DBRS Confirms Ireland at A (low), Negative Trend

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

The rating confirmation reflects Ireland’s strong commitment to fiscal consolidation, evidence of macroeconomic rebalancing, and emerging signs of economic recovery. The coalition government has already made substantial progress on fiscal consolidation and the 2014 budget aims to reduce the deficit further. Positive developments on the fiscal side have been accompanied by improving macroeconomic conditions. Recent data in the labor and housing markets are early signs that the recovery is broadening. The IMF projects the Irish economy will expand 0.6% in 2013 and 1.8% in 2014. However, these supportive factors are balanced by significant challenges: the fiscal deficit is still large, the public and private sectors are heavily indebted, and the banking system continues to face deteriorating asset quality and weak profitability.

The Negative trend reflects DBRS’s assessment that risks stemming from the external environment remain skewed to the downside and that the expected primary fiscal balance in 2014 is still short of its debt-stabilizing threshold. However, the trend could be changed to Stable, potentially in the near term, if there is greater evidence of a sustained economic recovery and fiscal consolidation remains on track.

Recent activity indicators are generally positive and appear broad-based. Perhaps most importantly, there are encouraging signs in the labor market. Total employment increased by 1.8%, or nearly 34,000 jobs, over the last year while the unemployment rate declined to 13.7% in the second quarter of 2013. Data on the number of people seeking unemployment assistance suggests that the unemployment rate continued to fall through October 2013. Headwinds to growth from the housing sector also appear to be receding. Residential property prices have stabilized overall, although dynamics vary significantly between Dublin and the rest of the country. In addition, investment and construction employment have bottomed out after six years of depressed activity. The Ulster Bank Construction PMI index suggests that a recovery in the sector is gaining traction, albeit from very low levels. If sustained, these positive dynamics bode well for consumption and investment.

Macroeconomic imbalances built up during the boom years are also being unwound. Fiscal accounts have already undergone a sizeable adjustment. Data through October 2013 suggest that the government is broadly on track to meet the 7.5% of GDP deficit ceiling set out in the EU-IMF program, and the 2014 budget aims to narrow the deficit to 4.8% of GDP. Moderate fiscal tightening in 2015 combined with some cyclical recovery will likely be sufficient to put debt dynamics on a downward trajectory. On the external side, improved competitiveness has supported export growth and this, combined with subdued domestic demand, has led to a large adjustment in the external balances. The current account is in a surplus position. In sum, the fiscal and external adjustments have put the economy in a better position to support sustainable growth.

Ireland is exiting a three-year EU-IMF program in a strong funding position. The buildup of cash balances by the NTMA, the promissory note deal, and the maturity extension of official loans have significantly eased post-program funding pressures. In fact, Ireland is fully funded through early 2015. Market conditions for Irish sovereign debt have also improved substantially over the last three years. Borrowing costs are currently well below levels prevailing prior to the EU-IMF program. The absence of a precautionary credit line does not have a material impact on the ratings or trends.

The principal risk to Ireland’s outlook, in DBRS’s view, stems from the external environment. As a highly open economy, the strength of Ireland’s recovery depends in large part on events in the Euro area, the United Kingdom and the United States. Policy action at the European level has helped calm market volatility, but the Euro area outlook is still characterized by a high degree of uncertainty with downside risks stemming from high debt overhang, weak competitiveness and the threat of political instability in several Euro area economies. An adverse external shock could have large effects on Ireland’s recovery and delay the stabilization of public debt dynamics.

On the domestic front, tight credit conditions and highly indebted households could pose challenges to the recovery. Irish banks face deteriorating asset quality and weak profitability. Further deterioration could result in greater-than-anticipated capital erosion and exacerbate credit conditions for the real economy. Moreover, Irish households remain heavily indebted, despite five years of deleveraging. A prolonged period of balance sheet repair could dampen the recovery in domestic demand.

DBRS is also concerned about the effects of high unemployment over the medium term. Of those unemployed aged 20 to 64, over 44% have been out of work for two years or longer. Disengagement from the labor market and the mismatch between the qualifications of the unemployed and those sought by employers could lead to higher structural unemployment, thereby lowering the economy’s potential rate of growth.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships. These can be found on www.dbrs.com at: http://www.dbrs.com/about/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.

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

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 July 2010

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