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’, while confirming the short-term foreign and local currency issuer ratings at R-1 (low) with a stable trend.
The ratings are underpinned by Ireland’s openness to trade and investment, young and educated workforce, flexible labour market, and access to the European market, all of which support the economy’s competitiveness and solid medium-term growth prospects, DBRS said.
The upgrade also reflects the assessment that the outlook for public debt sustainability in Ireland has improved. This is the result of a strengthening economic recovery, progress on reducing the fiscal deficit, and diminished risks stemming from contingent liabilities.
The New York-based rating agency said its expectation is that public debt ratios will trend downwards in the coming years, with improvements in the “Fiscal Management and Policy” and “Debt and Liquidity” sections of its analysis as 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,” DBRS said.
“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.”
DBRS explained that the recovery in Ireland is gaining momentum. The IMF estimates that GDP grew by 4.7% in 2014 driven by 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.
Supported by rising property prices and strong interest from international investors, the National Asset Management Agency (NAMA) had redeemed €16.6 bln out of €30.2 bln 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.
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 favourable funding conditions. Ireland is taking advantage of record low yields to refinance most of its €22.5 bln 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, 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, 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.
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.
