DBRS Downgrades Republic of Ireland to A (low) on Lower Growth

DBRS Inc. (DBRS) has downgraded the Republic of Ireland’s long-term foreign and local currency debt to A (low) from “A”. The trend on both ratings remains Negative. In spite of strong political commitment to fiscal consolidation and lower interest rates on official loans, the downgrade reflects weaker than expected growth prospects. As a result, public debt ratios are estimated to peak in 2013 at higher levels than previously anticipated. The Negative trend reflects DBRS’s view that downside risks to Ireland’s export-led recovery persist, particularly given heightened uncertainty over the economic outlook in the United States and Europe and ongoing turbulence in financial markets.

While the Irish economy is expected to return to growth this year, domestic demand continues to contract. According to the Central Bank of Ireland, deflationary pressures are expected to persist through 2011, reflecting significant slack in the economy. This is in part due to weak labour market conditions. Employment has fallen 15% since its peak in the fourth quarter of 2007, although the pace of contraction has moderated significantly. Downward price pressures improve Ireland’s cost competitiveness, but negatively affect nominal growth and make debt stabilisation more challenging.

Weaker than expected growth is likely to push public debt ratios higher than previously anticipated. In our revised baseline scenario, Ireland’s gross general government debt peaks at 120% of GDP in 2013 and gradually declines thereafter. This excludes NAMA bonds and its associated assets.

As a highly open economy, Ireland’s growth prospects largely depend on external demand. Strong export performance in 2010 and the first quarter of 2011 made a positive contribution to growth and partially offset the contraction in domestic demand. However, slower growth in the United States and Europe could dampen Ireland’s prospects for recovery, potentially delaying debt stabilisation.

The A (low) ratings for the Republic of Ireland are underpinned by the strong commitment of the newly elected government to reduce the fiscal deficit below 3% of GDP by 2015. Deficit reduction measures amounted to €6 billion (3.8% of GDP) in 2011, and could total at as much as €4 billion (2.5% of GDP) in 2012. Tax receipts and expenditures in the first half of 2011 were broadly in line with forecasts from the Department of Finance. Steps have also been taken to address financial stability concerns. Following the publication of bank stress tests in March 2011, measures to restructure, deleverage and recapitalise the banking system have proceeded on schedule. In addition, the EU-IMF programme fully covers Ireland’s financing needs through 2013, providing Ireland with over two years to stabilise its public finances.

DBRS believes that the recent lowering of interest rates on European Financial Stability Facility (EFSF) loans is marginally positive for Ireland (see Policy Announcements Positive but Euro Area Debt Sustainability Still a Concern published on 27 July 2011). Ireland’s previous loan program, of which €45 billion is borrowed from the EFSF, the European Financial Stabilisation Mechanism (EFSM) and bilateral sources, was scheduled to have an average maturity of 7.5 years and an average interest rate of approximately 5.8%. DBRS expects improved lending terms will be extended to EFSM and bilateral loans. Depending on the maturity structure and cost of funds, savings from the new loans could lower annual interest payments by approximately €1 billion, or 0.6% of GDP.

Ireland is also regaining competitiveness and unwinding external imbalances. According to the IMF, unit labor costs declined 11% relative to the euro area average from 2007 to 2010. Exports of goods and services increased 6.3% in 2010 and continued to perform well in the first quarter of 2011. Improved competitiveness is also reflected in the current account, which shifted from a deficit of 5.6% of GDP in 2008 to a surplus of 0.5% of GDP in 2010. As a result, Ireland is no longer reliant on net external financing.

However, the evolution of Ireland’s ratings ultimately depends on the prospects for debt stabilisation. If fiscal targets are achieved and there is clear evidence of economic recovery, the trend could be changed to Stable. On the other hand, possible downward rating action could be triggered by fiscal slippage or a material worsening of Ireland’s growth prospects.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

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

The sources of information used for this rating include The Central Bank of Ireland’s Financial Measures Programme Report, Ireland Stability Programme Update April 2011, NAMA Annual Report 2010, NTMA Annual Report and Accounts, Central Bank of Ireland, IMF First and Second Reviews (May 2011), EC – Economic Adjustment Programme for Ireland (Spring 2011 Review), CSO, Eurostat, AMECO, and the International Monetary Fund. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 July 2010
Most Recent Rating Update: 1 April 2011

For additional information on this rating please refer to the linking document under Related Research.