DBRS Morningstar Upgraded Ireland to AA (low), Trend Changed to Stable

DBRS Ratings GmbH (DBRS Morningstar) upgraded the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings to AA (low). The rating trends on the Long-Term Ratings have been changed to Stable. 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 ratings upgrade reflects DBRS Morningstar’s view that Ireland’s performance in the face of difficult external developments points to enhanced macroeconomic resiliency. The Economic Structure and Performance, and Debt and Liquidity building blocks are the most important for the rating changes. Ireland’s economic progress was on a path of high growth and diminishing vulnerabilities well before the onset of the pandemic. Real GDP expanded each year on average by 7.6% from 2017 to 2019. On public finance, the strong economy and healthy tax windfalls generated six consecutive years of primary surpluses, a balanced headline fiscal position in 2018, and a surplus in 2019. This fiscal effort improved debt sustainability metrics and allowed ample fiscal clearance for the government to confront the various exogenous disruptions over the last few years.

The Stable trend reflects our view that Ireland is well positioned to balance adverse credit implications stemming from the pandemic, global tax reform, and Brexit against the favorable growth outlook. The COVID-19 crisis and Ireland’s implementation of mobility rules have significantly affected the domestic economy and increased crisis-related deficit spending. However, strong growth by the multinational sector has prevented the dramatic output contraction seen elsewhere. GDP expanded above trend growth in 2020 and is forecast to have grown by double digits in 2021. When excluding activity of the multinational sector, the contraction of the domestic oriented economy in 2020 and its 2021 recovery outperformed the EU average. Thus, standard measures of public finances in Ireland deteriorated less than its peers, despite the Irish government adopting one of Europe’s largest direct fiscal support packages.

Ireland’s AA (low) 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 internal market. These features support the economy’s competitiveness and its medium-term growth prospects. The country’s credit strengths are countered by several weaknesses, including volatile fiscal revenue sources and medium-term fiscal cost pressure. Rising expenditure demands come at a time when efforts to change the global corporate tax landscape could challenge revenues. Using various debt ratios, Ireland is among the countries in Europe with the highest stocks of public debt.

RATING DRIVERS

The ratings could be upgraded if Irish authorities are able to reduce in a durable manner various fiscal deficit and debt metrics. Sustained strong economic performance combined with increased resilience against external risks would also support upward ratings pressure.

The ratings could be downgraded if there is 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.

RATING RATIONALE

Ireland’s Economic Growth Performance Has Remained A Global Outlier During the Pandemic

The COVID-19 shock has exacerbated what has long been an economy operating at two-speeds. Even with the reoccurring bouts of disruption to public health and social life over the last two years, Irish GDP expanded by 5.9% in 2020 and the government forecasts a 2021 expansion of 15.6%. As ever, the strong GDP outcome needs to be viewed with caution. The growth rate reflects strong performance of external-facing sectors such as pharmaceuticals and ICT, and overstates the wealth generation of the Irish domestic economy. At the same time, the complications with national accounting make the growth performance appear more volatile. For this reason DBRS Morningstar applies a positive qualitative assessment in the “Economic Structure and Performance” building block.

The strong headline figure masks the shock to the domestic oriented economy. Real modified domestic demand (MDD) contracted by 4.9% in 2020 and the COVID-adjusted unemployment rate ended the year above 20% after peaking above 30%. However, high rates of inoculation, the unwinding of COVID restrictions, and pent-up demand from increased household gross income and savings lifted economic activity in 2021. The government forecasts MDD growth of 5.2% in 2021 on the back of robust private sector consumption. The COVID-adjusted unemployment rate declined to 7.5% in December 2021, when 66,905 workers received pandemic unemployment payments, down from a peak of over 600,000 at the onset of the crisis. These results are slightly worse than a month earlier due to the recent resurgence of COVID cases linked to the Omicron variant and new restrictions. The medium-term recovery will nonetheless likely remain strong. The 2022 Budget forecasts the Irish economy to expand by 4.1% on average from 2022-2025.

Despite The Large Fiscal Effort, Ireland Avoided Dramatic Deterioration Of Public Finance Metrics

From a budget surplus in 2019, the deficit in 2020 widened to EUR 18.4 billion (4.9% of GDP) before narrowing in 2021 to around 9 billion (2.1% of GDP). This result outperforms European peers, despite the Irish government implementing one of the largest counter-cyclical spending programs to support the economy. The total fiscal response has thus far amounted to EUR 48.4 billion, or 12.9% of GDP (22.7% of GNI*). While the large public allowance will unlikely all be spent, more than 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 less severe deterioration of the deficit is explained by strong GDP growth and resilient revenue performance in the face of major economic disruption and loss of employment. The progressive nature of taxation has meant income tax receipts have been broadly unaffected during the crisis, and success of multinationals operating in Ireland has meant corporate tax receipts have actually grown since the start of the pandemic.

However, the fiscal position appears worse when measured against a modified denominator. The deficit was 8.8% of GNI* (a calculation of output that strips away output contributions from multinationals) in 2020 and around 4% of GNI* in 2021. These statistical considerations weigh negatively on DBRS Morningstar’s assessment in the “Fiscal Management and Policy” building block. Efforts at the multinational level to reform the global corporate tax system risks reducing Ireland's corporate tax base, although proposed changes appear manageable under current assumptions. The government expects profit-sharing could cost the exchequer roughly EUR 2 billion in corporate tax receipts each year. Including some corporate tax erosion, the 2022 Budget expects public finances to reach near-balance by 2023.

Ireland’s general government gross debt increased as a result of the health crisis from EUR 205 billion in 2019 to EUR 218 billion in 2020, equivalent to 58.4% of GDP or 104.7% of GNI. The still expansionary fiscal stance led to further debt accumulation in 2021, but by much less than previously expected. The 2022 Budget projects the stock of debt to have reached EUR 237 billion in 2021, a debt to GNI ratio of 106.2%. When using this or other alternative measures of debt, Ireland remains one of the most highly indebted countries in Europe. This factor weighs negatively on DBRS Morningstar’s “Debt and Liquidity” building block assessment. That said, Ireland’s strong growth performance, the expected repair of the budget, and favourable financing conditions point to a rapid reduction of the debt ratios. The government expects by 2025 the debt burden to decline to 46.6% of GDP or 89.5% of GNI*.

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. The improved financial sector has been evident by profitable banks with healthy levels of capital and stronger funding profiles. 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 2.8% as of the second quarter 2021, are below the EU average. Notwithstanding ECB liquidity support measures and loan payment break programmes offered by the government, DBRS Morningstar expects the current crisis to over time weaken banking sector asset quality, especially stemming from SMEs that had financial difficulties prior to the pandemic.

The pandemic created supply chain disruptions and capacity issues in some sectors that have increased price pressure in Ireland and across Europe. Inflation in Ireland increased by 5.4% yoy in November 2021. Furthermore, property prices have once again started to rise. The property price index grew by 13.5% as of October 2021 compared to a year earlier. DBRS Morningstar remains of the view that headline price pressures will trend down over the course of the year, and healthy private sector balance sheets and strong macroprudential measures safeguard the financial sector from the rise in property prices.

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 19.9% of GDP, followed by a smaller deficit in 2020, an expected surplus of 11.1% in 2021, and large surpluses forecast thereafter. The large swings in the data are due to the activity performed by large multinational firms. Contract manufacturing affects the accounting for exports, while movements of intellectual property products impact imports. The government calculates a measure of the current account surplus modified for these effects to have reached 11.5% of GNI* in 2020. Ireland’s large negative net international investment position, calculated by the IMF to reach -152% of GDP in 2021 overstates external sector risks. This supports DBRS Morningstar’s positive adjustment to the “Balance of Payments” building block.

Negotiations to reform the global corporate tax landscape intensified in 2021. International tax reform as currently envisioned by the OECD/G20 has two main pillars, each with possible varying effects on Ireland's budget, its existing capital stock, and future direct investment. The consequences for Ireland would depend on the precise details countries agreed upon, and how the Irish government and the corporate sector respond. While proposed reforms to global taxation may affect future direct investment inflows to Ireland, DBRS Morningstar is of the view that coordinated execution around global tax reforms will be difficult to implement. Furthermore, Ireland has significant advantages that keep it competitive should reforms threaten the country's economic model.

Ireland’s Institutional Strengths Evident By Effective Crisis Management

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. Though the inconclusive election occurred at a challenging time, the political cycle did not undermine Ireland’s strong institutional quality or its stable macroeconomic policy-making. A new coalition government that includes Fine Gael, Fianna Fáil, and the Greens took office in June 2020 and seamlessly continued the plan for containing the pandemic and supporting the economy. Ireland is a strong performer on the World Bank’s governance indicators, and its governments over the last decade have demonstrated policy continuity.

Brexit-related challenges have not been fully resolved. A Free Trade Agreement between the UK and EU was agreed in December 2020 following a long negotiation. The deal allows for tariff-free trade, and in conjunction with the 2019 Withdrawal Agreement, the worst-case scenarios concerning risks associated with lower output potential and a physical border on the island of Ireland from no-deal have for now been averted. However, goods moving between the UK and the EU are subject to customs and controls that require extra processes. Due to these non-tariff barriers, Brexit will likely result in lower levels of aggregate trade between the two blocks. Additional agreements around the trade of services and the contentious Irish Protocol will likely be necessary before accurately assessing the consequences of Brexit on Ireland.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/390781.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros (EUR) 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 9, 2021) https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include Department of Finance (Budget 2022), Central Bank of Ireland (Quarterly Bulletin October 2021), Central Statistics Office Ireland, NTMA (Investor Presentation January 2022), European Central Bank, European Commission (Autumn Forecast 2021), Eurostat, IMF WEO (October 2021), IMF IFS, Statistical Office of the European Communities, OECD, World Bank, The Economic and Social Research Institute, Irish Fiscal Advisory Council, Global Carbon Project, Social Progress Index, World Economic Forum, 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/390780.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: July 21, 2010
Last Rating Date: July 16, 2021

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