* DBRS confirms rating at A (high), ‘stable’ trend, Brexit risk remains *
DBRS, Inc. confirmed on Friday the Republic of Ireland’s long-term foreign and local currency issuer ratings at A (high) and its short-term foreign and local currency issuer ratings at R-1 (middle). All ratings have a Stable Trend.
The confirmation of the ratings reflects Ireland’s strong economic performance and improving public finances. Though the UK vote to exit the European Union poses downside risks, the Irish economy is benefiting from substantial growth momentum and public debt dynamics continue to improve.
The A (high) 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. These strengths are countered by several credit weaknesses, including high public debt, medium-term fiscal pressures, heavily indebted households and asset quality concerns in the banking system. DBRS said current expectations do not incorporate any ramifications from recent corporate tax-related announcements, but it will continue to follow these events as they develop.
The recent revision to Ireland’s National Accounts data led to a large increase in GDP in 2015. This appears to be largely driven by the onshoring of intellectual property by multinational firms in Ireland. According to the new series, GDP expanded 26.3% in 2015, up from previous reporting of 7.8%. The updated figure clearly does not reflect the pace of underlying growth in the Irish economy. Furthermore, the rating agency said the statistical revision does not change its view on Ireland’s sovereign creditworthiness, despite the beneficial effects on some public finance metrics expressed as a share of GDP.
Irrespective of the statistical revision, a range of indicators confirm that the Irish economy is growing at a strong pace. Improving labour markets and strengthening consumer confidence are lifting private consumption. Firms are investing following years of cutbacks. External factors have also bolstered the economy’s performance, with Ireland benefiting from low energy prices and moderate growth from key trading partners. Even including the fallout from the Brexit vote, the outlook for the Irish economy is favourable. The IMF projects GDP growth of 4.9% in 2016 and 3.2% in 2017, albeit with downside risks.
The 2015 fiscal deficit fell comfortably below 3% of GDP for the first time in eight years, thereby enabling Ireland to exit its Excessive Deficit Procedure on schedule. Ireland is now subject to the preventive arm of the Stability and Growth Pact (SGP). With spare capacity in the economy diminishing, fiscal policy is shifting to a more neutral stance. Revenue growth in 2016 is outpacing expenditure growth, signalling less fiscal impulse. The deficit is projected to narrow to EUR 2.0 bln in 2016, down from 3.2 bln last year (excluding one-offs). The commitment to remain compliant with EU fiscal rules was reinforced by the policy agreement reached between the Fine Gael minority government and the main opposition party.
With a growing economy and a modest fiscal deficit position, the outlook for public debt sustainability is improving. General government debt declined to 94% of GDP in 2015 (based on the old national accounts series) from 120% in 2013. The sharp decline reflects strong nominal growth, the drawdown of precautionary cash reserves by the Irish treasury and the liquidation of IBRC.
DBRS said it expects the debt ratio to continue trending downward due to primary surpluses and favourable growth-interest rate dynamics. Proceeds from the sale of government holdings in Irish banks could further reduce the public debt burden.
Although the public finances are improving, public debt remains high and vulnerable to adverse shocks. The UK’s exit from the European Union poses clear downside risks to the Irish economy. DBRS said it believes Ireland could be adversely affected through trade, investment and confidence channels, with the intensity and duration of the shock determined by the nature of the withdrawal agreement.
On the domestic front, the level of household indebtedness is still high by comparative and historical standards, despite six years of deleveraging. The process of balance sheet repair could take several more years, potentially dampening the recovery in domestic demand. Moreover, Irish banks still have a high stock of non-performing loans. Adverse shocks could worsen credit conditions for the real economy.
Enhancing the resilience of the sovereign balance sheet would require an extended period of strong fiscal results, DBRS said. However, sustaining a tight fiscal stance could be difficult as medium-term spending pressures mount. Demand for public services, notably in education and healthcare, are expected to increase due to changing demographics, and higher capital expenditures could be needed to support potential growth.
DBRS concluded that the ‘stable’ trend reflects the view that risks to the ratings are broadly balanced. Measures that enhance the economy’s resilience, particularly given that the economy is highly open and exposed to adverse shocks, could warrant upward rating action.
Specifically, the ratings could be upgraded if public debt declines to more moderate levels on the back of sound fiscal management. On the other hand, if medium-term public debt dynamics reverse course – due to either a material downward revision in the growth outlook or a weakening in fiscal discipline – the ratings could face downward pressure.
