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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Ireland’s (Ireland) 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 CREDIT RATING CONSIDERATIONS
The confirmations of the credit ratings and trends reflect DBRS Morningstar’s view that Ireland’s strong public finances and domestic economy resilience offset the risks stemming mostly from the external side. The effects of high inflation, tighter monetary policy, and external weakness are leading to a significant deceleration in economic growth metrics in 2023, after breakneck speed growth in 2021 and 2022. Still, Ireland’s economy is well positioned to face the headwinds given its strong labour market and continued fiscal support in 2024. Going forward, domestic demand is expected to continue expanding at a healthy pace and the export sector to recover after some sector/product-specific factors explaining the downturn this year. Despite significant fiscal support to address the pandemic and the rising cost of living, including the fiscal package for 2024, standard measures of public finance have improved and fiscal surpluses are expected in the coming years. DBRS Morningstar also views positively the government's plans to establish two long-term savings funds that would reduce the risks associated with a concentrated and volatile corporate tax base. If successfully capitalised, we expect the funds to improve the resilience of public finances and prepare Ireland to better manage its structural economic challenges.

Ireland’s credit 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, albeit rapidly declining. The benefits to the economy of large multinational enterprises domiciled in Ireland come with some concentration risk and economic volatility, which if not properly managed could translate into future fiscal vulnerabilities.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if Irish authorities are able to continue improving their various fiscal and debt metrics in a durable manner, which could be reinforced by the creation of the long-term savings funds. Sustained strong economic performance combined with increased resilience against external risks would also support upward credit ratings pressure.

The credit 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.

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

Ireland’s economic performance over the last decade stands out positively. For the years from 2013 to 2022, Irish real GDP grew at an annual average rate of 9.0% despite the successive economic disruptions linked to Brexit, the pandemic, and the global energy price and interest rate shocks. GDP per capita reached USD 103,331 in 2022, the second highest in the euro area after Luxembourg. As always, GDP figures in Ireland need to be viewed with caution, as the role of multinational enterprises headquartered in Ireland, the aircraft leasing sector, and the on-shoring of intellectual property assets have a large effect on its national accounts. These factors have led to much higher income per capita, economic size, and economic growth than otherwise, especially since 2015, while at the same time, inflating output volatility. DBRS Morningstar applies a positive qualitative adjustment to the “Economic Structure and Performance” building block assessment to reflect its view that these accounting effects are overstating the underlying volatility of the domestic economy. Importantly, even excluding the effects of the trade in aircraft by aircraft leasing companies and the imports of intellectual property, real Modified Final Domestic Demand (MDD) grew at an annual average rate of 3.8% during the last decade.

Despite the mounting external headwinds, real GDP grew by 9.4%, while real MDD grew by 9.5% in 2022. The buoyancy of private consumption and employment continued last year, while investment benefitted from robust housing construction as well as one-off business investments. Exports also performed strongly driven by the pharmaceutical and the information & communications technology (ICT) sectors. The effects of high inflation, the lagged effects of monetary policy tightening, and weaker external demand are taking a toll on activity this year. The slowdown is clear in the external sector, especially influenced by a sharp decline in pharmaceutical exports, while the domestic economy is holding up better. This, in part, reflects the resilience of private consumption, which benefits from continued employment growth, and wage growth is picking up. Against this backdrop, the government forecasts that real GDP will grow by 2.0% in 2023 and real MDD by 2.2%. Going forward, the government forecasts annual average real GDP growth of 4.5% during 2024-26, while real MDD growth is forecast to average 2.6% over the same period.

Revenue Windfalls Allow for Large Fiscal Support to Address Successive Shocks and Rapid Balance Sheet Repair

Ireland’s fiscal position remains strong as reflected by its quick post-pandemic fiscal repair. The fiscal balance swung to a surplus of EUR 8.5 billion (1.7% of GDP or 3.1% of GNI*) in 2022 from a deficit of EUR 18.7 billion (5.0% of GDP or 9.2% of GNI*) in spite of the substantial support mobilized to help the private sector absorb the impact of the pandemic and higher inflation. In addition to the gradual removal of pandemic support, public finances benefitted from the very strong growth of tax receipts boosted by the dynamism of the domestic economy – in terms of activity and employment gains – as well as the key role of multinationals operating in Ireland on corporate taxation. 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.

The government anticipates a fiscal surplus of EUR 8.8 billion (1.6% of GDP or 3.0% of GNI*) in 2023 despite the economic and tax revenue slowdown and extension of the cost of living support measures. In its Budget 2024, the government is providing a substantial budgetary package of EUR 14 billion including EUR 6.4 billion of permanent measures and EUR 7.6 billion in nonrecurring measures. Core spending will increase by 6.1% in 2024, including higher pensions and social benefits as well as higher capital investments, above the government´s self-imposed spending rule of 5.0%. This will be complemented by permanent tax cuts and credits worth EUR 1.2 billion. The temporary measures include a EUR 2.7 billion cost of living package, targeted pandemic support, humanitarian aid for Ukrainian refugees, along with some European Union (EU) and Brexit related funding. Even after this sizable budgetary package, the government forecasts a fiscal surplus of EUR 8.4 billion (1.5% of GDP or 2.7% of GNI*) in 2024.

The government forecasts budgetary surpluses over its forecast period, reaching EUR 14.6 billion (2.2% of GDP or 4.4% of GNI*) by 2026. The main risks to this very strong fiscal projection are linked to any reversal of strong corporation tax receipts. The Department of Finance estimates the revenue-at-risk/windfall corporation tax (i.e., receipts in excess of what can be explained by the domestic economy) at EUR 10.8 billion in 2023 (3.7% of GNI*). DBRS Morningstar views positively the government´s plans to create two long-term savings funds to help future-proof the budget and to mitigate the risks associated with those corporate tax revenues considered at-risk. The government plans to transfer to the Future Ireland Fund, 0.8% of GDP per annum until 2035 and only to be able to appropriate income earned after 2040. The objective is to partially prefund the fiscal costs of population ageing and the digital and climate transitions in coming decades. A second fund, the Infrastructure, Climate and Nature Fund, is planned to receive EUR 2 billion per year until reaching a maximum of EUR 14 billion. Its main objective is to support capital expenditure during downturns.

High Stock of Public Debt; But Favourable Debt Dynamics

Ireland’s public debt-to-GDP ratio stood at 44.4% of GDP in 2022, well below the pre-pandemic level of 57.0% in 2019, reflecting the fact that nominal GDP growth exceeded the fiscal response to the pandemic and the energy crisis. When using GNI* as the debt ratio denominator, Ireland’s debt burden appears much higher at 82.3% in 2022. These statistical considerations weigh negatively on DBRS Morningstar’s “Debt and Liquidity” building block assessment. In any case, even when using the debt-ratio-to-GNI*, the debt metric improved significantly in recent years and stood well below its pre-pandemic level of 96.7% in 2019. The strong economic recovery and quick repair to public accounts helped reduce the debt ratio faster than previously anticipated. Similarly, these favourable debt dynamics are expected to continue going forward. The government projects that debt-to-GNI* will decline to 64.8% by 2026. The IMF projects that the public debt-to-GDP ratio will decline to 42.7% this year and to approach 29.5% by 2028.

Ireland’s pro-active debt management strategy and favourable debt structure strengthen the government’s credit profile. The combination of low interest rates on public debt locked in at long average maturities, large cash balances, and still easy financing conditions, create significant financial flexibility and will help smooth out the impact of higher rates. Even when confronted with higher interest rates, the government expects interest expenditures to stay at 1.1% of GNI* until 2026.

The Irish Banking Sector is Well Placed to Face Stress; Housing Market Cooling Down But Undersupply Continues

The Irish banking system has strong capital and liquidity ratios, well above minimum requirements and strong in a European context, that supports its capacity to absorb potential shocks. Irish banks are profitable, with high interest rates acting as tailwinds, and have healthy asset quality. The outlook for the Irish economy and the strength of the labour market remain supportive; however, persistent inflation and higher interest rates risk exposing vulnerabilities, especially in the commercial real estate market. The pass-through from monetary policy to lending rates picked up in recent months after a slow start, with rate increases on new lending to the non-financial corporate sector moving earlier than mortgage rates. While the increase in mortgage rates in Ireland has been lower than in other euro area countries, rates still remain above the euro area average. DBRS Morningstar notes that the presence of fixed-rate mortgage lending, prudent underwriting standards, good coverage ratios, and strong macroprudential measures – coupled with Ireland’s strong labour markets and a decade of private sector deleveraging – help protect the financial sector from stresses linked to rising interest rates.

The real estate sector globally remains one of the sectors most vulnerable to the rapid increase in interest rates, after a prolonged period of extremely low rates. Similar to other countries, Irish residential property prices have cooled down significantly for much of the past year after sharp increases during the pandemic. Growth of the residential property price index moderated to 0.9% YOY in August 2023 from a 15.0% peak in March 2022. However, a prolonged period of undersupply, may offset the downward pressure on prices (see commentary “Ireland: High Building Costs Latest Threat To Housing Supply”). While completions ramped up to 30,000 new units last year, higher interest rates, higher costs of construction and building materials, and labour shortages will most likely prevent new housing supply from meeting current estimates of housing demand in coming years. Moreover, the commercial real estate sector (CRE) appears more vulnerable to rapid changes in interest rates, compounded with cyclical and structural factors influencing the sector. However, according to the Central Bank, while CRE prices have fallen considerably already and pressures are expected to continue, the Irish banks’ exposure to this sector is smaller and less risky than in the past. The increased foreign investment in recent years has resulted in a more diversified funding profile for the CRE sector, reducing the risk to domestic banks and the economy.

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 13.2% of GDP in 2019–20, followed by a 12.2% of GDP average surplus in 2021–22. 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 the depreciation of aircraft leasing. After the modification, the surplus amounted to 7.0% of GNI* in 2022. The government projects the CA* to remain in surplus and to reach 6.2% GNI* by 2026. Ireland’s large negative net international investment position (NIIP), at -116.8% 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 assessment.

Reform to the global corporate tax landscape as currently envisioned by the Organization for Economic Cooperation and Development (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 Underpin Sound Policy Making; Brexit-Related Uncertainty Diminishing

Ireland’s institutional quality, as reflected by its performance in Worldwide Governance Indicators, and a stable macroeconomic policy framework, underpin a very strong political environment. The last general elections in February 2020 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. Against these political changes, the current coalition government that includes FG, FF, and the Greens took office in June 2020. 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. The next general elections will be held no later than March 2025.

There has been recent progress reducing Brexit-related uncertainties. A Free Trade Agreement between the UK and the 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 helped to better clarify the regulatory trade relationship among the UK, Northern Ireland, and the EU. However, because of 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

Environmental (E) Factors
There were no Environmental factors that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factors that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factors that had a relevant or significant 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 https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (4 July 2023).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/422772/.

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 (6 October 2023) https://www.dbrsmorningstar.com/research/421590/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/416784/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 credit rating include Department of Finance (Budget 2024 – Economic and Fiscal Outlook, Budget 2024 – Draft Budgetary Plan, Stability Programme Update April 2023), Central Bank of Ireland (Quarterly Bulletin September 2023; Financial Stability Review 2023:I), Central Statistics Office Ireland, The National Treasury Management Agency (Investor Presentation September 2023 and October 2023), European Central Bank, European Commission (European Semester: Country Report 2023), Eurostat, International Monetary Fund (WEO and IFS), Statistical Office of the European Communities, OECD, World Bank, Bank of International Settlements, The Economic and Social Research Institute, Irish Fiscal Advisory Council, The Social Progress Imperative (2022 Social Progress Index), 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://registers.esma.europa.eu/cerep-publication. 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 credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/422774/.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Javier Rouillet, Vice President, Credit Ratings, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: July 21, 2010
Last Rating Date: May 5, 2023

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