S&P Slaughters Ireland’s Credit Rating

Ireland’s stock market dropped 6% yesterday. It is any wonder? After the close of the markets in Europe and the US, Standard & Poor’s cut the Republic of Ireland’s long-term sovereign rating, which will  make it more difficult for the troubled nation to borrow money in the global capital markets at reasonable interest rates.

Standard & Poor’s Ratings Services said that it lowered its long-term sovereign credit rating on the  Republic of Ireland to ‘AA-‘ from ‘AA’. At the same time, the ‘A-1+’short-term rating on the Republic was affirmed. The outlook is negative, the agency said.

The news will send a shudder through the EU where a number of national credit ratings have come under pressure and in some cases have been cut. The notion that the region is out of harm’s way financially and that austerity programs will begin to reduce nation’s deficits may be based on flawed reasoning.

Part of the cut in Ireland’s rating has to do with its troubled banking system and the cost of bailing that system out. Spain and Greece face similar issues, so Ireland is not alone with the problem.

There remains the strong case that austerity has come to the region too early. Cuts in stimulus packages may cause the early improvements in GDP shown early in 2010 to be reduced or even reversed as economies find that they are not recovered enough to stand on their own. The Congressional Budget Office offered related comments on the US economy and claimed that GDP was added by a percent point or perhaps more in the second quarter due to the Obama stimulus program.

Ireland is now caught in the stimulus/austerity vice. It is likely that S&P would have downgraded Ireland if it cut its budget or if it pushed government spending higher in the hope of improving unemployment and the access of businesses to capital.  The ratings would have been pressured even if the government’s actions lead to a faster restoration of the health of its banking system and consumer spending

Ireland’s borrowing costs, which will rise no matter what, are likely to be matched by other problems with EU nations that have slashed spending. The double-dip is nearly at hand and the weakest nations are in no position to weather it by spending less and less in the hope of closing deficits. Falling GDPs will prevent that.

Douglas A. McIntyre