DBRS Confirms Republic of Ireland at A (high), Stable Trend

DBRS Ratings Limited confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high) and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trends on all ratings are Stable.

KEY RATING CONSIDERATIONS

The ratings confirmation reflects DBRS’s view that upward pressures on the ratings remain balanced by credit challenges. The Irish credit profile is supported by the strong economic growth performance and improvement in the debt to GDP ratio. However, external developments continue to pose downside risks that weigh on the ratings.

The reported GDP figure, inflated by the activity of multinational companies, grew by 7.2% in 2017. Excluding some of the distortions, measures of underlying domestic activity are also strong. The robust economy and years of expenditure control narrowed the fiscal deficit to 0.4% of GDP last year and reduced gross government debt to 68.4% of GDP. Despite the improved macroeconomic fundamentals, DBRS expects that an outcome of the Brexit negotiations that fully misaligns the UK’s trade and regulatory relationship with the EU could adversely affect Ireland.

The A (high) ratings are underpinned by Ireland’s openness to trade and investment, its flexible labour market, young and educated workforce, and the country’s access to the European market. The country’s institutional strength and its favourable business environment encourage investment. These credit fundamentals support the economy’s competitiveness and its medium-term growth prospects. The country’s strengths are countered by several credit weaknesses, including sensitive exposure to external developments, medium-term fiscal pressures, high public debt, and lingering asset quality concerns in the banking system.

RATING DRIVERS

Upward rating pressure could be warranted if: (1) there is clear evidence of enhanced economic resiliency to external developments given that the Irish economy is highly open and exposed to adverse shocks; or (2) appropriate measures of public debt decline to more moderate levels on the back of sound fiscal management. On the other hand, the ratings could face downward pressure if material downward revision in the growth outlook or a weakening in fiscal discipline cause medium-term public debt dynamics to reverse course.

RATING RATIONALE

Strong Economic Growth Momentum Despite External Sector Risks

Irrespective of the statistical complexities associated with calculating GDP, a wide range of indicators suggests that the Irish domestic economy continues to grow at an exceptional pace. Excluding 2015, real GDP expanded on average by nearly 7.0% each year since 2014 and preliminary estimates point to annualised growth above 9.0% in the first quarter of 2018, despite broad consensus that reported GDP is inflated by multinational firms operating in Ireland and does not fully capture the pace of underlying economic growth.

Using alternative measures, however, the economic growth still appears robust. Real modified domestic demand has grown at an annual average rate above 4.0% in 2014-2017 and employment growth increased at an annual average pace of 3.2% from 2013-2017. Since current economic growth is above the trend in potential output, there are emerging concerns that the economy is overheating. Notwithstanding key labour and real estate indicators that show pre-crisis growth rates and a positive output gap, wage growth and inflationary pressures currently remain subdued. DBRS is of the view that the current composition of growth is less vulnerable to an economic slowdown than a decade ago and economic growth will gradually slow towards the IMF’s 3% measure of potential growth.

At the same time, Ireland is exposed to potential adverse external developments. Most scenario calculations of the UK’s exit from the European Union (EU) conclude that all forms of Brexit negatively affect the Irish economy in varying degrees. Depending on the final withdrawal agreement, Ireland would be adversely affected through trade and investment channels. The overall effects of the ongoing Brexit negotiations on the Irish economy have thus far been muted, and all negotiating positions appear to have ruled out the imposition of a historically sensitive hard border with Northern Ireland. However, the intensity and duration of a Brexit-related shock will ultimately be determined by the nature of the agreement, which remains unclear.

Lack of clarity over how multinational firms operating in Ireland will respond to changes in global trade and tax policies poses additional external risks. The current U.S. administration has demonstrated a preference to exit or renegotiate existing trade agreements and impose protectionist measures. It remains unclear what forthcoming shifts in U.S. trade policy will mean for the Irish economy. Furthermore, the recently passed changes to U.S. tax policy and the possible alignment of specific tax rates across European create an unpredictable environment for the activity of multinationals. Significant shifts in fiscal incentives could result in a reduction in future investment flows into Ireland.

Strong Fiscal Outcomes and Debt-to-GDP Metrics Conceal Corporate Tax Concentration and High Public Debt

The fiscal position reached near balance last year. The government measures the 2017 deficit at 0.4% of GDP, a slight improvement on the 0.5% deficit in 2016 and a large improvement on the 1.9% deficit in 2015, or the 3.6% outcome in 2014. Fiscal progress reflects expenditure control and over-performance of the tax intake. The relocation of assets by multinationals to Ireland in 2015 led to a sharp increase in corporate tax revenue, which has been a strong contributor to deficit reduction.

Corporate taxation in Ireland makes up 16% of total tax revenues, up from 11% in 2014, and is highly concentrated in a handful of large companies. This exposes Ireland’s fiscal outcome to shocks to the corporate tax base if multinational firms decide to shift operations, move intangible assets, or book profits outside of Ireland. However, multinational firms operate in Ireland for many reasons, including the stable legal and political system, access to the single European market, and the highly skilled workforce – all of which help reduce incentives for multinationals to leave Ireland and limit the risk associated with a shock to the corporate tax base. It is also important to note that fiscal strength is evident in structural terms. The EC expects the structural deficit to average 0.5% of GDP over the next two years, in line with the Medium-Term Objective of the Stability and Growth Pact.

Although public finances are improving, public debt remains high and vulnerable to adverse shocks. General government debt-to-GDP declined to 68.4% in 2017, which is moderate compared to other Euro area countries. Favourable nominal GDP expectations suggest debt to GDP will continue to decline, falling to 63.2% by 2019. Nevertheless, this ratio is distorted by Ireland’s GDP data. When using alternative debt metrics, including interest costs to total revenue at 7.6% in 2017 (or 6.5% if interest paid to the central bank is excluded), Irish debt is similar to other high public debt European countries such as Italy and Portugal. Debt as a share of total revenues was 263% last year, among the highest in the Euro area. To improve economic resilience from risks linked to high debt, economic overheating, and lingering external risks, the government plans to develop a ‘rainy-day’ fund that it expects to reach €3 billion by 2021.

Bank Asset Quality is Improving, but Impaired Assets are Still at High Levels

Notwithstanding the significant progress in restructuring the Irish banking system and the progress in reducing impairments, there remains high level of stressed assets across the sector. Ireland’s banking crisis left a large stock of impaired assets on bank balance sheets. Non-performing loans of the banking sector as a share of total loans, having declined according to the IMF from 25.7% in 2013 to 11.5% as of 2017, remains well above the EU average of around 5%. Impairments of the three large banks in which the state continues to hold a stake (AIB, BOI and PTSB) declined to €14.8 billion (or 9.2% of impairments as a share of total loans) in 2017, down from €20.3 (12.0%) in 2016 and €29.0 billion (15.5%) in 2015. Banks are nonetheless profitable with higher levels of capital and improved funding profiles.

Ireland has High Quality Institutions and a Stable Political Environment

Ireland is a strong performer on the World Bank’s Worldwide Governance Indicators and the governments over the last decade have demonstrated policy continuity. In the February 2016 election, Fine Gael formed a minority government after reaching a Confidence and Supply agreement with opposition party Fianna Fáil around fiscal policy. Both main parties agreed to extend the deal and not review the existing framework until 2020. While a general election is not required until 2021, an early election is possible. In recent polling, Fine Gael has opened a double-digit lead. DBRS does not expect the political cycle to undermine strong institutional quality or stable macroeconomic policy-making.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A (high) – A (low) range. The main points discussed during the Rating Committee include: Ireland’s macroeconomic performance, and the effects on Ireland from Brexit and changes to the U.S. tax policy.

KEY INDICATORS

Fiscal Balance (% GDP): -0.4 (2017); -0.2 (2018F); -0.2 (2019F)
Gross Debt (% GDP): 68.4 (2017); 65.6 (2018F); 63.2 (2019F)
Nominal GDP (EUR billions): 294.1 (2017); 314.9 (2018F); 332.0 (2019F)
GDP per Capita (EUR): 61,267 (2017); 64,900 (2018F); 67,801 (2019F)
Real GDP growth (%): 7.2 (2017); 5.6 (2018F); 4.0 (2019F)
Consumer Price Inflation (%): -0.2 (2017); 0.3 (2018F); 0.9 (2019F)
Domestic Credit (% GDP): 3.6 (2017)
Current Account (% GDP): 8.5 (2017); 9.8 (2018F); 8.7 (2019F)
International Investment Position (% GDP): -156.8 (2017)
Gross External Debt (% GDP): 725.9 (2017); 721.6 (Mar 2018)
Governance Indicator (percentile rank): 88.5 (2016)
Human Development Index: 0.9 (2015)

Notes:

All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/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, World Bank, UNDP, SNL, Allied Irish Bank, Bank of Ireland, Permanent TSB, The Economic and Social Research Institute, Bloomberg, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve-month period. DBRS’s outlooks and ratings are under regular surveillance.

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

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Sovereign Ratings
Initial Rating Date: 21 July 2010
Last Rating Date: 16 February 2018

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.