Irish economy shrinks for 3rd straight year

The Associated Press
Thursday, March 24, 2011; 10:53 AM

DUBLIN -- Ireland's economy shrank in 2010 for the third straight year and the yields on Irish bonds rose to euro-era highs Thursday amid fears that the cost of rescuing the country's failed banks will overwhelm its finances even with the international bailout.

Economists had expected marginally positive figures for 2010, and the government's deficit-fighting plans require at least tepid growth to bring in needed tax revenues.

But Ireland's 2010 gross domestic product instead fell a further 1.0 percent. Gross national product - which provides a better measure of Ireland's domestic economy because it excludes the largely expatriated profits of 950 foreign companies - fell 2.1 percent. In 2009, Irish GDP fell 7.6 percent and GNP 10.9 percent.

Ireland's finances have been ravaged by the 2008 collapse of a property-driven boom and its decision to insure the banks' foreign bondholders against losses. The country's economic turmoil led to an international bailout last year, early elections last month and a new government.

The payout on Irish bonds - which rise as their underlying value falls - has leaped this year despite Ireland's negotiation in November of an emergency credit line from the European Union and International Monetary Fund.

The investor selloff of Irish debt securities reflects growing expectations that Ireland will be forced to make bondholders absorb losses at Irish state-owned banks, a form of default, within the next few years.

The yield on Ireland's 10-year bonds broke through the 10 percent barrier for the first time Wednesday and peaked Thursday at 10.21 percent. More alarmingly, the yields on shorter-term securities surged even higher, reflecting the view that an Irish default could come within the next few years.

The yield on Irish 3-year bonds topped 11 percent for the first time Wednesday and reached 11.13 percent Thursday.

The latest signs of Irish economic weakness came as Prime Minister Enda Kenny attended an EU summit in Brussels focused on solving the wider eurozone debt crisis.

Irish lawmaker Gay Mitchell confirmed that Kenny would seek EU approval for Ireland to shift many billions' worth of its bank debt burdens over to senior bondholders - chiefly British, German and American banks and hedge funds.

Ireland over the past three years has guaranteed total repayment to senior bondholders in a futile effort to keep the flow of foreign bank lending alive. But over the past year, Ireland's six largely state-owned banks have been deserted by many investors regardless, leaving them heavily dependent on short-term funds from the European Central Bank and Irish Central Bank exceeding euro180 billion ($250 billion). A fresh wave of bank bonds is due to mature within the next few months.

"We have a problem with recapitalization of our banks. We're not threatening anybody. We're saying please help us out on this ... Ireland is not capable on its own of doing this," Mitchell from the governing Fine Gael party said in a phone interview from Brussels.

The rising bond yields do not directly hit Ireland's debt financing costs, because the EU-IMF's euro67.5 billion ($95 billion) loan package means Ireland has no immediate need to seek money from bond markets. Ireland would have to pay these higher yields only if it auctioned new bonds now.

Ireland this year has drawn more than euro11 billion ($15.5 billion) from the EU-IMF loan pool, which charges an average interest rate of 5.8 percent. If Ireland had to turn to the bond markets now for funds, it would have to pay nearly double that.

That bank insurance scheme, designed to prevent six Irish banks from falling like dominoes, failed to prevent Ireland from being forced to nationalize four of the banks and take a major stake in a fifth. Those moves transformed the banks' private bond obligations into a state debt burden currently estimated to exceed euro50 billion ($70 billion).

More than half of the EU-IMF's credit line has been earmarked for bolstering the banks. But Ireland says it will publish new stress-test results on four banks March 31 that could raise recapitalization needs by up to euro35 billion ($50 billion) more - unless the EU backs a new deal shifting some of those losses to bondholders.

© 2011 The Associated Press