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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). The rating trends on the Long-Term Ratings have been changed to Positive. At the same time, DBRS Morningstar confirmed its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The rating trends on the Short-Term Ratings remain Stable.

KEY RATING CONSIDERATIONS

The Positive trend reflects DBRS Morningstar’s view that macroeconomic fundamentals in Ireland are improving. Reported GDP expanded above 8% in 2017 and 2018 and is expected to have grown above 5% last year. Even excluding some of the external distortions stemming from the activity of multinational companies, measures of underlying domestic activity remain strong. On public finance, the robust economy and healthy corporate tax windfalls generated a fiscal surplus in 2019 for the second consecutive year. Debt sustainability metrics have improved, as evident by the steady decline in gross government debt ratios.

The ratification of the UK Withdrawal Agreement removes, at least for now, the possibility of a disorderly Brexit shock scenario. However, external developments – principally but not limited to uncertainty around the future UK-EU relationship – continue to pose downside risk to Ireland. Social and economic challenges to Ireland could reemerge if the UK and the EU are unable to agree on their future trade and regulatory relationship. Likewise, risks stemming from a slowdown in the U.S. economy, shifts in US-EU trade policy, and pending changes to global tax policy could also affect Ireland in a meaningful way.

The A (high) ratings are underpinned by Ireland’s robust trade and investment flows, 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 credit strengths are countered by several weaknesses, including volatile revenue sources and medium-term fiscal pressures, and a high stock of public debt. Ireland’s open economy, while also a credit strength, increases the country’s sensitivity to external developments.

RATING DRIVERS

The ratings are likely to be upgraded if: (1) evidence continues to point to enhanced economic resiliency to external developments; or (2) DBRS Morningstar’s assessment of debt sustainability improves to more moderate levels on the back of sound fiscal management. The trend could revert to Stable in the event of a material downward revision to the growth outlook or a weakening in fiscal discipline.
RATING RATIONALE

Ireland Begins 2020 with Temporary Relief from its Main External Challenges

Ireland is exposed to potential adverse external developments: (1) fallout from Brexit, (2) risk from the U.S., (3) changes to global tax policy. Recently, risks from all three have temporarily declined. The orderly withdrawal of the UK from the EU on January 31, 2020 removed the immediate social and economic disruptions of a no-deal Brexit. However, the threats are not yet resolved, as the likelihood of a no-deal Brexit could intensify once again if the EU and UK are unable to reach an agreement on their future relationship before the end of the transition period in December 2020. Most scenario calculations of the UK’s exit from the EU conclude that all forms of Brexit negatively affect the Irish economy in varying degrees, and the imposition of a hard border with Northern Ireland if no deal is agreed could reignite social tensions. The intensity and duration of a Brexit-related shock will be determined by the nature of the agreement.

Ireland reaps considerable benefits from the U.S. economic expansion. Strong performance in the U.S. provides high trade and investment returns to the Irish information and communications technology (ICT) sector, and consequently strong revenue growth to the government. Any slowdown of the U.S. economy will likely have meaningful spillover effects on the Irish economy and it remains unclear what potential shifts in U.S. trade policy could mean for Ireland.

Change in global tax policies is an ongoing concern for Ireland. The possible alignment of specific tax rates across Europe, especially following the introduction of digital taxes on large technology companies in the UK and France, could challenge Ireland’s growth model and create an unpredictable environment for the activity of multinational firms operating in Ireland. Significant shifts in fiscal incentives could result in a reduction in future investment flows into Ireland. For the time being, the OECD has taken the lead on how to standardize domestic tax base erosion and profit sharing (BEPS) arising from digitalisation. It will likely take time before consensus is found among EU member states.

Balance of payment data metrics in DBRS Morningstar’s scorecard are affected by Ireland-specific characteristics. Ireland’s high net international investment liabilities position reflects high quality inward direct investment and overstates external risks. Conversely, the strong current account surplus reflects the prevalence of contract manufacturing and overstates Ireland’s net savings position. DBRS Morningstar made qualitative adjustments to reflect these considerations in its Building Block Assessment.

Following Years of Exceptional Growth, Projections Point to Economic Performance More Aligned with EU

Real reported GDP expanded on average by nearly 7.0% each year from 2014 to 2018, excluding 2015. Underpinned by strong momentum in employment and construction investment, the economy grew by 4.9% yoy as of the third quarter 2019. However, there is broad consensus that reported GDP is overstated by multinational firms operating in Ireland. DBRS Morningstar makes a positive adjustment to its Building Block Assessment to reflect these statistical considerations.

A wide range of alternative measures also suggest that the domestic economy has grown at a strong pace. Employment growth increased at an annual average pace of 3.1% from 2013 to 2018, while value added construction advanced by 5.9% on average each year over the same period. Real modified final domestic demand, a preferred cyclical measure of underlying growth, grew at an annual average rate of 4.4% in 2014-2018 and slowed to 2.6% as of the third quarter 2019. DBRS Morningstar expects strong employment and wage growth, in a context of low inflation, to continue to support domestic demand. At the same time, weaker external demand will likely weigh on growth, which is expected to decelerate in the coming years to below 3% – a growth rate more in line with high income European peers.

Rapidly Improved Fiscal and Debt Ratios Conceal Corporate Tax Concentration and High Public Debt

The fiscal cash position tipped into surplus in 2019 for the second consecutive year. The surplus increased from 0.1% of GNI* (a preferred measure of national income that strips away some external distortions) in 2018 to 0.7% in 2019 thanks primarily to over-performance of the tax intake. The relocation of multinational assets to Ireland has sharply increased corporate tax revenues – which now account for 13% of revenue, up from the 20-year average of 9% – deriving from a handful of large companies.

The concentration of corporate tax revenue exposes Ireland’s fiscal outcomes to shocks if multinational firms decide to shift operations, move intangible assets, or book profits outside of Ireland. The Irish Fiscal Advisory Council has raised concern that the increasing importance of possibly volatile corporate tax revenues are being matched by increases in permanent spending. Expenditures overran budget targets last year. Nonetheless, DBRS Morningstar sees little incentive for large international corporates to leave Ireland. Multinational firms operate in Ireland for many reasons beyond its competitive corporate tax rate, including the stable legal and political system, access to the single European market, and the highly skilled workforce.

Despite improving public finances, public debt remains high and vulnerable to adverse shocks. General government debt-to-GDP is expected to have declined below the 60% threshold in 2019. Nevertheless, this ratio is distorted by Ireland’s GDP data. When using alternative debt metrics, Irish debt ratios are high and comparable to other European countries with high public debt. Interest costs to total revenue was 5.7% and debt as a share of total revenue was 250% in 2018, among the highest in Europe. Debt to GNI* in 2019 declined to around 100%. DBRS Morningstar makes a downward adjustment in the Debt and Liquidity Building Block to reflect these statistical considerations. It also makes a positive qualitative adjustment to the Fiscal Management and Policy Building Block Assessment to account for the large crisis-era deficits that currently over-state fiscal risk.

Ireland Has Largely Dealt with Crisis-Legacy Challenges to its Financial Sector.

There has been considerable progress over the years in restructuring the Irish banking system and in reducing impairments. 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 4.4% in as of the second quarter 2019, are below the EU average of around 5%. The improved financial sector is evident by profitable banks with healthy levels of capital and stronger funding profiles. The calming of property price growth in Ireland and strong macroprudential measures also strengthens the financial sector.

2020 Election is Unlikely to Affect Ireland’s High Quality Institutions and a Stable Political Environment

Ireland is a strong performer on the World Bank’s Worldwide Governance Indicators and its governments over the last decade have demonstrated policy continuity. In 2016, Fine Gael formed a minority government after reaching a Confidence and Supply Agreement with opposition party Fianna Fáil around fiscal policy. The framework was extended on several occations. Following the orderly Brexit transition, snap elections have been called in Ireland for February 8, 2020. Recent polling suggests the elections could yield another fractured outcome, which would result in another minority government or a multiparty coalition government. DBRS Morningstar does not, however, expect the political cycle to undermine strong institutional quality or stable macroeconomic policy-making.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal 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, Allied Irish Bank, Bank of Ireland, Permanent TSB, The Economic and Social Research Institute, Irish Fiscal Advisory Council, Bloomberg, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS Morningstar 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 Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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 GmbH are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: 21 July 2010
Last Rating Date: 2 August 2019

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