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Ireland

Author(s):
International Monetary Fund
Published Date:
September 2012
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Background—An Exceptionally Deep Banking Crisis

1. The “Celtic Tiger” years came to an abrupt end in 2008. Suddenly, Ireland had to contend with an interlocking sovereign-banking-real economy crisis. As property prices collapsed, banks’ losses on real estate loans mounted and domestic demand fell sharply. Fiscal deficits gapped outwards and public debt catapulted from 25 percent of GDP in 2007 to over 90 percent by 2010. Deepening uncertainty about the ultimate scale of the banking sector losses, and hence growing doubts about public debt sustainability, drove a brutal switch in market sentiment in the Fall of 2010, cutting the sovereign off from market financing and compelling the authorities to resort to EU and IMF financial support.

2. The boom years stored up immense problems. Following a decade of export- and FDI-led growth supported by broad-based productivity gains, from about 2003 on the Irish economy embarked on a domestic boom underpinned by lax lending. Stiff competition for market share from foreign-owned as well as domestic banks pushed underwriting standards lower, and the feedback effect of rising collateral values fuelled the leveraging process. Rapidly rising property prices also drove high fixed investment in commercial and residential property, and a positive wealth effect fed private consumption, raising incomes and employment. Wages and prices rose, eroding competitiveness and compressing real interest rates. The integration of the Irish financial system into the broader euro area financial landscape, as well as the apparently strong fiscal position of the sovereign, gave Irish banks unfettered access to wholesale funding that turbocharged their asset expansion. In the five years to mid-2008 the net foreign liabilities of the Irish banking system jumped from about 20 percent to about 70 percent of GDP, and wholesale funding rose to 55 percent of assets. Regulators—and the IMF, in its surveillance role—failed to issue proper warnings as a vast commercial and residential property bubble inflated and bank assets grew to some 500 percent of GDP (see Honohan report, May 2010, and Nyberg report, March 2011).

Household Borrowing and Debt

(Percent of household disposable income)

Sources: Central Bank of Ireland (CBI); and Central Statistical Office (CSO).

Unit Labor Cost Growth 1/

(Percent)

Sources: CSO; Eurostat; Haver; and IMF staff calculations.

1/ Average annual growth rates. Productivity gains depicted with negative sign.

3. The post-Lehman global financial turmoil tipped the vulnerable Irish banking system into a deep crisis. Ireland’s property price downturn began in 2007. After facing heavy losses on property-related assets in the Spring of 2008, the banks suffered a run on wholesale funding in the Fall—prompting massive recourse to Eurosystem liquidity support. Government actions included a blanket guarantee from September 2008, the transfer of large distressed property development and commercial real estate assets from banks to the National Asset Management Agency (NAMA) from April 2009, large scale support for two failed banks (Anglo Irish and Irish Nationwide Building Society), and large equity injections in other banks (Section IV.A). With a fiscal cost of some 40 percent of GDP, Laeven andValencia (2012) consider Ireland’s banking crisis the second costliest in advanced economies since at least the Great Depression.

Fiscal Cost of Ongoing Banking Crises, 2011 1/

(Percent of GDP)

Source: Laeven and Valencia (2012).

1/ Sample of ongoing systemic banking crises. Recapitalization and other restructuring costs, excluding liquidity support and asset guarantees. Greece includes bank recapitalization funds under the 2012 program (23 percent of GDP) although these funds had not been fully used as of May 2012.

4. A full-fledged economic bust ensued. A steep decline in construction activity drove the country into recession from 2008 with the sharp world trade contraction in 2009 adding to the shock to Ireland’s highly open economy. Financial accelerators, having put the economy into overdrive in the boom, played a major procyclical role in the bust as new lending stopped. Falling property prices dramatically reduced household net wealth, depressing consumption. Employment fell by 13 percent in the three years to 2010, and the unemployment rate jumped by 9 percentage points to 13.6 percent in 2010, dampened by declining labor force participation and the return of net emigration. Slack in the economy created deflationary pressures, with the CPI falling by 5½ percent from 2008 until 2010.1 Altogether real GDP fell by 8 percent over 2007–10, with nominal GNP slumping by 20 percent in the same period.

Construction Sector Share in GDP and Employment

(Percent)

Sources: Eurostat; CSO; Haver; and IMF staff calculations.

5. Confidence in the fiscal position crumbled, primarily as a consequence of the close sovereign-bank interlinkages. During the boom the underlying fiscal position weakened (Section IV.B), and an erosion of tax bases made for heavy reliance on property-related revenues such as stamp duties. Accordingly, tax revenues fell hard when the economy turned, down by 30 percent from 2007 to 2009. This, together with rising social outlays, drove up the deficit (before bank support) to over 10 percent of GDP per year in 2009–10, from fiscal balance in 2007. By 2010 these deficits raised net public debt by 33 percentage points of GDP. On top of this flow shock, support to banks heavily burdened the public balance sheet. By 2010 the government had recapitalized the banks to the tune of €46.3 billion, equivalent to 30 percent of 2010 GDP, with no cushion from burden sharing on banks’ senior debt as considered appropriate by the ECB due to concerns about pan-European financial stability.2 Given the already heavy public debt burden, high market uncertainty around the scale of banking sector losses yet to be recognized meant that by late 2010 the government was no longer in a position where its own guarantee could maintain confidence in the banks. Indeed, when the banks faced renewed private funding outflows, the sovereign also lost access to market funding, necessitating official support.3

Recent Developments—A Tentative Export-Led Recovery

6. Ireland returned to growth in 2011, but relied exclusively on exports (Table 1). Having declined for the three preceding years, real GDP grew by 1.4 percent y/y in 2011.4 Export growth of 5.1 percent y/y led the way, with slowing growth in goods exports offset by continued strong services growth. This performance benefitted from the relatively acyclical composition of exports (chemical and pharmaceutical products are around one-third of the total and computer services around one-fifth), as well as the importance of markets outside the euro area (U.K. and U.S. purchasers take some 45 percent of Irish exports). Significant unwinding of past competitiveness losses also assisted, with the real exchange rate on a unit labor cost basis falling 20 percent from its 2008 peak. This reversal benefits from a 5 percent nominal effective exchange rate decline, and from lower labor costs—especially relative to those in the euro area—but is largely driven by productivity gains from labor shedding, though these are partly compositional given high job losses in less productive sectors. Nonetheless, staff estimate that some modest exchange rate overvaluation remains, including in light of the large negative net international investment position (Annex I).

Table 1.Ireland: Selected Economic Indicators, 2008–13 (Annual percentage change unless indicated otherwise)
200820092010201120122013
Proj
National accounts (constant prices)
Real GDP−2.1−5.5−0.81.40.41.4
Domestic demand−3.7−11.0−4.3−3.7−2.3−0.5
Private consumption−0.1−5.41.0−2.4−1.9−0.2
Public consumption0.6−4.4−6.5−4.3−2.5−2.0
Gross fixed investment−10.0−27.6−22.6−12.6−4.00.0
Net exports 1/1.44.53.05.42.11.8
Exports of goods and services−1.1−3.86.25.12.83.5
Imports of goods and services−3.0−9.73.6−0.31.02.4
Real GNP−1.8−8.10.9−2.5−0.60.7
Gross national saving (in percent of GDP)16.112.612.811.411.612.3
Private18.920.821.319.819.519.7
Public−2.8−8.2−8.6−8.4−7.9−7.4
Gross investment (in percent of GDP)21.815.011.610.39.89.6
Private16.410.97.97.67.87.7
Public5.44.03.72.71.91.9
Prices, wages and employment (annual average)
Harmonized index of consumer prices3.1−1.7−1.61.11.41.0
Average wage, whole economy3.5−0.1−2.2−0.70.30.8
Employment−1.1−8.1−4.2−2.1−0.80.4
Unemployment rate (in percent)6.311.813.614.414.814.4
Money and credit (end-period) 2/
Irish resident private sector credit 3/8.8−1.7−3.7−2.9−3.3
Financial and asset markets (end-period) 2/
Three-month interbank rate2.90.71.01.40.7
Government bond yield (in percent, 10-year) 4/4.44.99.28.56.2
Annual change in ISEQ index (in percent)−33.8−23.413.23.07.3
House prices−5.9−18.3−13.1−13.2−14.4
Public finance (in percent of GDP)
General government balance 5/−7.3−13.9−30.9−12.8−8.3−7.5
General government balance (excl. bank support)−7.3−11.5−11.2−9.1−8.3−7.5
Primary balance (excl. bank support)−6.0−9.4−8.1−5.9−4.3−2.1
General government gross debt44.564.992.2106.5117.7119.3
General government net debt24.642.074.794.9103.0107.6
External trade and balance of payments (percent of GDP)
Balance of goods and services9.015.918.621.924.125.7
Balance of income and current transfers−14.7−18.2−17.5−20.8−22.3−23.0
Current account−5.7−2.31.11.11.82.7
Effective exchange rates (1999:Q1=100, average) 2/
Nominal111.6112.5107.8108.6105.5
Real (CPI based)123.1121.0111.6110.2107.1
Memorandum items:
Population (in millions) 6/4.44.54.54.64.64.5
GDP per capita (in euros)40,45236,16635,00334,70535,36736,641
GDP (in billions of euros)178.9161.3156.5159.0161.7165.9
Sources: Bloomberg; Central Bank of Ireland; Department of Finance; International Financial Statistics; and IMF staff estimates.

Contribution to growth.

2012 column refers to the latest available information: end-March fpr resident private sector credit, end-April for the competitiveness indicators, end-May for the three-month interbank rate, and end-June for other indicators.

Adjusted growth rate of credit to households and non-financial corporations.

For 2011, 9 year government bond yield is shown as no 10 year benchmark exists.

General government balance per ESA95 definition.

2011 figure revised following prelimary results from the 2011 Census, 2007–10 to be revised when available.

Sources: Bloomberg; Central Bank of Ireland; Department of Finance; International Financial Statistics; and IMF staff estimates.

Contribution to growth.

2012 column refers to the latest available information: end-March fpr resident private sector credit, end-April for the competitiveness indicators, end-May for the three-month interbank rate, and end-June for other indicators.

Adjusted growth rate of credit to households and non-financial corporations.

For 2011, 9 year government bond yield is shown as no 10 year benchmark exists.

General government balance per ESA95 definition.

2011 figure revised following prelimary results from the 2011 Census, 2007–10 to be revised when available.

Real GDP

(Pre-crisis peak, Q4 2007 = 100)

Sources: CSO; Haver Analytics; and IMF staff calculations.

7. Domestic demand, on the other hand, contracted by 3.7 percent y/y in 2011. The decline in domestic demand was broad-based, with fixed investment continuing to lead the fall as domestic and external uncertainties—together with credit supply constraints on some firms and households—lowered private investment, and fiscal consolidation limited public capital expenditure. Private consumption declined by 2.4 percent y/y, exceeding the decline in household disposable incomes, as the household saving rate rose to 14 percent—well above the pre-crisis average of 8¼ percent—in order to rebuild balance sheets and reduce high debt. Fears over job prospects likely added to precautionary saving, as employment fell a further 2 percent and the unemployment rate climbed past 14 percent.

8. The current account remained in modest surplus in 2011 while deflation came to an end (Table 5). With domestic demand weak, imports declined moderately in 2011, contributing to a 3.3 percentage point of GDP rise in the trade balance, almost all of it in services. However, these gains did not feed into domestic incomes and spending as they were offset by a 3.5 percentage point of GDP rise in income outflows—principally to the parents of the multi-national firms that lead Irish exports—leaving the overall current account surplus unchanged at about 1 percent of GDP. These higher income outflows also meant that real GNP declined by 2.5 percent even as real GDP grew. Following deflation in 2009–10, low but positive inflation was recorded in 2011 in both the GDP deflator and HICP, in part reflecting energy price rises.

Table 2.Ireland: Medium-Term Scenario, 2008–17(Annual percentage change, unless indicated otherwise)
20082009201020112012201220132014201520162017
6th Rev.Proj.
Real GDP−2.1−5.5−0.81.40.50.41.42.52.82.82.9
Domestic demand−4.3−12.1−8.1−3.7−2.1−2.3−0.51.21.82.12.3
Final domestic demand−3.0−11.4−8.7−4.3−2.1−2.3−0.51.21.82.12.3
Private consumption−1.1−6.9−3.7−2.4−1.7−1.9−0.21.41.81.82.0
Public consumption0.5−4.5−8.2−4.3−2.0−2.5−2.0−1.3−1.00.00.0
Gross fixed investment−10.2−28.7−25.9−12.6−4.5−4.00.04.06.06.57.0
Change in stocks 1/−1.2−0.70.60.50.00.00.00.00.00.00.0
Net exports 1/1.44.53.05.42.22.11.81.61.51.31.2
Exports of goods and services−1.1−3.86.25.13.02.83.54.54.54.74.7
Imports of goods and services−3.0−9.73.6−0.31.01.02.44.04.24.74.9
Real GNP−1.8−8.10.9−2.5−0.1−0.60.71.92.22.32.5
Current account 2/−5.7−2.31.11.10.91.82.73.73.83.93.8
Gross national saving 2/16.112.612.811.410.811.612.313.413.814.214.5
Private18.920.821.319.818.319.519.718.416.716.216.1
Public−2.8−8.2−8.6−8.4−79.59−7.9−7.4−5.0−2.8−2.0−1.6
Gross investment 2/21.815.011.610.39.99.89.69.710.010.310.7
Private16.410.97.97.67.77.87.78.08.38.79.1
Public5.44.03.72.72.21.91.91.71.71.61.6
Prices
Harmonized index of consumer prices3.1−1.7−1.61.11.71.41.01.41.61.81.8
GDP deflator0.5−4.6−2.20.21.21.31.21.41.61.61.7
Average wage, whole economy3.5−0.1−2.2−0.70.30.30.81.21.61.92.0
Labor market
Employment−1.1−8.1−4.2−2.1−0.8−0.80.41.32.02.12.2
Unemployment rate (in percent)6.311.813.614.414.314.814.413.713.111.510.6
Public finance
General government balance 2/3/−7.3−13.9−30.9−12.8−8.3−8.3−7.5−5.0−3.0−2.2−1.8
General government gross debt 2/44.564.992.2106.5117.6117.7119.3118.4115.0111.5108.4
General government net debt 2/24.642.074.794.9105.6103.0107.6108.7107.2104.0101.1
Output gap 3/3.5−2.4−3.3−2.1−2.7−2.3−2.0−1.0−0.30.20.4
Nominal GDP (in billions of euros)178.9161.3156.5159.0159.2161.7165.9172.4180.2188.3196.9
Sources: Central Statistics Office; Department of Finance; and IMF staff estimates.

Contributions to growth.

In percent of GDP.

General government balance per ESA95 definition

Sources: Central Statistics Office; Department of Finance; and IMF staff estimates.

Contributions to growth.

In percent of GDP.

General government balance per ESA95 definition

Table 3.Ireland: General Government Finances, 2008–17(In billions of euros)
2008200920102011201220132014201520162017
Proj. 3/
Revenue63.054.153.254.255.857.360.062.564.567.2
Direct taxes33.028.127.128.429.430.432.134.135.737.5
Personal income tax13.211.811.313.814.915.216.017.118.019.1
Pay-related social insurance 1/11.911.611.310.19.59.710.110.510.811.1
Corporate income tax5.13.93.93.84.24.65.05.45.86.1
Capital taxes2.90.80.60.70.80.91.01.11.21.2
Indirect taxes20.516.315.715.816.216.817.718.118.819.5
Value-added tax13.410.710.19.710.010.210.811.311.712.2
Excise tax5.44.74.74.74.95.15.35.55.76.0
Stamp duty1.70.91.01.41.31.51.61.21.31.3
Other revenue 2/9.59.710.410.110.210.110.110.310.010.1
Expenditure (ex. bank support)76.172.670.868.769.269.868.667.968.670.7
Current63.365.464.363.864.965.664.663.964.566.5
Interest payments2.43.24.95.16.58.99.510.09.710.5
Goods and services10.09.89.08.38.47.97.67.47.67.7
Compensation of employees21.120.519.018.919.018.818.518.218.518.8
Current transfers29.831.931.431.631.129.929.028.328.829.5
Capital (excl. bank support)12.87.26.54.94.44.24.04.04.14.2
Gross capital formation9.86.15.54.23.13.13.03.03.13.1
Capital transfers (ex. bank support)3.11.11.00.71.31.11.01.01.01.1
Bank support costs0.04.030.95.80.00.00.00.00.00.0
Overall balance (ex. bank support) 4/−13.1−18.5−17.6−14.5−13.4−12.5−8.6−5.4−4.1−3.5
Including bank support−13.1−22.5−48.4−20.3−13.4−12.5−8.6−5.4−4.1−3.5
Primary balance (ex. bank support)−10.7−15.2−12.6−9.4−7.0−3.60.94.65.67.0
Including bank support−10.7−19.2−43.5−15.1−7.0−3.60.94.65.67.0
Memorandum items (in percent of GDP, unless indicated otherwise)
Revenue35.233.634.034.134.534.534.834.734.334.1
Direct18.417.417.317.818.218.318.618.919.019.1
Indirect11.510.110.19.910.010.210.310.010.09.9
Other5.36.06.66.36.36.15.95.75.35.1
Expenditure (ex. bank support)42.645.045.243.242.842.139.837.736.435.9
Primary current34.138.538.036.936.134.232.029.929.128.5
Interest1.32.03.13.24.05.45.55.55.15.3
Capital (ex. bank support)7.24.44.13.12.72.52.32.22.22.1
Overall balance 4/−7.3−11.5−11.2−9.1−8.3−7.5−5.0−3.0−2.2−1.8
Including bank support−7.3−13.9−30.9−12.8−8.3−7.5−5.0−3.0−2.2−1.8
Primary balance−6.0−9.4−8.1−5.9−4.3−2.10.52.53.03.5
Including bank support−6.0−11.9−27.8−9.5−4.3−2.10.52.53.03.5
Structural balance−11.5−11.3−10.1−7.8−6.3−5.5−3.6−2.3−2.1−2.1
Structural primary balance 5/−10.5−9.1−6.7−4.5−2.2−0.11.83.23.13.3
General government gross debt44.564.992.2106.5117.7119.3118.4115.0111.5108.4
General government net debt24.642.074.794.9103.0107.6108.7107.2104.0101.1
Output Gap (percent of potential GDP)3.5−2.4−3.3−2.1−2.3−2.0−1.0−0.30.20.4
Nominal GDP (in billions of Euros)178.9161.3156.5159.0161.7165.9172.4180.2188.3196.9
Sources: Department of Finance; IMF and staff estimates.

Includes imputed social insurance contributions, which are recorded symmetrically under compensation of exployees. The 2011 downward jump in the series reflects the integration of health levy receipts into the universal social charge (now part of income tax).

These include customs duties, unallocated tax receipts, training and employment levy, trading, rental and investment incomes, and transfers from the rest of the world (not elsewhere included).

The projections for 2012–15 are consistent with the adjustment path set out in the Medium-Term Fiscal Statement and specified in Budget 2012.

The overall balance corresponds to the general government balance, as per ESA95 definitions.

In percent of nominal potential GDP.

Sources: Department of Finance; IMF and staff estimates.

Includes imputed social insurance contributions, which are recorded symmetrically under compensation of exployees. The 2011 downward jump in the series reflects the integration of health levy receipts into the universal social charge (now part of income tax).

These include customs duties, unallocated tax receipts, training and employment levy, trading, rental and investment incomes, and transfers from the rest of the world (not elsewhere included).

The projections for 2012–15 are consistent with the adjustment path set out in the Medium-Term Fiscal Statement and specified in Budget 2012.

The overall balance corresponds to the general government balance, as per ESA95 definitions.

In percent of nominal potential GDP.

Table 4.Ireland: Indicators of External and Financial Vulnerability, 2007–11
200720082009201020112012 7/
External indicators
Exports (annual percent change, value in euros)8.3−1.4−2.57.85.73.9
Imports (annual percent change, value in euros)9.5−1.1−10.16.62.81.9
Terms of trade (goods, annual percent change)−1.5−2.31.7−1.2−2.9−0.1
Current account balance (in percent of GDP)−5.4−5.7−2.31.11.11.8
Capital and financial account balance (in percent of GDP)6.49.0−1.44.2−18.0−14.8
Of which:
Inward portfolio investment86.7−10.213.848.319.22.3
Inward foreign direct investment9.6−6.311.520.75.25.3
Other investment liabilities92.486.0−53.6−39.6−52.0−43.3
U.S. dollar per euro (period average)1.371.471.391.331.39
U.K. pound per euro (period average)0.680.790.890.860.87
Financial markets indicators
General government debt (in percent of GDP)25.044.564.992.2106.5117.7
Government bond yield (in percent, 10-year, end-period) 1/4.54.44.99.28.56.2
Spread of government bond yield with Germany (in percent, end of period)0.10.52.03.27.14.9
Real government bond yield (in percent, 10-year, period average, based on HICP)1.51.46.97.68.64.2
Annual change in ISEQ index (in percent, end of period)−26.3−33.8−23.413.23.07.3
Personal lending interest rate (in percent)11.711.911.111.411.611.6
Standard variable mortgage interest rate (in percent)5.44.83.34.04.24.2
Financial sector risk indicators
Annual credit growth rates (to Irish resident private sector, in percent) 2/20.18.8−1.7−3.7−2.9−3.3
Personal lending as a share of total Irish resident credit (in percent)39.635.235.635.830.030.0
Of which:
House mortgage finance32.829.030.130.625.425.5
Other housing finance0.30.30.20.30.30.3
Other personal lending6.55.95.35.24.64.5
Irish resident household mortgage debt annual growth rates (in percent) 3/17.5−7.1−3.9−9.0−19.3−19.0
Foreign-currency denominated assets (in percent of total assets)36.531.734.330.329.429.4
Foreign-currency denominated liabilities (in percent of total liabilities)41.135.531.125.826.325.9
Non-performing loans (in percent of total loans) 4/0.82.69.08.69.19.8
Total provisions for loan losses (in percent of total loans)0.41.24.04.24.85.2
Regulatory capital to risk-weighted assets of domestic banks (in percent)10.710.610.910.417.517.8
Bank return on assets (before tax, in percent)0.7−0.3−1.6−3.1−0.9
Bank return on equity (before tax, in percent)16.4−8.0−40.6−67.6−18.2
Deposits to M3 ratio 5/1.41.41.41.51.21.3
Loan-to-deposit ratio vis-à-vis Irish residents 6/2.12.22.12.12.12.1
vis-á-vis total 6/2.12.22.22.12.12.0
Concentration ratios in the banking sector
No. of banks accounting for 25 percent of total assets322222
No. of banks accounting for 75 percent of total assets151413131414
Share of state-owned banks in total assets (in percent)0.00.06.08.01819
Share of foreign-owned banks in total assets (in percent)32.262.065.066.06259
Sources: Bloomberg; Central Bank of Ireland; International Financial Statistics; and IMF staff estimates.

For 2011, 9 year government bond yield is shown as no 10 year benchmark exists.

Adjusted growth rate of credit to households and non-financial corporations.

Including securitisations.

Owing to differences in classification, international comparisons of nonperforming loans are indicative only.

Deposits vis-à-vis Irish and nonresidents. The M3 compiliation methodology has been amended in line with Eurosystem requirements.

Nongovernment credit/nongovernment deposits ratio.

For 2012, staff projections for macroeconomic variables and debt, end-March 2011 for banking sector indicators, and end-July for financial sector indicators. Financial sector indiators cover all credit institutions licensed in Ireland except for personal lending rate, which is calculated based on a sample of retail banks, and a mortgage interest rate, which is calculated excluding IFSC.

Sources: Bloomberg; Central Bank of Ireland; International Financial Statistics; and IMF staff estimates.

For 2011, 9 year government bond yield is shown as no 10 year benchmark exists.

Adjusted growth rate of credit to households and non-financial corporations.

Including securitisations.

Owing to differences in classification, international comparisons of nonperforming loans are indicative only.

Deposits vis-à-vis Irish and nonresidents. The M3 compiliation methodology has been amended in line with Eurosystem requirements.

Nongovernment credit/nongovernment deposits ratio.

For 2012, staff projections for macroeconomic variables and debt, end-March 2011 for banking sector indicators, and end-July for financial sector indicators. Financial sector indiators cover all credit institutions licensed in Ireland except for personal lending rate, which is calculated based on a sample of retail banks, and a mortgage interest rate, which is calculated excluding IFSC.

Table 5.Ireland: Summary of Balance of Payments, 2008–17
2008200920102011201220132014201520162017
Proj.
(In billions of euros)
Current account balance−10.2−3.81.81.83.04.56.36.97.37.6
Balance of goods and services16.125.629.134.839.042.746.049.452.655.7
Trade balance23.832.535.836.638.340.743.747.050.453.4
Exports of goods81.077.682.684.987.291.496.4101.8107.3112.1
Imports of goods−57.2−45.2−46.9−48.3−49.0−50.7−52.7−54.8−56.9−58.7
Services balance−7.7−6.9−6.6−1.80.71.92.32.42.22.3
Credit67.967.674.381.486.190.295.2100.5106.8114.7
Debit−75.6−74.5−81.0−83.3−85.4−88.3−92.9−98.1−104.6−112.4
Income balance−25.2−27.9−25.9−31.8−34.8−36.9−38.4−41.2−43.9−46.7
Credit84.055.157.155.954.454.656.758.360.061.9
Debit−109.2−83.0−83.0−87.7−89.2−91.5−95.1−99.4−103.9−108.6
Current transfers (net)−1.2−1.4−1.4−1.2−1.2−1.2−1.3−1.3−1.4−1.4
Capital and financial account balance16.2−2.36.6−28.7−23.9−15.8−6.3−6.9−7.3−7.6
Capital account balance0.0−1.3−0.7−0.3−0.2−0.3−0.3−0.3−0.3−0.3
Financial account16.1−1.17.3−28.4−23.7−15.6−6.1−6.6−7.0−7.2
Direct investment−24.2−0.615.411.311.611.310.911.010.810.6
Portfolio investment−45.722.686.027.51.0−0.9−2.5−2.1−2.5−2.8
Other investment86.1−23.1−32.2−67.6−37.8−23.7−13.1−14.6−15.4−15.4
Change in reserve assets 1/−0.10.10.00.31.5−2.2−1.3−0.90.10.3
Net errors and omissions−6.06.1−8.4−7.6−0.80.00.00.00.00.0
Financing gap0.00.00.034.521.711.30.00.00.00.0
Program financing0.00.00.034.521.711.30.00.00.00.0
IMF0.00.00.012.66.53.50.00.00.00.0
EU0.00.00.021.915.27.90.00.00.00.0
(In percent of GDP)
Current account balance−5.7−2.31.11.11.82.73.73.83.93.8
Balance of goods and services9.015.918.621.924.125.726.727.427.928.3
Trade balance13.320.122.823.023.724.625.426.126.827.1
Services balance−4.3−4.3−4.2−1.10.41.21.31.31.21.2
Income balance−14.1−17.3−16.6−20.0−21.5−22.3−22.3−22.8−23.3−23.7
Current transfers (net)−0.6−0.9−0.9−0.7−0.7−0.7−0.7−0.7−0.7−0.7
Capital and financial account balance9.0−1.44.2−18.0−14.8−9.5−3.7−3.8−3.9−3.8
Of which:
Direct investment−13.5−0.49.97.17.26.86.36.15.75.4
Portfolio investment−25.614.054.917.30.6−0.6−1.4−1.2−1.3−1.4
Other investment48.1−14.3−20.5−42.5−23.4−14.3−7.6−8.1−8.2−7.8
Change in reserve assets 1/0.00.00.00.20.9−1.3−0.8−0.50.00.1
Net errors and omissions−3.43.8−5.4−4.8−0.50.00.00.00.00.0
Financing gap0.00.00.021.713.46.80.00.00.00.0
Program financing0.00.00.021.713.46.80.00.00.00.0
IMF0.00.00.07.94.02.10.00.00.00.0
EU0.00.00.013.89.44.70.00.00.00.0
Sources: Central Bank of Ireland; Central Statistics Office; and IMF staff estimates.

Includes financing need to build reserves for bank support.

Sources: Central Bank of Ireland; Central Statistics Office; and IMF staff estimates.

Includes financing need to build reserves for bank support.

Table 6.Ireland: Monetary Survey, 2008–12(In billions of euros, unless otherwise indicated; end of period)
Dec-08Dec-09Dec-10Dec-11Jun-12
Aggregate balance sheet of domestic market credit institutions
Assets801798742634604
Claims on Central Bank of Ireland912846
Claims on Irish resident Other MFIs1251291239281
Claims on Irish resident non MFIs374363357338332
General government39434245
Private sector371354314296287
Claims on non-residents250241206147138
Other assets4454475246
Liabilities801798742634604
Liabilities to Eurosystem 1/4558957276
Liabilities to Irish resident Other MFIs1261311329987
Deposits of Irish resident non MFIs170180161144145
General government33323
Private sector167176157141142
Deposits of non-residents2712291379890
Debt securities10098645241
Capital and reserves4153719197
Other liabilities (incl. Central Bank of Ireland)4850837869
Money and credit 2/
Net foreign assets−100−75−67−39
Central Bank of Ireland 3/−24−37−128−101
Commercial banks−77−38616252
Net domestic assets295283239208
Public sector credit310434346
Private sector credit394375335324313
Other−102−102−139−158
Irish Resident Broad money (M3) 4/194208173169168
Irish Resident Intermediate money (M2) 4/176188173167166
Irish Resident Narrow money (M1)78100979089
(percent of GDP)
Public sector credit 5/1.45.327.526.628.5
Private sector credit 5/207.4219.4200.8186.1177.8
(y-o-y percentage change)
Broad money - Irish contribution to euro area M3 6/−0.4−5.3−19.51.3−9.8
Irish Public sector credit 6/7/101.8176.9369.41.515.3
Irish Household and non-financial corporations credit 6//78.8−1.5−3.4−2.9−3.4
Memorandum items: 8/
Credit to deposits (in percent) 9/222.8200.8200.0209.2201.7
Deposits from Irish Private Sector (y-o-y percent change)1.12.1−9.8−9.2−2.8
Wholesale funding (billions of euros)439.6422.8315.3233.6203.2
Deposits from MFIs339.4324.8251.1182.0162.6
Debt securities100.298.164.351.640.6
Wholesale funding (y-o-y percent change) 10/14.90.1−21.9−27.1−19.5
Wholesale funding (percent of assets) 10/54.853.044.836.833.3
Sources: Central Bank or Ireland and staff estimates.

Relating to Eurosystem monetary policy operations.

Including banks in the International Financial Service Centre.

Sourced from quarterly IIP statistics.

Differs from the M3 (M2) Irish contribution to euro area as only liabilities vis-a-vis Irish residents are used.

Refers to credit advanced by domestic market credit institutions.

Includes IFSC.

Growth rates adjusted for valuation, reclassification, derecognition/loan transfer to non-MFIs, and exchange

Excludes IFSC.

Domestic market credit institutions’ private sector credit to deposits.

Includes resident and non-resident MFI deposits, and debt securities issued.

Sources: Central Bank or Ireland and staff estimates.

Relating to Eurosystem monetary policy operations.

Including banks in the International Financial Service Centre.

Sourced from quarterly IIP statistics.

Differs from the M3 (M2) Irish contribution to euro area as only liabilities vis-a-vis Irish residents are used.

Refers to credit advanced by domestic market credit institutions.

Includes IFSC.

Growth rates adjusted for valuation, reclassification, derecognition/loan transfer to non-MFIs, and exchange

Excludes IFSC.

Domestic market credit institutions’ private sector credit to deposits.

Includes resident and non-resident MFI deposits, and debt securities issued.

9. Recent data point to modest growth in 2012, though signals are mixed (Figure 1). Solid budget revenues in H1 suggest activity broadly in line with projections. Other indicators are less clear:

Figure 1.Real Sector and Inflation Indicators, 2006–12

  • Real GDP grew 1.2 percent y/y in Q1 2012, but fell 1.1 percent q/q. The 6.1 percent y/y rise in export volumes was notably robust. Declining consumption was the chief drag on growth, although this in part reflected the boost to consumption in Q4 2011 ahead of the VAT rate hike. Real fixed investment grew 8 percent, but this was mostly a one-off effect from aircraft purchases, largely offset by higher imports.
  • The unemployment rate hit 14.8 percent in Q1 2012. Total employment fell 1 percent y/y, with job shedding in nine of 14 sectors, including further losses in construction.
  • After a surplus in 2011, the current account balance returned to deficit in Q1 2012 in part reflecting some seasonality. Service exports performed well in Q1, with an almost 20 percent increase in computer service export values, although this was offset by significant income outflows.
  • High frequency indicators point to consumption declining much as expected, and continued buoyancy on the external front. Consumer sentiment improved somewhat in June 2012 and the pace of decline in retail sales (excluding automobiles) slowed to 1½ percent y/y in H1, from a 2.6 percent decline in 2011. Industrial production expanded 5.3 percent y/y in Q2 and the PMI index of new export orders remained above 50, even increasing in June and July, in contrast with most euro area countries.
  • The HICP inflation rate remained just under 2 percent y/y, compared with 2½ percent for the euro area, with prices flat in Q2 after jumping 1¾ percent in Q1. Energy and administered prices remain the most important drivers.

10. The correction in house prices, one of the largest in recent history, has continued (Figure 2). The decline in nominal residential property prices slowed to 14.4 percent y/y in June 2012. The index has halved since its peak in 2007, eclipsing recent U.K. and U.S. house price declines and comparable to the Japanese and Nordic experiences of the 1990s. As yet, clear signs of stabilization are limited to Dublin house prices (excluding apartments), which, after dropping by 55 percent, have been flat in H1 2012. Rural areas, in contrast, still show signs of oversupply.

Figure 2.Housing Developments, 2001–12

Real Estate Prices in Recent Crises

(Country, year of peak, percent decline in real terms from peak)

Sources: BIS; OECD; CSO; and IMF staff calculations.

* Ongoing.

11. Residential mortgage arrears continue to rise, but remain within the assumptions for bank recapitalization. As of end March 2012, almost 14 percent of the total principal balance of owner occupied residential mortgages outstanding was affected by arrears of 90 days or more, broadly doubling since end 2010. Nonetheless, the overall arrears balance, together with developments in house prices and unemployment, remain within the adverse scenario of the Prudential Capital Assessment Review (PCAR) that guided bank recapitalization in 2011. It is notable that about half of total arrears arise from loans that have already been restructured, although part of these arrears could have arisen prior to each loan restructuring, so the effectiveness of rescheduling of distressed loans is unclear. Repossessions and voluntary surrenders of property are also very low, cumulating to 0.2 percent of the stock of mortgages on owner-occupied dwellings in the 11 quarters to March 2012. This is consistent with the one-year moratorium on repossessions of primary residences under the Code of Conduct on Mortgage Arrears, but may also reflect a need to buttress the repossession framework.

Ireland: Residential Mortgage Arrears(in billion of euros)
Dec-09Dec-10Dec-11Mar-12
Outstanding118.3116.7113.5112.7
Mortgage loans in arrears over 90 days 1/5.38.613.915.4
in percent of outstanding4.57.412.313.7
Restructured mortgagesn.a.10.413.314.2
in percent of outstandingn.a.8.911.712.6
Repossessions and voluntary surrenders 2/21157411821352
Source: Central Bank of Ireland.

Includes restructured mortgages in arrears over 90 days.

Cumulative number since 2009Q3

Source: Central Bank of Ireland.

Includes restructured mortgages in arrears over 90 days.

Cumulative number since 2009Q3

PCAR Stress Scenario and Outcome, 2011–12

Sources: National Authorities; and IMF staff calculations.

1/ Nominal decline in percent. 2012 actual refers to January to June, y/y.

2/ In percent. 2012 actual refers to H1 average.

12. Lending to households and SMEs has declined to low levels (Figure 3). New mortgagelending almost halved from 2010 levels to €2.5 billion in 2011, and eased to €1.0 billion in H1 2012. New loans to SMEs (excluding financial intermediation and property related loans) drawn down remained around €2.2 billion in 2010 and 2011, yet slowed somewhat in Q1 2012 to €0.4 billion, sufficient to keep outstanding credit to these SMEs stable at about €27 billion since late 2010. An ECB survey finds 25 percent of Irish SMEs identify access to finance as the most pressing concern in the six months to March 2012, the third highest in the euro area. Nonetheless, the rejection rate for Irish SME credit applications of 17 percent is only modestly above the euro area average of 13 percent, and is driven by a particularly high rate (38 percent) for micro enterprises (1–9 employees). A domestic survey covering the same period with broader enterprise coverage in Ireland found that of the 38 percent of SMEs seeking credit, 28 percent of requests were declined (excluding pending applications). The Credit Review Office, which is available to review such rejections, has ruled that credit be granted in 60 percent of cases referred to it, and it suggests that banks better assess performance fundamentals in processing SME credit applications.

Figure 3.Credit Developments, 2006–12

13. Bank funding pressures have eased recently and deleveraging targets have been met. Corporate and household deposits have stabilized, but attracting deposits has come at the cost of high interest rates. Although there are some signs of an easing of deposit rates in recent months, they remain high relative to the euro area average. Banks’ deleveraging has continued to progress largely as planned under the Prudential Liquidity Assessment Review (PLAR) of early 2011, with €42 billion achieved by end April out of an indicative three-year target of €70 billion. Together these developments allowed banks to taper down their reliance on ECB financing: by mid-2012, ECB refinancing of the domestic banks was back to the pre-turmoil level.

Household Deposit Rates 1/

(Percent per year)

Source: ECB; and Haver.

1/ Average for deposits outstanding with agreed maturity up to 2 years.

Eurosystem Borrowing, PCAR Banks and IBRC

(Billions of euros)

Sources: Irish authorities; Haver; and IMF staff calculations.

1/ Proxied by sum of CBI’s other claims on euro area credit institutions and other assets.

14. The three PCAR banks continue to be well capitalized but their restructuring efforts have not yet generated concrete improvements in financial performance (Box 1).5 With equity increased by €24 billion in 2011, average core tier 1 regulatory capital stood at 16½ percent of risk-weighted assets as of Q1 2012. However, preprovision profits turned negative in Q1 2012, at minus 0.1 percent (annualized) of total average assets, down from 0.2 percent in 2011. Five main issues depress bank revenue generation: (i) a large legacy overhang of tracker mortgages indexed to (low) policy rates; (ii) high fees on the Eligible Liabilities Guarantee (ELG) Scheme; (iii) foregone interest on impaired loans; (iv) high operational costs; and (v) the high interest cost of deposits and covered bond funding issued to date. These factors highlight the need to work out sizeable NPLs (21 percent of gross loans) and for more rapid progress in operational restructuring to reduce costs.

15. Benefitting from important assurances from European leaders, Ireland returned to the sovereign bond market in July 2012. Developments in Irish bond spreads since mid 2011 had suggested the potential for a “decoupling” of Ireland. More recently, the euro area summit statement of June 29, 2012, which committed to examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment program, drove spreads down by 80–100 basis points. Taking advantage of this opportunity, Ireland returned to the bond market on July 26, 2012—for the first time since September 2010—with a new five-year issue and a reopened eight-year issue which together raised €4.2 billion, mostly subscribed by foreign investors. The average yield of 5.9 percent was consistent with a modest premium over the secondary market. Financing needs in 2013 and 2014 were reduced by a further €1 billion through a bond swap.

Two-Year Sovereign Bond Spreads

(Basis points)

Sources: Bloomberg; and IMF staff calculations.

Ten-Year Sovereign Bond Spreads

(Basis points)

Sources: Bloomberg; and IMF staff calculations.

1/ Irish 9-year government bond yield spread over 9-year bund.

Box 1.PCAR Banks’ Financial Performance, Q1 2012

The financial performance of the PCAR banks remained weak in Q1 2012. While the banks continue to show high regulatory capital (an average risk-based core tier 1 ratio of 16½ percent), net preprovision operating profits were negative 0.1 percent of total average assets, down from 1.7 percent in Q4 2011. The factors that depressed performance during 2011 remain at play:

  • The already low net interest margin fell by 40 basis points in Q1, to 0.8 percent of average assets. Though funding costs fell by 35 percent from Q4 2011 reflecting the actions of a leading bank to lower deposit rates, this was not enough to compensate for weakening interest income due to higher loan impairments and the drag from low yielding tracker mortgages.
  • The ELG fee remained high, at 110 basis points in Q1, absorbing some 40 percent of the net interest margin (up from 28 percent in Q4 2011).
  • Fee income declined to a very low 0.3 percent of average assets, following the contraction in underlying economic activity, and covering only about one-quarter of banks’ operating costs.
  • Already high operating costs remained at 1.1 percent of average assets, consuming 1.3 times the banks’ net interest margin in Q1. Cost rationalization efforts are underway, with staff reductions of about 3,400 full-time equivalents anticipated by end 2013.

Other sources of income were small. Nonrecurring items were negligible, and trading gains fell to negative 0.1 percent in Q1 2012. Staff estimates that the underlying cash flow from operations currently runs at minus €1.1 billion annually (after adjusting noncash revenue for the unwind discount on impaired loans, about €1 billion per year). In sum, the banks have not achieved profitability and are not positioned to absorb loan loss provisioning costs. In Q1, they made provisions covering 1.2 percent of assets, leading to a net income loss of €1 billion and a negative ROA of 1.2 percent.

PCAR Banks’ Aggregated Summary Financial Statements, Q4 2011 - Q1 2012
Balance SheetQ4 2011Q1 2012q/q changeProfit and Loss AccountQ4 2011Q1 2012
€ bn€ bn.€ bn.%€ bn.% of TAA€ bn.% of TAA
Cash & due from Eurosystem12.214.62.419.7Interest income3.64.42.42.9
Net loans215.2211.9−3.3−1.5Interest expense−2.6−3.2−1.7−2.1
Due from banks14.511.4−3.1−21.4Net interest margin1.01.20.70.8
Securities & derivatives69.568.5−1.0−1.4Net fee income0.40.50.20.3
Other assets14.913.9−1.0−0.1Net trading gains0.91.1−0.1−0.1
Total assets326.3320.3−6.0−1.8Other nonrecurrent items0.30.40.00.0
Total average assets (TAA)328.2323.3−4.8−1.5Gross operating income2.63.20.81.0
Operating expenses−0.9−1.1−0.9−1.1
Due to Eurosystem67.864.9−2.9−4.3o/w: administration & other−0.3−0.3−0.4−0.5
Due to banks17.616.9−0.7−4.0o/w: staff−0.6−0.7−0.5−0.6
Deposits148.9151.32.41.6Preprovision profits (PPP)1.72.1−0.1−0.1
Debt & derivatives56.752.1−4.6−8.1Loan loss & NAMA provisions−6.9−8.4−1.0−1.2
Other liabilities7.17.0−0.1−1.4Loss on derecognized assets−0.9−1.10.00.0
Total liabilities298.1292.2−5.9−2.0Net income before tax−6.1−7.4−1.1−1.3
Net equity28.228.1−0.1−0.4Tax effects & other 2/0.91.10.10.1
Total liabilities & equity326.3320.3−6.0−1.8Net income−5.2−6.3−1.0−1.2
Gross loans 1/240.9235.7−5.2−2.2PPP net of other nonrecurrent items1.41.7−0.1−0.1
Loan loss provisions23.524.30.83.4Return on equity−79.0−13.9
Gross NPLs47.048.91.94.0Provisions to gross loans4.11.6
Gross NPLs to gross loans (%)19.520.71.2Risk weighted assets (RWA)166.850.8160.449.6
Provisions to gross NPLs (%)50.049.7−0.3Core tier 1 capital (CT1) to RWA (%)16.416.5
Net NPLs to net equity (%)83.387.54.2CT1 to total assets = leverage ratio (%)8.48.2

Includes loans held for sale, classified on balance sheet as other assets.

Includes net tax credits of €0.1 bn. in Q1 2012 and €0.9 bn. in Q4 2011.

Sources: CBI and Fund staff estimates.

Includes loans held for sale, classified on balance sheet as other assets.

Includes net tax credits of €0.1 bn. in Q1 2012 and €0.9 bn. in Q4 2011.

Sources: CBI and Fund staff estimates.

Outlook—Uncertainties Threaten Recovery and Exit

16. Real GDP is expected to grow by about ½ percent in 2012, a significantly slower pace than in 2011. Net exports should remain the main driver, but with a smaller contribution than in the past two years as trading partner growth is expected to decelerate from 1.6 percent to 0.7 percent, although recent data signal some upside potential for exports. Real private consumption is projected to shrink by a further 1.9 percent as disposable income growth remains weak despite the supportive impact of lower ECB rates on mortgage interest payments. Gross fixed investment will likely contract again given domestic and external uncertainties and low lending to SMEs and households, yet private investment is already very low at 7½ percent of GDP. Weak domestic demand limits job creation, with the unemployment rate expected to remain at almost 15 percent, its highest level since 1995. A negative output gap is expected to limit inflation to 1.4 percent, driven by energy costs and administered prices.

17. The macroeconomic outlook is based on an external recovery and on restoring over time a well functioning financial sector (Table 2). Ireland in 2008–10 was no exception to the international experience of slow recoveries after housing busts; indeed, its recession was much deeper than typical. Yet Ireland demonstrated its capacity to grow in 2011, and a similar 1½ percent growth rate is projected in 2013, led by stronger export growth from trading partner recovery. While fiscal consolidation remains a significant drag in 2013, the pace of decline in domestic demand is expected to slow further as household saving gradually eases from high levels while still keeping household debt burdens on a declining path; as stabilizing housing prices in certain areas strengthen demand from the younger cohort of households with little debt; and as private investment bottoms out. 6 The medium-term growth projection, for an average of 2¾ percent annual growth in 2014–17, is low in relation to the scale of underutilized resources. It hinges on continued external recovery to drive export growth averaging 4½ percent—which is modest by historical standards—supported by a revival of domestic demand. The latter is expected to be a protracted process given the continued yet moderating fiscal adjustment, with domestic demand growth projected to turn positive only in 2014 and to reach just 2 percent y/y by 2015–17. Exports could outperform this outlook and machinery and equipment investment could also rebound more substantially in the medium term.

Real GDP in Downturn and Recovery

(Year-on-year percent change)

Sources: CSO; Haver and IMF staff calculation.

18. There are, however, a range of interconnected downside risks to this baseline outlook:

  • Spillovers from the euro crisis. The medium-term growth scenario assumes resolution of the euro area crisis over the next year. Conversely, an intensification of stresses would impact Ireland’s growth outlook through exports given the high openness of the economy, and also by undermining household and business confidence and domestic spending. Adverse effects on debt trajectories and on financial sector health could also result in higher Irish spreads and rating downgrades, thwarting market access.
  • Domestic demand and the banks. The eventual gradual resumption of private consumption and investment growth—now not expected until 2014—hinges on a bottoming out of house prices, some pick up in lending to SMEs and the less indebted younger cohort of households, well targeted private debt restructurings, and a sense that the crisis is being overcome. Slower progress on these issues, meshed with concerns about the stability of the euro area, would risk unleashing a renewed pernicious cycle of falling confidence, declining demand, rising unemployment, and renewed asset price declines, with bank capital needs emerging if this stress is lasting.
  • Unemployment. Gradual economic recovery and slow job creation could imply higher structural unemployment, limiting potential growth over the medium-term, while persistent high youth unemployment could risk sustained high emigration.

19. If these risks to growth materialize, the effect on the fragile public debt path would be profound, with adverse implications for Europe (Table 1 and Annex II). In the current baseline, gross general government debt peaks at 119 percent of GDP in 2013—slightly lower than previously projected given upward revisions to nominal GDP data—and then declines to 108 percent of GDP by 2017. This debt outlook limits Ireland’s fiscal space, so contingent policy options in an adverse scenario would be severely constrained. Risks to the trajectory remain high: in a slow growth scenario with real GDP expanding by only ½ percent per year over the medium term, gross debt would instead rise to 129 percent of GDP by 2017. In such a scenario, the still tight bank-sovereign linkages may yet result in additional debt increases as higher unemployment and lower asset prices lead over time to rising arrears and loan losses. Such setbacks in Ireland, in turn, would exacerbate the broader European crisis.

General Government Gross Debt

(Percent of GDP)

Source: IMF staff projections.

20. Robust implementation of the June 29 euro area summit statement could markedly improve Ireland’s debt dynamics and prospects for sustained market financing. The ESM’s bank recapitalization instrument is key to improving sustainability and to addressing the euro area leaders’ imperative of breaking the vicious cycle between banks and sovereigns. If, for illustrative purposes, the ESM invested €24 billion in the banks (the full value of the bank equity increase under the EU-IMF supported program), and the government used the proceeds towards debt reduction, government debt would drop 14½ percentage points to 105 percent of GDP in 2013. Market perceptions of the banks would benefit as ESM equity broke banks’ links to the sovereign, enhancing the value of the banks and their potential to support economic recovery. The other main component of such a package would be a refinancing of the €28 billion in promissory notes (debts that formed a major part of bank recapitalization costs) to extend their debt service schedule. Either long-term government securities or an EFSF/ESM loan could provide such a refinancing, but the former would avoid adding to debts that markets may consider senior. While this refinancing would only modestly lower Ireland’s debt path, it would significantly reduce financing needs in coming years. Together these steps would much improve Ireland’s prospects for the durable market access needed to avoid prolonged dependence on official financing.

Policy Discussions—Working Toward Economic Revival

21. The key medium-term challenge is to promote sustained recovery amidst ongoing fiscal consolidation and private sector deleveraging. Recent growth has been export-led, benefiting from early competitiveness gains, but sustained recovery will increasingly require a job creating domestic demand revival. Hence the consultation focused on:

  • How to get the financial sector to a point where it will step up and lend to credit constrained but creditworthy borrowers.
  • The design of fiscal consolidation with regard to both the phasing and composition of measures to mute adverse growth effects and limit risks to achievability.
  • Heading off higher structural unemployment that would constrain growth potential.

General Government Gross Debt

(percent of GDP)

Sources: IMF staff projections.

The analysis is supported by a Selected Issues volume comprising four chapters: (i) household deleveraging and consumption; (ii) lending to SMEs and households; (iii) the medium-term fiscal strategy; and (iv) approaches to counter structural unemployment.7

A. Building a Healthy Financial Sector and Reviving Domestic Demand

22. At end March 2011, the CBI completed a comprehensive assessment of the capital and liquidity conditions and needs of domestic banks. This Financial Measures Programme served to much reduce market uncertainties through robust analysis and a high degree of transparency, with bond yields and spreads declining notably. It comprised:

  • The PCAR stress test, which assessed the capital needs of four domestic banks (now merged into three) under a baseline scenario and a stringent three-year stress scenario. These tests identified the additional capital required to meet minimum core tier 1 capital ratios of 10½ percent in the baseline and 6 percent in the stress scenario. Including a significant buffer on top of the stress test results, the PCAR found a further €24 billion was required to ensure sound capitalization of the banks.
  • An independent loan loss forecasting exercise, performed by BlackRock Solutions. These loss forecasts, which were notably more conservative than those of the banks, were the foundation for the assessment of capital needs in the PCAR.
  • The PLAR deleveraging plan, which set targets for banks participating in the PCAR to reduce their leverage and reliance on central bank funding.

23. At the same time, the authorities laid out a comprehensive reform strategy for the banks.8 The aim was to put the banking system on a firm footing for the future so that it would support economic recovery. Accordingly, rather than just recapitalizing the banks, the authorities’ considered it important to reorganize them and deleverage (downsize) their balance sheets, to better serve the needs of the Irish economy. Thus the three-year deleveraging process would not only address the excessive scale of bank assets, it would also be part of the restructuring to focus the banks on their core operations, and would do so in a way that avoided fire sales. Much progress has been made in implementing this three pronged strategy, with recapitalization complete and deleveraging well advanced (Table 2).9

Text Table 1.Risk Assessment Matrix1/(High, medium, or low)
Source of RisksRelative Likelihood2/Impact if Realized
MediumHigh
Strong intensification of euro area crisis.Heightened financial stress could hurt the outlook for the euro area.Renewed recession via trade and confidence channels, and reduced investor appetite for Irish bonds.
MediumMedium
Stagnation of world growth.Softer demand from the United Kingdom and the United States.Lower net exports compounding subdued domestic demand.
MediumMedium
Increased reliance by banks on ELA.Bank debt maturities and possible slower deleveraging could lead to additional liquidity support, possibly via ELA, depending on ECB collateral policies.Reduced market funding prospects for banks and higher barriers to sovereign market financing given increased need for government guarantees to CBI.
MediumHigh
Delayed or insufficient improvement in debt sustainability from implementation of June 29 commitments of euro area leaders, e.g., due to valuations of ESM bank equity purchases.Public debt levels left too high and bank-sovereign linkages left intact, reducing market confidence in both banks and the sovereign.Significant risk of inadequate access to market financing, with banks continuing to face funding and profitability challenges; risk of more official support undermines confidence and recovery.
MediumMedium
Domestic demand revival is further delayed.Efforts to strengthen banks’ lending capacity work more slowly, delaying demand recovery and house price stabilization.Temporarily weaker growth is manageable, but fiscal adjustment would be more difficult and unemployment higher.
MediumMedium
Unemployment increases become structural.Lengthening unemployment spells erode skills and raise emigration.Lower potential growth, impinging on debt sustainability

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path discussed in this report (which is the scenario most likely to materialize in the view of the staff). The RAM reflects staff’s views on sources of risks and levels of concern at the time of discussions with the authorities. The relative likelihood of risks listed is the staff’s subjective assessment.

In the event that the baseline does not materialize.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path discussed in this report (which is the scenario most likely to materialize in the view of the staff). The RAM reflects staff’s views on sources of risks and levels of concern at the time of discussions with the authorities. The relative likelihood of risks listed is the staff’s subjective assessment.

In the event that the baseline does not materialize.

Text Table 2.Status of Financial Sector Reform Implementation
StrategyProgress
Reorganization



Aimed at creating a two-pillar banking system with two universal full-service banks servicing the needs of the Irish economy.
The first stages of this strategy were delivered swiftly. The first pillar was created around Bank of Ireland, and the second pillar by merging Allied Irish Banks and EBS. Anglo Irish Bank and Irish Nationwide Building Society, the failed banks, were merged to form the Irish Bank Resolution Company (IBRC).

Irish Life & Permanent Group was restructured to separate Irish Life, the life assurance and fund management unit, from Permanent TSB (PTSB), the bank, with the former bought by the state to finalize the recapitalization of the latter. 1/



The restructuring of PTSB is proceeding, with three separate business units being established: a core retail bank, an asset management unit, and the U.K. mortgage loan book (Capital Home Loans).



Institutional arrangements were put in place in mid 2011. The Department of Finance has established a banking division, whose role and interaction with the CBI was defined in a memorandum of understanding. Relationship frameworks detailing the nature and modalities of the (arm’s-length) interaction with the banks have been adopted and published.
Recapitalization



Deliberately conservative, targeting core tier 1 capital ratios of 10½ percent and 6 percent under base and stress cases, respectively.
Banks were asked to forecast their financial statements through end 2013. An independent third party, BlackRock Solutions, estimated future losses on banks’ portfolios, and the CBI overlaid additional conservative assumptions.



This exercise generated aggregate recapitalization needs of €24 billion, with equity injections completed in June 2012. The total cost to the state was limited to €17.8 billion (including the purchase of Irish Life), through capital raising from private investors and burden sharing with subordinated debtholders.



The PCAR exercise will be re-run in concert with the European Banking Authority’s next euro area stress test exercise.
Deleveraging



The three-year deleveraging framework to downsize the banking system, improve prospects for market funding, and reduce reliance on Eurosystem funding.
Core and noncore assets were delineated. Core assets are those principally serving the needs of the Irish economy and thus needing to be supported by stable funding even as reliance on ECB financing is reduced. Noncore assets principally consist of foreign claims to be disposed or run off.



The initial overarching yardstick of the deleveraging plan was to reduce loan-to-deposit ratios from 180 percent in the aggregate at end 2010 to no more than 122½ percent by end 2013. Banks identified €70 billion of assets at the outset, of which more than half have been disposed or amortized.



Overall, deleveraging has advanced faster than planned, in some cases owing to frontloaded disposals by banks, but also to a stronger-than-anticipated run off of core asset portfolios reflecting writeoffs and lackluster credit demand.

Irish Life & Permanent Group Holdings plc and Irish Life & Permanent plc have been renamed Permanent TSB Holdings plc and Permanent TSB plc respectively.

Irish Life & Permanent Group Holdings plc and Irish Life & Permanent plc have been renamed Permanent TSB Holdings plc and Permanent TSB plc respectively.

24. Creating the conditions for robust credit flow in support of sustained economic recovery is, nonetheless, a difficult challenge requiring deep and sustained reform efforts. In view of the progress already made, and in light of financial market developments, a number of interrelated challenges are now key priorities:

  • Arresting the deterioration in asset quality is essential. As residential mortgage arrears rose during 2011, the CBI stepped in appropriately to identify operational weaknesses in banks’ management of distressed credit and to require the banks to develop mortgage arrears resolution strategies. Banks are now accelerating work to build credit collection and workout functions. Similar supervision of workout efforts for loans to SMEs has begun, and should proceed apace considering the importance of this sector for job creation. The authorities also recently introduced to parliament a comprehensive reform of the personal insolvency framework to help address borrower financial distress while maintaining debt service discipline, which will provide an important backstop to bilateral efforts to resolve distressed loans.10 Nonetheless, progress with loan workout and resolution has not advanced as rapidly as would be desirable. Consistent implementation and close monitoring of these combined efforts are essential to enable a much needed transition toward long-term solutions tailored to borrowers in difficulty. In parallel, it will be important to ensure that the repossession framework works efficiently in practice so that it complements the personal insolvency reforms.
  • Regaining profitability is necessary for banks to sustain new lending. As discussed, interest margins are compressed by high deposit interest rates and guarantee fees. It is now appropriate to begin phasing out the ELG Scheme in an orderly manner while preserving access to funding. Moreover, banks remain burdened by cost structures that are too high; in this sense the reorganization of banks remains to be completed. Plans to reduce operational expenses will need to be fully implemented in a timely manner, and progress in achieving reasonable cost-to-income ratios should be reviewed periodically.
  • Banks’ funding also remains a constraint on lending that needs to be addressed. The current strategy to regain bank access to market funding rests on a combination of strengthened capital, improved liquidity through deleveraging, loan restructuring to clarify asset values and reduce arrears, and operational restructuring and other measures to restore profitability. There have been positive funding developments, with the Irish deposit base recovering somewhat recently, and banks have obtained repo funding secured on U.K. collateral. However, in common with banks in other euro area countries, accessing material volumes of secured market funding to support new lending faces difficulties. In addition, there are now increased risks of losses from deleveraging, with much of the banks’ more attractive foreign assets already sold and deleveraging by European banks on the rise. In the absence of viable funding alternatives, banks may be unable to avoid increased reliance on Eurosystem funding when further bond maturities occur. This would result in substantial encumbrance of banks’ assets, and renewed reliance on ELA if ECB-eligible collateral is exhausted, limiting potential market funding. These circumstances undermine prospects for a revival of lending, and a sustainable solution will need to be found for the euro area as a whole.
  • A further concern is that prevailing high economic uncertainty will leave even a well capitalized banking system reluctant to lend. While lack of aggregate demand is critical to low investment and credit, there appear to be some pockets of creditworthy but credit constrained borrowers, notably in the SME sector.11 Staff therefore supported the roll out of a small Temporary Partial Credit Guarantee Scheme, through which the state will guarantee 75 percent of creditors’ exposure, up to €150 million annually.

25. The authorities broadly agreed with the thrust of the analysis on the main challenges in restoring a healthy flow of credit to the economy. They considered the financial sector reform strategy adopted in March 2011 to have proven its effectiveness in restoring financial stability, which was critical to stabilizing the economy. At the same time, they agreed that further work was needed to ensure the financial system can return to healthy operation. Improving the quality of bank assets is a key priority for the authorities, and one that is being addressed through a combination of supervisory measures and the reform of household bankruptcy, where sound implementation is both resource intensive and time consuming. In particular, the authorities are alert to the need for careful implementation of the personal insolvency reforms. The authorities noted that they are developing a roadmap to wean banks off the ELG Scheme while preserving financial stability, and are supporting the implementation by banks of restructuring plans to reduce operational costs. On funding, the authorities indicated they would continue to assist banks in developing collateral quality to increase the scope for market funding, yet noted that reviving bank funding markets is a broader challenge for the euro area.

B. Growth-Friendly Consolidation that Protects the Vulnerable

26. Although Ireland had a balanced budget going into the crisis, booming revenues masked a significant weakening in the underlying fiscal position. After a period of rapid export-led growth in the 1990s where spending and tax revenues declined to low levels relative to GDP, public finances were, at the turn of the millennium, redirected toward improving social outcomes and expanding public services. Nominal primary spending rose 140 percent over 2000–08 (11 percentage points of GDP in structural terms), with welfare rates doubled (tripled in the case of the universal child benefit), the number of public servants enlarged by 35 percent, and public wages raised 60 percent.12 The spending surge was accompanied by structural tax cuts: the already high entry point to the income tax (25 percent of per capita GDP in 2000) was doubled by 2009, while statutory income tax rates were lowered by 5 percentage points. The structural primary deficit, hidden by a flood of property-related revenues during the boom years of 2003–07, rose to over 10 percent of GDP in 2008.

Primary Expenditure

Source: IMF staff calculations.

27. The crisis prompted a sharp course correction, with substantial consolidation implemented in recent years. Cumulative budget measures in the last four years (2009–12) are estimated to strengthen the structural primary balance by 8 percent of GDP. This large effort was expenditure-led (two-thirds of total measures), combining a 14 percent cut in public wages, an 8 percent cut in welfare rates (except pensions), an almost 10 percent reduction in public service numbers from 2008, and savings in the non-pay current and capital budgets (17 and 63 percent, respectively). Revenue contributions included personal income tax base broadening (10 percent reduction in income tax bands, introduction of universal social charge, elimination of Pay-Related Social Insurance (PRSI) reliefs and exemptions); higher taxes on capital and savings; and an increase in indirect taxes, most notably, the 2 point hike in the standard VAT rate to 23 percent in 2012.

Composition of Fiscal Consolidation

(percent of GDP)

Sources: IMF staff estimates.

SPB denotes structural primary balance ratio.

28. This major consolidation was achieved during a deep economic slump while preserving social cohesion and protecting key public services and the most vulnerable. Political commitment to consolidation has been a welcome constant, as reflected in the affirmation by the new government (which took office in March 2011) of the medium-term fiscal targets in the EU-IMF supported program agreed in December 2010. An agreement with the public service following the 2009–10 pay cuts (the “Croke Park Agreement”) stipulated that future savings would be achieved through voluntary retirements and redundancies, rather than cuts in pay, and that the public service would be flexible in redeploying staff in order to protect services. The June 2012 Progress Report of the CPA Implementation Body found that significant targeted reductions in the wage bill had been achieved in the second year of the agreement, while protecting public services. The progressive design of the consolidation, together with strong social protection, has helped Ireland retain the second-lowest relative at-risk-of-poverty gap in Europe in 2010, despite suffering a deeper crisis (Box 2).

Medium-Term Fiscal Adjustment
2012201320142015
Budget measures
€ billion 1/4.33.53.12.0
Percent of GDP2.72.11.81.1
General government deficit target
Percent of GDP8.67.55.12.9
Source: Medium-term Fiscal Statement, November 2011

In 2012, includes carry-over from the Universal Social Charge.

Source: Medium-term Fiscal Statement, November 2011

In 2012, includes carry-over from the Universal Social Charge.

29. With the overall deficit expected to still exceed 8 percent of GDP in 2012, significant further consolidation is required over the medium term. The Medium-Term Fiscal Statement (November 2011) set out the parameters for a 5 percent of GDP consolidation over 2013–15 to deliver a deficit of 3 percent of GDP in 2015. The quantum, phasing, and objective of this consolidation is broadly appropriate. At the same time, given the fragility of Ireland’s economic recovery, should any significant additional consolidation need be identified in future updates of the Statement, this should be spread over outer years (2014–15) while still reaching the medium-term fiscal goal.13 The plan envisages a continuation of the expenditure-led approach (maintaining the two-thirds share), which can be justified given Ireland’s now fourth-highest primary expenditure ratio in the OECD (as a share of GNP), and given the opportunities for savings discussed below. In addition, maintaining a freeze on nominal wage and welfare rates is expected to generate a further reduction in the expenditure ratio of about half 3½ percentage points of GDP by 2015.

Box 2.The Impact of the Crisis on Poverty and Inequality

Ireland has avoided a decline in poverty rates relative to Europe despite facing a deeper economic slump. Ireland’s at-risk-of poverty (ARP) threshold—set at 60 percent of median equivalized household disposable income—was above the EU average (left panel) in both 2006 and 2010. The share of population below the ARP threshold fell from 18.5 percent in 2006 to 16.1 percent in 2010, just below the EU average (center panel). Moreover, at 15.3 percent, Ireland’s 2010 relative poverty gap (percent deviation of ARP threshold from the median income of those below it) is the second lowest in Europe (right panel). Overall, Ireland’s strong social supports have avoided a rise in poverty during the crisis.

Selected Poverty Indicators in Ireland and the EU - 2006, 2010

Source: Eurostat. Notes. 2006 figures in orange; 2010 figures in blue. At-Risk of Poverty Threshold is in Purchaing-Power-Standard terms.

The consistent poverty rate (the official poverty indicator in Ireland, which combines data on incidence of deprivation with the ARP measure) has also been relatively stable. At 6.2 percent in 2010, the consistent poverty rate was still below 2006 levels. Although it rose during the crisis for the population as a whole, this poverty measure fell to low levels for those aged 65 and above.

Consistent Poverty in Ireland (% of individuals, equivalized)
20062007200820092010
Total6.55.14.25.56.2
0–17 yrs10.37.46.28.78.2
18–64 yrs5.64.73.94.96.4
65+ yrs2.22.01.41.10.9
Source: Central Statistics Office
Source: Central Statistics Office

While some recent data has raised concerns about rising inequality, this may partly reflect sampling variations, as budget consolidation has been progressive overall to date. Recent data from the Survey on Income and Living Conditions showed a rise in the ratio of net disposable income in the top quintile to that in the bottom quintile from 4.4 to 5.3 between 2008 and 2010 (slightly above the EU average of 5.0). However, sample composition changes were large, with half the respondents being new. Measured inequality may have increased because self-employed people—who typically receive few social transfers—moved disproportionately into the bottom quintile, while large one-off retirement and redundancy payments were included in social transfers. Indeed, the ESRI finds the cumulative budgetary consolidation over 2009–12 has been progressive, with the exception perhaps of the 2012 standard VAT rate increase, although this only applied to half of consumption, as many essentials are zero-rated.

30. Nonetheless, even with the authorities’ strong capacity to deliver, risks to reaching these consolidation goals remain. The authorities’ track record of delivering against plans, and a robust new framework of tri-annual spending reviews and multi-annual nominal expenditure ceilings, support the achievement of the expenditure-led consolidation. However, after several successive years of adjustment, few low-hanging fruit are left. Evidence from past European consolidations, especially the recent Latvian experience, suggests that expenditure reductions become progressively more difficult in later phases of consolidation, or when key services begin to be affected.14 Moreover, a weaker than expected growth recovery would erode savings from the nominal wage and welfare rate freeze, while the demographic outlook will put significant upward pressure on pension, education, and health spending over the medium to longer term.15

31. In these difficult circumstances, a strategic approach that keeps all high-quality expenditure and revenue options on the table is needed to complete the consolidation in a durable manner.16 Given the still-fragile economy and high unemployment, it is vital that the choice of budget measures minimizes the drag on demand and job creation. At the same time, the measures need to entail fair burden-sharing across income groups, generations and family types, while effectively protecting the most vulnerable. To achieve these goals, staff encouraged the authorities to base fiscal consolidation on the following approaches:

  • Better targeting the state’s social supports and subsidies to ensure support is directed to those who need it;
  • Reforming key government services, especially health and education; and
  • Focusing revenue effort on base-broadening rather than rate hikes.

To best achieve a growth-friendly and fair consolidation, which is more likely to endure, staff recommended to not to rule out any high-quality expenditure or revenue options, some of which may be needed as fallbacks in case any shortfalls arise.

32. While ensuring the most vulnerable are protected, comprehensive targeting of spending can deliver timely spending reductions. Maintaining expensive universal supports and subsidies is difficult to justify under present budgetary circumstances. Better targeting of spending, including the child benefit, medical cards, the household benefits package, and subsidies on college fees, can generate significant immediate savings and contain demographic related spending pressures over the longer term, while effectively protecting the poor.17 In the case of some universal benefits such targeting could be achieved by making them taxable. State pensions have been exempted from the adjustment to date, yet a targeted reduction should also be considered given the broad decline in consumer prices, especially in view of the expected 3 percent annual growth in the eligible population. One approach would be to reduce or eliminate the premium—currently 5 percent—on the contributory pension over the means-tested pension. While recognizing the benefits of the Croke Park agreement for industrial peace, the public sector paybill remains high, and staff urged continued monitoring of the adequacy of savings in the net public pay and pensions bill and of public service provision.18

33. In parallel, reforms of key public services are needed to underpin savings in the medium term. Despite spending significantly more than the OECD average on health and education, Ireland’s performance indicators are around the OECD average. Moreover the spending pressures in health during 2012 appear to have structural roots. Deeper reforms in health and higher education are therefore needed, by identifying service priorities and delivering them more efficiently. In health, potential reforms could include new working models to minimize premium and overtime payments, greater use of primary care rather than hospital stays, and substantially increasing the currently low share of generic drug use. Similarly, a new funding model for higher education can deliver broad access to high quality education without additional public investment by (i) better taking into account skills priorities in course availability, and linking college fees to the costs and earnings potential of courses while supporting low income students through affordable loans and grants, and (ii) striking the appropriate balance between degree and vocational education. While savings from such reforms can take time to realize, they are important to help ensure the consolidation can be sustained by enabling the growing needs for these services to be met at manageable cost.

34. A base-broadening approach to raising revenue will help mitigate potential adverse growth effects. Relative to other OECD economies, Ireland has a combination of high personal and indirect tax rates and relatively narrow tax bases.19 This provides considerable room to raise revenues without increasing the already elevated marginal tax rates, and while also avoiding higher effective rates on lower income workers that could undermine work incentives. For example, special income tax reliefs—which currently benefit only those employees earning above the high entry point for income tax—could be better targeted to low-income taxpayers, and options to broaden the PRSI base could be examined. The planned introduction of a value-based property tax in 2013 will provide a progressive and stable source of revenue. A suitably high level for this tax—where staff favored around the 0.5 percent mark—would help maximize these benefits. There is also scope to expand the well designed carbon tax to all fuel types, and to redesign vehicle taxes in a way that can provide significantly higher revenues, while fully preserving incentives for environmental conservation.

35. The authorities agreed that further fiscal consolidation would be more difficult and concurred with much of the thrust of the staff’s analysis. They emphasized that improving prospects for growth and job creation was critical, including to make the necessary budget adjustments more tolerable, and there were also significant positive implications for the public finances. The authorities generally concurred that all high-quality expenditure and revenue options needed to be kept on the table in order to deliver the consolidation in a durable manner, while also highlighting the range of savings options that had been identified in the 2011 Comprehensive Expenditure Review, on which the government would be able to draw. At the same time, the authorities emphasized the benefits of the Croke Park Agreement in delivering a leaner and more effective public service, while maintaining industrial peace. The authorities also noted the importance of calibrating social transfers to budgetary resources, labor market developments and demographic pressures. Regarding reforms of public services, the authorities agreed there is scope for savings, such as via greater use of generic drugs and primary care in health, and in improved procurement more generally.

C. Supporting Growth and Reducing Unemployment

36. In recent years, the Irish authorities have undertaken a range of reforms aimed at boosting medium-term growth and reducing unemployment. The main elements of these reforms have included:

  • Reforms of sheltered sectors: The authorities introduced two bills to the Oireachtas in the autumn of 2011 to improve competition in the legal and medical services sectors. The Legal Services Regulation Bill aims to increase transparency on legal costs, better protect customers, and create independent oversight bodies for professional misconduct and disputes over legal costs. Margins on pharmaceuticals were reduced and other legislation would make it easier for general practitioners to obtain contracts under the General Medical Services Scheme.
  • Improving competition enforcement: The Competition (Amendment) Act 2012 came into effect in July 2012 with the aim of strengthening enforcement of competition law. In addition, the authorities have recently increased the resources of the Competition Authority by about 25 percent.
  • Strengthening labor activation and training: The Pathways to Work initiative, adopted in February 2012, sets out a strategy to improve activation and training policies for the unemployed by (i) intensifying engagement between jobseekers and employment services, (ii) better aligning the provision of training with labor market needs, (iii) establishing effective enforcement mechanisms to ensure that jobseekers comply with activation and training requirements; (iv) strengthening links with employers to ensure a higher share of vacancies is filled by persons registered as unemployed; and (v) reforming institutions to deliver better services to the unemployed.
  • Facilitating labor market adjustment: Sectors covered by Employment Regulation Orders (EROs) and Registered Employment Agreements (REAs) were hit hard by the crisis, yet wage adjustment was limited.20 Moreover, a High Court ruling in July 2011 found sections of the legislation related to EROs to be unconstitutional. Accordingly, the authorities published a draft Industrial Relations (Amendment) Bill in December 2011, which following amendments in June, was signed into law in July 2012. Appropriately, the reform requires greater focus on economic conditions and competitiveness in wage setting, better safeguards employment in circumstances where the employer is unable to pay, and allows REAs to more readily be reviewed, challenged and cancelled. It also streamlines EROs by allowing for fewer sectors with EROs and a lower number of minimum wages set in each ERO, and by excluding employment conditions covered in other legislation. e.g., the Sunday pay rate. Next steps include a formal review of all EROs before re-negotiation under the new legislation can occur, most likely starting in 2013.

37. Against this backdrop, staff focused on policies to increase the potential for an employment-rich recovery and to contain structural unemployment.21 Although economic recovery will be the main vehicle to reduce unemployment, it is important to help ensure that the recovery is job-rich, and that jobseekers are willing and able to fill positions when they become available.

38. Education and training policies will be crucial to facilitate mobility of the unemployed to other sectors for the economy. Given the high share of unemployed persons with lower educational attainment, and the expectation that formerly booming sectors will only partially recover, there is a need to improve skills among the unemployed to facilitate the inter-sectoral reallocation of labor. Hence staff considered that:

  • Expansion of return-to-education programs like Youthreach, Back to Education, or Springboard is especially important, as short-term courses might be insufficient to provide jobseekers with marketable skills.
  • Course provision should be increasingly driven by effectiveness in meeting labor market needs. To achieve that, training outcomes should be evaluated on a regular basis, and the assessment results should be the key element in the decision process to expand or close the courses. In this respect, timely creation of the new authorities for further education and training (SOLAS and the Education and Training Boards) should be considered a priority, and the authorities could consider the introduction of a voucher system for courses.
  • Reform of the Community Employment (CE) scheme should be considered. Before it was moved to the Department of Social Protection, CE used to consume more than half of the training resources of the Irish National Training and Employment Authority. While a well designed public works program can help preserve jobseekers links with the labor market in an environment of depressed labor demand, it is important to ensure that over time entry to the scheme is limited to jobseekers without other employment possibilities. Moreover, participants should receive suitable training that will help them secure employment after their exit from the scheme.

39. Enhancing resources to help the long-term unemployed get back into the workforce is also needed. Staff strongly supported the direction of reforms of activation policies under the Pathways to Work initiative and encouraged sustained implementation effort in this area. Reform of welfare payments to avoid unemployment and inactivity traps, and reviews of PRSI on low-incomes and of minimum wages, also warrant consideration to maximize the employment benefits of economic recovery. In particular:

  • Private provision of employment services. The number of employment services staff with case worker training is low relative to the number of unemployed, which may impede more active engagement, so additional well trained case workers are needed. Involving private sectors firms with the provision of activation services should be considered, especially for the long-term unemployed, though international experience indicates careful design of such arrangements is crucial.
  • Principle of mutual obligation. To ensure jobseekers meet their obligations to actively seek employment and improve their skills and qualifications so as to reenter the labor market, it is critical to strictly apply the system of sanctions for jobseekers that are not complying with activation and training requirements.
  • Welfare benefits. The flat structure of unemployment payments results in replacement rates for the long-term unemployed that are high by international standards. The highest replacement rates affect those also receiving housing benefits, resulting in unemployment and inactivity traps that lower exit rates from unemployment, making it especially important to reform to reform the structure of social payments in this area.
  • Labor costs. Almost 9 percent of the work force, or over 60 percent of the unemployed, have been out of work for over a year. In these circumstances, it is important to maximize opportunities to regain access to the job ladder. One step would be to retain the reduced rate of PRSI for the lowest pay beyond 2013 if the planned evaluation of this measure shows it to be effective. While there are relatively few workers employed at the National Minimum Wage (NMW) of €8.65 per hour for adults, this has a broader impact through wage setting in EROs and REAs which cover almost one-quarter of employment. A reduction in the NMW should be considered given the broad fall in consumer prices including rents in recent years, and because it is notably above the minimum wage in Northern Ireland and the United Kingdom despite the highly integrated labor market. Nonetheless, with jobseeker payments at about 62 percent of the NMW (assuming a 35 hour work week), there are limits to reductions given the need to ensure the NMW provides adequate incentives to take up employment.

40. The authorities consider the reduction of unemployment a core priority. The Pathways to Work project is a major endeavor across a range of government bodies, and the authorities emphasized their full commitment to making the sustained effort needed to achieve a modern and effective approach to engaging with the unemployed and addressing their training and other needs to help them return to work. At the same time, they had no immediate plan to materially reform Community Employment, which played an important role in local communities. Regarding resources for employment services, they were considering how these needs could best be met, including the potential role for the private sector, where they had researched experience in Australia and the United Kingdom. The authorities noted they had identified issues in the structure of welfare payments, which are limited to a relatively small group of long-term unemployed also receiving housing supplements, and that the Housing Assistance Payment would address those incentive concerns. The authorities noted that as a share of average and median wages, Ireland’s minimum wage was not so high when compared with other countries, and that both coalition partners in the government had agreed to reverse an earlier reduction in the national minimum wage, so the authorities were not planning to review this matter.

Minimum Wage 1/

(Euro per hour)

Sources: OECD; IMF WEO; and IMF staff calculations.

1/ EA minimum wage is calculated as an average of the minimum wages in Belgium, Estonia, France, Greece, Ireland, Luxembourg, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Staff Appraisal

41. In the wake of an exceptionally deep banking crisis, the Irish authorities’ steadfast efforts have restored policy credibility. Determined actions have been taken to restructure, downsize, and recapitalize banks at a cumulative public cost of some 40 percent of GDP. Budgetary efforts have necessarily been substantial but social cohesion has been maintained through careful design and sound implementation of fiscal measures. Together with strong support from European partners, and expectations of a further strengthening of that support, these efforts have helped rebuild confidence as demonstrated by the recent successful return to the sovereign bond market. The underlying strengths of Ireland’s highly open economy allowed a return to growth in 2011 even as domestic demand continued to decline.

42. Risks to the economic outlook remain substantial nonetheless. The origin of Ireland’s crisis lay in debts accumulated to support the banking system, yet public debt remains high and continues to grow. The banking system is still in the process of restructuring its assets and operations, and is not yet meeting the financing needs of the economy. Households are dealing with high debts and depleted net wealth and some face deep financial distress. High unemployment plays a key role in such distress, and it also undermines skills and drives emigration. Small and medium enterprises bear the brunt of weak domestic demand and also have debt distress and some face more limited access to credit. The euro area crisis creates uncertainty for both financial markets and fixed investment. In these circumstances, the risks to economic recovery remain high, with profound implications for debt sustainability, including through potential effects on bank health if weak growth were to persist.

43. Ireland must continue to deliver on the many difficult steps needed to underpin a sustained economic recovery. Fiscal consolidation remains a necessary condition for sustainable growth, but needs to be conducted in as growth-friendly manner as feasible. To best support growth during this consolidation a revival of domestic demand must be facilitated, while also enhancing competitiveness and the readiness of the unemployed to take up jobs, as an employment intensive recovery is needed to reduce unacceptably high unemployment.

44. Deep and sustained financial sector reform efforts are needed to restore banks’ ability to support sound credit and revive domestic demand. The authorities have forcefully implemented their strategy to reorganize, recapitalize, and downsize the banking system, yet bank lending and profitability remain weak. A key remaining challenge is to arrest the deterioration in bank asset quality, where progress with loan workout and resolution has not advanced as rapidly as would be desirable. Ongoing supervisory pressure is needed for timely development of long-term solutions for distressed households, and to closely monitor their implementation over time. Intensive pursuit of a similar approach for loans to SMEs is important given their critical role in job creation. Reforms of the personal insolvency framework are key to help address borrower financial distress while maintaining debt service discipline and it will be important to ensure that the repossession framework complements these reforms in practice.

45. Returning the banks to profitability is needed for a lasting revival of lending, where breaking sovereign-bank linkages would greatly assist this process. Reducing funding and operational costs are needed to return the banks to profitability, and banks’ plans to reduce operational expenses must be fully implemented. Developing a roadmap to phase out the costly ELG Scheme in an orderly manner, while preserving access to funding, is appropriate. However, with limited viable funding alternatives, banks may continue to face high deposit rates. Temporary ownership of the banks by the ESM could overcome this hurdle, and by eliminating the need for guarantees and increasing access to other funding options, banks’ profitability and value could be much improved. In the process, their capacity to provide sound lending could be restored more quickly, supporting Ireland’s recovery.

46. Substantial further fiscal consolidation is needed, and a combination of strategies can help limit the impact on growth while protecting public services and the vulnerable. Careful targeting of spending is needed to deliver more immediate savings while ensuring supports and subsidies are directed to those who need them, where making benefits taxable is an option in some cases. State pensions are one area where targeted savings can be found, while further reductions in public sector wages cannot be excluded if wage bill targets cannot be met while ensuring adequate public services. Medium-term savings will entail deeper reforms of core government services, especially health and education, where service priorities must be identified, and reforms designed to deliver those services more efficiently so growing needs can be met at manageable cost. The Croke Park agreement can serve an important role in facilitating the timely implementation of these reforms. There is considerable scope for further base broadening measures to raise revenues while containing the drag on growth, and the introduction of a value-based property tax is important as a progressive and stable source of revenue.

47. Reducing unemployment requires firm implementation of a broad based approach. Although economic recovery will be the main vehicle to reduce unemployment, it is also important to ensure that jobseekers are willing and able to fill jobs when they become available. Realizing the full benefits of the Pathways to Work initiative will require additional well trained case workers to support jobseekers get back into employment, where involving private sector firms, especially for the long-term unemployed, could also play a useful role if well designed. Facilitating the mobility of jobseekers needs regular monitoring of training outcomes and effective delivery of further education and training. Reforming the structure of social benefits can support this strategy, especially by avoiding unemployment and inactivity traps for the long-term unemployed that are also receiving housing benefits, and other steps to reduce labor costs and promote a job-rich recovery should be explored.

48. The prospects for these efforts to succeed hinge on stabilization and recovery across the euro area and strengthened European support. Ireland’s small open economy has regained much of the competitiveness it lost during the boom, yet high trade and financial openness implies reliance on a revival of trading partner growth and calmer euro area financial conditions. Euro area leaders have pledged to break the vicious circle between banks and sovereigns by enabling the ESM to recapitalize banks directly, to treat similar cases equally, and to examine the situation of the Irish financial sector with the view of further improving the sustainability of Ireland’s well-performing adjustment program. Meeting these commitments is critical to improving Ireland’s debt sustainability and reviving sound lending, as stepping stones to ensuring Ireland’s economic recovery and durable return to private financing.

49. The next Article IV consultation with Ireland is expected to take place on a 24-month cycle.

Figure 4.Selected Trends in General Government Finances, 2007–15

Annex I. Assessing Ireland’s External Sector Risks1

Ireland’s external debt is high and the net international investment position (IIP) has reached negative 100 percent of GDP (though large valuation changes contributed to this deterioration). While the current account moved into surplus in 2010 and 2011, it did so in an environment of falling domestic demand which compressed imports. A range of methodologies indicate that the real effective exchange rate remains moderately overvalued, by around 5–10 percent, and the unemployment rate of 14.8 percent underscores the need to further improve competitiveness to support a job-rich recovery.

Net International Investment Position and External Debt

Ireland’s net negative IIP is large. Excluding the IFSC, it deteriorated from about minus 55 percent of GDP in the years to 2007 to minus 92 percent of GDP in 2009 and has remained around that level since. The level of the net IIP was not regarded as an issue during the boom because of its moderate size and the collapse in risk premiums prior to the crisis. However, as the financial crisis started to unfold, the value of Ireland’s gross foreign assets halved, while the retrenchment in external financing lowered foreign liabilities, though to a smaller extent, resulting in an enlarged negative net IIP. It is important to note that the extent of the fall in the net IIP was not matched by the cumulative current account deficit, suggesting that valuation changes, especially on the foreign assets, may have contributed significantly to the deterioration (see Lane (2012)). Rising gross government debt added to the negative net position as the Irish authorities resorted to official funding. The net external liabilities of the CBI also grew, due to an increased reliance of domestic banks on Eurosytem funding, although most of this substituted for private wholesale lending, de facto reducing the external risks. At the end of Q1 2012 Ireland’s gross external debt stood at around 300 percent of GDP, 40 percent of which was official external debt of the general government and CBI.

Current Account Improvement

Current account adjustment is already underway, albeit in part due to cyclical factors. Exports have risen 14 percent since 2009, with goods exports registering 9 percent growth, while services exports increased by over 20 percent. However, declining domestic demand compressed merchandise imports, which in 2011 stood 15 percent below their pre-crisis peak. As a result, the current account balance recorded a surplus of 1.1 percent of GDP in 2010 and 2011, significantly improved from the peak deficits of over 5 percent of GDP in 2007–08.

Real Exchange Rate Developments

Indicators based on consumer prices and ULCs indicate that the real exchange rate remains moderately overvalued, although the size of the competitiveness gap is narrowing. Since the peak in 2008, the CPI-deflated REER fell 17.5 percent while the ULC-deflated REER declined even more (around 22 percent). Productivity improvements and falling ULCs were the major factors behind this depreciation, though they came at the cost of significant labor shedding—some 16 percent since 2008—resulting in an unemployment rate of 14.8 percent. Nominal labor costs fell by 3 percent since the 2009 peak, which is more significant when compared with the 4½ percent rise in nominal labor costs in the euro area during the same period. The weakening euro helped as well, given Ireland’s extensive trade links with non-euro area countries (notably, the United Kingdom and United States).

Change in Labor Costs in Manufacturing and Construction

(Percent, 2009–2011)

Source: Eurostat.

Contributions to Changes in REER 1/

(Percentage change)

Sources: ECB; Eurostat; IMF INS; Haver Analytics; and IMF staff calculations.

1/ Changes are with respect to the peak for Ireland which was in 2008-Q2.

However, compositional changes in the economy have led to some overstatement of the competitiveness improvement by conventional measures. A contraction of a low-productivity yet high-wage sector (e.g. construction) could lead to an increase in average productivity and a fall in average wages in the economy even if no changes in other sectors took place. CBI (2011) estimates that compositional effects could account for 40 percent of the decline in the headline ULC between 2007 and 2010 (see also O’Brien (2010)).

Real Exchange Rate Assessment

Standard methods of assessing the real exchange rate indicate that it remains moderately overvalued:

  • Direct estimation of the deviation from equilibrium of the real exchange rate based on a set of macroeconomic variables points to 8 percent overvaluation under the CGER2-type Equilibrium Real Exchange Rate method, and 12 percent overvaluation under External Balance Assessment. This is in part due to a modest overvaluation of the euro, notwithstanding its recent nominal depreciation.
  • The CGER-type Macrobalance Approach indicates a norm for the current account of a 0.6 percent of GDP deficit. This is below the projected underlying value of the current account of 2.4 percent of GDP, which the medium-term projection adjusted for any remaining output gaps. Nonetheless, as the projection allows for a 2.5 percent real exchange rate depreciation given high unemployment, this approach suggests that the exchange rate is fairly valued.
  • A variant on the CGER-type Sustainability Approach would note that a higher current account balance would be required to unwind the large negative IIP. For example, to reduce the net IIP liability to a lower level of 35 percent of GDP (the indicative guideline for net foreign liabilities under the European Commission’s Macroeconomic Imbalance Procedure) in the next ten years, Ireland would have to run a current account surplus of around 4 percent of GDP each year. To stabilize the current account balance at this level thereafter would require additional depreciation, implying around 3.5 percent overvaluation.

Policy implications

Even as the large negative net IIP position is not a pressing source of risk, further competitiveness gains are important to help accelerate the reduction in unemployment. The IIP can be expected to improve over time, in part as a result of private saving exceeding investment in order to reduce private debt, and also as a consequence of continued fiscal consolidation needed to ensure public debt sustainability. Further improvements in competitiveness will facilitate this adjustment being achieved with higher overall activity levels. Setting aside the external sector perspective, there is also a need for further improvements in competitiveness in order to encourage a job-rich recovery, where strong growth in the tradable sector is important to compensate for the likelihood that the recovery in domestic demand will be a protracted process.

Annex Figure 1.Ireland: Competitiveness Indicators

Competitiveness continues to improve, helped by nominal depreciation of the euro…
Annex II. Debt Sustainability Analysis

This Annex presents the public and external debt sustainability analysis based on staff’s revised medium-term macroeconomic framework and the Irish authorities’ fiscal consolidation plan.

General Government Debt

The upward revision in nominal GDP has resulted in a lower debt path. An upward revision of nominal GDP by 1.6 percent in 2011 has lowered the debt ratio by some 1.7 percentage points.1 Combining the higher 2011 GDP outturn with the slightly lower growth path in staff’s medium term scenario (see Table 2) reduces the debt ratio by some 0.9 percentage points in the medium term. Overall, debt is projected to peak at 119 percent in 2013, slightly lower than in the previous review and some 5 percentage points below the projection at program inception.

While prefinancing has temporarily increased gross debt in 2012, fiscal consolidation will put debt on a declining path after 2013. The authorities’ decision to prefinance a larger portion of their 2013 financing needs increases gross debt temporarily by €3.2 billion (2 percent of GDP). The resulting end 2012 cash buffer is projected to increase to a very strong €18 billion (11 percent of GDP) before returning to previous levels during 2013.2 Based on the authorities’ continued adherence to their medium-term fiscal plans, the primary deficit is assumed to fall below the debt stabilizing threshold in 2014. Under the baseline scenario of a deficit declining towards its 0.5 percent of GDP Medium-Term Objective by 2019, gross general government debt is projected to fall to 94 percent of GDP by 2021.

Risks to debt sustainability remain high:

  • Risks to growth are the key concern. A slower economic expansion in the medium term could easily derail the baseline outlook, with debt rising to 146 percent of GDP by 2021 if GDP growth were to stagnate at ½ percent per year. Close fiscal-banking linkages could also cause additional debt-increasing outlays if banks incur additional loan losses under such a scenario. However, a temporary growth shock remains manageable. If GDP growth temporarily slowed to only ½ percent in 2013 (vis-à-vis the current projection of 1.4 percent) before accelerating along the current baseline path, gross general government debt would instead peak at 120 percent of GDP before declining to 96 percent by 2021.
  • Contingent liabilities present a sizable risk. Identified contingent liabilities are falling as the ELG Scheme is phased out. However, as long as the state continues to own large stakes in the banking system, economic shocks can amplify risks to debt sustainability given the potential realization of contingent liabilities from banking losses. Other contingent liabilities arise from NAMA and IBRC. The IBRC meets bank capital requirements, and NAMA acquired assets at heavy discounts—averaging 57 percent—to protect its viability. Nonetheless, asset recoveries by both institutions in the coming years remain subject to property price and other risks. A standard 10 percent contingent liability shock would capture one-third of the gross contingent liabilities from NAMA and IBRC, and would impose a parallel shift on the debt path, taking it to 105 percent of GDP in 2021, compared with 94 percent in the baseline.
  • Divestments of state participation in the banking sector are an upside risk. No allowance for ESM equity investments in the banking sector or other bank equity divestments is made. Similarly, the projections do not allow for the modest state asset disposal program, as preparations are still underway and half the proceeds are to be reinvested.
  • Interest rate shocks pose less immediate risks to the debt trajectory. Ireland has a high share of fixed rate borrowing which shields it from the immediate effect of higher interest rates. The interest bill is also contained by the fact that one third of the debt stock consists of official debt at yields below prevailing market rates. The current baseline scenario includes the effect of higher average interest rates as Ireland returns to market financing at elevated spreads. An additional shock to the cost of new funding (including short term debt) of 200 basis points would have a negligible impact in the short run. If such a shock was sustained, it would increase the effective interest rate by 140 basis points in 2021, and debt would decline more gradually to 101 percent of GDP in 2021.
Ireland Contingent Liabilities(in percent of projected 2012 GDP)
Senior NAMA bonds18.9
Guarantees for Emergency Liquidity Assistance10.0
Other Bank Liabilities covered by Eligible Liability Scheme18.6
Total47.5
Source: Irish authorities; and IMF staff calculations.
Source: Irish authorities; and IMF staff calculations.

External Debt

The external debt of the non-IFSC sector continues to decline, though it remains at a very high level.3 At the end of Q1 2012, it fell to around 300 percent of GDP, from 322 percent of GDP recorded in 2011.4 This decline mostly represented a continued fall in the external debt of the Central Bank of Ireland, as Target 2 liabilities declined as banks reduced their reliance on Eurosystem funding. At the same time, debt of the general government continued to rise as the authorities drew on the external support under the EU-IMF program, though this increase was more than offset by falling debt of the other sectors.

By 2017, external debt is expected to fall to 212 percent of GDP, but this forecast is subject to substantial downside risks. A macroeconomic scenario at historical averages would not put the debt-to-GDP ratio on a declining path, bringing the external debt to over 316 percent of GDP in 2017. A permanent ½ standard deviation shock to growth, implying a renewed recession in 2013 and significantly slower recovery thereafter would raise the medium-term debt-to-GDP ratio to 239 percent of GDP. A permanent ½ standard deviation shock to the non-IFSC current account (excluding interest payments) would raise debt by around 22 percentage points compared to the baseline in the medium term. A standard combined shock of ¼ of the standard deviation applied to the current account, interest rates, and the GDP growth rate would increase debt to 241 percent of GDP in the medium term.

Including the IFSC, total external debt remains very high, at around 1,025 percent of GDP in Q1 2012, down from 1,075 percent at end 2011. In addition to a reduction in the non-IFSC debt, the IFSC has reduced its gross external debt by 27 percentage points of GDP since end 2011. The net IIP deteriorated to 100 percent of GDP as the IFSC’s net IIP position turned negative, while non-IFSCs reduced their external exposure.

External Debt Composition, 2012–Q1

(Percent of projected 2012 GDP)

Sources: Central Statistics Office Ireland; and IMF staff calculations.

Ireland: Net International Investment Position(In percent of GDP)
2005200620072008200920102011Q1–2012
Assets1,0311,1321,2031,2761,5031,69716871673
Direct investment abroad54525468127163153158
Portfolio investment abroad615692709707839932901954
Other investment abroad362388439501536602633560
Reserve assets00001111
Liabilities1,0561,1371,2221,3531,5961,78617831773
Direct investment to Ireland85677376108137122128
Portfolio investment to Ireland6296897057169081,06610851101
Other investment to Ireland342382444561580583576545
Net investment position−25−5−20−76−93−89−96−100
Direct investment, net−31−15−19−819263031
Portfolio investment, net−1545−9−69−134−184−147
Other investment, net 1/206−5−60−44185716
Reserve assets00001111
Memorandum items
Net IIP of the IFSC15−1
Net IIP of the non-IFSC−111−99
Source: Central Statistics Office.

Includes valuation changes and errors and omissions.

Source: Central Statistics Office.

Includes valuation changes and errors and omissions.

Annex I Table 1.Ireland: Public Sector Debt Sustainability Framework, 2007–2021 1/(In percent of GDP, unless otherwise indicated)
ActualProjections
200720082009201020112012201320142015201620172018201920202021Debt-stabilizing
1Baseline: General government debt24.844.265.292.5106.5117.7119.3118.4115.0111.5108.4105.0101.297.694.1primary

balance 10/

1.2
2Change in general government debt0.119.420.927.314.011.31.6−0.9−3.4−3.4−3.1−3.4−3.8−3.6−3.5
3Identified debt-creating flows (4+7+12)−1.68.723.935.718.06.54.50.5−2.1−2.8−3.0−3.3−3.7−3.5−3.4
4Primary deficit−1.16.09.78.15.94.32.1−0.5−2.5−2.9−3.5−4.2−4.7−4.6−4.6
5Revenue and grants36.335.033.734.134.134.534.534.834.734.334.134.134.134.134.1
6Primary (noninterest) expenditure 2/35.140.943.442.240.038.836.734.332.131.330.629.929.429.529.5
7Automatic debt dynamics 3/−0.52.87.45.11.52.22.41.00.40.20.50.91.01.11.2
8Contribution from interest rate/growth differential 4/−0.52.87.45.11.52.22.41.00.40.20.50.91.01.11.2
9Of which contribution from real interest rate0.72.03.93.42.82.64.03.93.63.33.53.53.63.53.6
10Of which contribution from real GDP growth−1.20.83.51.7−1.3−0.4−1.6−2.9−3.2−3.1−3.1−2.6−2.5−2.4−2.3
11Contribution from exchange rate depreciation 5/0.00.00.00.00.0
12Other identified debt-creating flows0.00.06.822.510.60.00.00.00.00.00.00.00.00.00.0
13Privatization receipts (negative)0.00.00.00.00.00.00.00.00.00.00.00.00.00.00.0
14Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.00.00.00.00.0
15Other (bank recapitalization) 6/0.00.06.822.510.60.00.00.00.00.00.00.00.00.00.0
16Residual, including asset changes (2–3) 7/1.710.7−3.0−8.4−4.04.7−3.0−1.4−1.3−0.7−0.1−0.1−0.1−0.1−0.1
General government debt-to-revenue ratio68.5126.5193.1271.0312.0341.0345.4340.2331.7325.6317.7307.7296.6286.0275.9
Scenario with key variables at their historical averages 9/117.7117.8119.3121.0123.3126.2129.1132.1135.1138.11.5
Scenario with no policy change (constant primary balance) in 2012–2021117.7121.5125.4128.8132.7137.4142.8148.4154.2160.42.0
Key Macroeconomic and Fiscal Assumptions Underlying Baseline
Real GDP growth (in percent)5.2−3.0−7.0−2.61.40.41.42.52.82.82.92.52.52.52.5
Average nominal interest rate on public debt (in percent) 10/4.55.34.14.73.63.84.74.84.94.75.05.05.25.35.4
Average real interest rate (nominal rate minus change in GDP deflator, in percent)3.27.68.25.03.12.53.53.43.23.13.43.43.63.73.8
Nominal appreciation (increase in US dollar value of local currency, in percent)7.40.0−5.4−5.1−0.3
Inflation rate (GDP deflator, in percent)1.3−2.3−4.1−0.30.51.31.21.41.61.61.71.61.61.61.6
Growth of real primary spending (deflated by GDP deflator, in percent) 2/14.213.0−1.4−5.2−3.9−2.6−4.2−4.2−3.60.30.50.20.72.82.6
Primary deficit 2/−1.16.09.78.15.94.32.1−0.5−2.5−2.9−3.5−4.2−4.7−4.6−4.6

General government gross debt. The projections include Fund and EU disbursements. Government-guaranteed NAMA bonds are excluded, based on Eurostat guidance. From 2018, no policy change is assumed.

Excluding bank support costs.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

Total bank recapitalization costs net of proceeds, including funds provided by the National Pension Reserve Fund.

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt and short-term debt at end of previous period, and bank recapitalization costs.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

General government gross debt. The projections include Fund and EU disbursements. Government-guaranteed NAMA bonds are excluded, based on Eurostat guidance. From 2018, no policy change is assumed.

Excluding bank support costs.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

Total bank recapitalization costs net of proceeds, including funds provided by the National Pension Reserve Fund.

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt and short-term debt at end of previous period, and bank recapitalization costs.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Annex I Figure 1.Ireland: Public Debt Sustainability: Bound Tests 1/

(General government debt in percent of GDP)

Sources: International Monetary Fund, country desk data, and staff estimates.

1/ Shaded areas represent actual data. The interest rate shock is a permanent 200 basis point shock applied to short-term debt and new market lending, the growth shock is a stagnation of growth at 0.5 percent per annum, and the primary balance shock is a one-half standard deviation shock. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ Permanent 1/4 standard deviation shocks applied to the growth rate, interest rate, and primary balance.

3/ One-time 10 percent of GDP shock to contingent liabilities occur in 2013.

Annex I Table 2.Ireland: External Debt Sustainability Framework, 2007–2017(In percent of GDP, unless otherwise indicated)
ActualProjections
20072008200920102011201220132014201520162017Debt-stabilizing non-interest current account 6/
1Baseline: External debt258.9305.0325.6333.7322.1308.7291.9271.7250.4230.6211.8-0.8
2Change in external debt51.746.120.68.1−11.6−13.4−16.7−20.2−21.3−19.8−18.8
3Identified external debt-creating flows (4+8+9)−2.622.836.218.0−0.8−9.2−13.1−16.2−16.9−15.9−15.0
4Current account deficit, excluding interest payments1.0−6.2−5.5−14.1−19.2−20.3−19.7−18.5−18.7−18.6−18.4
5Deficit in balance of goods and services−5.5−5.0−11.1−13.8−17.0−17.8−19.2−20.0−20.7−21.1−21.3
6Exports69.072.078.086.891.092.194.095.596.497.698.6
7Imports−63.5−66.9−66.8−73.0−73.9−74.3−74.9−75.4−75.7−76.5−77.4
8Net non-debt creating capital inflows (negative)0.0−0.6−2.56.02.6−7.2−6.8−6.3−6.1−5.7−5.4
9Automatic debt dynamics 1/−3.729.644.226.115.718.313.48.67.98.58.7
10Contribution from nominal interest rate8.315.410.916.121.019.417.615.615.315.315.1
11Contribution from real GDP growth−10.65.818.52.6−4.7−1.1−4.2−7.0−7.4−6.8−6.3
12Contribution from price and exchange rate changes 2/−1.58.514.87.4−0.6
13Residual, incl. change in gross foreign assets (2–3) 3/54.323.3−15.6−9.8−10.8−4.2−3.7−4.0−4.4−3.9−3.7
External debt-to-exports ratio (in percent)375.2423.9417.7384.4354.1335.2310.4284.7259.8236.3214.8
Gross external financing need 4/17.757.3393.9354.7337.5330.6325.7320.9316.3312.8309.1
in percent of GDP9.432.0244.3226.7212.3204.5196.3186.1175.5166.1157.0
Scenario with key variables at their historical averages 5/10-Year10-Year308.7310.1311.6313.1314.7316.2
HistoricalStandard
Key Macroeconomic Assumptions Underlying BaselineAverageDeviation
Nominal external interest rate (in percent)4.35.63.24.86.44.61.36.15.95.65.96.46.8
Growth of exports (in percent)8.4−1.2−2.38.06.54.04.72.94.85.55.65.85.7
Growth of imports (in percent)9.50.0−10.06.02.92.77.12.23.44.74.95.55.8
Current account balance, excluding interest payments−1.06.25.514.119.25.68.420.319.718.518.718.618.4
Net non-debt creating capital inflows0.00.62.5−6.0−2.6−2.94.17.26.86.36.15.75.4

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (∊ > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (∊ > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Annex I Figure 2.Ireland: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Ireland desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2013.

1

Price declines were broad based, with the share of the 616 items in the CPI that fell on an annual basis peaking at 84 percent in March 2010; see Colin Bermingham, Recent Trends in Irish Expenditure and Prices.

2

This is part of the total recapitalization cost of €64.1 billion, or some 40 percent of GDP.

3

For a description of the EU–IMF supported program, see Ireland—Request for an Extended Arrangement.

4

Real and nominal GDP data for 2008–11 have recently been revised upward by the Central Statistical Office (CSO), affecting historical ratios to GDP.

5

The three PCAR banks are: Allied Irish Banks (AIB), Bank of Ireland (BoI), and Permanent TSB (PTSB), with public sector stakes of 99.9 percent, 15.2 percent, and 99.0 percent, respectively.

6

Household consumption, debt, and saving linkages are discussed in Chapter I of the selected issues paper, where a gradual consumption recovery is consistent with an easing in household debt burdens over time.

7

Staff also confirmed that there have been no changes to Ireland’s exchange system since the last Article IV consultation in July 2010. Ireland maintains an exchange system free of restrictions on payments and transfers for current international transactions (see Informational Annex).

9

Underpinning the progress in reforming the banking system, the authorities put in place a permanent bank resolution framework in October 2011 (see Box 2 in Ireland—Fourth Review Under the Extended Arrangement). This framework, which implements a key recommendation of the 2010 Article IV consultation, initially exists in parallel with an emergency regime adopted during the crisis that is expected to be phased out by end 2012.

10

An overview of the new regime is in Box 2 of Ireland—Fifth Review Under the Extended Arrangement.

11

Lending to SMEs and households is discussed in Chapter II of the selected issues paper.

12

In comparison, per capita GDP growth was 45 percent over 2000–08 and 24 percent over 2000–11.

13

The authorities expect to update this statement in October 2012, in preparation for Budget 2013.

14

For evidence on past European consolidations, see Abbas et al (2011). For a summary view on the Latvian case, see Blanchard (2012).

15

Between 2012 and 2020, Ireland’s population of over-65 year olds will rise by about one-third, while there will be a roughly 15 percent increase in the number of primary school age children.

16

A detailed analysis of Ireland’s medium-term fiscal consolidation options is provided in Chapter III of the selected issues paper.

17

The 2011 combined spending on these items was about 3½ percent of GDP.

18

For a recent staff analysis of the public wage bill, see Box 5 in Ireland—Sixth Review under the ExtendedArrangement – IMF Staff Report.

19

Due to very high entry points for income tax and employee PRSI, and despite elevated marginal rates for those around the average wage, Ireland’s effective PIT rates are quite low for persons earning up to 167 percent of average wage. Similarly, due to several lower-tier rates, the relatively-high 23 percent standard VAT rate currently applies to just half of consumption.

20

EROs, prepared by Joint Labor Committees (a government-appointed chairman and representatives of workers and firms) applied mostly to low-skill sectors such as retail, catering, and accommodation and set minimum wages for the sector (10 percent above the national minimum wage on average) as well as other employment conditions, such has overtime or Sunday rates. REAs are collective agreements registered with the Labor Court, which then became legally binding on the individual firm, or—in case of industry-wide agreements (mainly in construction and electrical contracting)—for all employees and workers in the sector. EROs and REAs cover approximately 23 percent of private sector workers (Report of the Independent Review of Employment Regulation Orders and Registered Employment Agreement Wage Setting Mechanisms, 2011).

21

Averting structural unemployment is discussed in Chapter IV of the selected issues paper.

1

The analysis excludes the International Financial Services Centre (IFSC), which comprises of a broad range of financial institutions including banks, insurance companies, investment funds, and their support firms, which provide financial services mostly to nonresidents, constituting a de facto offshore financial center.

2

See Lee et al. (2008), “Exchange Rate Assessments: CGER Methodologies,” IMF Occasional Paper No. 261

2

The cash buffer is based on the assumption that financing contingencies are not being spent.

3

The discussion focuses on the non-IFSC sector, as the IFSC principally serves nonresidents.

4

This gross debt figure includes debt of large multinational corporations, including both intra-company and intra-group debt, which is expected to be sizable in Ireland.

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