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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). The trends on the Long-Term Ratings have been changed to Stable from Positive. At the same time, DBRS Morningstar confirmed its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trends on the Short-Term Ratings remain Stable.

DEVIATION FROM DBRS MORNINGSTAR’S EU CALENDAR

This is a deviation from DBRS Morningstar’s EU Sovereign, Sub-Sovereign, and Supranational Calendar due to new information becoming available on the creditworthiness of the issuer related to the Coronavirus Disease (COVID-19). DBRS Morningstar believes that this new information makes it inappropriate to wait until the next scheduled review of the issuer on the July 31, 2020. The credit rating considerations and rationale are presented below.

KEY RATING CONSIDERATIONS

The change in trend to Stable from Positive reflects renewed challenges to Ireland’s macroeconomic fundamentals posed by the current health and economic crisis. Measures of Irish economic growth have for many years been strong, even after excluding external distortions stemming from the activity of multinational companies. The government also generated a fiscal surplus in 2019 for the second consecutive year and debt dynamics had been on a declining trend. However, DBRS Morningstar expects the shock to the global economy brought on by the Coronavirus Disease (COVID-19) and the associated confinement measures to cause the Irish economy to contract this year, perhaps even by double-digit percentage points, and to cause its public finances to deteriorate well beyond previous assumptions.

The COVID-19 shock adds to existing Irish challenges. The ratification of the UK Withdrawal Agreement in early 2020 temporarily removed the possibility of a disorderly Brexit shock scenario. However, little progress has been made this year around the future UK-EU relationship. Social and economic challenges to Ireland could re-emerge if the UK and the EU are unable to agree on their future trade and regulatory relationship. Other external developments could also pose downside risk to Ireland. Risks stemming from shifts in U.S. and European Union (EU) trade policy and pending changes to global tax policy could affect Ireland in a meaningful way.

Nevertheless, the A (high) ratings are underpinned by Ireland’s robust trade and investment flows, 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 credit strengths are countered by several weaknesses, including volatile revenue sources and medium-term fiscal pressures, and a high stock of public debt. Ireland’s open economy, while also a credit strength, increases the country’s sensitivity to external developments.

RATING DRIVERS

The ratings are likely to be upgraded if: (1) evidence points to enhanced economic resiliency to external developments; or (2) DBRS Morningstar’s assessment of debt sustainability improves to more moderate levels on the back of sound fiscal management.

Conversely, the ratings could be downgraded if: (1) the economic shock persists longer than expected and Ireland's medium-term economic outlook substantially deteriorates, or (2) the country experiences a more permanent relaxation of fiscal discipline that significantly weakens its public debt position.

RATING RATIONALE

The Global Health Crisis Imposes a Significant Shock to Ireland and its Economy

As elsewhere, social life in Ireland has been affected by the global spread of COVD-19. In order to slow the transmission of the virus, the government on March 27, 2020 introduced mobility restrictions. These measures, while not as prohibitive as in other European countries, limit the reasons citizens should leave their homes. Shutdown rules have helped slow the spread of transmission in Ireland, yet the crisis has as of May 15, 2020 resulted in 1,500 deaths. The government’s plan to ease restrictions consists of five reopening phases, at 3-week intervals starting on May 18, 2020.

In a short time period, the economic landscape has dramatically changed. Following strong 5.5% growth in 2019, measures of economic activity have since fallen sharply. Health protocols in place in Ireland and around the world have depressed external demand and weighed on Irish exports. Large sectors of the domestic economy have also come to a stand-still as employment losses have been severe during the shutdown months. From a sectoral perspective, large domestic consumer-oriented sectors like retail, real estate, construction, entertainment, transport, and hospitality have significantly reduced capacity. The effects on finance, industry (including the pharmaceutical sector), and the information and communications technology (ICT) sector have been less severe.

In its Stability Programme, the government expects real GDP to contract by 10.5% in 2020 and to partially recover by 6.0% in 2021. The forecast for real modified final domestic demand, a preferred cyclical measure of underlying growth that strips away external sector distortions, is projected to contract by 15.1% in 2020 followed by 8.2% growth next year. These government projections, as with all current economic forecasts, are subject to considerable uncertainty. The size and duration of the growth shock will depend on the progress made in containing the spread of the virus. The strength of the recovery is contingent on the speed economic sectors come back on line, the capacity of the labour market to reabsorb side-lined employment, and the degree to which the shock imposes permanent economic damage.

External Challenges, Principally Brexit, Add to the Current Uncertainty

The orderly withdrawal of the UK from the EU on January 31, 2020 removed the immediate social and economic disruptions of a no-deal Brexit. However, negotiating differences are not yet resolved and the likelihood of a no-deal Brexit could resurface if the EU and the UK are unable to reach an agreement on their future relationship before the end of the transition period in December 2020. Negotiations are ongoing, but the pace of discussion has been slowed by the pandemic and there appears little appetite among UK officials for extending the transition period. Both sides would need to agree to an extension by July 1, 2020. Most scenario calculations of the UK’s exit from the EU conclude that all forms of Brexit negatively affect the Irish economy in varying degrees, and the imposition of a hard border with Northern Ireland if no deal is agreed could reignite social tensions. The intensity and duration of a Brexit-related shock will be determined by the nature of the agreement.

In addition, external risks to Ireland from potential changes to U.S. trade policy and global tax policies are ongoing concerns. When economic performance in the U.S. is strong, high trade and investment returns flow to the Irish ICT sector, and consequently strong revenue growth to the government. The COVID-19 crisis will also shock U.S economic performance, and it remains unclear what potential shifts in U.S. trade policy could mean for Ireland.

Furthermore, the possible alignment of specific tax rates across Europe, especially following the introduction of digital taxes on large technology companies in the UK and France, could challenge Ireland’s growth model and create an unpredictable environment for the activity of multinational firms operating in Ireland. Significant shifts in tax rates could result in a reduction in future investment flows into Ireland. The OECD has taken the lead on how to standardize domestic tax base erosion and profit sharing (BEPS) arising from digitalisation. It will take time, especially given the more pressing pandemic-related challenges, before consensus is found on this among EU member states.

Economic Support Measures will Result in a Return to a Large Fiscal Deficit

The shock to the public balance sheet will stem from both revenue and expenditure channels. After reporting a small surplus in 2019, the fiscal outlook has dramatically changed. The economic shock will cause a steep decline in tax revenues and the counter-cyclical expenditure measures implemented by the Government to try and support the economy has been large and may likely increase further. Income support measures to employees, households, and businesses as well as increased health sector spending to combat COVID-19 initially totalled EUR 6.8 billion (2.0% of GDP).

The Stability Programme forecasts a headline fiscal deficit of 7.5% of GDP in 2020, yet DBRS Morningstar sees considerable downside risk to this projection. The fiscal cost could be higher if economic activity does not bottom out in the second quarter, as is expected. EUR 6.5 billion in new funding was passed in May 2020 to strengthen businesses, via guaranteed loans and tax deferrals, as restrictions are slowly lifted. While some of these specific measures are contingent on the formation of a government and may over time have less of a budgetary impact, DBRS Morningstar does not rule out additional economic recovery spending in the near future.

Whether this crisis causes Ireland to experience a more permanent shock to tax revenues is an open question. The relocation of multinational assets to Ireland has sharply increased corporate tax revenues – which now accounts for nearly 20% of tax revenue, up from around 11% in 2011-2014 – deriving from a handful of large companies. The concentration of corporate tax revenue exposes Ireland’s fiscal outcomes if this crisis spurs multinational firms to ‘re-shore’ activity, shift operations, move intangible assets, or book profits outside of Ireland. DBRS Morningstar at present sees little incentive for large international corporates to leave Ireland. Firms operate in Ireland among other reasons because of the stable legal and political system, access to the single European market, and the skilled workforce.

Ireland’s Public Debt Stock has Been High for Years Prior to the Coronavirus Crisis and Will Remain High For Now

All measures of Irish government debt will increase as a result of the current shock. The general government debt-to-GDP ratio, having declined below the 60% threshold in 2019, is distorted by Ireland’s GDP data. The expected increase in this debt ratio to 69% in 2020 as a result of the crisis may seem mild when compared to other countries, but when using alternative debt metrics, Irish debt ratios are high and comparable to other highly indebted European countries. Debt to GNI* (gross national income less external factors that distort measures of output) in 2019 was just under 100% and is expected to increase to 125% this year. Interest costs to total revenue at 5.1% and debt as a share of total revenue at 233% in Ireland are among the highest in Europe, comparable to Spain, and higher than in Belgium and France – countries whose debt-to-GDP ratios are at or near 100%.

Having Dealt with Legacy Challenges From the Previous Crisis, The Irish Banking Sector Braces for the Current Shock

There has been considerable progress over the years in restructuring the Irish banking system and in reducing impairments. Ireland’s banking crisis a decade ago 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 3.8% in as of the third quarter 2019, are below the EU average of around 5%. The improved financial sector has been 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. This crisis will once again challenge the sector. Notwithstanding ECB liquidity support measures and loan payment break programmes offered by the government, DBRS Morningstar expects the crisis to over time weaken banking sector asset quality.

The Inconclusive 2020 Election Does Not Affect Ireland’s High Quality Institutions and 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. The February 2020 general election resulted in significant seat loses for the two main political parties Fine Gael (-15) and Fianna Fáil (-6) and gains by Sinn Féin (+14) and the Greens (+10). The current breakdown of seats in the Dáil means that no two parties together can form a government and a multiparty coalition has yet to emerge. No new legislation can be passed without government formation. DBRS Morningstar expects a coalition to likely form in the coming months and does not expect the political cycle to undermine Ireland’s strong institutional quality or its stable macroeconomic policy-making.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
https://www.dbrsmorningstar.com/research/361059

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 (17, September 2019) : https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRSMorningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include Department of Finance (Stability Programme May 2020), Central Bank of Ireland, Central Statistics Office Ireland, NTMA (Investor presentation April 2020), European Central Bank, European Commission, Eurostat, IMF WEO (October 2019 and April 2020), Statistical Office of the European Communities, World Bank, UNDP, The Economic and Social Research Institute, Irish Fiscal Advisory Council, Bloomberg, BIS, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/361060

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: July 21, 2010
Last Rating Date: January 31, 2020

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