DBRS Confirms Ireland at A (low) with Negative Trend

DBRS, Inc. (DBRS) has confirmed the Republic of Ireland’s long-term foreign and local currency issuer ratings at A (low). The trend on both ratings remains Negative. DBRS has also confirmed the short-term foreign and local currency issuer ratings at R-1 (low). The trend on both short-term ratings remains Stable.

The rating confirmation reflects signs of stabilisation in the Irish economy, progress reducing fiscal imbalances and evidence of improved international competitiveness. Strong policy implementation in the context of a EU-IMF program combined with measures taken at the European level have helped improve investor confidence, as illustrated by Ireland’s declining borrowing costs and recent return to the bond markets. However, the Negative trend reflects DBRS’s assessment that risks to the growth outlook are skewed to the downside. In particular, further escalation of the Euro area crisis would likely damage Ireland’s fragile recovery, make medium-term fiscal consolidation more difficult and delay prospects for debt stabilisation.

The Irish economy returned to growth in 2011 following three consecutive years of recession. Last year, the decline in domestic demand was more than offset by a large positive contribution from net exports. The economy is expected to decelerate modestly this year amid weak trading partner growth, fiscal tightening and private sector deleveraging. Unemployment remains high at 14.8% although the pace of job losses has moderated. The IMF forecasts GDP growth of 0.4% in 2012 and 1.4% in 2013, which is broadly in line with consensus forecasts.

The Irish government continues to achieve its fiscal consolidation targets. Exchequer tax receipts and expenditures in the first ten months of 2012 are on track to meet, if not surpass, the EU-IMF deficit ceiling of 8.6% of GDP. The government also announced deficit-reduction measures totalling €3.5 billion (2.2% of GDP) for 2013. Although specific measures have not yet been identified, the adjustment aims to reduce the budget gap to 7.5% of GDP next year. In DBRS’s view, proposed reforms to the budgetary framework, including the establishment of an independent Fiscal Advisory Council, the introduction of multi-annual expenditure ceilings and the implementation of new EU fiscal rules, reinforce the credibility of Ireland’s medium-term fiscal consolidation plan.

Ireland continues to recover lost competitiveness and unwind external imbalances. Nominal depreciation of the euro against the dollar and sterling has supported the recovery in price competitiveness, particularly given the large share of Irish exports destined for the United States and United Kingdom. At the same time, unit labour costs in Ireland have improved relative to other euro area economies. While this partly reflects the contraction in low-productivity sectors, such as construction, it also reflects wage adjustments and productivity gains. Amid improving competitiveness and weak domestic demand, the external accounts have rapidly adjusted. The current account shifted from a deficit of 6.7% of GDP in the third quarter of 2008 to a surplus of 3.4% in the second quarter of 2012.

There has also been progress reorganising the domestic banking system, although major challenges remain. Deposits at Irish banks in October 2012 were up €10.9 billion, or 7.6%, from one year earlier. This trend has been accompanied by progress in achieving deleveraging targets. By June 2012, ongoing Irish banks had divested or amortized approximately two-thirds of the €70 billion in non-core assets identified in the 2011 stress tests while remaining within the confines of the haircuts assumed under the adverse scenario. Consequently, reliance on central bank funding by ongoing banks has gradually declined from its peak of €93 billion in January 2011 to €60 billion in September 2012.

DBRS views Ireland’s resumption of regular Treasury-Bill auctions and the country’s return to the bond markets as a positive step toward exiting official financing support and a sign of strengthening investor confidence in the Irish economy. Borrowing costs have declined substantially since July 2011. While Ireland’s gross financing needs are covered by the EU-IMF program through the end of 2013, new issuances and debt management operations have reduced post-program funding requirements.

Despite these positive developments, Ireland’s growth outlook is characterized by a high degree of uncertainty with risks skewed to the downside. As a highly open economy, Ireland’s recovery largely depends on external demand, particularly from Europe and the United States. In particular, concerns over sovereign debt sustainability and financial sector fragility in the Euro area, combined with uncertainty over the future of Greece, could adversely affect growth in Ireland, principally through trade and confidence channels.

On the domestic front, private sector deleveraging and fiscal tightening pose downside risks to consumption and investment. Households have sharply increased savings and reduced spending in response to heightened economic uncertainty and declining net wealth. Although falling, household debt remains high at 117% of GDP. A prolonged period of deleveraging could delay a revival in domestic demand, with negative implications for the banking system and labour market.

Moreover, credit conditions remain tight as banks face deteriorating asset quality, stressed funding conditions and weak profitability. Mortgages over 90 days in arrears as a percentage of total outstanding balances increased from 5.9% in June 2010 to 14.7% in June 2012, although there are signs that the pace is moderating and banks have continued to make provisions. Further deterioration could result in greater-than-anticipated capital erosion and exacerbate credit conditions for the real economy. Lending to households and firms continued to contract through September 2012, although at a stable rate, reflecting both tight credit standards and low demand.

Ireland’s public debt levels are high and the trajectory is sensitive to growth. General government debt is expected to peak at 120% of GDP in 2013 and gradually decline thereafter, in line with our 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 facilitate Ireland’s return to the market and mitigate fiscal risks stemming from the banking system would also help stabilize the ratings. On the other hand, substantial deviations from the fiscal targets, the materialisation of contingent liabilities or deterioration in Ireland’s growth prospects – as a result of external shocks or weakness in the domestic economy – could lead to downward rating action.

Notes:
All figures are in Euros unless otherwise noted.

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

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: 8 August 2012

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