DBRS Confirms Republic of Ireland at A (high), Stable Trend

DBRS Ratings Limited has confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high) and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trends on all ratings are Stable.

The ratings confirmation reflects DBRS’s view that while the Irish economy is growing at a solid pace and public debt dynamics continue to improve, external developments continue to pose downside risks. The headline GDP figure, inflated by the activity of multinational companies in the third quarter, is expected to have grown by 7.3% in 2017. Excluding some of the distortions, underlying domestic activity is still strong, growing by 4.9% on an annual basis in the third quarter. The robust economy and years of expenditure control narrowed the fiscal deficit to an estimated 0.4% of GDP last year and reduced gross government debt to 69.9% of GDP. Despite the improving fundamentals, it remains broadly unclear what effect recent changes to U.S. tax legislation or the outcome of Brexit negotiations will have on Ireland.

The A (high) ratings are underpinned by Ireland’s openness to trade and investment, its flexible labour market, young and educated workforce, and the country’s access to the European market. The country’s institutional strength and its favourable business environment encourage investment. These credit fundamentals support the economy’s competitiveness and its medium-term growth prospects.

The country’s strengths are countered by several credit weaknesses, including sensitive exposure to external developments, medium-term fiscal pressures, high public debt, and lingering asset quality concerns in the banking system. When using alternative indicators like debt to interest payment or debt to revenues, Ireland’s debt is measured among the highest in the Euro area. Potential adverse external developments, principally the inplications for Ireland of Brexit and uncertainty over U.S. tax and trade policy, present uncertainty and downside risks to the outlook.

STRONG GROWTH MOMENTUM DESPITE EXTERNAL SECTOR RISKS

Irrespective of the statistical complexities associated with the GDP revision in 2016, a wide range of indicators suggests that the Irish economy continues to grow at a durable pace. According to Ireland’s revised National Accounts, output increased by 26% in 2015, driven largely by the on-shoring of intellectual property by multinational firms operating in Ireland. There is broad consensus that this series does not fully reflect the pace of underlying economic growth. The economy has, nonetheless, benefitted from strong employment growth and improved building and construction investment amid pent-up demand. These underlying domestic factors should continue to support the economy, and DBRS expects growth in the 3-4% range over the next few years.

At the same time, Ireland is exposed to potential adverse external developments. The UK’s exit from the European Union (EU) is potentially negative for the Irish economy. Depending on the final withdrawal agreement, Ireland could be adversely affected through trade, investment and confidence channels. The overall effects of Brexit on the Irish economy have thus far been subdued, and the first phase of Brexit negotiations that ended in December 2017 appeared to rule out the imposition of a historically sensitive hard border with Northern Ireland. However, the intensity and duration of the Brexit-related shock will ultimately be determined by the nature of the agreement, which remains unclear.

Lack of clarity over how multinational firms operating in Ireland will respond to the change in U.S. trade and tax policy poses a second external risk. The current U.S. administration has demonstrated a preference to exit or renegotiate existing trade agreements, and it remains unclear what forthcoming shifts in U.S. trade policy will mean for the Irish economy. Furthermore, the recently passed changes to U.S. tax policy creates an unpredictable environment for the activity of multinationals. The new fiscal incentives could result in a reduction in future investment flows into Ireland.

A NEAR BALANCE FISCAL STANCE STABILIZES THE PUBLIC DEBT RATIO

After years of budgetary tightening, the fiscal position is near balance. The latest European Commission (EC) forecast measures the 2017 deficit at 0.4% of GDP, a moderate improvement on the 0.7% deficit in 2016 and a large improvement on the 1.9% deficit in 2015. Fiscal progress reflects expenditure control and over-performance of the tax intake. The relocation of assets by multinationals to Ireland in 2015 led to a sharp increase in corporate tax revenue, which has been a strong contributor to deficit reduction. The tax increase does not appear to have been a one-off but rather a level increase in government receipts from the increase in the capital stock.

Corporate taxation in Ireland makes up 16% of total tax revenues, up from 11% in 2014, and is highly concentrated in a handful of large companies. This exposes Ireland’s fiscal outcome to shocks to the corporate tax base if multinational firms decide to shift operations, move intangible assets, or book profits outside of Ireland. However, multinational firms operate in Ireland for many reasons, including the stable legal and political system, access to the single European market, and the highly skilled workforce – all of which help reduce incentives for multinationals to leave Ireland and limit the risk associated with a shock to the corporate tax base. It is also important to note that fiscal strength is evident in structural terms. In line with the preventive arm of the Stability and Growth Pact, Ireland is set to reduce its structural deficit to 0.5% of GDP in 2018.

Although public finances are improving, public debt remains high and vulnerable to adverse shocks. General government debt-to-GDP is expected to have declined to 69.9% in 2017, which is moderate compared to other Euro area countries. This ratio is distorted by Ireland’s GDP data. When using alternative debt metrics, including interest costs to total revenue at 7.9% yoy as of the third quarter of 2017, Ireland performs similar to Italy and Portugal. Debt as a share of total revenues was 285% as of the third quarter 2017, among the highest in the Euro area.

The country’s prudent fiscal and debt management reflects its quality institutions and stable political environment. Ireland is a strong performer on the World Bank’s Worldwide Governance Indicators and the governments over the last decade have demonstrated policy continuity. In the February 2016 election, Fine Gael formed a minority government after reaching a Confidence and Supply agreement with opposition party Fianna Fáil around fiscal policy. An election is likely later this year or in early 2019, as both main parties agreed to review the existing framework by September 2018. DBRS does not expect the political cycle to undermine strong institutional quality or stable macroeconomic policy-making.

BANK ASSET QUALITY REMAINS A NOTEWORTHY CHALLENGE

Although significant progress has been made in restructuring the Irish banking system, the remaining high level of impaired assets across the banking system continues to be a challenge for the sector. Ireland’s banking crisis left a large stock of impaired assets on bank balance sheets. Non-performing loans of the banking sector as a share of total loans, having declined according to the IMF from 25.7% in 2013 to 12.8% as of the second quarter of 2017, remains well above the EU average of around 5%. Despite the high stock of non-performing loans, banks are profitable with higher levels of capital and improved funding profiles.

RATING DRIVERS

The Stable trend reflects DBRS’s view that upward pressures on the ratings remain balanced by credit challenges. Upward rating action could be warranted if: (1) there is clear evidence of enhanced economic resiliency, given that the Irish economy is highly open and exposed to adverse shocks; or (2) public debt as a share of output declines to more moderate levels on the back of sound fiscal management. On the other hand, the ratings could face downward pressure if material downward revision in the growth outlook or a weakening in fiscal discipline cause medium-term public debt dynamics to reverse course.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A (high) to A (low) range. The main points discussed during the Rating Committee include: Ireland’s macroeconomic performance, and the effects on Ireland from Brexit and changes to the U.S. tax policy.

KEY INDICATORS

Fiscal Balance (% GDP): -0.7 (2016); -0.4 (2017F); -0.2 (2018F)
Gross Debt (% GDP): 72.9 (2016); 69.9 (2017F); 69.1 (2018F)
Nominal GDP (EUR billions): 275.1 (2016); 290.2 (2017F); 304.9 (2018F)
GDP per Capita (EUR): 58,039 (2016); 61,312 (2017F); 63,761 (2018F)
Real GDP growth (%): 5.1% (2016); 7.3% (2017F); 4.4% (2018F)
Consumer Price Inflation (%): -0.2 (2016); 0.4 (2017F); 1.5 (2018F)
Domestic Credit (% GDP): 354.4 (2016); 317.9 (Jun-2017)
Current Account (% GDP): 3.3 (2016); 2.9 (2017F); 2.5 (2018F)
International Investment Position (% GDP): -176.2 (2016); -170.6 (Sept-2017)
Gross External Debt (% GDP): 767.6 (2016); 696.0 (Sept-2017)
Governance Indicator (percentile rank): 88.5 (2016)
Human Development Index: 0.92 (2015)

Notes:

All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Department of Finance, Central Bank of Ireland, Central Statistics Office Ireland, NTMA, NAMA, European Central Bank, European Commission, Eurostat, IMF, Statistical Office of the European Communities, World Bank, UNDP, SNL, Allied Irish Bank, Bank of Ireland, Permanent TSB, The Economic and Social Research Institute, Bloomberg, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve-month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Sovereign Ratings
Initial Rating Date: 21 July 2010
Last Rating Date: 18 August 2017

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