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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS Morningstar confirmed its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

Confirmation of the Stable trend balances Ireland’s strong policy institutions and its productive economy against the severe consequences of the current health crisis on the country’s key macroeconomic indicators. Measures of Irish economic growth have for many years been strong, even after excluding external distortions stemming from the activity of multinational companies. The government also generated a fiscal surplus in 2019 for the second consecutive year and debt dynamics had been on a declining trend. However, the pandemic will this year result in a sharp decline in economic output and deterioration in public finances.

The global shock brought on by the Coronavirus Disease (COVID-19) adds to existing Irish challenges. Principally, little progress has been made this year around the future UK-EU relationship, following ratification of the UK Withdrawal Agreement in early 2020. DBRS Morningstar considers the greatest threat to Ireland stems from the possibility that the UK and the EU are unable to agree on their future trade and regulatory relationship. A no-deal Brexit, where trade between Ireland and the UK reverts to World Trade Organization status, could be accompanied by increased restrictions in the trade of goods and the mobility of citizens between the two countries and the possible re-emergence of social and economic tensions across the island of Ireland. Pending changes to global tax policy also pose downside risk to Ireland.

Ireland’s A (high) ratings are underpinned by the country’s institutional strength, robust trade and investment flows, flexible labour market, young and educated workforce, and its access to the European market – features that 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 vulnerability to external developments.

RATING DRIVERS

The ratings could be downgraded if the current health crisis or a no-deal Brexit event causes substantial deterioration in Ireland’s medium-term economic outlook; or if the country experiences a more permanent relaxation of fiscal discipline that significantly weakens its public debt position.
The ratings could be upgraded if DBRS Morningstar sees evidence of enhanced resiliency of the Irish economy to external developments; or if its assessment of debt sustainability improves to more moderate levels on the back of sound fiscal management.

RATING RATIONALE

Ireland’s High Quality Policy Institutions Confront the Health Crisis in 2020 and Possible Brexit Shock in 2021

Ireland’s general election in February 2020 coincided with the early spread of COVD-19 across Europe. The election resulted in a significant loss of seats for the two main political parties, Fine Gael and Fianna Fáil, and gains by Sinn Féin and the Greens. While the inconclusive election occurred at challenging time, the political cycle has not undermined Ireland’s strong institutional quality or its stable macroeconomic policy-making. Ireland is a strong performer on the World Bank’s governance indicators, and its governments over the last decade have demonstrated policy continuity.

The government introduced mobility restrictions from late March to early May 2020 in order to slow the transmission of the virus. Following successful suppression during the summer months, the easing of restrictions in Ireland and across Europe, as well as increased testing capacity, have led to a recent uptick of case counts in Ireland. A new coalition government that includes Fine Gael, Fianna Fáil, and the Greens took office in June 2020, and in September the government implemented a 5-level restriction plan on social mobility for citizens. The reintroduction of restrictions in Ireland will likely slow the economic recovery, in an effort to make it more durable.

Complicating matters further, the threat of a Brexit-related shock to Ireland looms at the end of the year. The possibility of a no-deal Brexit remains and there is limited time for the EU and UK 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 adversely affect the Irish economy in varying degrees. Without a formal deal, the trade relationship would likely revert to WTO status and likely require checks along the border with Northern Ireland, possibly weakening the 1998 Belfast Agreement that was integral to improving community relations following decades of difficult social conflict. The intensity and duration of a Brexit shock will ultimately be determined by the nature of the relationship.

The Global Health Crisis Is Imposing a Significant Shock to the Irish Economy

Ireland’s economic landscape in 2020 has dramatically changed from recent years. Real Modified Final Domestic Demand (MDD), a preferred growth measure that adjusts for external factors, expanded on average by 4.3% each year from 2015 to 2019. When mobility restrictions were strictest in the second quarter of 2020, MDD contracted by 16.4% compared to a year earlier. Weighing on domestic demand, the unemployment rate once adjusted to include the employed population on temporary wage assistance remained elevated at 14.7% in September 2020. Moreover, the six week stalling of construction in the second quarter led to a 28% decline in modified investment. Other consumer-oriented domestic services like retail, real estate, entertainment, transport, and hospitality have also reduced capacity.

However, performance of externally focused sectors have been able to mitigate the adverse crisis impact on GDP. Real GDP declined by just 3.7% year-over-year in the second quarter, among the best performers among advanced countries. This is because the impact from the crisis on internationally-traded sectors, principally pharmaceutical and the information and communications technology (ICT) sectors, has been less severe. The European Commission expects the economy to contract by 8.5% this year and recover by 6.3% in 2021. Statistical considerations specific to Ireland’s national accounts overstate economic risk in DBRS Morningstar’s scorecard, supporting its assessment in the “Economic Structure and Performance” building block.

Public Support Measures Will Result in a Return to a Large Fiscal Deficit and Keep Public Debt Elevated

Counter-cyclical expenditure measures implemented to support the economy have been large. The total fiscal response has amounted to EUR 24 billion, or 14% of GNI* (gross national income adjusted for external factors). Roughly four-fifths of the response consists of direct expenditure measures to support employees, households, and businesses as well as increased health and capital spending. The government expects the deficit in 2020 to widen to around EUR 25-30 billion (7.0%-9.0% of GDP) and preliminary 2021 budget estimates show deficit borrowing around EUR 15-19 billion (4.5%-5.5% of GDP) next year. Statistical considerations specific to Ireland overstate fiscal risk in DBRS Morningstar’s scorecard. This supports its assessment in the “Fiscal Management and Policy” building block.

The concentration of corporate tax revenue exposes Ireland’s fiscal outcomes. The relocation of multinational assets to Ireland has sharply increased corporate tax revenues, which now accounts for nearly 20% of tax revenue, up from around 11% in 2011-2014. 40% of corporate taxes were paid by ten companies in 2019. Risk to revenue collection could result if multinational firms decide to ‘re-shore’ activity, shift operations, move intangible assets, or book profits outside of Ireland. DBRS Morningstar at present sees little incentive for large international corporates to leave Ireland. Firms operate in Ireland among other reasons because of the stable legal and political system, access to the single European market, and the skilled workforce.

All measures of Irish government debt will increase as a result of the current shock. The general government debt-to-GDP ratio, having declined to 57.3% in 2019, is forecast to increase to 69% in 2020 as a result of the crisis. However, using alternative debt metrics, Irish debt ratios are high and comparable to other highly indebted European countries. This factor weighs on DBRS Morningstar’s “Debt and Liquidity” building block assessment. Debt to GNI* in 2019 was 95% and is expected to increase to 125% this year. Interest costs to total revenue at 5.1% and debt as a share of total revenue at 229% are among the highest in Europe, comparable to Spain, and higher than Belgium and France – countries whose debt-to-GDP ratios were at or near 100% in 2019.

Following Considerable Progress, the COVID-19 Shock Will Likely Renew Challenges for the Banking Sector

Progress has been made over the years in restructuring the Irish banking system and in reducing impairments. Ireland’s banking crisis a decade ago 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 3.0% as of the first quarter 2020, are below the EU average of around 5%. The improved financial sector has been evident by profitable banks with healthy levels of capital and stronger funding profiles. The deceleration of property price growth in Ireland and strong macroprudential measures also strengthens the financial sector. This crisis will likely once again challenge the sector. Notwithstanding ECB liquidity support measures and loan payment break programmes offered by the government, DBRS Morningstar expects the crisis to over time weaken banking sector asset quality.

External Accounts Are Distorted; Changes to Global Tax Policies May Affect Future Investment Flows

The IMF’s measure of the headline current account deficit for 2019 was 9.5% of GDP, following a surplus of 10.3% a year earlier. This data is distorted by the activity performed by large multinational firms. Contract manufacturing affects the accounting for exports, while movement of intellectual property products impacts imports. A measure of the current account adjusted for these effects showed a surplus of nearly 8% of GNI* last year.

The possible alignment of specific tax rates across Europe could challenge Ireland’s growth model and create an unpredictable environment for the activity of multinational firms operating in Ireland. Significant shifts in tax rates could result in a reduction in future investment flows into Ireland. The OECD has taken the lead on how to standardize domestic tax base erosion and profit sharing (BEPS) arising from digitalisation. It will take time, especially given the more pressing pandemic-related challenges, before consensus is found on this among EU member states.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/367805

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 (July 27, 2020) https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include include Department of Finance (Stability Programme May 2020), Central Bank of Ireland, Central Statistics Office Ireland, NTMA (Investor presentation September 2020), European Central Bank, European Commission, Eurostat, IMF WEO (April 2020), Statistical Office of the European Communities, World Bank, UNDP, The Economic and Social Research Institute, Irish Fiscal Advisory Council, Bloomberg, BIS, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be 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 12-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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/367804.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: July 21, 2010
Last Rating Date: May 15, 2020

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