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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Ireland’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS Morningstar confirmed its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

Confirmation of the Stable trend balances Ireland’s strong policy institutions and its productive economy against the severe consequences of the current health crisis on the country’s key macroeconomic indicators. 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, the pandemic resulted in a sharp decline last year in economic output and deterioration in public finances.

The global shock brought on by the Coronavirus Disease (COVID-19) will continue to weigh on key credit metrics. Ireland’s comparatively strict mobility restrictions during most of the 2020 meant COVID-19 case numbers were among the lowest in Europe. The easing of restrictions during the holiday season led to a rapid deterioration in the health situation, forcing authorities to impose a third lockdown. However, the outlook has improved beyond the near-term, as the vaccination rollout has begun and the trade agreement between the UK and the EU allows Ireland to avoid the worst-case scenario.

Ireland’s A (high) ratings are underpinned by the country’s institutional strength, robust trade and investment flows, flexible labour market, young and educated workforce, and its access to the European internal market – features that support the economy’s competitiveness and its medium-term growth prospects. The country’s credit strengths are countered by several weaknesses, including volatile fiscal revenue sources and medium-term fiscal cost pressures, and a high stock of public debt. Ireland’s open economy, while also a credit strength, increases the country’s vulnerability to external developments.

RATING DRIVERS

The ratings could be upgraded if DBRS Morningstar sees evidence of enhanced resiliency of the Irish economy to external developments; or if sound fiscal management results in gradual consolidation of the deficit once crisis conditions have passed.
The ratings could be downgraded if the current health crisis causes substantial deterioration in Ireland’s medium-term economic outlook; or if the country experiences a more permanent relaxation of fiscal discipline that significantly weakens its public debt position.

RATING RATIONALE

2021 Started with the Health Situation Having Once Again Deteriorated and the End of the Brexit Transition Period

During the first wave of viral contagion authorities implemented containment measures that were among the most stringent in Europe. Restrictions eased during most of the summer months, but were then increased when the government applied a 5-level restriction plan on social mobility. At the start of December 2020, Ireland’s confirmed cases as a share of the population was comparatively low. The health situation deteriorated following the easing of restrictions during the holiday period. In what constitutes a third wave of infections, Ireland’s 14-day incidence per 100,000 population increased to among the highest in Europe. This in part reflects the emergence of a new and more transmissible virus variant. Despite the recent increase in COVID-19 fatalities, mortality ratios remain below the peak seen during April and May 2020.

A Free Trade Agreement between the UK and EU was agreed in December 2020 following a long negotiation. The deal allows for tariff-free trade, and in conjunction with the 2019 Withdrawal Agreement, the worst-case scenarios concerning risks associated with lower output potential and a physical border on the island of Ireland from no-deal have been averted. However, goods moving between the UK and the EU will still be subject to customs and controls that require extra processes. Due to these non-tariff barriers, Brexit will likely result in lower levels of aggregate trade between the two blocks. Additional agreements around the trade of services will likely be necessary before accurately assessing the economic effects of Brexit on Ireland.

The Global Health Crisis Will Continue to Weigh on the Irish Economy

The COVID-19 shock exacerbates what has long been an economy operating at two-speeds. Ireland is one of the few economies in the world to have expanded in 2020, with flash estimates of real GDP growth last year above 2%. This is due to the strong performances of external-facing sectors, principally pharmaceutical and the information and communications technology (ICT) sectors, which have been able to offset the adverse effects of the crisis on the domestic economy. Statistical considerations specific to Ireland’s national accounts overstate economic risk in DBRS Morningstar’s scorecard, supporting our positive qualitative assessment in the “Economic Structure and Performance” building block.

Real Modified Final Domestic Demand (MDD) is an alternative growth measure that adjusts for external factors. Compared to a year earlier, MDD contracted by just under 16% in the second quarter of 2020 when mobility restrictions were strictest. The strong third quarter helped recover some lost output, but the most recent deterioration in health outcomes once again weakens the prospects for domestic demand. The unemployment rate once adjusted to include the employed population on temporary wage assistance remained elevated at 20% in December 2020. Moreover, modified investment – having recovered after the 25% second quarter decline – remained 4.4% weaker than a year earlier.

Notwithstanding the challenging context at the beginning of the year, conditions are hopeful for a recovery of the domestic economy in 2021, given the vaccine rollout. Furthermore, government support measures designed to preserve employment and income have increased measures of household gross income and savings. The combination of pent-up demand and higher rates of inoculation in Ireland and across Europe should lift economic activity as the year progresses.

Public Support Measures Will Result in a Return to a Large Fiscal Deficit and Keep Public Debt Elevated

Counter-cyclical expenditure measures implemented to support the economy have been large. The total fiscal response in 2020 amounted to EUR 25 billion, or 12% of GNI* (gross national income adjusted for external factors). About four-fifths of the response consists of direct expenditure measures to support employees, households, and businesses as well as increased health and capital spending. From a budget surplus of EUR 2.5 billion in 2019, the government expects the deficit in 2020 to have widened to EUR 19 billion (6.2% of GDP). Because tax revenues have held up despite the pandemic, the 2020 deficit was better than worst-case scenario estimates made in the second quarter of a EUR 30 billion shortfall. Risks to the fiscal outlook weigh negatively on DBRS Morningstar’s assessment in the “Fiscal Management and Policy” building block.

The 2021 Budget assumed the UK would exit the transition period with the EU adopting WTO trade and that there would be no viable vaccinations available in 2021. Since neither adverse scenario has occurred, the growth and spending assumptions were purposefully conservative, allowing the Treasury (NTMA) to enter the new year with a higher cash balance. Nonetheless, the spending commitments for this year are still large, dominated by income and business support measures, health expenditures, and temporary cuts to taxation. The European Commission (EC) expects the deficit to remain close to 6% of GDP in 2021. DBRS Morningstar sees upside risk to this forecast because it does not include the EUR 1.3 billion committed revenue to Ireland through 2023 from the EU Recovery and Resilience Facility. Ireland is also set to receive EUR 1 billion in 2021 from the first instalment of the Brexit Adjustment Reserve.

All measures of Irish government debt will increase as a result of the health crisis. The 2021 Budget forecasts the general government debt-to-GDP ratio, having declined to 57.4% in 2019, will increase to 62.6% in 2020 and 66.6% in 2021. However, using alternative debt metrics, Irish debt ratios are high and comparable to other highly indebted European countries. This factor weighs negatively on DBRS Morningstar’s “Debt and Liquidity” building block assessment. Debt to GNI* in 2019 was 96% and is expected to have increased to 108% in 2020 and 115% in 2021. Interest costs to total revenue at 5.0% and debt as a share of total revenue at 229% are among the highest in Europe, comparable to Spain, and higher than Belgium and France – countries whose debt-to-GDP ratios will approximate 120% in 2020.

Following Considerable Progress, the COVID-19 Shock Will Likely Renew Challenges for the Banking Sector

Progress has been made 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 3.5% as of the second quarter 2020, 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 deceleration of property price growth in Ireland and strong macroprudential measures also strengthens the financial sector. The COVID-19 crisis will likely 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.

External Accounts Are Distorted; Changes to Global Tax Policies May Affect Future Investment Flows

The IMF’s measure of the headline current account deficit for 2019 was 11.4% of GDP, following a surplus of 6.0% a year earlier. The large swings in the data are due to the activity performed by large multinational firms. Contract manufacturing affects the accounting for exports, while movement of intellectual property products impacts imports. A measure of the current account adjusted for these effects showed a surplus of roughly 8% of GNI* in 2019. Ireland’s large negative net international investment position (-180% of GDP) overstates external sector risks. This supports DBRS Morningstar’s positive adjustment to the “Balance of Payments” building block.

The possible alignment of specific tax rates across Europe 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.

Effective Crisis Management During Government Formation Negotiations Highlights Ireland’s Institutional Strengths

Ireland’s general election in February 2020 coincided with the early spread of COVD-19 across Europe. The election resulted in a significant loss of seats for the two main political parties, Fine Gael and Fianna Fáil, and gains by Sinn Féin and the Greens. While the inconclusive election occurred at a challenging time, the political cycle did not undermine Ireland’s strong institutional quality or its stable macroeconomic policy-making. A new coalition government that includes Fine Gael, Fianna Fáil, and the Greens took office in June 2020 and seamlessly continued the plan for containing the pandemic and supporting the economy. Ireland is a strong performer on the World Bank’s governance indicators, and its governments over the last decade have demonstrated policy continuity.

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/372962.

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.

The principal methodology is the Global Methodology for Rating Sovereign Governments (July 27, 2020) https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments

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

The sources of information used for this rating include include Department of Finance (Irish Draft Budgetary Plan 2021), Central Bank of Ireland (Quarterly Bulletin October 2020), Central Statistics Office Ireland, NTMA (Investor Presentation January 2021), European Central Bank, European Commission, Eurostat, IMF WEO (October 2020), IMF IFS, Statistical Office of the European Communities, OECD, 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at https://www.dbrsmorningstar.com/research/372960.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas Torgerson, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: July 21, 2010
Last Rating Date: October 2, 2020

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