Beyond the headlines: Risks and opportunities in Ireland and Italy
Economists at Dun & Bradstreet urge investors to look beyond the sovereign ratings.
On 12 July Ireland became the third euro-zone country after Greece and Portugal to be downgraded to ‘junk status’ after sovereign credit rating agency Moody’s downgraded Ireland’s foreign- and local-currency government bond ratings by one notch to Ba1 from Baa3.
This rating downgrade is significant because it raises borrowing costs for Ireland, reduces the pool of potential investors in Irish debt (as pension funds, for example, are not allowed to invest in junk-rated bonds) and signals the rising risk that Ireland will default on its large and growing public debt burden. In particular, Moody’s expressed concern that, just like Greece, Ireland may require a second EU-IMF bailout once the current bailout runs out at the end of 2013; any such additional external financing may be conditional on substantial private-sector participation, i.e. involving significant losses for European banks that have invested in Irish government bonds. This could cause further financial sector distress in Ireland and the euro area as a whole.
Meanwhile, Italy (the country with the largest bond market in Europe and second-largest public-debt-to-GDP ratio in the euro area after Greece), has recently come under pressure amid political disagreement over the depth of budget cuts. The yield on Italian 10-year government bonds rose above 6% for the first time since 1997, signalling increasing financial market concern about Italy’s creditworthiness.
The developments in Ireland and Italy matter in the financial markets as contagion from debt markets can spread quickly to equity and credit markets, thus undermining corporate funding and profitability. However, it is important to bear in mind that the kind of risk that financial markets and the sovereign credit rating agencies are worried about at the moment, namely sovereign risk, is only one element of the risk of doing business in a country. Indeed, the sovereign rating agencies are primarily concerned with a country’s creditworthiness, i.e. whether a country will be able to service its debt.
This matters particularly to the financial sector (banks, pension funds etc.) that is exposed to sovereign debt directly. This can have wider economic and commercial implications, e.g. impaired bank lending and higher borrowing costs for companies. Apart from sovereign risk there are many other elements of risk that can impact on firms’ investment and trade exposures.
Non-financial corporations should look at a much broader measure of country risk (the key political, economic and commercial risks that can affect export and investment returns when doing business in a country) as part of their decision-making processes on exporting or investing in a country. Customers should be up to date on the latest developments in a country pertaining to the main risk factors that can affect their exposures; not just sovereign risk.
For example, Ireland’s downgrade to ‘junk’ status does not mean that it is suddenly more risky to do business in Ireland as such; in fact, just as was the case when Greece and Portugal were downgraded to ‘junk’, sovereign credit risk downgrades tend to be lagging indicators and therefore do not necessarily give an accurate picture of whether business risk has increased or decreased in the country.