DBRS Assigns AA Ratings to Ireland on Strong Policy Response

DBRS has today assigned ratings on the Republic of Ireland’s long-term foreign and local currency debt at AA. The trend on both ratings is Stable. The new AA ratings balance Ireland’s structural strengths – an open economy, highly skilled workforce, flexible labor market and strong political institutions – with the large increase in public indebtedness and a weakened financial sector.

“Ireland’s policy response to the crisis has been exemplary and has helped stabilize both public finances and the financial sector,” says Michael Heydt, DBRS’s Ireland analyst. “While public debt ratios will continue to rise until 2012, the public sector balance sheet is sufficiently robust to absorb the additional stress.” These factors, as well as the initial signs of economic recovery, explain the Stable trends. However, the trends could be changed to Negative if the planned austerity measures for the 2011 budget are not fully implemented, or if financial market volatility or weak demand from Ireland’s main trading partners impair the recovery.

The bursting of Ireland’s massive property bubble and, to a lesser extent, the global economic and financial crisis, contributed to one of the most severe recessions of any advanced economy in the last 60 years. These events also revealed the unsustainable structure of Ireland’s public finances and threatened the stability of the banking system.

Notwithstanding the scale of these challenges, Ireland’s policy response has been timely, transparent and well-articulated. First, the government has taken decisive action to address its large fiscal imbalances. The budgetary consolidation program is front-loaded, realistic and aims to reduce the deficit below 3% of GDP by 2014. Political commitment to fiscal sustainability has helped firm up market confidence and forestall negative feedback loops to the real economy.

Second, extraordinary policy action has been taken to rehabilitate a severely weakened financial system. Since September 2008, the government has provided a guarantee for bank liabilities, nationalized Anglo-Irish Bank, created the National Asset Management Agency (NAMA) to transfer EUR81 billion in risky loans off bank balance sheets, and provided EUR25 billion (16% of GDP) in recapitalizations. DBRS estimates recapitalizations could ultimately total more than EUR33 billion. In addition, Ireland’s Central Bank and Financial Regulator is demanding that banks recapitalize, either through private markets or with public support, to meet new capital standards. While the financial system remains under considerable stress, these measures, in addition to ECB support, have helped improve funding conditions and reduce uncertainty about the health of bank balance sheets.

Third, the government is tackling past regulatory failures with a series of legislative proposals that will enhance accountability, strengthen oversight and improve transparency in the financial sector.

After contracting 7.6% in 2009, Ireland’s economy is in the early stages of recovery. GDP growth was 2.7% in the first quarter of 2010, retail sales are rebounding and consumer confidence is improving. The European Commission estimates 3.0% GDP growth in 2011, double the rate of the euro area. DBRS estimates that net public debt will peak at 74% of GDP in 2012 and fall to 70% by 2014. Strong liability management helps reduce liquidity concerns. Ireland has already raised EUR18.1 billion, or 90% of this year’s financing needs, and funding for 2011, estimated at EUR20 to EUR25 billion, appears to be manageable. Furthermore, the Exchequer has approximately EUR20 billion in cash balances, providing flexibility in the event of market turbulence.

Internal rebalancing of the economy to the tradable sector is helping set the stage for an export-led recovery. Over the past decade, high price and wage inflation eroded Ireland’s cost competitiveness. Regaining lost competitiveness is a multi-year process, but there are clear signs of progress. Inflation in Ireland has been below the euro area average for more than two years and the European Commission expects unit labor costs in Ireland to decline through 2011. However, with a subdued outlook for domestic demand, Ireland’s economic performance going forward will depend in large part on a sustained recovery in global demand.

Notes:
All figures are in euros unless otherwise noted.

The applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

This is a Public Finance (Sovereign) rating.