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

DBRS, Inc. has confirmed the Republic of Ireland’s long-term foreign and local currency issuer ratings at A 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 changed the trend to Positive from Stable.

The ratings are underpinned by Ireland’s openness to trade and investment, young and educated workforce, flexible labor market, and access to the European market, all of which support the economy’s competitiveness and solid medium-term growth prospects. These strengths are countered by several credit weaknesses, including high public debt, heavily indebted households and medium-term fiscal pressures.

The Positive trend reflects DBRS’s assessment that the outlook for public debt sustainability in Ireland is improving. This is the result of: (1) a strengthening economic recovery, (2) progress on reducing the fiscal deficit, and (3) diminished risks stemming from contingent liabilities. We now expect public debt ratios to trend downwards at a more rapid pace than previously anticipated. Improvements in the “Fiscal Management and Policy” and “Debt and Liquidity” sections of our analysis were the key factors for the trend change.

Upward rating action is dependent on enhancing the economy’s level of resilience, particularly given that the economy is highly open and exposed to adverse shocks. Specifically, the ratings could be upgraded if the outlook for public debt dynamics is sustained and greater fiscal policy space is created. The Positive trend indicates that DBRS does not foresee a downgrade of the ratings in the near term. However, if public debt dynamics underperform expectations – due to either a material downward revision in the growth outlook or a weakening in the political commitment to sustainable fiscal policy – the trend could be changed back to Stable.

The Irish economy is experiencing a strong and broad-based recovery. The economy expanded 5.2% in 2014. This was driven by a revival in domestic demand, which made its strongest contribution to GDP growth since 2007. Private consumption benefited from better labor market conditions, wealth effects driven by rising home prices, and strengthening consumer sentiment. Machinery and equipment investment also increased at a solid pace. Moreover, the growth outlook is positive. The IMF forecasts GDP growth of 4.0% in 2015 and 3.3% in 2016. In DBRS’s view, risks to this forecast are skewed to the upside. Lower energy prices, a weaker euro, economic strength among key trading partners, and a pick-up in residential investment could act as tailwinds, providing further support to the recovery.

Ireland has also made substantial progress putting its public finances on a sustainable path. Bolstered by a strengthening economy, the government is targeting a deficit of 2.3% of GDP in 2015. In the first eight months of the year, all major tax headings – income tax, VAT, corporation tax and excise tax – are ahead of profile. On the expenditure side, healthcare overruns continue to be a source of concern but they are offset by lower debt service costs. General elections, which must take place by April 2016, present some uncertainty over the political outlook. Nevertheless, DBRS expects prudent fiscal policy to be sustained through the electoral cycle.

Risks stemming from contingent liabilities in the financial system have materially declined. The National Asset Management Agency (NAMA) expects to wind up operations by 2018 with a small surplus. The Irish Bank Resolution Corporation (IBRC) was liquidated and unsecured creditors, including the Irish government, could be repaid. In addition, Ireland’s two pillar banks passed the ECB/EBA comprehensive assessment in October 2014 without requiring additional capital. This, combined with fact that both banks returned to profitability in 2014, suggest that financial sector-related risks to public finances have diminished.

As a result of these factors, the outlook for public debt sustainability in Ireland has clearly improved. General government debt declined to 108% of GDP in 2014 from 120% in 2013, largely reflecting the liquidation of IBRC. The debt ratio is expected to continue trending downward – reaching 100% of GDP by 2016 – due to primary surpluses and favorable growth-interest rate dynamics. Proceeds from the sale of government holdings in Irish banks, which are valued at approximately 8.5% of GDP, could further reduce the public debt burden.

These positive developments are countered by several credit weaknesses. Though public debt ratios are declining, they remain high and vulnerable to adverse shocks. The principal risk stems from the external environment. International conditions in 2015 have been favorable for Ireland, but the outlook for the euro area as a whole is still weak and clouded by downside risks. Economic deceleration in China, fallout from disruptive events in Greece or escalating tensions with Russia could dampen the growth in Europe and adversely affect the recovery in Ireland.

On the domestic front, the level of household indebtedness is still high by comparative and historical standards, despite over six years of deleveraging. The process of balance sheet repair could take several more years, potentially dampening the recovery in domestic demand. Moreover, Irish banks still have a high stock of non-performing loans. Adverse shocks could worsen credit conditions for the real economy.

Sustaining a tight fiscal stance could also be difficult as medium-term spending pressures mount. Demand for public services, notably healthcare and education, is expected to increase due to demographics, and higher capital expenditures could be required to sustain strong potential growth, particularly after years of fiscal consolidation. Moreover, the government has signaled its intention to reduce taxation on labor over a multi-year period. If tax cuts are not accompanied by other offsetting measures or if expenditures outpace current expectations, complying with the new fiscal rules could be difficult.

Notes:
The main points discussed in the Rating Committee were: (1) Ireland’s recent economic performance, (2) the fiscal outlook as general elections approach, and (3) developments in the financial sector. Other factors discussed include the balance of risks in the external environment.

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, National Asset 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.

DBRS does not typically accept editorial changes other than to correct for factual, accuracy and/or to remove confidential, material non-public, or sensitive information that might otherwise be inadvertently disclosed.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 July 2010
Most Recent Rating Update: 13 March 2015