DBRS Upgrades Republic of Ireland to A, Stable Trend

DBRS, Inc. has upgraded the Republic of Ireland’s long-term foreign and local currency issuer ratings to A from A (low) and changed the trend to Stable from Positive. DBRS has also confirmed the short-term foreign and local currency issuer ratings at R-1 (low) and maintained the Stable trend.

The ratings are underpinned by Ireland’s openness to trade and investment, young and educated workforce, flexible labor market, and access to the European market, all of which support the economy’s competitiveness and solid medium-term growth prospects.

The upgrade reflects DBRS’s assessment that the outlook for public debt sustainability in Ireland has improved. This is the result of: (1) a strengthening economic recovery, (2) progress on reducing the fiscal deficit, and (3) diminished risks stemming from contingent liabilities. Our expectation is that public debt ratios will trend downwards in the coming years. Improvements in the “Fiscal Management and Policy” and “Debt and Liquidity” sections of our analysis were key factors in the decision to upgrade the ratings.

The Stable trend reflects our view that risks to the ratings are broadly balanced. If sustained improvement in the fiscal accounts place public debt ratios on a firm downward trajectory and create greater policy space to accommodate adverse shocks, the ratings could be upgraded. On the other hand, Ireland’s growth outlook is subject to a high degree of uncertainty and spending pressures could intensify. If debt dynamics deteriorate – due to either a markedly weaker growth performance than currently expected or fiscal slippage – the ratings could face downward pressure.

The recovery in Ireland is gaining momentum. The IMF estimates that GDP grew by 4.7% in 2014. The main driver was exports, which benefited from strengthening demand in the United States and United Kingdom. Robust export expansion was accompanied by a revival in domestic demand, which made its first positive contribution to GDP growth since 2007. Private consumption was supported by an improving labor market, positive wealth effects driven by rising home prices, and strengthening consumer sentiment. Machinery and equipment investment also accelerated at a solid pace. The recovery is expected to continue this year. The IMF forecasts GDP growth of 3.3%. However, the near-term growth outlook faces upside and downside risks. Lower energy prices, a weaker euro, and a pick-up in residential investment as the market starts to address a housing shortage could act as tailwinds, providing further support to the recovery. On the other hand, economic weakness in the euro area and debt overhang among Irish households could pose obstacles to stronger growth.

Ireland has made substantial progress putting its fiscal accounts on a sustainable path. The fiscal results for 2014 outperformed targets. The headline deficit narrowed to an estimated 4.0% of GDP, well below the Excessive Deficit Procedure (EDP) ceiling of 5.1% as well as the government’s initial deficit target of 4.8%. With the recovery strengthening, Ireland appears well-positioned to reduce the deficit below 3.0% of GDP this year and exit the EDP on schedule.

Risks stemming from contingent liabilities in the financial system have also materially declined. Supported by rising property prices and strong interest from international investors, the National Asset Management Agency (NAMA) had redeemed €16.6 billion out of €30.2 billion in government-guaranteed bonds by the end of 2014, and now expects to wind up operations by 2018, two years ahead of schedule. The liquidation of Irish Bank Resolution Corporation (IBRC) could generate a surplus sufficient to repay unsecured creditors, including the Irish government. In addition, Ireland’s two pillar banks passed the ECB/EBA comprehensive assessment in October 2014 without requiring additional capital. This, combined with fact that both banks returned to profitability in 2014, suggest that financial sector-related risks to public finances have diminished.

As a result of these factors, the outlook for public debt sustainability in Ireland has improved. Gross general government debt is estimated to have declined to 111% of GDP in 2014. With additional improvements in the fiscal position as the economy recovers, the primary surplus should increase sufficiently to put debt ratios on a clear downward path over the medium term. Debt dynamics also benefit from exceptionally favorable funding conditions. Ireland is taking advantage of record low yields to refinance most of its €22.5 billion in IMF loans, thereby reducing interest costs and extending its maturity profile. In addition, proceeds from the sale of government holdings in Irish banks could potentially be used to reduce the public debt burden.

However, these positive developments are countered by several credit weaknesses, including high levels of public debt, a heavily indebted household sector, and medium-term fiscal pressures. Though public debt ratios are declining, they remain high and vulnerable to adverse shocks. The principal risk stems from the external environment. The outlook for the euro area is fragile, with weak growth expected in 2015. Fallout from disruptive events in Greece or escalating tensions with Russia could further weaken European demand. This would likely have adverse effects on Ireland’s recovery and public debt dynamics.

On the domestic front, tight credit conditions and highly indebted households could pose constraints on growth. Irish banks face weak profitability and a high stock of non-performing loans. Adverse shocks could worsen credit conditions for the real economy. Moreover, Irish households remain heavily indebted, despite six years of deleveraging. A prolonged period of balance sheet repair could dampen the recovery in domestic demand.

Sustaining a tight fiscal stance could also be difficult as medium-term spending pressures mount and the general election approaches. Demand for public services, notably healthcare and education, is expected to increase due to demographic changes, and pressure to increase public sector pay could build. General elections, which need to take place by April 2016, pose some uncertainty over the policy outlook. Nevertheless, DBRS believes it is most likely that prudent macroeconomic policy will be maintained through the electoral cycle.

Notes:
The main points discussed during the rating committee were: (1) Ireland’s economic outlook, (2) the issuer’s fiscal position, and (3) developments in the financial sector. The committee concluded that significant progress had been made in these areas, although public debt ratios remain high and risks stemming from the external environment remain. Other factors discussed included the political outlook, the reduction in contingent liabilities, and uncertainty over potential growth estimates.

All figures are in euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the Department of Finance, Central Bank of Ireland, Central Statistics Office Ireland, National Treasury Management Agency, National Asset Management Agency, European Commission, Eurostat, IMF, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Michael Heydt
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 July 2010
Most Recent Rating Update: 26 September 2014