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 persistently strong performance of Ireland’s economy and its public finances. 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. Even when excluding activity of the multinational sector, the performance of the domestic oriented economy has outperformed trend growth. The resilience of the Irish economy and the corresponding revenue windfalls allowed authorities the fiscal cushion to direct large support measures since 2020 to offset the compounding global shocks. Despite a fiscal impulse ranked among the largest in Europe, standard measures of public finances in Ireland continue to improve.

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. Credit weaknesses counter these strengths. The stock of Ireland’s public debt when set against adjusted national income remains comparatively high, and the benefits to the economy of large multinational enterprises domiciled in Ireland come with some concentration risk and economic volatility.

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 structural deterioration of the fiscal position significantly weakens the public debt outlook.

RATING RATIONALE
Ireland’s Two-Speed Economy Has Been Resilient To Recent External Shocks

Irish real GDP expanded on average by 9.1% in the six years from 2017 to 2022, including the 12.0% expansion last year. This stand-out performance was despite reoccurring economic disruptions linked to Brexit, the pandemic, and the global energy price and interest rate shocks. In its recent Stability Programme update, the government expects GDP to expand by 4.8% on average from 2023 to 2026. As always, the strong GDP outcome needs to be viewed with caution, as it reflects the strong performance of external-facing sectors such as pharmaceuticals and information and communications technology, and exaggerates wealth generation of the economy. It also overstates the volatility of the economy. 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 GDP figure is an imprecise measure of output, the domestic oriented economy has also expanded at a healthy pace. Real final modified domestic demand (MDD), which contracted by 6.1% in 2020 before expanding by 5.7% in 2021, surprised to the upside in the second half of 2022. The fall-out from the energy price shock has been milder than anticipated, and employment and consumer spending expanded beyond expectations. MDD grew by 8.5% in in 2022. However, non-energy price inflation remains elevated. Growth of the harmonized consumer price index (HCPI) declined to 6.3% in April 2023, from a high of 9.6% last July. Over the same time period, HCPI net of energy and unprocessed food expanded to 6.9%, up from 5.8%. While price growth should moderate over the course of the 2023, the impact of still high inflation weighs on household’s real disposable income and dampens investment spending. Against this backdrop, the government expects MDD to grow by 2.1% this year and 2.5% next year.

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

Strong GDP and fiscal revenue growth in the face of recent major economic disruptions resulted in a more resilient fiscal performance in Ireland. The EUR 18.8 billion (5.0% of GDP) deficit in 2020 was narrow relative to European peers and public accounts were quick to recover. 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 (see commentary - Magic Money: Corporate Tax Receipts In Ireland). 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 in 2022 of EUR 8.0 billion, 1.6% of GDP or 3.0% of GNI* (output net of contributions from multinationals).

It should be noted that public finances are slightly worse when considering the government’s adjusted underlying general government balance (GGB), which strips away what the government considers potentially transitory corporate tax receipts. The Department of Finance estimates roughly EUR 12 billion (over 4% of GNI) of the direct revenue-at-risk. With this adjustment, GGB* recorded a EUR 2.8 billion deficit (roughly 1% GNI) in 2022. Even with the roughly EUR 12 billion in support measures this year announced in the 2023 budget and in February 2023, the government forecasts larger surpluses, reaching EUR 20.8 billion or 6.3% of GNI by 2026. 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. Strong anticipated surpluses would help bolster the government’s new national reserve fund, which has reached EUR 6 billion. The fund is meant to save excess windfalls from corporate tax receipts.

High Stock Of Public Debt; But Favourable Debt Dynamics

Ireland’s general government gross debt increased from EUR 203 billion in 2019 to EUR 236 billion in 2021 due to the reoccurring crises. Because nominal GDP overperformed in these years, the debt to GDP ratio actually declined over the same period from 57.0% to 55.4%. The IMF expects debt to GDP to fall under 40% this year and approach 30% by 2026. When using GNI* as the debt ratio denominator, Ireland’s debt burden appears much higher. Debt to GNI* was 97% in 2019 and increased to 109% in 2020. These statistical considerations weigh negatively on DBRS Morningstar’s “Debt and Liquidity” building block assessment. That said, the strong economic recovery and quick repair to public accounts helped reduce the debt ratio faster than previously anticipated, to 101% and 83% of GNI* in 2021 and 2022. Various factors 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, expected budget surpluses, large cash balances, and still easy financing conditions all underpin Ireland’s favourable debt dynamics. Even when confronted with marginally higher interest rates, the government by 2026 expects interest expenditures to decline to 1.0% of GNI* (1.2% in 2022) and gross debt to decline to 65% of GNI*.

Rising Costs Complicate Ongoing Housing Challenges; 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 price shock was then exacerbated by Russia’s invasion of Ukraine, raising the cost of goods and services across the consumption basket. These global supply shocks have fed through to more expensive building costs in Ireland’s already undersupplied property market. The building and construction wholesale price index increased by 35% from 2020 to 2022. Years of inadequate housing investment has meant renting or purchasing property has become increasingly unaffordable in Ireland. While completions ramped up last year, the 30,000 new units falls short of the average target of 33,000 new units the government aims to build each year by 2030 to satisfy existing housing demand. Property price growth started to moderate over the last year due to inflation-constrained buyers and macroprudential policies. Growth of the residential property price index grew 5.0% yoy in February 2023, from the 15.0% peak in March 2022 (see commentary - Ireland: High Building Costs Latest Threat To Housing Supply).

The Irish banking system in general has made significant progress over the years to safeguard the system against risks associated with high inflation, rapidly rising interest rates, global banking sector volatility, and external economic uncertainty. The prevalence of fixed rate lending, prudent underwriting standards, and strong macroprudential measures – coupled with Ireland’s strong labour markets and healthy private sector balance sheets – help protect the financial sector from stress linked to rising interest rates. Likewise, mortgage rates in Ireland were already comparatively high at the onset of last year's ECB rate-hiking cycle. Thus, monetary policy pass-through to Ireland has been slow, functioning as a useful shock absorber, and not materially dissuading mortgage lending. Banks are profitable, have solid levels of capital, strong funding profiles, and healthy asset quality.

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 averaged 13.3% of GDP in 2019-2020, followed by large 11.5% of GDP average surplus in 2021-2022. The large swings in the data are due to 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 (CA) that strips away among other items intellectual property and depreciation of aircraft leasing. After the modification, the surplus amounted to 9.7% of GNI in 2022. The government projects the CA* to remain in surplus and reach 7.2% GNI* by 2026. Ireland’s large negative net international investment position (NIIP), at -146% of GDP in 2022 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; Brexit-Related Uncertainty Diminishing

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. The 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.

There has been recent progress reducing Brexit-related uncertainties. 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. The Windsor Framework agreed in February 2023 helps to by better clarifying the regulatory trade relationship between the UK, Northern Ireland, and the EU. However, due to non-tariff barriers Brexit has resulted in lower levels of aggregate trade between the two blocks. Goods moving between the UK and the EU are subject to customs and controls that require extra processes. More time is necessary to accurately assess the social and political consequences of Brexit on Ireland.

ENVIRONMENTAL, SOCIAL, GOVERNANCE 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 (May 17, 2022) https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://www.dbrsmorningstar.com/research/413593.

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 (August 29, 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. 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 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for this rating include Department of Finance (Budget 2023, Stability Programme Update April 2023), Central Bank of Ireland (Quarterly Bulletin December 2022), Central Statistics Office Ireland, NTMA (Investor Presentation April 2023), European Central Bank, European Commission (Winter Forecast 2023), Eurostat, IMF WEO (April 2023), IMF IFS, Statistical Office of the European Communities, OECD, World Bank, IFS, BIS, The Economic and Social Research Institute, Irish Fiscal Advisory Council, Global Carbon Project, Social Progress Index, World Economic Forum, 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. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/413592.

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: January 13, 2023

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