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Scope Ratings GmbH today affirmed the Republic of Ireland’s long-term local-currency and foreign-currency issuer ratings at A+ and revised the Outlook to Positive, from Stable. The agency also affirmed Ireland’s senior unsecured debt in both local and foreign currency at A+ and revised the Outlook to Positive. The sovereign’s short-term issuer ratings are affirmed at S-1+ in both local and foreign currency, with Outlooks Stable.

Rating drivers

The revision of the Outlook to Positive from Stable on Ireland’s A+ sovereign ratings reflects the following three drivers:

1. Ongoing reductions in government debt ratios, driven by improvements in the nation’s budget balances and continued robust economic growth;
    
2. Additional strides made in trimming high private-sector debt loads and improvements in the resilience of Ireland’s banking system; and
    
3. Reductions in vulnerabilities to external risks via external debt deleveraging, alongside some momentary easing of risks that affect Ireland such as those related to Brexit and global trade conflicts.

The assignment of a Positive Outlook reflects changes in Scope’s assessments in the ‘public finance risk’ category of its sovereign methodology. Going forward, Scope’s decisions on Ireland’s ratings will hinge on i) Ireland’s continued adoption of prudent fiscal and debt management policies, and ii) further credit-positive reductions in sovereign vulnerabilities tied to still-high economy-wide levels of debt and exposures to sudden turns in the global economic cycle stemming from Ireland’s very open and interconnected economy. A maintenance of ongoing debt deleveraging, prudent economic and fiscal policies and enhanced resilience to any deterioration in global economic growth conditions are conditions for an upgrade to AA- over the next 12 to 18 months.

The first driver underpinning Scope’s assignment of a Positive Outlook is ongoing reductions in Ireland’s government debt to GDP ratio, supported by improvements in budget balances, very robust economic growth, proceeds from state asset disposals, alongside support from current highly accommodative financing conditions. General government debt has continued a steady decline to 63.9% of GDP as of Q2 2019, nearly halving from a 124.7% peak level as of Q1 2013. Scope expects the debt ratio to continue a downward trajectory over the forthcoming period, with a baseline projection to around 53.5% of GDP by this year – with the ratio estimated to have fallen under the Maastricht rules’ 60% of GDP ceiling in 2019. Ireland’s debt to GDP ratio is expected, by 2020, to be below that of higher-rated euro area countries such as France (rated AA/Stable), Belgium (AA/Stable), Finland (AA+/Stable) and Austria (AAA/Stable).

Scope’s expectation for Ireland’s 2020 budgetary performance, premised around the United Kingdom exiting the European Union in an orderly manner, is for a modest fiscal surplus of 0.5% of GDP this year, after an estimated 0.4% budget surplus in 2019. By contrast, the Irish government’s 2020 budget forecasts embedded a fiscal deficit this year of 0.6% of GDP, owing to an assumption of the UK leaving the EU without a deal on 31 October 2019. The government’s incorporation of a no-deal adverse scenario as its original baseline for Ireland’s 2020 budgetary planning purposes demonstrates prudence in the nation’s fiscal framework and capacity to programme for more severe economic scenarios. Ireland’s structural balance is seen moreover improving from an estimated -0.8% of GDP in 2019 to -0.3% in 2020.

The improving budgetary position has also benefitted from very low financing rates. Similar to declines in yield levels seen elsewhere in the world, ten-year Irish yields are near all-time lows, at just above 0% at the time of this writing (with the spread to German 10-year Bunds at only around 25bps). The weighted average maturity of Ireland’s debt (marketable and official) is very long at about 10 years, also due to the repayment extensions granted by its official creditors. Ireland’s National Treasury Management Agency has prudently taken advantage of highly benign borrowing conditions to extend the maturity of outstanding debt instruments, including via conducting bond swaps, repaying higher-interest-rate IMF loans early, pre-funding ahead of future obligations, and issuing Ireland’s first 100-year note in March 2016. Ireland’s long debt maturity and reduced interest payments support moderate annual gross government financing needs, estimated at 8% of GDP in 2020. Liquidity is further abetted by government cash and other financial assets of EUR 18.5bn (5.4% of GDP) as of December.

Additional strides made in curtailing private-sector debt and improving the resilience of Ireland’s banking system are the second driver underlying the Positive Outlook assignment. Private-sector indebtedness remains high, with total non-financial private-sector debt totalling 365% of rolling four-quarter GDP as of Q2 2019. At the same time, the gradual reduction in household debt relative to gross disposable income (to 79.8% as of Q3 2019, less than half 2007’s peaks at 165%) has been furthered by strong income growth and ongoing loan repayments. Corporate indebtedness totalled 321% of GDP in Q2 2019, well under Q1 2015 levels of 432% of GDP though remaining high in a comparison against ‘aa’-model-indicative peers and well above a euro area average of about 148% of GDP.

Irish banks have continued to deleverage (with outstanding financial system debt of 438% of rolling four-quarter GDP as of Q2 2019, down on 2013 peaks of 652%) and system-wide “fully-loaded” common equity tier 1 capital ratios have strengthened to 17% of risk-weighted assets. Balance sheet structures and asset quality have improved, supported by a growing economy, restructurings, asset sales and write-offs as well as rising collateral values. While still high, non-performing loans on domestic retail banks’ balance sheets have fallen by around 85% since 2014. Still, the level of leverage within Ireland’s banking system remains a major vulnerability. Here, Scope observes that the European Banking Authority’s 2018 EU-wide stress tests showed that Ireland’s two systemic banks (Allied Irish Banks and Bank of Ireland) could withstand a recession, however, supported by stronger capitalisations and lower non-performing loans.

The last driver of Scope’s decision to assign a Positive Outlook relates to the easing of external vulnerabilities. Gross external debt stocks have been trimmed from Q1 2015 peaks of 1,062% of rolling four-quarter GDP to a still highly elevated 746% as of Q3 2019. The net international investment position remains moreover in a significant net liability position at -169% of GDP in Q3 2019. However, external risks that could stress the Irish economy and the Irish banking system have somewhat eased of recent. Although Brexit is far from resolved, the UK’s expected exit from the European Union at the end of this month with the Withdrawal Agreement in hand has mitigated immediate no-deal concerns. Still, market volatility could resume, possibly testing Ireland’s external resilience, with an upcoming end-year deadline for negotiating the future trading relationship between the UK and the EU. However, in the absence of a no-deal Brexit, a scenario Scope considers unlikely, the UK exiting the EU smoothly and entering phase two negotiations with the EU around the future trading relationship could give a near-term boost to Ireland’s economy via sentiment and trading channels. Similarly, the achievement between the United States and China of a phase one trade agreement to roll back some tariffs has improved global trading sentiment, even if international trading conditions remain fraught and tensions could re-escalate in 2020.

Robust economic growth in Ireland has significantly outperformed that of peers since 2014; real GDP grew by an estimated 5.6% in 2019 – the highest of EU member states. While economic growth has nonetheless moderated from above 8% in 2017 and 2018, consumer and business sentiment indicators have displayed some improvement since November 2019 as external risks have momentarily eased. Scope expects real growth to remain robust at 4-5% in 2020, nonetheless converging towards a potential rate of around 4%.

However, Ireland’s ratings remain constrained by the economy’s vulnerability to sudden reversal. In addition, the still high public-debt levels (especially when assessed against underlying economic activity) and meaningful leverage within the financial system and the non-financial private sector, even after extensive deleveraging, represent risks. The size and complexity of Ireland’s financial and corporate sectors, when considered in the context of a small (with nominal GDP of an estimated EUR 343bn in 2019) and very open economy, creates susceptibilities to both domestic and international shocks, captured in the A+ rating. This moreover considers that 58% of Irish government bonds are held by non-residents as of November 2019 – a risk should market sentiment deteriorate. Questions surrounding the impact of global corporation tax reforms and EU actions against illegal state aid are further areas for monitoring – with government estimates that the Irish State could lose EUR 2bn of its corporation tax receipts longer-term due to OECD proposed BEPS (base erosion and profit shifting)-related changes.

In addition, drawbacks in GDP data due to the activities of mainly US-based multinationals add uncertainty to analytics premised on ratios that use nominal GDP. To address this, Ireland’s Central Statistics Office has published a measurement of Irish annual product: modified GNI, which aims to remove the effects of globalisation. Public debt to modified GNI is considerably higher: at around 104.3% as of 2018 (versus 63.6% that year as a share of nominal GDP). This 104% of modified GNI figure is higher than it was pre-crisis (27.7% in 2006), even though Ireland has reduced this ratio as well from peaks of 166.1% in 2012. In its considerations of Ireland’s long-term debt sustainability, Scope takes into account both the debt ratio as a share of nominal GDP as well as that relative to modified GNI. Continued public-sector debt reduction remains a core priority under either measurement in the facilitation of greater resilience and shock-absorption means.

Ireland’s current account balance is highly volatile – reflecting in part the effects from contract manufacturing and intellectual property-related imports. The current account balance reverted to -1% of GDP in the year to Q3 2019, after it amounted to 10.6% of GDP in the year 2018. The IMF foresees Ireland’s current account balance in a significant surplus position over its forecast horizon, concluding in 2024 at 5.7% of GDP.

Finally, Ireland’s Prime Minister Leo Varadkar has set the stage for a general election to be held on 8 February. The bid for an election comes on the back of Ireland’s strong economy, Prime Minister Varadkar’s success in helping shape a Brexit deal with UK Prime Minister Boris Johnson and the UK’s forthcoming exit from the EU as well as the reconvention of Northern Ireland’s power-sharing assembly, ending a three-year deadlock after a deal was brokered by the Irish government and the UK government.

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

The rating committee reviewed Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals and assigned 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, the following relative qualitative credit strength is identified: i) market access and funding sources. The following relative credit weaknesses are identified: i) macro-economic 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.

The 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.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope considers ESG sustainability issues during the rating process as reflected in the sovereign methodology. Ireland’s performance on sustainability factors is considered in Ireland’s A+ sovereign rating. Governance-related factors are explicitly captured in Scope’s assessment of ‘Institutional and Political Risk’ in its methodology, within which Ireland has strong CVS scores on a composite index of six World Bank Worldwide Governance Indicators. Qualitative governance-related assessments reflect Scope’s QS evaluations of ‘neutral’ on ‘recent events and policy decisions’ and ‘neutral’ on ‘geo-political risk’ compared with Ireland’s sovereign peer group.

Social factors are captured in Scope’s CVS in Ireland’s high GDP per capita (of USD 77,771 in 2019), low level of risk associated with the national unemployment rate (of 4.8% as of December), and moderate level of risk from its old-age dependency ratio. Ireland’s Gini coefficient – designating income inequality – is moderate compared to that of sovereign peers after taxes and transfers. Labour force participation has been roughly stable at around 62%. Social considerations and impacts of social factors on the economy are reflected in Scope’s QS evaluation of ‘neutral’ on Ireland’s ‘growth potential of the economy’, ‘neutral’ on ‘economic policy framework’ and ‘poor’ on ‘macro-economic stability and sustainability’ compared with the economy’s ‘aa’-indicative sovereign peers.

Ireland has maintained a mixed record on environmental sustainability. The nation placed ninth (out of 180 countries) on the 2018 Environmental Performance Index – an index developed by Yale University. However, the Climate Change Performance Index 2019 concluded that Ireland’s performance on climate action ranked the worst within the EU. Ireland’s 2020 budget includes several new revenue-raising measures, including a carbon tax increase and amendments to the electricity and vehicle registration taxes.

Outlook and rating-change drivers

The Positive Outlook reflects Scope’s assessment that risks to Ireland’s ratings are skewed to the upside over the forthcoming 12 to 18 months.

The ratings 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 take additional strides and banking system resilience improves; and/or iii) vulnerabilities to external risks are trimmed, and/or Scope gains greater confidence surrounding the longevity of the present global economic cycle, such as to reduce external risks relevant to the Irish economy over Scope’s rating horizon. The latter could, for example, relate to reduced risks concerning global trade disputes, Brexit and/or shifts in international corporate taxation policies.

Conversely, the outlook and/or ratings 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 macro-economic 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) Ireland’s sensitivity to the global cycle; 2) debt metric improvements and sustainability; 3) Ireland’s growth potential and economic policy framework; 4) impact of Brexit; 5) public- and private-sector deleveraging; 6) Irish nominal GDP data; 7) financial stability and vulnerabilities; and 8) peers comparison.

Methodology
The methodology used for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.
The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: Ireland’s Department of Finance, Central Statistics Office (Ireland), Central Bank of Ireland, NTMA, IMF, OECD, European Commission, United Nations, World Bank, Eurostat, and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst: Dennis Shen, Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director, Public Finance
The ratings/outlook were first assigned by Scope in January 2003. The ratings/outlooks were last updated on 20 July 2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2020 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5, D-10785 Berlin.

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