Morningstar DBRS Upgrades Republic of Ireland to AA, Changes Trend to Stable from Positive

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

KEY CREDIT RATING CONSIDERATIONS
The credit rating upgrades reflect Morningstar DBRS' assessment that the improvement in public finances will continue in the medium term, and the creation by law of two long-term savings funds should help manage windfall revenues. Public debt metrics are expected to continue to improve driven by the combination of large primary surpluses, strong nominal economic growth, and a low effective interest rate. Using Modified Gross National Income (GNI* ), the authorities' preferred measure for assessing fiscal and debt sustainability, the Central Bank of Ireland (CBI) estimates average fiscal surpluses of 3.0% of GNI* for the period of 2024 to 2026 and that public debt to GNI* will fall to 65.4% in 2026 from 77.1% in 2023. Morningstar DBRS also views positively the creation of the Future Ireland Fund (FIF) and the Infrastructure, Climate and Nature Fund (ICNF), which, if successfully capitalised, would improve the resilience of public finances and prepare Ireland to better manage structural economic challenges. These credit rating actions reflect the improvement in the "Fiscal Management and Policy" and "Debt and Liquidity" building blocks.

Ireland's credit ratings are underpinned by the country's institutional strength, strong fiscal performance, and favourable public debt dynamics. Furthermore, Ireland's robust trade and investment flows, flexible labour market, young and educated workforce, and its access to the European internal market also support its credit ratings. These features strengthen the economy's competitiveness and its medium-term growth prospects. Still, Ireland's public debt to GNI* remains elevated given Ireland's small and open economy. Moreover, the benefits to the economy from large multinational enterprises domiciled in Ireland come with some concentration risks and economic volatility, which, if not properly managed, could translate into fiscal vulnerabilities.

CREDIT RATING DRIVERS
Morningstar DBRS could upgrade the credit ratings if Ireland's public finances substantially improve, and there is evidence of significant economic and fiscal resilience to Ireland's concentration risk.

Morningstar DBRS could downgrade the credit ratings if a substantial deterioration in Ireland's medium-term economic outlook occurs, or if a structural deterioration in Ireland's fiscal position significantly weakens its public debt outlook.

CREDIT RATING RATIONALE

Ireland's Fiscal Position to Remain Strong in the Coming Years; Revenue Concentration Risks to be Mitigated by New Funds

Ireland's fiscal performance has been strong, as reflected by sizable fiscal surpluses since 2022. Despite providing significant support to the economy to overcome the successive shocks in recent years, public finances improved quickly. Ireland recorded fiscal surpluses of 3.2% of GNI* in 2022 and 2.9% in 2023, following deficits of 9.4% in 2020 and 2.8% in 2021, when the pandemic was at its peak. The improvement was mainly driven by the removal of pandemic-related support measures and strong revenue growth, which more than offset additional spending measures to address the cost-of-living crisis and humanitarian aid to Ukrainian refugees displaced by the Russian invasion of Ukraine. Robust revenue growth was driven by an increase in employment, exceptionally strong growth in corporation tax receipts, and the effects of high inflation. The CBI forecasts a surplus of 3.5% of GNI* in 2024 despite the government's expansionary package of EUR 14 billion in Budget 2024. This surplus is larger than previously anticipated as the strong performance of corporate income tax (CIT) collection is outpacing the stronger than projected expenditures thus far this year. The government included in its Summer Economic Statement an overall package of EUR 8.3 billion for Budget 2025 to provide for higher capital spending and additional public services in light of larger than expected population growth. The government expects this package to be consistent with a surplus of just under EUR 6 billion (or slightly below 2.0% of GNI* ) for 2025.

These very strong fiscal projections are nonetheless subject to concentration risks around corporate tax revenues, which accounted for about 27% of total revenues last year. In 2023, ten large multinational companies accounted for 52% of corporate income tax revenues and 10% of total revenues. The Department of Finance estimates that windfall corporation tax, or receipts in excess of what can be explained by the domestic economy, amounted to around EUR 11 billion in 2023 (3.7% of GNI* ). On top of this, multinational companies also generate a significant proportion of other tax receipts such as income tax and VAT revenues. This makes public finances vulnerable to company or sector-specific shocks and the potential effects of changes to international corporation tax rules. In its Stability Programme, the Government noted that the net effect of the two-pillar BEPS solution in Ireland will be a significant loss of corporate tax revenue. Morningstar DBRS applies a negative qualitative adjustment to the "Fiscal Management and Policy" building block assessment to reflect the risks associated with revenue volatility. However, it is worth noting that even excluding the so-called windfall revenues, the estimated fiscal deficit would average 1.8% of GNI* during 2024-2026, according to the CBI.

Morningstar DBRS welcomes the legislative creation of two long-term savings funds that will manage the resources generated by the windfall income. The final size of the funds is subject to uncertainty linked to the trajectory of GDP and corporate tax revenues. The government plans to transfer 0.8% of GDP annually to the FIF through 2035. The government suggests as much as EUR 100 billion could end up residing in the fund. Starting in 2041, the government will be able to draw down as much as 3% of the fund each year, provided that the withdrawal does not affect the capital value. The purpose is to help address future spending pressures including ageing, climate and the digital transitions, in a consistent and sustainable manner from 2041 onwards. A second fund, the ICNF, was created with the objective of supporting capital spending during downturns and supporting climate and nature related objectives. The government will contribute EUR 2 billion each year from 2025 to 2030.

Ireland's Public Debt Metrics Rapid Decline Expected to Continue Driven By Favourable Dynamics

Irish public debt metrics have improved rapidly over the past decade thanks to a stronger fiscal position and a rapidly growing economy. The public debt-to-GDP ratio stood at 44.0% of GDP in 2023, well below the 118.7% peak in 2012 and the pre-pandemic level of 55.9% in 2019. Public debt-to-GNI* also declined substantially during the same period. Debt-to-GNI* stood at 77.1% in 2023, much lower than the 163.4% 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. Looking ahead, favourable debt dynamics are expected to continue. The CBI projects that debt-to-GNI* will decline to 65.4% and debt-to-GDP to 37.8% by 2026, driven by the combination of large primary surpluses, strong nominal economic growth, and a low effective interest rate. The picture for public finances could be even better than the falling debt metrics would suggest, in that the government is planning to build up substantial financial assets in the two funds. Furthermore, the Court of Justice of the European Union's (CJEU) final ruling in September 2024 confirmed the European Commission's 2016 decision that Ireland granted state aid to Apple. Therefore, Ireland will receive in due course the current value of the EUR 13 billion plus interest placed by Apple in an escrow account. The use of these funds remains undefined, however, we do not expect the government to use it to finance current spending.

Ireland's proactive debt management strategy and favourable debt structure strengthen the government's credit profile. The National Treasury Management Agency (NTMA) managed to lengthen the debt's maturity profile at the same time as locking in low interest rates during the period of extremely easy monetary conditions in the euro area. The weighted-average maturity of outstanding government debt stood at 10.7 years and the average cost of debt is around 1.5%. On top of this, Ireland's large cash buffer at around EUR 25 billion as of end-2023 provides significant financial flexibility. The strength of CIT revenues and the one-off cash windfall as a result of the CJEU's ruling will likely prevent the cash balance from declining by the end of 2024 despite the transfers to the new long-term funds. Projected fiscal surpluses and modest redemptions should keep Ireland's bond issuance at a low level. All of this is helping to absorb the higher funding costs resulting from the ECB's tighter monetary policy. Interest expenditures are expected to be around 1.0% of GNI* out to 2026.

The Irish Economy's Performance and Outlook Remain Favourable Despite External Headwinds

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. The multinational-dominated sector accounted for, on average, about 47% of Ireland's GDP between 2020 and 2023. The size and performance of the multinational-dominated sector have complicated the assessment of the Irish economy, inflating per capita income, nominal GDP, real GDP growth, and output volatility, especially since 2015. 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). The annual average growth rate of real GNI* and MDD was 4.3% and 3.6% between 2013 and 2023, respectively. This highlights the strong performance of the domestic economy despite the successive economic shocks caused by the United Kingdom leaving the European Union, the pandemic, and the global energy price and interest rate shocks, among others. The strong evolution of the economy is also reflected in the labour market. The number of employees in Q2 2024 was 46.0% higher than in Q1 2012, benefiting from strong net migration flows and rising labour force participation. The unemployment rate stood at 4.4% in Q2 2024.

Real GDP contracted by 5.5% in 2023, largely due to a 13.8% drop in goods exports, which were affected by sector-specific issues in the pharmaceutical and ICT manufacturing sectors. Indeed, the MNE dominated sectors declined 16.2%, the first contraction since 2013, while the rest of the sectors grew 6.1% in 2023. Real GNI* and real MDD, a better reflection of the underlying domestic economy, expanded 5.0% and 2.6% in 2023, respectively. Headline HICP inflation has fallen to 1.1% YOY in August 2024, although services inflation is proving stickier. The CBI forecasts headline inflation to stay around or below 2% over the next two years.

Despite some loss of momentum in the second quarter of this year, the growth outlook looks solid. The CBI projects real MDD growth of 2.6% and real GDP growth of 2.7% on average during 2024-26. The domestic economy is expected to benefit from rising real household incomes and increased residential investment, while the normalisation of activity in the multinational-dominated sector and an improving global backdrop will boost the expected recovery in the external sector. The main risks to the growth outlook are related to geopolitical tensions and more adverse external demand conditions, especially in sectors such as pharmaceuticals 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 will likely keep the economy competitive. 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 Prepared to Face Stress; the Housing Market Heats up Again While the CRE Sector Faces Challenges

The Irish banking system has strong capital and liquidity ratios, well above minimum requirements, that support its capacity to absorb potential shocks. Irish bank profitability has risen rapidly, driven by higher interest margins, but these tailwinds are expected to moderate as the ECB gradually eases monetary policy. Asset quality remains adequate, although nearly two years of restrictive monetary policy and cost pressures could create some lagged impacts on activity and borrowers. Housing prices are heating up again in Ireland, with the residential property price index accelerating to 8.6% YOY in June 2024, compared with 1.1% YOY in August 2023. The dampening effects on the housing market from tighter monetary policy on mortgage costs seem to be wearing off, as strong demand for housing continues to outpace supply. The presence of fixed-rate mortgage loans, prudent underwriting standards, good coverage ratios, and strong macroprudential measures, together with the strength of Ireland's labour markets and a decade of private sector deleveraging, mitigate the risks to financial stability. Nevertheless, the continued deterioration in housing affordability, if left unaddressed, could limit Ireland's growth and competitiveness over time and stoke social tensions.

The global and local commercial real estate (CRE) sector is experiencing a marked downturn, but with limited effects on the national economy so far. Irish banks' exposure to this sector is lower and less risky than in the past. The increase in foreign investment in recent years has resulted in a more diversified funding profile for the CRE sector, which has reduced 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 spillover effects on the CRE sector in Ireland and should be monitored, according to the IMF.

Ireland's External Savings are Expected to Remain Significant in the Coming Year; External Liabilities Inflated by Multinational Activity

Ireland's external accounts are heavily influenced by the internationalisation of its corporate sector, which is dominated by foreign-owned multinationals producing goods and services mainly for exports and large offshore financial services sector intermediating non-resident borrowers and lenders. This leads to large swings in its balance of payments data. The current account averaged a deficit of 13.9% of GDP in 2019-20 but then shifted to an average surplus of 10.5% of GDP in 2021-22. The pharmaceuticals and ICT manufacturing sectors are recovering in 2024, after significant declines in 2023, and are expected to remain strong. Computer services are expected to continue to contribute strongly to export growth. Ireland's annual savings remain large, even when adjusted for the large multinational sector. The modified current account (CA* ) calculated by the Central Statistics Office provides an estimate of the underlying current account correcting for the effects related to intellectual property, aircraft leasing activities, and R&D service imports, among other items. The CA* surplus amounted to 3.3% of GNI* in 2023, and the CBI estimates it to average 3.6% over 2024 to 2026. Ireland's large negative net international investment position (NIIP) at 93.1% of GDP in Q1 2024 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

The high quality of Irish institutions, as reflected in the Worldwide Governance Indicators, and the stable macroeconomic policy framework underpin a very strong policy environment. The current coalition government is made up of Fine Gael (FG), Fianna Fáil (FF), and the Greens as a junior partner. Simon Harris became the Prime Minister (Taoiseach) and the leader of FG in April 2024 following the resignation of Leo Varadkar (FG) from both leadership positions. The next general election will be held no later than March 2025, although Prime Minister Harris could decide to bring forward the election to the autumn of 2024. Sinn Féin's popularity, which has led opinion polls since the previous general election, has fallen significantly in the past year and is now treading behind both FG and FF, according to Politico Poll of Polls. Independent candidates have been the main beneficiaries of Sinn Féin's decline in the polls. Given the increasing fragmentation of the traditional party system and rising popularity of independent candidates, the next government will need to obtain support from several parties to govern. Regardless of the electoral outcome, Morningstar DBRS believes there is a high likelihood that the next government will remain committed to prudent fiscal policies while, at the same time, using the available fiscal space to deal with structural constraints to the economy, including housing and infrastructure. While the economic uncertainty and risks surrounding Brexit have declined markedly because of the different agreements in place, more time is needed to accurately assess the potential social and political 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/439732/.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 these credit ratings include the Department of Finance (Summer Economic Statement, July 2024; Stability Programme Update, April 2024), House of the Oireachtas (Future Ireland Fund and Infrastructure, Climate and Nature Fund Act 2024), Central Bank of Ireland (Quarterly Bulletin September 2024; Quarterly Bulletin June 2024; Financial Stability Review 2024:I), Central Statistics Office Ireland, The National Treasury Management Agency (Investor Presentation September 2024), European Central Bank, European Commission (European Semester: Country Report 2024, Spring 2024 Economic Forecast), Politico Poll of Polls, International Monetary Fund (Ireland 2023 Article IV Consultation - December 2023, WEO and IFS), Statistical Office of the European Communities (Eurostat), OECD, World Bank, Bank of International Settlements, The Economic and Social Research Institute, Irish Fiscal Advisory Council (Fiscal Assessment Report, June 2024), The Social Progress Imperative (2024 Social Progress Index), and Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

Morningstar DBRS 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. Morningstar DBRS' outlooks and 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/439733/.

These credit ratings are 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: March 22, 2024

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