Ireland: Staff Report for the 2005 Article IV Consultation
Author: International Monetary Fund
Publication Date:
17 Oct 2005
eISBN:
9781451818819
Language:
English
Keywords:
ISCR; CR; price; house price appreciation; Ireland; asset ratio; GDP; housing market; unemployment rate; General government; deposits ratio; government balance; Housing prices; Wages; Global
Download PDF (308.5 KB)

This 2005 Article IV Consultation for Ireland reports that economic performance has been impressive, owing in significant measure to sound policies. In line with the global cycle, growth picked up strongly in 2004. Rapid employment growth has been supported by immigration, so the unemployment rate has been roughly unchanged and wage growth remained moderate. Housing price appreciation has slowed, but housing prices are high on various measures. Important progress has been made in preparing for population aging, but there are concerns that households are not saving enough for retirement.

Abstract

This 2005 Article IV Consultation for Ireland reports that economic performance has been impressive, owing in significant measure to sound policies. In line with the global cycle, growth picked up strongly in 2004. Rapid employment growth has been supported by immigration, so the unemployment rate has been roughly unchanged and wage growth remained moderate. Housing price appreciation has slowed, but housing prices are high on various measures. Important progress has been made in preparing for population aging, but there are concerns that households are not saving enough for retirement.

I. Background

1. Economic performance in Ireland was extraordinary during the 1990s and has remained impressive in recent years. Real GNP grew by 6½ percent per year on average between 1990–99 and by 4¾ percent per year during the 2000-04 cycle.1 The unemployment rate fell sharply to one of the lowest rates among industrial countries. HICP inflation is now

uA01fig01

Real GDP Growth

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

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Unemployment Rate

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

close to the euro area average. This remarkable performance reflected both good policies and fortunate circumstances. Prudent government spending created the scope for reductions in both public debt and taxes. Social partnership agreements and income tax cuts supported wage moderation, which—along with low corporate tax rates, EU membership, and the global ICT boom—encouraged investment. The EU provided funds for infrastructure investment, and participation in EMU lowered interest rates. Favorable demographics increased the share of the working-age population.

2. Following a downturn in 2001-02, real GNP growth picked up in 2003-04 (Table 1). Notwithstanding the appreciation of the euro, export growth rebounded in line with the global upturn, and net exports made an increased contribution to growth. Investment accelerated strongly, supported by improving business confidence and low ECB interest rates. Consumption growth was somewhat less buoyant, reflecting contractionary fiscal policy and a slow recovery of consumer confidence from its post-ICT boom decline. All in all, real GNP expanded by 5½ percent in 2004.

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Real GNP Growth

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

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Contributions to Growth

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Table 1.

Ireland: Selected Economic Indicators

(Annual change unless otherwise stated)

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Sources: Department of Finance; Central Bank of Ireland; IMF, International Financial Statistics; and Fund staff calculations.

Based on National Income and Expenditure, compiled in accordance with the new European System of National Accounts (ESA 95).

Underlying productivity growth data may be overstated because of problems related to the measurement of output produced by multin companies operating in Ireland.

The methodology used to compile M3 has been amended in line with Eurosystem requirements. Therefore, there is a break in the seri

As of April 2005.

Adjusted change, which includes the effects of transactions between credit institutions and non-bank international financial companie effects arising from exchange rate movements.

As of March 2005.

Excludes allocations for financing of future pensions liabilities and one-off expenditures.

3. In line with the economic upturn, labor demand strengthened in 2004. Employment grew by 3 percent, boosted by immigration, especially from new EU member states. As a result, the unemployment rate was roughly unchanged at 4½ percent, and wage growth in the private sector remained moderate. However, with the appreciation of the euro, compensation per employee is now higher in Ireland than in the EU-15 or the U.K. The dampening impact of euro appreciation on consumer prices more than offset upward pressure from higher oil prices, so average HICP inflation fell to 2¼ percent.

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Gross Compensation per Employee

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Source: AMECO.
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Inflation

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Source: EuroStat.

4. House price appreciation has slowed, but house prices remain relatively high. The pace of house price increases has slowed gradually since mid-2003 to 3–5 percent (annual rate) in recent months (Figure 1). In line with easing house price appreciation, the rise in house completions has slowed. However, staff analysis suggests that not all of the increase in house prices over the past several years can be attributed to fundamentals and that the estimated house price overvaluation in Ireland is relatively large compared to other countries (though—given the inherent uncertainties in these types of calculations—it is difficult to be precise about the degree of overvaluation).2 The size of the construction sector is correspondingly large, with the ratio of gross value added in construction to GNP surpassed only by Spain in Europe. Despite slowing house price appreciation, mortgage credit growth remains high, and household debt as a share of disposable income continues to rise sharply.

Figure 1.
Figure 1.

Ireland: Housing Market Indicators

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

5. A center coalition government has been in power since June 1997 and was reelected in May 2002. Fianna Fail, the senior coalition partner, lost ground at the local and European elections in June 2004. In the subsequent cabinet reshuffle, a new minister for finance was appointed. General elections must take place by mid-2007.

II. Report on the Discussions

6. Ireland’s continuing economic success reinforces the view that good policies have powerful effects. Indeed, the economy is enviably well positioned to sustain strong growth over the medium term. Nonetheless, the authorities and staff acknowledged that even good policies can be improved, that turbulence from various disturbances—both domestic and external—is always a risk, and that population aging presents challenges. As in recent years (Box 1), the discussions focused on attuning policies to the key challenges to maintaining strong economic performance:

  • Given rapid real GNP growth recently, could the continuation of very strong growth give rise to pressures on capacity constraints?

  • How can fiscal policy help to relieve potential overheating and build a cushion in the event that downside risks, notably in the housing market, materialize?

  • Is competitiveness at risk, and how can the forthcoming national wage agreement and public sector benchmarking exercise help to safeguard it?

  • With credit growth—especially to the property sector—remaining high, what further efforts are needed to maintain financial stability?

  • From a longer-term perspective, how can households be encouraged to save for retirement, given Ireland’s relatively frugal state pension system?

Fund Policy Recommendations and Implementation

Ireland’s impressive economic performance since the early 1990s reflects in significant measure the implementation of sound policies consistent with Fund advice. In recent years, the authorities have generally responded appropriately to policy challenges identified in previous consultations (the 2004 PIN is available at http://www.imf.org/external/np/sec/pn/2004/pn04122.htm):

Fiscal policy: The authorities are committed to the SGP, including the medium-term fiscal objective of close to balance or surplus, which the Fund fully supports. However, the fiscal stance has tended to be procyclical, contrary to Fund recommendations. To limit the potential for procyclical stimulus while increasing the predictability, transparency, and efficiency of spending, the Fund has called for a medium-term expenditure framework. Spending envelopes have been introduced for capital spending but not for current spending.

Wage policies: The present three-year national wage agreement contained a considerable degree of wage moderation relative to the past and offered no fiscal concessions, consistent with Fund recommendations. However, progress in limiting public sector wages has been more limited.

Housing market: The authorities’ public communication strategy to tame expectations and help induce a soft landing in the housing market, as well as the absence of new fiscal measures to attempt to fine tune the housing market, have been in line with Fund advice.

Financial sector: Financial supervision has been and continues to be strengthened along the lines recommended in the 2000 FSAP and subsequent consultations. An FSAP Update is planned for 2006.

Competition: The pace of regulatory reform has been slower than recommended by the Fund.

A. Outlook: Strong Growth Creates Potential for Wage Pressures

7. The authorities and the staff agreed that economic growth is likely to be very strong in the short term (Table 2). Staff project real GNP growth in 2005-06 of about 5 percent, driven by an acceleration in private consumption, in turn supported by strong employment and income growth, fiscal stimulus in 2005, and withdrawals from the Special Savings Incentive Accounts (SSIAs) that will begin in mid-2006.3 Business investment is expected to remain robust, reflecting low interest rates and the continued strength of the global economy. With the gradual cooling of the housing market, residential investment is projected to decline modestly starting next year. Net exports are expected to continue to make significant contribution to growth, but at a declining rate, as domestic demand in Ireland is stronger than that in its main trading partners. Officials at the central bank and the Department of Finance gave broadly similar characterizations of the outlook.

Macroeconomic Projections

(Percentage change, unless otherwise indicated)

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Contributions to growth

In percent of potential output

3/ In percent of GDP
Table 2.

Ireland: Contributions to GDP Growth, 2001-06

(In percent) 1/

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Source: Fund staff estimates.

Rounding may effect totals.

8. The shared view was that the economy is at about full employment, so continued rapid growth could give rise to overheating. The unemployment rate in the first quarter was 4¼ percent, not far from its historical low and in the vicinity of most estimates of the NAIRU. While there are uncertainties about the economy’s supply potential, including with regard to the role of immigration in relieving incipient labor shortages, there was agreement that projected growth in 2005-06 is somewhat above potential growth, which could give rise to upward pressures on wages and prices. Staff’s baseline projection is for a slight increase in HICP inflation to 2½ percent next year.

uA01fig07

Output Gap 1/

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

1/ Staff Projections.
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Unemployment Rate

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

9. The authorities and staff agreed that a further erosion of external competitiveness would be a concern. The economy-wide ULC- and CPI-based real effective exchange rates have appreciated substantially since 2002, though the pace of appreciation slowed in 2004.4 Real effective exchange rate appreciation has reflected a combination of nominal effective exchange rate appreciation and relatively high growth of prices and wages.

uA01fig09

Nominal and Real Effective Exchange Rates

(24 trading partners, economy-wide)

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Source: Euro Stat.
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Ireland’s Exprt Share

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

With the strengthening of the euro against the U.S. dollar and—to a lesser extent—sterling, the nominal effective exchange rate has increased by about 14 percent since 2002. At the same time, consumer price and economy-wide ULC inflation rates in excess of partner country rates have raised Ireland’s cost levels above those of its main trading partners. Notwithstanding the real effective exchange rate appreciation, the authorities noted that the pipeline of inward foreign direct investment remains healthy and prospects for export growth continue to be strong (Table 3). Staff did not see the current level of competitiveness as an immediate, major concern, observing that Ireland’s share of industrial country exports of goods and services—after rising during the late 1990s—now appears to have stabilized.

Table 3.

Ireland: Summary of Balance of Payments 2001-06

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Sources: The Central Statistics Office; and Fund staff estimates.

10.The housing market is widely regarded as headed for a soft landing, though the authorities and staff acknowledged the risk of a sharp decline. Survey evidence suggests that expectations of house price appreciation have declined in line with the easing of actual house price appreciation. The authorities argued that the underlying demand for housing is relatively strong, noting that the number of dwellings per capita in Ireland is still low compared to other advanced economies in Europe. Nonetheless, the authorities and staff agreed that house prices are relatively high on a variety of measures, including the price-earnings ratio in the housing market, which is still about double its historical average and one-and-a-half times its 2002 level. Although the authorities cited estimates that only about one sixth of the houses built between 2000-04 are second homes or buy-to-let properties, market analysts indicate that a much higher percentage of recent construction falls into these two categories.

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Dwellings per 1000 Inhabitants, 2002

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

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Ratio of Average House Price to Rental Income

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Sources: CSO; Department of Environment; 2003 Quarterly National Household Survey; and staff calculations.
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House Prices and Household Saving 1/

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

1/ 2003 and 2004 data are ESRI estimates.

11. The authorities and staff saw the risks to the forecast as being broadly balanced. Upside risks include stronger-than-expected effects of fiscal stimulus and recovering confidence on domestic demand, especially private consumption and residential investment. On the downside, the key domestic risk is that the housing market could slow more quickly than currently envisaged, with adverse consequences for employment and wealth. However, the house price boom does not appear to have depressed household saving, so price declines would not necessarily weaken consumption directly. The main external risks are oil prices and the possibility of a disorderly resolution of global imbalances, which could sharply dampen external demand and inward foreign direct investment.

B. Fiscal Policy: Avoiding Procyclicality and Building a Cushion

12. Ireland’s public finances are currently strong, but staff noted that fiscal policy has been procyclical in recent years (Table 4). Gross public debt is about 30 percent of GDP, among the lowest in the EU; taxes on labor and business income are relatively low; and the general government fiscal position has been either close to balance or in surplus since 1996. However, fiscal policy was expansionary during 2001-02, when economic activity was somewhat higher than potential, and contractionary during 2003-04, when the output gap was negative. In addition, staff analysis finds that between 1991–2003 revenue windfalls, reflecting higher-than-projected economic growth, were usually associated with increased spending (Box 2). The improvement in the general government balance in 2004 (of 1.1 percent of GDP to a surplus of 1.3 percent of GDP) was much stronger than expected, reflecting higher-than-projected growth and one-off factors (receipts from revenue investigations and underspending of the capital budget).

Table 4.

Ireland: General Government Finances

(In percent of GDP)

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Sources: Department of Finance and Fund staff estimates.

Revenues in 2002 exclude UMTS receipts of 0.2 percent of GDP.

Favorable Fiscal Surprises: Luck or Prudence?

Public debt has fallen sharply, reflecting in part favorable fiscal surprises, i.e., outcomes that exceeded budget projections. Staff analysis finds that favorable surprises between 1995–2003 reflected primarily fortunate circumstances (stronger-than-expected economic growth and buoyant asset prices) but prudence also played a role (under-projection of revenue elasticity).1 Interestingly, revenue overperformance tended to be associated with higher-than-projected expenditure, i.e., some of the good luck was spent (more so than in other industrial countries, see left panel). As a result, the favorable surprises on the overall fiscal balance were not much greater than the average for other industrial countries (see right panel).

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Decomposition of Fiscal Surprises

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

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Fiscal Balance Surprises

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

1Selected Issues Paper, Favorable Fiscal Outturns: Is It Just the Luck of the Irish?

13. The authorities acknowledged that the budget for 2005 implies a fiscal deterioration (Table 5). The budget envisages a swing in the overall balance of 1.7 percent of GDP, reflecting mainly higher social welfare payments (0.6 percent of GDP; for old age pensions, child benefit, and unemployment assistance), increased income tax credits and rate bands (0.4 percent of GDP; to ensure that workers on the minimum wage are fully outside the tax net and to partially compensate for the lack of indexation of the bands), and higher public sector pay (0.3 percent of GDP; consistent with previously announced wage increases). Since the budget was released in December, revenues in 2004 and the first few months of 2005 have been stronger than expected. At the same time, the Supreme Court has ruled that the government must reimburse certain nursing home charges received over the past 30 years. Altogether, staff now project that the cyclically adjusted general government balance excluding one-off factors will decline by more than 1 percent of GDP to a deficit of about ½ percent of GDP. Staff observed that the size and timing of the fiscal stimulus are ill-advised for an economy that is close to full employment. While not disputing this point, the authorities noted that the fiscal expansion in 2005 followed two years of contractionary budgets, while also reflecting certain social priorities.

General Government Balances

(In percent of GDP)

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Table 5.

Ireland: Medium-Term General Government Finances 1/

(As a percent of GDP)

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Sources: Fund staff estimates and Department of Finance

Based on current policies. The staff estimates assume that tax revenues will perform according to the latest SP projections in 2006-07, but are adjusted for the difference between the government’s and staff’s growth assumptions. From 2008 onwards, tax revenues (excluding indirect taxes) are projected using the OECD’s estimates of tax elasticities. Expenditure estimates for 2004 are based on the latest available official information, whereas projections for 2005-07 assume expenditure to increase at the pace envisaged in the SP (except for interest rate expenditure). Due to different accounting conventions, the staff’s estimates of total revenue and expenditure ratios differ from the Stability Program.

As a percent of potential GDP.

14. Staff suggested that, given Ireland’s cyclically advanced position and accommodative euro area monetary policy, fiscal tightening would be desirable. The authorities agreed that, during the remainder of 2005, budget execution should remain prudent and any revenue windfalls should be saved, as they had been in 2004. Staff recommended an improvement in the cyclically adjusted fiscal balance of ½ percent of GDP in 2006. While noting strong pressures for higher spending, the authorities said that next year’s fiscal position would be in line with their medium-term objective of close to balance or surplus, though preparatory work for the 2006 budget is not yet underway. Staff noted that a balanced budget target in 2006 would be consistent with its call for fiscal tightening. The authorities shared the view that, if aggregate demand were to weaken unexpectedly and abruptly, possibly due to a sharper-than-currently envisaged slowdown in the housing market, automatic stabilizers should be allowed to operate fully.

15. The authorities concurred that fiscal restraint is needed from medium- and long-term perspectives. They noted that a small open economy like Ireland is subject to global shocks, such as the equity market bust in 2001, which led to a 3½ percent of GDP deterioration in the fiscal balance. They also acknowledged that the cooling housing market would reduce the yield from property-related taxes, though precise quantification is difficult. With age-related spending (on health and pensions) projected to rise by about 5 percentage points of GDP by 2050, the government is setting aside every year 1 percent of GNP in the National Pensions Reserve Fund (NPRF) to prepare for future old-age and civil service pension spending (this does not affect the fiscal balance, but does add to gross debt). Staff welcomed the pre-funding, but noted that it is expected to cover only about one third of the increase in pension spending. The authorities observed that a decline in government spending on infrastructure over the long term would provide room for higher age-related spending. Staff accepted this point, but noted that the scope for reducing infrastructure spending might not be that great (between 2002-04, Ireland spent 4¾ percent of GNP while the industrial country average was 3 percent of GDP). Staff argued that, besides the pre-funding under the NPRF (which currently amounts to about 10 percent of GNP), a further gradual reduction in gross public debt would help prepare for higher age-related spending. In addition, staff suggested that the NPRF avoid potential conflicts of interests in its investment strategy, which could arise in recently authorized (but not yet undertaken) investments in domestic private public partnerships.

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Projected Increase in Age-Related Public Spending 2010–2050

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

16. Regarding the composition of adjustment, staff suggested that the growth of current spending should be restrained and that the tax base should be broadened. Given Ireland’s relatively low level of public capital, the authorities argued—and staff agreed—that a continued high level of government investment is appropriate. However, staff noted that non-interest current spending had risen by more than 3 percent of GDP between 2000-04, reflecting across-the-board increases. On the revenue side, there was agreement that Ireland’s relatively low levels of business and labor taxes are appropriate, and that the tax net should be broadened. The authorities noted that a review of property-related tax reliefs is currently underway, and staff observed that a useful way to curtail these reliefs would be to establish across-the-board limits on allowances. Staff also suggested preserving the nominal ceiling on mortgage interest tax relief (MITR) and introducing a property tax. The authorities noted that there are no plans at present to raise the MITR ceiling, but that the appetite for a property tax is limited, recalling the short-lived experience with a property tax on high-value homes between 1983 and 1996.

uA01fig17

Government Net Capital Stock

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Source: Kamps (2004).
uA01fig18

Non-Interest Current Expenditure

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

17. The authorities agreed that further efforts are needed to improve value for money in the delivery of public services. They noted the introduction of five-year capital envelopes and the recent publication of guidelines for the appraisal and management of capital expenditure proposals. While they acknowledged that multi-year envelopes for current spending would improve predictability and reduce the risk of procyclicality, they felt that the experience with capital envelopes should be assessed first. Staff also suggested extending the fiscal projections (currently only three years) to at least five years. Regarding construction projects, the authorities noted that they intended to increase competition at the tendering stage and improve contracting arrangements. In health services, they pointed to progress in the implementation of the government’s reform plan launched in mid-2003, including the establishment of a single national entity to manage health services, the modernization of management planning, and the introduction of a plan indicating services to be delivered and the links between services and staffing.

18. The authorities disagreed with the staff’s suggestion to automatically index tax credits and bands and social welfare payments to prices. Staff argued that, because income tax credits and bands and their interaction with social welfare payments have important effects on work incentives, changes in their real burdens should be explicit policy decisions rather than an untransparent side effect of price inflation. Staff also observed that the current system gives rise to periodic, and thus lumpy, adjustments, which partly underlies the fiscal stimulus in 2005. The authorities responded that the lack of indexation provides important room for maneuver, which can be used for consolidation if necessary. They added that—for consistency—excise rates would also need to be automatically indexed. Staff recognized that the benefits of fiscal neutrality and reduced risk of procyclicality need to be weighed against the loss of fiscal discretion, but observed that most major industrial countries, including Canada, France, the U.K., and the U.S., have adopted automatic indexation to prices.

19. Given pressures to raise spending and the softening of the SGP, staff saw a role for broader third-party assessment of fiscal policy, but the authorities were not convinced of the merits. The authorities and staff agreed on the need to deepen public understanding of a number of fiscal issues, including the need to avoid fiscal procyclicality because it tends to exacerbate pressures on capacity when times are good and to deepen economic downturns; the desirability of building a fiscal cushion to prepare for risks over the medium term; and the need to maintain a strong underlying fiscal position so as to help Ireland face rising age-related spending over the long term. In staff’s view, broader third-party assessments would enhance the public debate. This could be done by building on existing institutions, such as the National Economic and Social Council (which consists of the social partners and provides the background analysis for the national wage agreements), or by establishing a new body such as a fiscal council. The authorities agreed on the need to improve the focus of the public debate, noting the commitment in the 2005 Budget to expand parliamentary examination of existing budgetary material produced by the government. In their view, however, the key issue is not the lack of third-party assessment, observing that several academics and private analysts make their views known, but rather that the public debate tends to focus on specific budget measures instead of strategic issues. More generally, they doubted whether Ireland’s budgetary performance points to the need for major institutional innovations, wondered whether fiscal councils in other countries have always been effective, and were concerned whether, at least in Ireland, a fiscal council would not end up providing a venue for special interests.

C. Labor Market and Wage Policy: Need for Wage Moderation

20. Labor market flexibility in Ireland is relatively good. Rapid employment growth since the early 1990s has been driven by rising labor force participation, including by women, and immigration. The decline in the unemployment rate has reflected the rapid growth of aggregate demand and reforms of the tax and benefit systems (Box 3). The tax wedge is now one of the lowest among industrial countries. The authorities observed that Ireland has allowed immigrants from the new EU member states full access to the labor market, and that immigrants have played a key role in relieving labor shortages.

uA01fig19

Labor Force Participation Rate 1/

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

1/ Age 15–64.Source: OECD.
uA01fig20

Labor Force Participation Rate for Women 1/

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

1/Age 15–64.Source: OECD.
uA01fig21

Net Migration

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

uA01fig22

tax wedges 1/

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Source: OECD.1/ Income tax plus employee and employer social security contributions less cash benefits as a percentage of labour costs.

What Explains the Fall in Unemployment?

The unemployment rate in Ireland declined from one of the highest to the lowest level in Europe over the past fifteen years. The improvement was broad-based: long- and short-term unemployment rates fell across age groups and education levels. Although estimates of the NAIRU are inherently uncertain, staff analysis finds that more than half of the fall in unemployment is structural.1 Further analysis shows that the decline in the NAIRU is well explained by changes in labor market policies. Specifically, taxes on labor have been reduced to the lowest level in the OECD and the tax burden on the second earner in married couples has fallen, improving the incentives for work. In addition, the introduction of strict enforcement of eligibility for benefits, the reduction in effective net benefit replacement ratios, the adoption of a system of coordinated wage negotiations, and various active labor market policies have also contributed to the activation of the unemployed.

1Selected Issues Paper, The Evolution of Unemployment in Ireland: The Role of Labor Market Policies.

21. However, with labor costs already high relative to euro area partners, the authorities and staff agreed that wage moderation is needed to preserve competitiveness going forward. National wage agreements and public sector benchmarking exercises play important roles in the wage setting process. Regarding the national wage agreements, social partners (labor unions, employers, and the government) broadly concurred that the agreements have provided a useful vehicle for developing a common view of economic prospects, established sensible guidelines for wage increases while allowing considerable flexibility at the firm level, and preserved peaceful labor relations. Going forward, the authorities observed that the next wage agreement (to cover 2006-08) would need to take account of lower expected inflation and lower projected productivity growth.

22. The authorities were satisfied with the first public sector benchmarking exercise, but acknowledged that improvements are needed in the next one. They noted that the first exercise succeeded in reducing the rigidity of pay relativities across the public sector and enhancing the delivery of public services. Looking ahead to the second exercise, beginning in the second half of 2005 and reporting in 2007, the authorities were of the view that there should be greater focus on recruitment and retention in pay determination, better valuation of pensions, and more emphasis on the flexibility of work practices, especially in education and health. To ensure public accountability, the authorities recognized the importance of making the exercise as transparent as possible, though they pointed to limits on the disclosure of confidential information. Staff noted the risk of spillovers from excessive public sector pay increases to the private sector.

uA01fig24

Nominal Wage Growth

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

1/ Staffes timate.

D. Financial Sector: Need for Continued Supervisory Efforts

23. Banking system profitability and capitalization are strong, but vulnerabilities exist (Table 6). Credit growth—while slowing—remains high, property-related lending accounts for more than half of the stock of bank lending, and net interest margins have declined as reliance on more expensive wholesale funding has increased. Household debt has risen sharply and now exceeds 110 percent of disposable income. The authorities argued that efforts to increase awareness of risks—including the central bank’s public warnings about the eventual rise in interest rates and the more recent roundtable discussions with heads of financial institutions organized by the central bank and financial regulator—have helped to cool the housing market. They said that a drop in house prices remains a possibility, but the banking system could withstand a considerable fall, as shown by the scenario analysis in the September 2004 Financial Stability Report. They added that only one tenth of households have debt service burdens greater than 23 percent of disposable income. The authorities observed that the international diversification of banks’ assets is increasing, but staff noted that much of this lending is also property-related. The central bank and financial regulator have established a financial stability committee, which recently conducted a crisis simulation exercise. The authorities noted that asset-covered securities provide relatively inexpensive funding for mortgage lenders.

Table 6.

Ireland: Indicators of External and Financial Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources: Data provided by the authorities; Central Bank of Ireland; International Financial Statistics; Bloomberg; and Fund staff estimates.

Represents non-euro debt of the government sector.

Includes lending for construction and real estate activities.

Credit equivalent values.

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

Non-government deposits vis-à-vis Irish and nonresidents to M3 ratio.

The methodology used to compile M3 has been amended in line with Eurosystem requirements. Therefore, there is a break in the series.

Nongovernment loans/nongovernment deposits ratio.

Financial Indicators

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uA01fig25

Private Sector Credit Growth

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

uA01fig26

Property-related Private Credit

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

24. Looking ahead, the authorities noted that the supervisory priorities are to implement Basel II and further strengthen stress-testing and credit standards. Basel II requires establishing more risk-based capital requirements. The authorities were satisfied with the latest stress-testing exercise, but are considering further methodological improvements, such as incorporating second-round effects, increasing the variety of shocks, and enhancing the treatment of the realizability of collateral. A recent review of credit standards at major mortgage lenders found that—while standards are generally good—there is a need to tighten lending criteria and establish stricter guidelines for credit officers. In the insurance sector, the authorities are planning to introduce a supervisory regime for reinsurance companies in late 2005 or early 2006, in line with the EU Reinsurance Directive.

25. The authorities agreed that there is room to further strengthen competition in the financial sector. A recent report commissioned by the Competition Authority found obstacles to competition in personal current accounts and lending to small- and mediumsized enterprises. The authorities observed that the double stamp duty charge on switching financial cards has already been removed and that banks have recently agreed to a voluntary code of behavior on switching current accounts. This voluntary code is now being reviewed, as are other measures to increase competition. The authorities are reluctant to eliminate the legal requirement to notify fees on current accounts before they are satisfied that competition has been improved. In the non-life insurance sector, the authorities agreed that greater disclosure of information on claims histories by insurers would facilitate entry and said that they are now addressing practical issues, like the appropriate level of detail and the precise mechanism for disclosure.

E. Population Aging: How to Encourage Saving for Retirement?

26. Ireland has already made important progress in preparing for population aging. The elderly dependency ratio will rise considerably over the coming half century, but the increase is back-loaded compared to the rest of the euro area. Incentives to keep older people in the workforce are relatively strong, so that the effective retirement age is one of the highest among advanced economies. The authorities noted that the pensionable age in the civil service has recently been increased and that provision of an old-age pension bonus for those who work beyond 65 is being considered. Staff suggested phasing out the Retirement Pension, which requires people to effectively stop working in order to be eligible.

uA01fig27

Elderly Dependency Ratio

(2010–2050)

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001

Source: U.N. World Population Prospects, The 2002 Revision.1/ Average of France, Germany, Italy.
uA01fig28

Disincentives for Older Workers

Citation: IMF Staff Country Reports 2005, 369; 10.5089/9781451818819.002.A001