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Scope affirms the Republic of Ireland’s credit rating at A+; Outlook Stable

Scope assigns new A+ Issuer Rating to Lloyds Banking Group following ring-fencing-related changes

Euro area membership, strong institutional framework, continued deleveraging, and robust growth potential support the rating. Still high public- and private-debt levels as well as external vulnerabilities constrain rating upside.
For the detailed rating report, click here.

Scope Ratings GmbH today affirms the Republic of Ireland’s long-term local-currency issuer rating at A+. The agency also affirms Ireland’s long-term foreign-currency issuer rating at A+, along with its short-term issuer rating at S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in both local and foreign currency are affirmed at A+. All Outlooks are Stable.

Rating drivers

Ireland’s A+ sovereign ratings are underpinned by its European Union (EU) and euro area membership within a large common market, a strong reserve currency, an independent European Central Bank effectively acting as a lender of last resort, and a regional economic and financial governance framework that has been enhanced since the Great Financial Crisis and supports the creditworthiness of euro area member states. Ireland’s ratings are further reinforced by its strong national institutions and wealthy, diversified economy that generates one of the highest per-capita incomes in Scope’s rated universe (at USD 70,638 in 2017). The rating acknowledges the strengths in Ireland’s robust growth potential, improving public finances and declining public-debt ratios, long maturity of public debt, increase in Ireland’s current account surplus alongside private-sector debt reductions and the mending of financial system weaknesses.

However, Ireland’s ratings remain constrained by the economy’s vulnerability to sudden reversal, learning the lessons from the Great Financial Crisis and subsequent euro area debt crisis. In addition, the still high public-debt levels (especially when assessed against underlying economic activity) and meaningful leverage within the financial system and non-financial private sector, even after years of significant deleveraging, represent risks. The size and complexity of Ireland’s financial and corporate sectors, when considered in the context of a small and very open economy (with nominal GDP of EUR 294bn in 2017) alongside the Irish government’s weakened balance sheet relative to pre-crisis levels, creates susceptibilities to both domestic and international shocks, captured in the A+ rating. In addition, ongoing risks concerning Brexit, uncertainties around the global economic cycle (and Ireland’s sensitivity to this), and questions surrounding the impact of US and European corporate tax reforms are further areas for monitoring. Steps taken to reduce some of these vulnerabilities and/or evidence that risks will prove less meaningful than anticipated could support a stronger assessment on Ireland’s sovereign creditworthiness.

Robust economic growth in Ireland has significantly outperformed that of peers since 2014; real GDP expanded by 7.2% in 2017 – the highest of EU member states. The strong performance has been broad-based across private and public consumption, investment, and net exports. Further improvement in private-sector balance sheets can be expected to support private consumption and investment. GDP growth is projected to converge towards a potential of about 3.5% over the medium term.

The 2017 fiscal deficit dropped to 0.3% of GDP, from 0.5% in 2016. In 2018, the headline government deficit is foreseen at 0.2% of GDP, with a general government surplus aimed for by 2020. In structural terms, the cyclically-adjusted fiscal deficit is seen at 0.6% of GDP in 2018, up from 0.1% in 2017, before dipping under the medium-term objective of 0.5% by 2019. In its latest assessment, the European Commission cautioned about deviations in the structural deficit and expenditure growth benchmarks in 2018. General government debt has declined to 69.3% of GDP as of Q1 2018, from 75.8% a year prior and 124.6% during the Q1 2013 peak. This decline has been driven by high nominal growth, improvements in the fiscal position, and proceeds from the state’s bank holdings. Scope expects the debt ratio to continue the downward path moving ahead.

Ireland is in the process of collecting EUR 13bn in back taxes (plus interest and penalties) that the European Commission in August 2016 ordered Apple to pay; both the company and Ireland have appealed. Irish officials expect to have all funds (worth over 4% of GDP) in an escrow account by the end of September. In addition, the weighted average maturity of Ireland’s long-term debt (marketable and official) is very long at about 12 years. However, 57% of Irish government bonds was held by the rest of the world as of March 2018 – a risk in stressed scenarios, in Scope’s view.

Ireland’s current account surplus increased to 9.7% of GDP in the year to Q1 2018, from -2.6% of GDP in the year to Q1 2017, in large part due to globalisation effects. The IMF foresees a gradual correction of Ireland’s volatile current account balance, though remaining elevated at 6.5% of GDP by 2023. The current account surplus has, alongside external debt deleveraging, helped improve the net international investment position, albeit to a still negative -156.6% of GDP in 2017.

Ireland’s credit strengths are balanced by credit weaknesses, such as the still very high levels of private- and public-sector indebtedness, which accentuate external vulnerabilities and limit the system’s shock absorption capacity. Corporate indebtedness amounted to 312% of GDP in Q4 2017, bringing total non-financial private-sector debt to 364% of GDP – which is high under a comparison against peers. The size and complexity of the Irish banking system (with outstanding financial system debt of 423% of GDP, although down from the 2011 peak of 646%) remains a further risk.

Despite meaningful improvements in general government debt metrics, Scope notes that government debt relative to GDP remains elevated at 69%. In addition, drawbacks in GDP data due to the activities of mainly US-based multinationals add uncertainties to analytics premised on ratios using nominal GDP.

To address this, the central statistics office prudently designed a “de-globalised” measure of Irish annual product: modified GNI. Public debt to modified GNI is higher: around 111.1% of modified GNI as of 2017. This 111% of modified GNI figure remains higher than it was pre-crisis (27.7% of modified GNI as of 2006), even though Ireland has reduced this also meaningfully from peaks (debt to modified GNI peaked in 2012 at 166.1%). Given Ireland’s propensity for economic volatility, coupled with the still leveraged private sector (and thus, greater risk for spill-over in a stressed case), continued public-sector debt reduction remains a core priority in facilitating greater resilience and shock-absorption means.

As an economy highly integrated with the global cycle, Ireland is vulnerable to adverse shifts in the external environment that can impact economic activity and revenue generation. The economic slowdown in the UK, together with a weak British pound, adversely impacts Irish trade. A hard Brexit, while not anticipated by Scope, nonetheless represents a risk. Also of concern are the recent EU-US trade disputes, international tax policy changes, and EU actions against illegal state aid. Over recent decades, Ireland has been a favoured destination for foreign direct investment by multinationals. Corporate tax cuts in the US and EU may slow such flows and affect multinational operations.

Several years after the crisis, Irish banks have deleveraged significantly and strengthened capital positions. Balance sheet structures and asset quality have also improved, supported by robust economic conditions, restructurings, asset sales and write-offs as well as rising collateral values. While still high, non-performing loans have also declined to 10.7% of total loans as of Q4 2017, from 27.1% in 2013.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative “AA” (“aa”) rating range for the Republic of Ireland. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the extent of relative credit strengths or weaknesses as compared with peers, based on Scope analysts’ qualitative findings.

For Ireland, relative credit weaknesses have been identified for the following analytical categories: i) macroeconomic stability and sustainability; ii) current account vulnerability; iii) external debt sustainability; iv) vulnerability to short-term external shocks; and v) financial imbalances and financial fragility. No relative qualitative credit strengths against peers were identified. Combined relative credit strengths and weaknesses generate a downward adjustment and signal an AA- sovereign rating for the Republic of Ireland. The lead analyst has recommended a further adjustment of the indicated rating to A+ in order to take into account important distortions in Irish economic data that tend to overstate the performance of underlying fundamentals and credit metrics in the CVS. The results have been discussed and confirmed by a rating committee.

For further details, please see Appendix 2 in the rating report.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s assessment that the challenges Ireland faces are manageable over the foreseeable horizon.

The ratings and/or outlook could be upgraded if, individually or collectively: i) improvements in public finances and economic growth bring about a further, significant reduction in government debt ratios; ii) private sector debt reductions make additional strides and banking system resilience improves; and/or iii) vulnerabilities to external risks are reduced via continued external debt deleveraging, and/or Scope gains greater confidence surrounding Ireland’s resilience to risks stemming from Brexit, global trade disputes and global economic growth, and/or shifts in international corporate taxation policies.

Conversely, the ratings and/or outlook could be downgraded if: i) economic growth or growth potential proves substantially weaker than anticipated, or the fiscal balance weakens significantly, threatening or even reversing the decline in general government debt relative to GDP; ii) private-sector and banking system risks begin to regather, impacting long-term macroeconomic and financial stability; and/or iii) net external debt increases or external shocks result in substantially weaker medium-term growth and damage financial stability.

Rating Committee

The main points discussed during the rating committee were: 1) economic and fiscal policy framework; 2) debt metric improvements and sustainability; 3) Ireland’s economic model and boom/bust structure; 4) impact of Brexit on the Irish economy; 5) public- and private-sector deleveraging and lingering vulnerabilities; 6) Irish nominal GDP data issues; 7) financial stability and vulnerabilities; and 8) peers comparison.

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