Morningstar DBRS Changes Trend on Ireland to Positive, Confirms at AA (low)

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Ireland’s (Ireland) Long-Term Foreign and Local Currency – Issuer Ratings at AA (low) and changed the trend to Positive from Stable. At the same time, Morningstar DBRS confirmed its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle) and changed the trend to Positive from Stable. Also, Morningstar DBRS confirmed Ireland’s USD 50 billion Euro-Commercial Paper Programme (ECP Programme) Rating at R-1 (middle) and changed the trend to Positive from Stable.

KEY CREDIT RATING CONSIDERATIONS
The Positive trends reflect the significant improvement in Ireland’s public finances. After providing substantial budgetary support to the economy during the pandemic and inflation shocks, fiscal accounts shifted to sizable surpluses in 2022 and 2023, and the government projects a structural surplus over the medium term. Strong fiscal results combined with robust economic growth led to a sharp decline in government debt ratios. The Central Bank of Ireland (CBI) estimates that public debt as a share of Modified Gross National Income (GNI*), the authorities' preferred measure for assessing debt sustainability, declined from 107.4% in 2020 to 78.4% in 2023, and projects it will fall to 73.6% in 2024. Morningstar DBRS also views positively the government's plans to establish two long-term savings funds that if successfully capitalised could improve the resilience of public finances and prepare Ireland to better manage structural economic challenges. The Irish economy has shown resilience in the context of tighter monetary policy. While headline GDP contracted in 2023, this was largely driven by developments in the multinational sector. The domestic economy sustained modest but positive growth amid higher interest rates, a weaker global economic backdrop and some temporary effects. The domestic economy is expect to expand annually by around 2.0% over 2024-2026, driven by consumer spending and housing construction.

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. However, the stock of Ireland’s public debt when set against adjusted national income is high, albeit rapidly declining. Moreover, 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 fiscal vulnerabilities.

CREDIT RATING DRIVERS
Morningstar DBRS could upgrade the credit ratings if Irish authorities continue to strengthen public finances in a durable manner.

Morningstar DBRS could return the Positive trends on the credit ratings to Stable if the improvement in public finances proves less durable than anticipated. Morningstar DBRS could downgrade the credit ratings if there were 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
Revenue Windfalls Allow for Large Fiscal Support to Address Successive Shocks and A Rapid Repair of the Public Balance Sheet

Ireland’s fiscal position remains strong as reflected in its quick post-pandemic fiscal repair. After two large deficits during the worst of the pandemic in 2020 and 2021, the CBI estimates that Ireland recorded fiscal surpluses of 3.1% of GNI* in 2022 and of 2.7% in 2023. This reflects the fact that the removal of pandemic support and the very strong revenue growth spurred by job gains, multinational-led corporate taxation, and inflation have more than offset the additional support to deal with the cost-of-living crisis and the humanitarian aid for Ukrainian refugees. In its Budget 2024, the government is planning to temporarily increase spending on cost-of-living measures and humanitarian aid. Permanent measures include higher pension and social benefits as well as some targeted tax cuts. Even after this sizable budgetary package, the CBI forecasts a fiscal surplus of 2.5% of GNI*, which will rise to 3.8% by 2026 assuming temporary measures are unwound.

The main risk to this very strong fiscal projection relates to corporation tax receipts. In 2023, corporate tax revenue reached EUR 23.8 billion, roughly doubling the corporate tax generated in 2020. Ireland´s reliance on corporate taxation has increased, with CIT accounting for 27% of total tax revenues in 2022. Moreover, the high concentration on certain sectors or multinational companies presents risks. The Department of Finance estimates windfall corporation tax (i.e., receipts in excess of what can be explained by the domestic economy) amounted to around EUR 11 billion in 2023 (3.7% of GNI* ). Morningstar DBRS applies a negative qualitative adjustment to the “Fiscal Management and Policy” building block assessment to reflect the risks associated with this volatile revenue source. However, it is worth noting that even when excluding the so-called windfall revenues, the estimated fiscal deficit would be moderate at 1.2% of GNI* in 2023 and would turn to a surplus of 0.2% of GNI* by 2025, according to the CBI. While Pillar Two of the BEPS reform requiring a 15% minimum effective rate came into operation in 2024, it will not affect tax revenues until 2026, and the government improved R&D tax credits in the Budget 2024 to maintain Ireland´s net benefit for firms. The introduction of BEPS Pillar One could also impact corporate tax receipts, although there is not yet an international agreement on its implementation.

Furthermore, Morningstar DBRS views positively the government’s plans to create two long-term savings funds 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, when it could hold up to EUR 100 billion in total funds, and only 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 expected 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, although part of the fund can be used to ensure that Ireland’s 2030 climate and nature goals are met.

High Stock of Public Debt; but Favourable Debt Dynamics

Ireland public debt metrics have rapidly improved over the last decade on the back of a stronger fiscal position and a rapidly growing economy. The CBI projects the public debt-to-GDP ratio at 44.3% of GDP in 2023, well below the 120.1% peak in 2013 and the pre-pandemic level of 57.0% in 2019. When using GNI* as the debt ratio denominator, Ireland’s debt burden is projected to be 78.4% in 2023, much lower than the 165.6% peak in 2012. Still, Ireland’s public debt-to-GNI* remains relatively elevated and underpins Morningstar DBRS’ negative qualitative adjustment of the “Debt and Liquidity” building block assessment. Going forward, these favourable debt dynamics are expected to continue. The CBI projects that debt-to-GNI* will decline to 66.2% and the debt-to-GDP to 37.8% by 2026.

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 creates significant financial flexibility and will help smooth out the impact of higher rates. The weighted-average maturity of outstanding government debt stood at 10.5 years and the average cost of debt is around 1.5%. The NTMA’s cash buffer stood at around EUR 25 billion at end-2023. Ireland is not expected to have any funding issues due to the withdrawal of monetary stimulus in the euro area, including the reduction of government bond holdings by the euro-system central banks. Projected fiscal surpluses and modest redemptions should maintain Ireland’s bond issuance at a low level. On top of this, despite the higher interest rate environment, bonds maturing in 2024 and 2025 have interest rates higher than the current yield on Ireland’s 10-year bond (2.8%). The government expects interest expenditures to stay at 1.1% of GNI* until 2026.

The Irish Economy Slowed as a Result of Higher Rates and External Headwinds; Multinationals Dragged on Headline Growth

The activity of large foreign-owned multinational enterprises (MNEs) headquartered in Ireland, the aircraft leasing sector, and the on-shoring of intellectual property assets have large effects on national accounts. These factors, which accounted for close to 50% of Ireland’s GDP in 2022, have raised headline income per capita, nominal GDP, and economic growth more than otherwise, especially since 2015, while at the same time overstated output volatility. Morningstar DBRS 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. Underlying conditions of the domestic economy are better reflected by GNI* or Modified Domestic Demand (MDD). Ireland's average annual real GDP growth of 9.0% between 2013 and 2022 is inflated by the role of multinational companies. Real GNI* growth averaged 4.7% over the same period, highlighting the strong performance of the domestic economy. This is despite the successive economic disruptions linked to the United Kingdom leaving the European Union, the pandemic, and the global energy price and interest rate shocks. The strong evolution of the national economy is also reflected in the labour market. The number of employees in Q4 2023 was 43.4% higher than in Q4 2012, benefiting from strong net migration flows and a very low unemployment rate, of 4.5% in in Q4 2023.

After two years of very strong economic activity, preliminary estimates suggest real MDD growth slowed to 0.5% in 2023, as investment normalised after a large one-off physical investment in the semiconductor industry in 2022. The resilience of private consumption and some fiscal support underpinned growth. On the other hand, real GDP contracted by 3.2% due to volatility in MNE-dominated sectors. The industrial sector (excluding construction) declined by 11.0%, pulled down by the pharmaceutical and ICT manufacturing sectors, while the ICT services and other services provided partial compensation. The significant drop in exports from the pharmaceutical sector most likely reflects a one-off normalization after the pandemic boom rather than a more permanent drag on growth. From a value-add perspective, the MNE-dominated sector contracted by 6.8% in 2023, while the rest of the economy grew by 3.8%. Inflation is expected to continue to decline towards 2%, although services inflation has proven stickier thus far.

Ireland´s growth outlook remains favourable. The CBI projects real MDD growth of 2.0% and real GDP growth of 3.2% on average during 2024–26. The likely increase in real wages amid tight labour markets and residential investment will remain supportive. The growth outlook remains subject to uncertainties in part linked to the effects of monetary policy tightening domestically and abroad, geopolitical developments, as well as the evolution of external demand, especially in sectors such as pharmaceutical and ICT manufacturing. The reforms to global taxation might affect future direct investment inflows to Ireland in the long-term, but Morningstar DBRS is of the view that Ireland has significant advantages that keep its economy competitive should reforms threaten the country's economic model. Domestically, capacity constraints stemming from the labour market and from physical infrastructure/housing could put pressure on competitiveness and limit growth.

The Irish Banking Sector Is Well Placed to Face Stress; CRE Facing Challenges

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. Higher interest are helping profitability, although the pass-through from monetary policy to lending rates has been lower in Ireland than in other euro-area countries, and asset quality remains adequate. Higher interest rates and cost pressures could lead to moderate asset quality deterioration for vulnerable households and leveraged firms. Still, Morningstar DBRS 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, mitigate the risks.

After a temporary cooling down amid monetary policy tightening, Irish residential property prices have started to increase again. Despite the negative impact of monetary policy tightening, housing demand is expected to remain strong in Ireland after years of undersupply and continued strong net migration. 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, 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 direct risk to domestic banks and the economy. On the other hand, Ireland’s large and complex market-based financial sector (more than 20 times GNI*), despite being mainly externally oriented, could still have some spill over effects on the CRE sector in Ireland and needs to be monitored, according to the IMF.

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

Large swings in the balance of payments data reflect multinational activity. The current account averaged a deficit of 13.2% of GDP in 2019–20 but then shifted to an average surplus of 12.2% of GDP in 2021–22. Contract manufacturing affects the accounting of 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 adjusted for the large multinational sector. The CBM calculates a modified current account (CA* ) that strips away, among other items, intellectual property and the depreciation of aircraft leasing. The CA* surplus amounted for 7.0% of GNI* in 2022, and the Central Bank estimates it to average 7.0% between 2023 and 2026. Ireland’s large negative net international investment position (NIIP) at 106.1% of GDP in Q4 2023 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 Morningstar DBRS’ positive adjustment to the “Balance of Payments” building block assessment.

Ireland’s Institutional Strengths Underpin Sound Policy Making; Brexit-Related Uncertainty Contained

Ireland’s high-quality institutions, as reflected by the Worldwide Governance Indicators, and stable macroeconomic policy framework underpin a very strong political environment. The current coalition government is composed of Fine Gael (FG), Fianna Fáil (FF), and the Greens as junior partner. The coalition agreement included a transfer of Prime Ministerial duties from Micheál Martin (FF) to Leo Varadkar (FG) in December 2022. Following the defeat of the family and care referendums earlier this month, with FG advocating strongly in favour, Leo Varadkar announced on 22 March 2024 that he would resign as Prime Minister once a new FG leader is selected to succeed him with the support of the current coalition. The next general election will be held no later than March 2025, although snap elections could be called earlier. Sinn Féin is leading most opinion polls, although their advantage has narrowed over the past year. The two parties that have dominated Irish politics for decades, FG and FF, have not recovered the significant ground they lost in the February 2020 general election. While the upcoming electoral cycle generates uncertainty about the specific fiscal and economic policies of the next government, Ireland’s lengthening track record of sound fiscal management will likely remain intact.

The different agreements in place have diminished the economic risks generated by Brexit. The December 2020 UK-EU Free Trade Agreement and the 2019 Withdrawal Agreement avoided worst-case scenarios related to the risks associated with lower production potential and a physical border on the island of Ireland because of a Hard Brexit or no deal. The Windsor Framework agreed in February 2023 helped to better clarify the regulatory trade relationship among the UK, Northern Ireland, and the EU. From a trade perspective, Brexit has resulted in lower levels of aggregate trade between the two blocs due to non-tariff barriers, while trade between Ireland and Northern Ireland (NI) has increased significantly because of NI's special status. From a social and political perspective, more time is needed to accurately assess the consequences of Brexit in Ireland.

ENVIRONMENTAL, SOCIAL, AND 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.com/research/429954/.

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 (October 6, 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.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), Central Bank of Ireland (Quarterly Bulletin March 2024; Financial Stability Review 2023:II), Central Statistics Office Ireland, The National Treasury Management Agency (Investor Presentation March 2024), European Central Bank, European Commission (European Semester: Country Report 2023), Eurostat, International Monetary Fund (Ireland 2023 Article IV Consultation – December 2023, 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 (2024 Social Progress Index), and Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.

Morningstar DBRS does not audit the information it receives in connection with the credit 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. Morningstar DBRS’ outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS 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 Morningstar DBRS 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://dbrs.morningstar.com/research/429956/.

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Javier Rouillet, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: July 21, 2010
Last Rating Date: January 26, 2024

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