-times that of Barclays’ UK guaranteed 3-yr £3bn deal this week, which priced at 35bp over mid-swaps and Roche’s huge €5.25bn 4-yr deal at 225bp over”. Yes, it is pricey, but it is not priced to sell.

Getting under the radar?
What is even more dodgy is that the NTMA claimed that the bond was over-subscribed to the tune of €1.2bn over the placed €4bn amount. In other words, the NTMA decided not to take more money today under the present bond issue despite knowing that it will have to tap markets for much more than that in the near future (here). Why? I have nagging suspicion – and this is speculative at this moment in time – that the bonds were issued to be placed primarily with the banks who can now roll them over to the ECB’s lending window. Clearly, as a test case for the future, such a ‘roll-over’ had to be modest enough for the ECB (or other European states) not to smell a rat. Hence the €4bn ceiling.

Of course, there can be other possible explanations for the bizarre nature of the issue, but these are equally unflattering (see the update below). However a mere suspicion that something as problematic as the state issuing bonds for placement via the banks at the ECB would be a sign of desperation…

ECB’s blind eye to Ireland?
From ECB’s point of view, this might fly for only a short period of time. Here is why. The ECB is fully aware that the Irish Exchequer is bound to come knocking at its doors sooner, rather later. Yet, a publicly open and transparent loan from the ECB would have to carry serious policy prescriptions with it that would be matching those impose by the IMF on other countries: a 15-25% pay cut for the public sector, a 10-15% contraction in public expenditure across the board, a reform of public sector pensions and a significant divestment by the state out of its industrial shareholdings. These policies – necessary to keep cool other would be borrowers from ECB – will cost Brian-Brian-Mary their jobs and can potentially derail the Lisbon II ratification.

Hell, they might spell the end to the Euro itself, as a transparent rescue loan to Ireland will be followed by the demands for the similar lending from Italy, Greece, Spain, Portugal and possibly Austria.

So the ECB is absolutely desperately trying to find some face-saving formula to allow Ireland access to funds without opening the door for other Eurozone states and without imposing punishing conditions on our incompetent Government and overweight public sector.

Hmmmm… has anyone gave it a thought how are we going to squeeze out the remaining €15bn without anyone noticing, then?

Update I
It is now being rumored (hat tip to BL) that the NTMA was originally in the market for placing €6bn worth of bonds, got interest in €5.2bn, but due to extremely low offers (high yields) was forced to claw the issue back to €4bn. If correct, this implies that we have issued a bond with subscription rate of only 67% – by any reasonable measure constituting a failure by the state to finance less than 1/4 of its annual budgetary requirement. In other words – a failure of borrowing on a 3-year basis. Things can’t get much more embarrassing than this, folks. And yet, to this moment, I have not seen a single media article, actually recognizing this reality. Is our media going ‘soft’? or have we, engulfed in a rediculous charade of the Anglo Irish Banks scandals forgot about the reality of having to tap the markets for at least €15bn more in cash, having in effect failed to raise the mere €6bn last night?..

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