The statement accompanying S&P’s upgrade of Irish government debt from A- to A is below the fold – though there is little of note in it bar the indication that a further upgrade is a possibility even though they have put the outlook at stable.
There are five more steps back to AAA --- A+, AA-, AA, AA+ and then AAA.
- We have revised our 2014-2016 average real GDP growth projections for Ireland to 3.7% from 2.7%.
- The National Asset Management Agency, which has benefited from a recovering property market, has now repaid about half of its original government-guaranteed senior bonds.
- We are therefore raising our long- and short-term sovereign credit ratings on Ireland to 'A/A-1' from 'A-/A-2'.
- The stable outlook balances our view that government finances have improved and that financial system asset quality is on the mend, against the prevailing downside risks associated with eurozone trading partners' uncertain growth prospects and the Irish government's still highly-leveraged balance sheet.
On Dec. 5, 2014, Standard & Poor's Ratings Services raised its long- and short-term foreign and local currency sovereign credit ratings on Ireland to 'A/A-1' from 'A-/A-2'. The outlook is stable.
The upgrade reflects our view of Ireland's solid economic growth prospects, which we expect to underpin further improvements in the government's budgetary position. During the first nine months of 2014, private-sector employment grew by 2.2%; the improving jobs market is healing financial sector asset quality and benefiting the government's budget.
We also note that National Asset Management Agency (NAMA), the governmental entity that supported Irish banks by acquiring those banks' "bad" loans in exchange for Irish government guaranteed senior bonds, has made early payments of such bonds. We expect these payments will have reduced net general government debt by about 15% of GDP in 2013 and 2014, to 103.5% of GDP by year end. This is because, as with the debt of all asset management companies ("bad banks"), we include NAMA's debt in the general government sector. As we expected, NAMA increased the pace of its redemptions this year, bringing cumulative redemptions to about half of the total issued.
While FDI inflows, estimated at nearly €30 billion (21% of GDP) in 2013 alone, are likely overstated (due to tax incentives for foreign parent companies to book and reinvest their earnings in Ireland), even on an adjusted basis inflows remains exceptionally high. FDI, including into the labor-intensive services sector, is bolstering Ireland's real GDP growth, which we now believe will average 3.7% over 2014-2016. Moreover, since the third quarter of 2013, GNP growth has exceeded GDP, implying that the domestic economy is replacing the foreign-owned sectors as the key driver of the Irish economy.
We view Ireland's labor and product markets as highly flexible on a price (via wage adjustments) and supply (via net emigration) basis. Since 2008, these markets have facilitated a correction of the 2005-2008 overshoot in nominal wage and price levels. Between March 2009 and December 2010, Harmonised Index of Consumer Prices 12-month inflation averaged -1.8%, a rapid and substantial internal devaluation only seen, elsewhere in the eurozone, in Latvia and Greece. As a consequence, Irish unit labor costs have declined to an estimated 9% below pre-2008 crisis levels, the strongest adjustment in the eurozone, with the exception of Greece. Over the same period, labor productivity per person has risen by over 8% compared to the eurozone average of 2%, while Ireland's export share in global trade has continued to expand. The 5% real effective exchange rate appreciation of the euro since early 2011--and a modest terms-of-trade deterioration--have so far not undermined Ireland's external performance. This has supported a rise in its current account surplus to an estimated 5% of GDP in 2015 from 1.2% in 2011.
We project current account surpluses to average close to 4.8% of GDP through 2017. With exports now 25% above 2009 levels, we assume that services exports (particularly information and communications technology [ICT] and business services such as aircraft leasing) will continue to expand and the goods trade surplus will remain substantial and stable. We also expect that export receipts will continue to offset sizable income deficits (averaging 23.2% of GDP through 2017). These deficits will remain highly sensitive to the timing of dividend and interest payments on Ireland's high external debt and investment liabilities.
We observe that Ireland's economic recovery broadened and quickened in the second quarter of 2014. GDP expanded by 1.5% in the quarter (7.7% over the year), reflecting a rebound in domestic-facing sectors (construction, retailing, distribution, transport, communications, agriculture) and a further strengthening in export performance, namely exports of goods and ICT and business services. Signaling a sharp recovery in Ireland's domestic economy, GNP gained 9.0% year-on-year over the same period, though this data series is subject to considerable backward revisions. With continuing strength in the labor market (employment grew by 0.5% in the September quarter, up 1.5% on the year) we estimate the unemployment rate will continue to fall to around 9% by 2017, the lowest since 2008.
Improving economic conditions, as well as Ireland's strong track record of meeting its fiscal goals since its December 2013 exit from the EU/IMF program, underpin our expectation of further improvement in its fiscal performance. For 2014, we expect the general government deficit to be about 3.7% of GDP, on the back of expenditure control and, to a lesser extent, outperformance of tax receipts.
We expect net general government debt to peak at 117% of GDP in 2013 (partly reflecting a strong cash buffer) and to decline to 91.4% by 2017. This pace of debt reduction stands out in the context of high and static public debt levels in most of the eurozone. Our estimate of Ireland's gross and net general government debt includes NAMA's obligations issued to purchase loans and other distressed assets from participating Irish banks at a discount. Between 2011 and 2013 it also includes the debt liabilities of the Irish Bank Resolution Corporation (IBRC; the entity formed in 2011 from the merger of the state-owned banking institutions Anglo Irish Bank and Irish Nationwide Building Society).
Although we consolidate NAMA's debt into general government debt, we do not consider NAMA's assets, apart from cash and cash equivalents, as liquid; this reflects our methodology for only including the liabilities of state-backed asset management companies, but not their assets, in general government debt. Should NAMA convert its housing and loan assets into cash through sale or redemption more quickly than we expect, Ireland's general government debt net of liquid assets could commensurately decline faster than we project.
We believe that Ireland's policy and institutional effectiveness is supported by the strong consensus--among most of its largest political parties--in favor of fiscal consolidation and policies aimed at promoting economic flexibility, competitiveness, and openness. In our opinion, under the IMF/EU bailout program, Ireland's government has generally strengthened its regulatory and legal framework.
While its external performance has improved, our assessment of Ireland's external risks is qualified by our view of flow and stock data regarding current account receipts from companies domiciled in Ireland for tax purposes; should these companies re-domicile outside of Ireland, this would likely result in reductions in the current account surpluses.
Regarding the stock of Ireland's external position, the large asset and liability positions of multinational companies operating in Ireland give rise to similar analytical issues. We believe the valuation of these assets and liabilities explains the apparent discrepancy between Ireland's balance-of-payments flows and its net external debt stock measurements.
The government's access to international capital markets has improved, and the maturity extension of its European Financial Stability Facility and European Stability Mechanism official debt, agreed in 2013, has reduced its near-term financing needs. The government's large cash buffer--equivalent to 10.7% of GDP at year end-2013 and all of its 2014 borrowing requirements--has also helped. While Ireland's banks also successfully accessed debt markets in the first half of 2013, we continue to view private-sector access to external funding as fragile in light of the still-elevated uncertainties relating to global liquidity.
Our upward revisions to Ireland's growth prospects also underpin our assessment of the improving health of its banks. We believe that credit losses will continue to decline through 2016 and pose less of a risk to sector profitability, and ultimately government finances.
We note that the banking system continues to shrink its loan book. We assume that domestic credit will be around 10% lower in 2014 and a further 3.0% lower in 2015, before starting to grow in 2016. Against this backdrop, we expect an uneven return to profitability among Ireland's banks; we believe two of the five main banks will become profitable in 2014. This assessment partly assumes that, besides structural factors (such as the beneficial impact of reducing Eligible Liabilities Guarantee scheme fees and wider deposit liability spreads) revenue growth will remain weak as redemptions continue to outpace new lending through to 2016. This reflects low new business volumes, significantly reduced loan balances, high nonperforming loans, and possible European Central Bank quantitative easing and further rate cuts.
We regard the Irish banks as having made important strides in balance sheet repair and consolidation (partly reflected in gross financial sector external debt halving in 2009-2013). Prompted by their regulator, the banks have developed improved mortgage arrears and collections capability. When combined with the removal of legal obstacles to repossession and a new personal insolvency regime and enhanced code of conduct, we expect that banks will now be better placed to respond effectively to distressed borrowers. Recovering property prices are facilitating this process as well.
We expect a gradual improvement in Irish bank capitalization over the next two years absent more proactive responses by banks or authorities. Given the thoroughness of the restructuring of the Irish banking system, however, we assess contingent liabilities from the financial sector (currently below 30% of GDP) as limited, under our criteria. Over time, our expectation is that there will be a lessening of dependency of the Irish banks on the sovereign, and this process will accelerate as the economic recovery broadens further and gathers pace.
The stable outlook balances our view of Ireland's improved government finances, capital market access, and financial system asset quality against the prevailing downside risks linked to eurozone trading partners' uncertain growth prospects, financial-sector stability, and still highly-leveraged balance sheet.
We could raise our ratings on Ireland within the next two years if:
- GDP growth continues on the upside, exceeding our revised expectations of 3.7% over 2014-2016; or
- General government debt, including that of NAMA, reduces faster than we project--in particular, if state assets are monetized more rapidly or if there is a fiscal outperformance; or
- Banks' asset quality materially improves.
On the other hand, the ratings could come under downward pressure if the Irish economy returned to weaker economic performance, asset prices became depressed, and debt reduction slowed--or if banks' asset quality materially deteriorated further.
Table 1 (click to enlarge)
Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private-sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. CARs--Current account receipts. The data and ratios above result from Standard & Poor's own calculations, drawing on national as well as international sources, reflecting Standard & Poor's independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.