DBRS Morningstar Confirms Republic of Ireland at AA (low), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (low). 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
The confirmations of the ratings and trends reflect DBRS Morningstar’s view that external risks to Ireland are balanced against the economy’s persistently strong growth performance. Notwithstanding the disruptions to global trade and price trends caused by the pandemic and Russia’s invasion of Ukraine, the strong expansion of Ireland’s multinational sector allowed the economy to continue its multi-year path of high growth. GDP expanded above trend in 2020, when most economies contracted, and grew by double digits in 2021 and likely again in 2022. Even when excluding activity of the multinational sector, the contraction of the domestic oriented economy in 2020 and its 2021-22 recoveries outperformed the EU average. Thus, standard measures of public finances deteriorated less in Ireland than among peers, despite its direct fiscal support ranking among Europe’s largest.

Ireland’s 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. Several credit weaknesses counter these strengths. Rising public expenditure demands come at a time when efforts to change the global corporate tax landscape could challenge future revenues. Using various debt ratios, Ireland’s public debt stock remains comparatively high.

RATING DRIVERS
The ratings could be upgraded if Irish authorities are able to durably improve various fiscal 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 Two-Speed Economy In 2022 Again Overperformed Trend Growth

Irish real GDP expanded by 6.2% in 2020, and then by 13.6% in 2021 and likely again by double digits in 2022. This strong performance occurred despite reoccurring economic disruptions linked to Brexit, the pandemic, and the global energy price shock. As always, the strong GDP outcome needs to be viewed with caution. The growth rate reflects the strong performance of external-facing sectors such as pharmaceuticals and information and communications technology (ICT), and overstates the wealth generation of the economy. It also overstates the volatility of the economy. GDP expanded by 2.3% qoq (or 10.9% yoy) in the third quarter of 2022 due to accounting shifts by multinationals. DBRS Morningstar applies a positive qualitative assessment in the “Economic Structure and Performance” building block to reflect accounting complications that make the economy appear more volatile.

While the strong headline GDP figure is an imprecise measure of output, the domestic oriented economy also expanded at a healthy pace. Real modified domestic demand (MDD), which contracted by 6.1% in 2020 before expanding by 5.8% in 2021, grew by 5.9% in the third quarter 2022 compared with the third quarter 2021. There is evidence that the rising cost-of-living started to weigh on the domestic economy by the end of 2022. As a result of the price shock – the harmonized consumer price index grew by 8.2% yoy in December 2022 – the Central Bank of Ireland forecasts that average household disposable income declined by 3.3% in 2022, and the latest KCB Bank consumer sentiment index reached a level among the lowest recorded over the last decade. Despite slowing domestic conditions, the products and services supplied by the multinational sector will likely remain the driving force behind Ireland’s economic growth, which the European Commission (EC) forecasts above 3% in each of the next two years.

Revenue Windfalls Allow For Large Fiscal Support To Address Reoccurring Crises And Rapid Balance Sheet Repair

Strong GDP and fiscal revenue growth in recent years have resulted in a less severe deterioration of Ireland’s fiscal deficit in the face of major economic disruptions. The EUR 18.8 billion (5.1% of GDP) deficit in 2020 was narrow relative to European peers and it improved to EUR 7.1 billion (1.7% of GDP) in 2021. The fiscal position appears worse when measured against a modified denominator. The deficit was 9.4% of GNI* (a calculation of output that strips away contributions from multinationals) in 2020 and 3.0% of GNI* in 2021. These statistical considerations weigh negatively on DBRS Morningstar’s assessment in the “Fiscal Management and Policy” building block.

The success of multinationals operating in Ireland and the progressive nature of taxation have meant robust corporate and income tax revenues. Corporate tax receipts in 2022 reached EUR 23 billion, roughly double the corporate tax generated in 2020. Revenue windfalls allowed authorities over the past years to implement one of Europe’s largest counter-cyclical spending programs in direct assistance. Despite the large support, Ireland recorded a fiscal surplus of EUR 5.2 billion in 2022. It should be noted, however, that the government’s adjusted underlying general government balance (GGB) resulted in a EUR 5.2 billion deficit (roughly 2% GNI). GGB* strips away what the Department of Finance considers potentially transitory corporate tax receipts. Though the 2023 budget directs an additional EUR 11 billion in permanent and one-off measures, the government expects surpluses to remain over the forecast period. The strength and durability of projected surpluses will depend on whether the government can comply with its spending rule, where annual expenditure growth does not exceed 5%, by 2024.

High Stock Of Public Debt; But Favourable Debt Dynamics

Ireland’s general government gross debt increased due to the reoccurring crises from 96% of GNI* in 2019 to 109% of GNI* in 2020. When using this or other alternative measures of debt, Ireland’s debt burden remains high. This weighs negatively on DBRS Morningstar’s “Debt and Liquidity” building block assessment. That said, the strong economic recovery helped reduce the debt ratio to 101% of GNI* in 2021, and there are various factors that are likely to ensure the rapid reduction of the debt ratios over the coming years. The combination of low interest rates on public debt locked-in at long average maturities, along with high nominal growth, repair to the budget balance, large cash balances, and still easy financing conditions all underpin Ireland’s favourable debt dynamics. Despite higher rates, the IMF forecasts the cost of servicing debts will decline to 0.5% of GDP by 2025, from 1.0% in 2020. The government expects debt to have fallen to 86% of GNI* in 2022, and to decline to 78% of GNI*, or 39% of GDP, by 2024.

External Shocks Complicate Already Rising Property Prices; Irish Banking Sector In Stronger Position Than In Past Crises

The pandemic created supply chain disruptions and capacity issues in some sectors that increased price pressure in Ireland and across Europe. The global supply shock was particularly acute in Ireland’s property market, where demand for new housing completions remains strong. The construction price index increased by over 10% year-over-year in November 2022, and the residential property price index increased by 9.8% as of October 2022, having declined from the 15.0% growth peak in March 2022. Strong labour markets, healthy private sector balance sheets, the prevalence of fixed rate lending, prudent underwriting standards, and strong macroprudential measures help protect the financial sector from stress linked to rising interest rates. The Irish banking system in general has made significant progress over the years to safeguard the system. Banks are profitable, have healthy levels of capital, and strong funding profiles. Asset quality also remains strong even if the consequences of the recent crises – stemming from SMEs that had financial difficulties prior to the pandemic and the price shock – are not yet clear.

All External Balance Measures Show Large Savings Position; Global Tax Changes May Affect Future Investment Flows

The IMF’s measure of the headline current account deficit for 2019 was 19.8% of GDP, followed by a smaller deficit in 2020, a surplus of 14.2% in 2021, and similarly large surpluses forecasted 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 imports are affected by movements and the depreciation of Irish-based foreign-owned capital assets. Ireland’s savings position remains large even when adjusting for the large multinational sector. The Central Bank of Ireland calculates a modified current account that strips away among other items intellectual property and depreciation of aircraft leasing. After the modification, the surplus amounted to EUR 26 billion in 2021, or 11.1% of GNI. The 2023 budget forecasts a gradual decline of the current account balance, reaching 6.3% GNI by 2025. Ireland’s large negative net international investment position (NIIP), at -146% of GDP in 2021 according to the IMF, overstates external sector risks. Much of the NIIP liabilities are not owed by Irish residents, but result from cross-border financing of large corporates. This supports DBRS Morningstar’s positive adjustment to the “Balance of Payments” building block.

Reform to the global corporate tax landscape 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 how the Irish government and the corporate sector respond to the changes. The main long-term risk is that reforms to global taxation affect future direct investment inflows to Ireland. DBRS Morningstar is of the view that Ireland has significant advantages that keep its economy 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 (FG) and Fianna Fáil (FF), 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 FG, FF, and the Greens took office in June 2020 and seamlessly continued the plan for containing the pandemic and supporting the economy. As part of the coalition agreement, FF’s Micheál Martin handed over Prime Ministerial duties to FG’s Leo Varadkar in December 2022, a unique demonstration of policy continuity between historically rival parties.

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 were 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.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings. (May 17, 2022).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/408360.

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 https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments (August 29, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.

The sources of information used for this rating include Department of Finance (Budget 2023), Central Bank of Ireland (Quarterly Bulletin October 2022), Central Statistics Office Ireland, NTMA (Investor Presentation December 2022), European Central Bank, European Commission (Autumn Forecast 2022), Eurostat, IMF WEO (October 2022), IMF IFS, Statistical Office of the European Communities, OECD, World Bank, IFS, BIS, The Economic and Social Research Institute, Irish Fiscal Advisory Council, KCB Bank consumer sentiment index, Global Carbon Project, Social Progress Index, World Economic Forum, Bloomberg, 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://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/408359.

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: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: July 21, 2010
Last Rating Date: July 15, 2022

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