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

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 to Positive from 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 and open economy, commitment to sound economic management and evidence of macroeconomic rebalancing. The coalition government has made substantial progress on fiscal consolidation and Ireland appears well-positioned to reduce the deficit below 3% of GDP in 2015, thereby exiting the Excessive Deficit Procedure (EDP) on schedule. Positive developments in the fiscal accounts have been accompanied by competitiveness gains and a strengthened growth outlook. In addition, the government has benefited from substantially improved funding conditions since exiting its EU-IMF program at the end of 2013. However, these supportive factors are balanced by significant challenges: the public and private sectors are heavily indebted, the fiscal deficit is still large and the banking system continues to face weak profitability and a high stock of impaired loans.

The change in trend to Positive reflects DBRS’s assessment that prospects for debt sustainability have improved. This is the result of: (1) greater evidence of economic recovery in Ireland (2) progress on reducing the fiscal deficit, and (3) diminished risks stemming from contingent liabilities. Our expectation is that a tight fiscal stance in 2015 combined with some cyclical recovery will be sufficient to put public debt dynamics on a downward path. Improvements in the “Fiscal Management and Policy” and “Debt and Liquidity” sections of our analysis made the most important contributions to the trend change.

DBRS views risks to the ratings as skewed to the upside. The ratings could be upgraded if improvement in the fiscal accounts place public debt ratios on a firm downward trajectory and greater progress is made to resolve the high stock of non-performing loans in the financial system. On the other hand, weakened political commitment to prudent fiscal management or a material downward revision to growth prospects could lead to a change in the trend back to Stable.

Improving labor market conditions, rising property prices and a rebound in investment suggest that the Irish recovery is broadening. The unemployment rate declined to 11.5% in the second quarter of 2014, down over three and a half percentage points from its peak in early 2012. Residential property prices, which declined 51% from September 2007 to March 2014, are now 41% below their pre-crisis high. Dublin accounts for most of the rebound but prices outside the capital are also rising. Improvements in the labor and property markets – which have been accompanied by strengthening consumer and business confidence indicators – are supporting a recovery in domestic demand. This is evident in recent investment data, where business investment and non-residential construction are picking up. Although homebuilding remains weak, the growing demand for houses in urban areas amid limited supply bodes well for residential investment over the medium term. In fact, residential investment is likely to be a source of growth in the coming years.

Encouraging signs in the domestic market are accompanied by a supportive external outlook. Despite weakness in the euro area, two of Ireland’s main trading partners – the United Kingdom and the United States – are expected to expand at relatively strong rates in 2015 and 2016. Moreover, Ireland’s openness to trade and investment, flexible labor market, and access to the European market underpin its competitiveness and strong medium-term growth prospects. In DBRS’s current assessment, real GDP is forecast to expand 2.5% in 2014 and 2015. However, the recent publication of national accounts data for the second quarter of 2014 suggest there is clear upside risk to the outlook.

Ireland has made substantial progress putting its public finances on a sustainable path. The fiscal deficit this year will likely fall well below the EDP ceiling of 5.1% of GDP. Upward revisions to GDP have mechanically reduced the deficit ratio, but far more importantly, Exchequer data in the first eight months of the year has been strong. All major tax headings – income, VAT, corporation and excise – are ahead of budget, and spending has been tightly managed across most departments. With positive momentum in the fiscal accounts, Ireland appears well-positioned to reduce the deficit below 3% of GDP next year. In DBRS’s view, the 2015 Budget will likely be calibrated to minimize the consolidation effort while still achieving the 3% deficit target with a margin of safety. Government plans to repay a portion of its IMF loans early could help deficit-reduction efforts by reducing interest payments by up to €400 million per year.

In addition to positive growth-fiscal dynamics, contingent liability risks stemming from the banking system have diminished. The National Asset Management Agency (NAMA), which acquired distressed property development loans from Irish banks in 2010, announced that it now expects to redeem its senior and subordinated debt on an accelerated timetable. The liquidation of the Irish Bank Resolution Corporation (IBRC) has also progressed well. The sales process is on track to conclude by the end of 2014 without any additional government support. Furthermore, the performance of the domestic Irish banks has improved in 2014 and this should reduce the potential for additional capital requirements as a result of the ECB/EBA comprehensive review. Although the need for additional capital cannot be ruled out, DBRS does not anticipate this in its baseline scenario.

The principal risk to Ireland’s outlook stems from the external environment. The outlook for the Euro area is fragile. Growth is expected to be weak in 2014 and 2015. Escalating tensions with Russia could further weaken European demand, potentially with adverse effects on Ireland’s recovery.

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.

Notes:
The main points discussed during the rating committee were: (1) Ireland’s economic recovery, particularly developments in the labor and housing market, (2) the issuer’s fiscal position and medium term budgetary outlook, (3) risks stemming from contingent liabilities, and (4) recent developments in the financial sector. The committee concluded that the economic recovery appears to be gaining momentum, the fiscal deficit is narrowing faster-than-previously anticipated (although medium-term pressures remain) and the banking system continues to face challenges. Other factors discussed include the balance of risks in the external environment 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, Central Statistics Office Ireland, 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: 28 March 2014