DBRS Confirms Ireland at A (low) with Negative Trend

DBRS, Inc. (DBRS) has today confirmed the ratings on the Republic of Ireland’s long-term foreign and local currency debt at A (low), and assigned a Negative trend on both ratings. Today’s action concludes DBRS’s review of these ratings that commenced on 22 May 2012. As such, the ratings are no longer Under Review with Negative Implications.

The confirmation of the ratings reflects tentative signs of stabilisation in the Irish economy, progress reducing fiscal imbalances, and the restoration of lost competitiveness as reflected by two consecutive years of current account surpluses. The Negative trend recognises that downside risks to growth in the Euro area have intensified as a result of systemic concerns. Further escalation of the Euro area crisis would likely damage Ireland’s nascent recovery, make medium-term fiscal consolidation more difficult, and delay prospects for debt stabilisation.

After three consecutive years of contraction, the Irish economy returned to growth in 2011. Real GDP expanded 1.4% as net exports more than offset the decline in domestic demand. Unemployment remains high at 14.8%, but the pace of job losses has moderated significantly. Growth projections for 2012 and 2013 are largely unchanged, with the IMF forecasting GDP growth of 0.5% and 1.9%, respectively.

Ireland has made clear progress unwinding external imbalances and regaining lost competitiveness. The current account shifted from a deficit of 5.7% of GDP in 2008 to surpluses of 1.1% of GDP in 2010 and 2011. The adjustment has been supported by strong export growth, particularly services. As a result, Ireland is no longer reliant on net external financing.

The Irish government continues to achieve its fiscal consolidation targets despite weakness in domestic demand. The general government deficit (excluding bank support) narrowed from 10.9% of GDP in 2010 to 9.3% in 2011, well ahead of the 10.6% EU-IMF target. Exchequer tax receipts and expenditures in the first seven months of 2012 are also on track to meet, if not surpass, this year’s target of 8.6%. In DBRS’s view, proposed reforms to the budgetary framework, including the establishment of an independent Fiscal Advisory Council and the implementation of new EU fiscal rules, reinforce the credibility of Ireland’s medium-term fiscal consolidation plan.

There has been progress in reorganising the domestic banking system, although challenges remain. The deleveraging process is ahead of schedule. Asset disposal at the end of March 2012 amounted to EUR 17.6 billion, with discounts within the PCAR baseline assumptions. Moreover, private deposits at covered Irish banks have increased modestly since bottoming out in November 2011. Consequently, reliance on funding from the Central Bank of Ireland has gradually declined from a peak of EUR 156 billion in February 2011 to EUR 107 billion in June 2012.

Ireland successfully re-entered the Treasury bill and bond markets in July 2012. DBRS views this as a positive step toward exiting official financing support and a sign of strengthening investor confidence in the Irish economy. Bond swaps carried out in January and July 2012 also reduced funding needs in 2013 and 2014. However, given the uncertain economic and financial outlook for the Euro area, it is not clear, in DBRS’s opinion, if Ireland will be able to utilise market-based financing on the scale necessary to cover its gross financing needs in 2014. Nevertheless, the A (low) ratings incorporate DBRS’s expectation that additional official financing would be provided to Ireland, if necessary, as long as the performance criteria and structural benchmarks are largely met.

Despite these positive developments, concerns over sovereign debt sustainability and financial sector fragility in the Euro area, combined with uncertainty over the future of Greece, have increased downside risks to growth across the Euro area. As a highly open economy, Ireland’s recovery is largely dependent on the performance of its exports, particularly to its main trading partners in Europe.

Fiscal austerity, private sector deleveraging, and the negative wealth effect of declining home values point to subdued prospects for domestic demand. Lending to households and firms continued to contract through May 2012, although at a stable rate, reflecting both tighter credit standards and low demand. Moreover, Irish banks are facing deteriorating asset quality and weak profitability. Residential mortgage arrears as a percentage of total outstanding balances increased to 13.7% in March 2012, up from 8.3% one year earlier. Further deterioration could result in greater-than-anticipated capital erosion and exacerbate credit conditions for the real economy.

Ireland’s public debt levels are high and the trajectory is sensitive to growth and the fiscal program. General government debt is expected to peak around 120% of GDP next year and gradually decline thereafter, broadly in line with DBRS’s previous expectations. If fiscal consolidation continues to advance on schedule and there is greater evidence of economic recovery, the trend could be changed to Stable. Further support from European partners to mitigate fiscal risks stemming from the banking system and lower the public debt burden would also help stabilise the ratings. On the other hand, fiscal slippage, the materialisation of contingent liabilities or a material worsening of Ireland’s growth prospects – as a result of external shocks or weakness in the domestic economy – could lead to downward rating action.

DBRS will host a teleconference on 9 August 2012, which will focus on the review of DBRS’s sovereign ratings of: Italy, Ireland, and Spain.

Notes:
All figures are in Euros unless otherwise noted.

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

The sources of information used for this rating include the Central Bank of Ireland, Department of Finance, National Treasury Management Agency, Eurostat, European Commission, IMF and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 July 2010
Most Recent Rating Update: 22 May 2012

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