January 13, 2017 / 9:09 PM / 7 months ago

Fitch Affirms Ireland at 'A'; Outlook Stable

(The following statement was released by the rating agency) LONDON, January 13 (Fitch) Fitch Ratings has affirmed Ireland's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'A' with Stable Outlooks. The issue ratings on Ireland's senior unsecured foreign- and local-currency bonds have also been affirmed at 'A'. The Country Ceiling has been affirmed at 'AAA' and the Short-Term Foreign- and Local-Currency IDRs and short-term debt at 'F1'. The rating of National Asset Management Ltd's (NAMA) guaranteed issuance has also been affirmed at 'F1', in line with the sovereign rating. KEY RATING DRIVERS Ireland's 'A' IDRs reflect the following key rating drivers: Ireland's sovereign ratings are supported by strong institutions and a wealthy, flexible economy, with the highest per-capita income in the 'A' category. Moreover, economic growth has outpaced peers in the last three years and the sovereign balance sheet is rapidly improving. These factors are balanced by downside risks, primarily related to external developments such as Brexit and shifts in global policies on corporate tax. Economic growth remains strong, underpinned by private and public consumption and higher investment in previously ailing sectors such as construction. Preliminary estimates from the Central Statistical Office indicate GDP growth of 6.9% y-o-y in 3Q16, the fastest rate in the EU. Although headline GDP is heavily influenced by developments in the multinational sector with limited impact on domestic activities, labour figures also point to a robust recovery, with employment growth averaging close to 3% in 2016. The impact of the Brexit vote on the Irish economy has been limited so far, although a few export sectors such as agri-processing have struggled from a weaker pound. In this context, Fitch has revised its 2016 GDP growth estimate to 4.3%, from 4.0% previously. Fitch expects GDP growth to average over 2.5% in 2017-19, but it is subject to risks. Although formal UK-EU negotiations are yet to start, the prospects of the UK leaving the EU single market is high, raising the risks that Ireland will eventually face trade and mobility barriers with its biggest economic partner. The UK accounts for about 17% of total Irish goods and services.. Long-standing financial and investment linkages could also be at risk. According to various studies, the UK leaving the single market could reduce Irish GDP by up to 4% over the next decade relative to a no-change baseline. Changes to corporate tax policies in the US or Europe is another important downside risk. Ireland's low and stable tax regime has helped attract multinationals over the last two decades, but it could face increased competition and/or pressure if other countries apply a similar model. We expect the general government deficit to have fallen to a nine-year low of 0.9% of GDP in 2016, in line with official estimates. Revenue growth in 2016 outperformed original expectations thanks to high corporate tax income. Expenditure was kept at bay, even with extra healthcare costs. Fitch expects a further narrowing of the deficit in 2017-18, with the government maintaining a strong commitment to fiscal prudence in light of rising external risks. Public debt continues to fall in line with robust nominal growth and lower interest expenditure. Under our baseline scenario, which does not include any asset disposals of state-controlled banks, we forecast general government debt to fall from 75.1% in 2016 to 53.0% of GDP by 2025. This compares with 120% of GDP in 2012 and would be in line with the current 'A' median of 52.1%. However, debt/GDP ratios are flattered by recent upward revisions to GDP, with other measures such as interest payments/revenue and debt/revenue remaining at significantly higher levels than the peer median. The private sector remains highly leveraged, weighing on the performance of the overall economy and the banking sector. According to Central Bank of Ireland (CBI) data, non-financial corporate debt stood at 260% of GDP in Q216, from 200% in 2012 and one of the highest levels in Europe. The majority of this debt is tied to non-resident borrowers (multinationals), but domestic companies still report high levels of NPLs and difficulties accessing new finance. Similarly, although household indebtedness is now more moderate (at 150% of income in 2Q16), there is still a significant proportion of households with high exposure to tracker mortgages and hence vulnerable to interest rate changes. Asset quality at Irish banks remains weak despite strong improvements driven by positive economic momentum. NPLs as a percentage of outstanding loans stood at 17% in Q316, even though impaired loans in most sectors are falling at a brisk pace. The profitability of Irish banks continues to be affected by the low interest environment. Demand for new lending should continue to increase fuelled by increasing domestic consumption and employment growth. Macro-prudential measures imposed by the CBI should continue to moderate house price growth. The current account posted large surpluses in the first three quarters of 2016, averaging over 12% of GDP. However, the positive data hide developments in the domestic economy, as the surplus is inflated by activities of large multinationals. For instance, disaggregated merchandise trade data highlights the impact from the Brexit vote, with exports to the UK falling by almost 10% y-o-y in 3Q16. Revisions to financial account and external debt data are common and complicate the assessment of Ireland's external position. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Ireland a score equivalent to a rating of 'AA+' on the Long-Term FC IDR scale. In accordance with its rating criteria, Fitch's sovereign rating committee decided to adjust the rating indicated by the SRM by more than the usual maximum range of +/-3 notches because: in our view the country is recovering from a crisis. Consequently, the overall adjustment of four notches reflects the following adjustments:- -Macro: -1 notch, to reflect the fact that GDP growth figures (including the exceptional 2015 outturns) do not entirely reflect real developments in the economy; and macroeconomic data is subject to large revisions. - Public Finances: -1 notch, to reflect still high levels of government debt. The SRM is estimated on the basis of a linear approach to government debt/GDP and does not fully capture the higher risk at high debt levels. Moreover, the activities of multinationals inflate GDP and flatter debt ratios but it's a sector that is hard to tax. - External Finances: -1 notch. The model gives 2-notch enhancement for reserve currency but one-notch uplift is more appropriate for Ireland given the country's recent financial crisis and need of an IMF programme. Net external debt is well above peers and exposure to Brexit highlights vulnerabilities to shocks. - Structural Factors: -1 notch, to reflect weakness in the banking system for which the average viability rating is two categories below the sovereign rating. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The following factors may, individually or collectively, result in positive rating action: -Significant reduction in the general government debt/GDP ratio. -Reduction in external vulnerabilities, including evidence that the economy is resilient to Brexit. The following factors may, individually or collectively, result in negative rating action: -Divergence from the fiscal targets that reverses the decline in the GGGD/GDP. -Weaker economic performance, e.g. trigger by external shocks, resulting in a substantial deterioration of banks' existing loan portfolios or a negative impact on the fiscal stance. KEY ASSUMPTIONS In its debt sensitivity analysis, Fitch assumes a primary surplus averaging 1.5% of GDP in 2017-25, trend real GDP growth averaging 2.4% per year, an average effective interest rate of 2.8%, and GDP deflator inflation of 1.7%. Contact: Primary Analyst Federico Barriga Salazar Director +44 20 3530 1242 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Marina Stefani Associate Director +44 20 3530 1809 Committee Chairperson Ed Parker Managing Director +44 20 3530 1176 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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