DBRS Confirms the Republic of Ireland at A (low), Trend Changed to Stable

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

The rating confirmation reflects Ireland’s highly productive economy, strong political commitment to fiscal consolidation and evidence of macroeconomic rebalancing. The coalition government has already made substantial progress on fiscal consolidation and the 2014 budget will reduce the deficit further. Positive developments in the fiscal accounts have been accompanied by improved competitiveness and a strengthened growth outlook. Moreover, Ireland exited its EU-IMF program at the end of 2013 in a strong funding position. The buildup of cash balances, the promissory note deal, and the maturity extension of official loans have helped ease post-program funding pressures. In fact, Ireland is fully funded through mid-2015. 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 a high stock of impaired loans and weak profitability.

The change in trend to Stable from Negative reflects DBRS’s assessment that prospects for debt sustainability have improved. This is the result of: (1) greater evidence of economic recovery in Ireland and the Euro area (2) progress on fiscal adjustment and (3) diminished risks stemming from contingent liabilities. Our expectation is that moderate fiscal tightening in 2015 combined with some cyclical recovery will be sufficient to stabilize debt dynamics. Improvement in the “Debt and Liquidity” section of our analysis made the most important contribution to the trend change.

Consequently, DBRS sees risks to the ratings as broadly balanced. If structural improvement in the fiscal balance firmly places public debt ratios on a downward path and substantial progress is made to resolve the high stock of non-performing loans in the financial system, the ratings could experience upward pressure over the medium term. On the other hand, weakened political commitment to fiscal consolidation or a material downward revision to growth prospects could pressure existing rating levels.

Despite weaker-than-expected GDP data in 2013, most activity indicators suggest that Ireland’s economic recovery is picking up. Domestic demand is stabilizing as labor and property markets continue to heal. Total employment increased by 3.3% in the fourth quarter of 2013, the fifth consecutive quarter of employment growth. Residential property prices were up in 2013, although dynamics varied between Dublin and the rest of the country. Construction investment is also starting to rebound, and the recovery in the value of housing assets has supported households’ efforts to repair their balance sheets. Encouraging signs in the domestic market have been accompanied by a strengthening outlook for external demand. The 2014 growth forecasts for Ireland’s key trading partners – the United Kingdom, the United States and the Euro area – have all been revised upwards over the last three months. Moreover, Ireland’s openness to trade and investment, its young and educated workforce, and its flexible labor market support medium-term growth prospects.

Macroeconomic imbalances built up during the boom years are being unwound. The fiscal deficit likely fell below 7.5% of GDP in 2013, suggesting Ireland met its deficit target for the third consecutive year. The 2014 budget aims to narrow the deficit to 4.8% of GDP. On the external side, improved competitiveness has supported export growth and this, combined with subdued domestic demand, has led to a large external adjustment. The current account is now in a large surplus position. In sum, the fiscal and external adjustments have put the economy in a better position to support sustainable growth in the future.

Contingent liabilities stemming from sovereign support of the banking system are large but declining. The National Asset Management Agency has redeemed €10.5 billion of the original €30.2 billion in senior government-guaranteed bonds and is well-positioned to make further redemptions this year. Although additional fiscal costs stemming from support of the banking system cannot be ruled out, the position of the domestic Irish banks has strengthened, partly as a result of improvements made following the Central Bank of Ireland’s 2013 balance sheet assessment. Moreover, the Eligible Liability Guarantee scheme, which was introduced at the height of Ireland’s financial crisis, was allowed to expire in March 2013. As a result, outstanding guarantees have declined significantly.

The principal risk to Ireland’s outlook 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 degree of uncertainty. 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. Irish banks face weak profitability and a high stock of non-performing loans. Further deterioration could 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 longer term effects of high unemployment. Of those unemployed aged 20 to 64, nearly half 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:
The main points discussed during the rating committee were: (1) Ireland’s economic outlook, in particular, developments in the labor and housing markets, (2) the issuer’s fiscal position, and (3) the health of the financial system. The committee concluded that significant progress has been made in these areas, although the fiscal deficit remains large and domestic Irish banks continue to face challenges. Other factors discussed included the balance of risks in the external environment, contingent liabilities on the sovereign balance sheet, and uncertainty over potential growth estimates.

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 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.

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
Most Recent Rating Update: 22 November 2013