DBRS Confirms Republic of Ireland at A (high), Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS confirmed its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The rating trends are Stable.

KEY RATING CONSIDERATIONS

The ratings confirmation reflects DBRS’s view that upward pressure on the ratings remain constrained by lingering credit challenges. The Irish credit profile is supported by the strong economic growth performance and improvement in the debt-to-GDP ratio. However, external developments – principally but not limited to Brexit-related uncertainty – continue to pose downside risks that weigh on the ratings.

Reported GDP according to the European Commission (EC), inflated by the activity of multinational companies, expanded by 8.3% in 2018. Excluding some of the external distortions, measures of underlying domestic activity have slowed slightly but also remain strong. The robust economy and healthy corporate tax windfalls generated a slight fiscal surplus last year, and gross government debt to GDP is expected to have declined to 63.6%. Despite the improved macroeconomic fundamentals, DBRS expects any outcome of the Brexit negotiations that misaligns the UK’s trade and regulatory relationship with the EU to adversely affect the Irish economy.

The A (high) ratings are underpinned by Ireland’s openness to trade and investment, its flexible labour market, young and educated workforce, and the country’s access to the European market. The country’s institutional strength and its favourable business environment encourage investment. These credit fundamentals support the economy’s competitiveness and its medium-term growth prospects. The country’s strengths are countered by several credit weaknesses, including medium-term fiscal pressures, a high stock of public debt, and lingering asset quality concerns in the banking system. The open nature of the Irish economy, while also a credit strength, increases the country’s sensitivity to external developments.

RATING DRIVERS

Upward rating pressure could be warranted if: (1) there is clear evidence of enhanced economic resiliency to external developments; or (2) DBRS’s assessment of debt sustainability improves to more moderate levels on the back of sound fiscal management. On the other hand, the ratings could face downward pressure if material downward revision in the growth outlook or a weakening in fiscal discipline cause medium-term public debt dynamics to reverse course.

RATING RATIONALE

Strong Economic Growth Performance Despite External Sector Risks

Irrespective of the statistical complexities associated with calculating GDP in Ireland, a wide range of indicators suggests that the Irish domestic economy continues to grow at a strong pace. Excluding 2015, real GDP expanded on average by nearly 7.0% each year since 2014. There is broad consensus that reported GDP is inflated by multinational firms operating in Ireland and does not fully capture the pace of underlying economic growth.

Using alternative measures, economic growth still appears robust. Real modified domestic demand, a preferred cyclical measure of underlying growth, grew at an annual average rate of 4.4% in 2014-2017 and slowed to 3.3% in 2018. Employment growth increased at an annual average pace of 3.1% from 2013 to 2018. For the time being, wage growth and inflationary pressures remain subdued, damping down concern of economic overheating. DBRS considers the current composition of growth less vulnerable to an economic slowdown than a decade ago and economic growth is expected to gradually slow towards measures of potential growth of around 3%.

At the same time, Ireland is exposed to potential adverse external developments. Most scenario calculations of the UK’s exit from the European Union (EU) conclude that all forms of Brexit negatively affect the Irish economy in varying degrees. Depending on the final withdrawal outcome, Ireland could be adversely affected through trade and investment channels. While all negotiating positions appear to have ruled out the imposition of a hard border with Northern Ireland, the risks of a no-deal Brexit, while still not DBRS’s baseline Brexit scenario, appear to have increased. The intensity and duration of a Brexit-related shock will ultimately be determined by the nature of the agreement.

Lack of clarity over how multinational firms operating in Ireland will respond to changes in global tax and trade policies is an ongoing concern. Recent changes to U.S. tax policy and the possible alignment of specific tax rates across Europe, especially following the introduction of a digital tax on large tech companies in the UK and France, create an unpredictable environment for the activity of multinationals. Significant shifts in fiscal incentives could result in a reduction in future investment flows into Ireland. Furthermore, the current U.S. administration has demonstrated a preference to exit or renegotiate existing trade agreements and impose protectionist measures. It remains unclear what forthcoming shifts in U.S. trade policy will mean for the Irish economy.

Strong Fiscal Outcomes and Debt-to-GDP Metrics Conceal Corporate Tax Concentration and High Public Debt

The fiscal cash position tipped into surplus last year. The exchequer recorded a small budget surplus thanks primarily to higher than expected corporate tax receipts. The estimated 0.1% of GDP surplus improved on the underlying deficits of 0.5% in 2016 and 3.6% in 2014. Fiscal progress initially reflected expenditure control and more recently over-performance of the tax intake. The relocation of multinational assets to Ireland has sharply increased corporate tax revenues, which continues to be a strong contributor to deficit reduction.

Corporate tax in Ireland – 19% of total tax revenues in 2018, up from 11% in 2014 – is concentrated in a handful of large companies. This exposes Ireland’s fiscal outcome to shocks to the corporate tax base if multinational firms decide to shift operations, move intangible assets, or book profits outside of Ireland. The Irish Fiscal Advisory Council has raised concern that the increasing importance of possibly volatile corporate tax revenues are being matched by increases in permanent spending. Expenditures increased by over a billion euros beyond previous estimates in 2018, largely due to healthcare related overruns.

Multinational firms nonetheless operate in Ireland for many reasons, including the stable legal and political system, access to the single European market, and the highly skilled workforce – all of which help reduce incentives for large international corporates to leave Ireland and limit the risk associated with a shock to the corporate tax base. It is also important to note that the EC expects the structural deficit to narrow to within 0.5% of GDP in 2020, in line with the Medium-Term Objective of the Stability and Growth Pact.

Despite improving public finances, public debt remains high and vulnerable to adverse shocks. General government debt-to-GDP is expected to decline below the 60% threshold by 2020. Nevertheless, this ratio is distorted by Ireland’s GDP data. When using alternative debt metrics, including interest costs to total revenue at 7.6% (or 6.5% if interest paid to the central bank is excluded), Irish debt is comparable to other European countries with high public debt such as Italy and Portugal. Debt to GNI*, which strips away some external distortions, was 104% in 2018. Debt as a share of total revenue was 251% in 2018, among the highest in the Euro area.

The Recent Reduction in Bank Impairments has been Significant

There has been considerable progress in restructuring the Irish banking system and in reducing impairments. Ireland’s banking crisis left a large stock of impaired assets on bank balance sheets. Non-performing loans of the banking sector as a share of total loans, having declined according to the IMF from 25.7% in 2013 to 5.7% in 2018, are more in line with the EU average of around 5%. The improved financial sector is evident by profitable banks with healthy levels of capital and stronger funding profiles. The calming of property price growth in Ireland and strong macroprudential measures also strengthens the financial sector.

Ireland has High Quality Institutions and a Stable Political Environment

Ireland is a strong performer on the World Bank’s Worldwide Governance Indicators and its governments over the last decade have demonstrated policy continuity. In the February 2016 election, Fine Gael formed a minority government after reaching a Confidence and Supply Agreement with opposition party Fianna Fáil around fiscal policy. In December 2018, both main parties agreed to extend the existing framework. It remains unclear whether the current government will survive its full term to February 2021. Assuming an orderly Brexit transition, an early election is possible. DBRS does not expect the political cycle to undermine strong institutional quality or stable macroeconomic policy-making.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A (high) – A (low) range. The main points discussed during the Rating Committee include: Ireland’s macroeconomic performance and the effects on Ireland from Brexit.

KEY INDICATORS

Fiscal Balance (% GDP): 0.1 (2018); -0.1 (2019F); 0.2 (2020F)
Gross Debt (% GDP): 63.6 (2018); 61.3 (2019F); 55.9 (2020F)
Nominal GDP (EUR billions): 324.0 (2018); 336.0 (2019F); 353.9 (2020F)
GDP per Capita (EUR): 65,517 (2018); 68,493 (2019F); 71,528 (2020F)
Real GDP growth (%): 8.3 (2018); 4.2 (2019F); 3.6 (2020F)
Consumer Price Inflation (%): 0.7 (2018); 1.2 (2019F); 1.4 (2020F)
Domestic Credit (% GDP): 3.7 (2017); 3.5 (2018)
Current Account (% GDP): 11.8 (2018); 9.1 (2019F); 8.3 (2020F)
International Investment Position (% GDP): -164.8 (2018); -162.1 (Mar-2019)
Gross External Debt (% GDP): 740.4 (2018); 709.6 (Mar-2019)
Governance Indicator (percentile rank): 88.5 (2016); 87.0 (2017)

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in Euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Department of Finance, Central Bank of Ireland, Central Statistics Office Ireland, NTMA, NAMA, European Central Bank, European Commission, Eurostat, IMF, Statistical Office of the European Communities, World Bank, UNDP, Allied Irish Bank, Bank of Ireland, Permanent TSB, The Economic and Social Research Institute, Irish Fiscal Advisory Council, Bloomberg, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve-month period. DBRS’s outlooks and ratings are under regular surveillance.

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

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Global Sovereign Ratings
Initial Rating Date: 21 July 2010
Last Rating Date: 1 February 2019

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