DBRS Upgrades Republic of Ireland to A (high)

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

The upgrade reflects DBRS’s assessment that the outlook for public debt sustainability in Ireland has materially improved. This is due to (1) a strong economic recovery, and (2) progress reducing the fiscal deficit. Public debt ratios are now expected to trend downwards at a more rapid pace than previously anticipated. Ireland’s strengthened credit profile warrants the upgrade even as the UK referendum on European Union membership on June 23rd presents some downside risk to the growth outlook. Improvements in the “Fiscal Management and Policy” and “Debt and Liquidity” sections of our analysis were key factors in the rating decision.

The inconclusive election on February 26th is unlikely to alter the fiscal outlook. Although the results raise the likelihood of a hung parliament or the formation of a weak coalition, all major parties, including Sinn Féin, have promised to respect Ireland’s budget rules under the Stability and Growth Pact. Regardless of the composition of the next government, the overall direction of macroeconomic policy is unlikely to change.

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, medium-term fiscal pressures, heavily indebted households and asset quality concerns in the banking system.

The Stable trend reflects DBRS’s view that risks to the ratings are broadly balanced. Measures that enhance the economy’s resilience, particularly given that the economy is highly open and exposed to adverse shocks, could warrant upward rating action. Specifically, the ratings could be upgraded if public debt levels decline to more moderate levels on the back of sound fiscal management. On the other hand, if public debt dynamics reverse course – due to either a material downward revision in the growth outlook or a weakening in fiscal discipline – the ratings could face downward pressure.

Ireland is experiencing a strong and broad-based recovery. The economy expanded 5.2% in 2014 and 7.8% in 2015. Domestic demand has been the principal driver of growth. Positive momentum in the labor market has strengthened consumer confidence and lifted private consumption, while firms have begun to invest following years of cutbacks. Favorable external factors have also bolstered the economy’s performance, with Ireland benefiting from euro depreciation, lower energy prices and strong growth from key trading partners. With these trends set to continue, the near-term outlook remains favorable. The IMF estimates GDP growth of 4.2% in 2016 and 3.3% in 2017.

The fiscal balance in 2015 outperformed expectations despite supplemental spending in the final months of the year. The deficit narrowed to an estimated 1.5% of GDP, significantly better than projections of 2.1% in the 2016 Budget (published in October 2015). Consequently, Ireland is expected to formally exit its Excessive Deficit Procedure on schedule. The deficit would have been even lower if the government had not allocated additional spending in October 2015 to accommodate sizable overruns in healthcare and social protection. Nevertheless, Ireland’s headline fiscal position now compares favorably to the euro area as a whole, a significant change from the previous seven years. The 2016 Budget projects a deficit of 1.2% of GDP, but a better-than-expected starting position suggests that fiscal results could outperform again.

With a recovering economy and improving fiscal accounts, the outlook for public debt sustainability has clearly improved. General government debt declined to a projected 97% of GDP in 2015 (perhaps lower given recent national accounts data) from 120% in 2013. This is faster than previously anticipated. The sharp decline reflects strong nominal growth, the drawdown of precautionary cash reserves by the Irish treasury and the liquidation of IBRC. DBRS expects the debt ratio to continue trending downward – approaching 90% of GDP in 2017 – due to primary surpluses and favorable growth-interest rate dynamics. Proceeds from the sale of government holdings in Irish banks, which are valued at roughly 7% of GDP, could further reduce the public debt burden.

Although the debt ratio is declining, public debt remains high and vulnerable to adverse shocks. For Ireland, several uncertainties cloud the external outlook, including the UK referendum on European Union membership in the scheduled for June 23rd. If the “out” camp wins, DBRS believes Irish economy could be adversely affected through trade, investment and confidence channels, although the intensity of the impact would depend on the future relationship between the UK and the EU.

On the domestic front, the level of household indebtedness is still high by comparative and historical standards, despite 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.

Enhancing the resilience of the sovereign balance sheet would require an extended period of strong fiscal results. However, sustaining a tight fiscal stance could be difficult as medium-term spending pressures mount. Demand for public services, notably in education and healthcare, are expected to increase due to changing demographics, and higher capital expenditures could be needed to support potential growth.

Notes:
The main points discussed in the rating committee were: (1) the pace and composition of Ireland’s economic recovery, and (2) the 2015 fiscal results. The committee concluded that significant progress had been made in these areas. On the other hand, the committee noted that public debt ratios remain high and risks stemming from the external environment remain significant, including a possible UK exit from the European Union. Other factors discussed include the political outlook following the February 2015 elections as well as recent developments in the financial sector.

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 Department of Finance, Central Bank of Ireland, Central Statistics Office Ireland, NTMA, NAMA, European Central Bank, European Commission, Eurostat, IMF, Statistical Office of the European Communities, SNL, Allied Irish Bank, Bank of Ireland, Permanent TSB, Bloomberg, The Economic and Social Research Institute, 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: Roger Lister
Initial Rating Date: 21 July 2010
Most Recent Rating Update: 11 September 2015