Ireland: Staff Report for the 2016 Article IV Consultation and Fifth Post-Program Monitoring Discussions—Supplementary Information

This 2016 Article IV Consultation highlights that the rebound of the Irish economy has been exceptional. High frequency indicators suggest that growth momentum has continued in 2016. Solid job creation has reduced the unemployment rate below 8 percent. Inflation has hovered around zero as low commodity and food prices more than offset rising cost of services, particularly housing rents. Taking into account negative spillovers, real GDP growth is projected to decline to just below 5 percent in 2016 and converge to its estimated potential over the medium-term on the back of more moderate export growth and investment activity.

Abstract

This 2016 Article IV Consultation highlights that the rebound of the Irish economy has been exceptional. High frequency indicators suggest that growth momentum has continued in 2016. Solid job creation has reduced the unemployment rate below 8 percent. Inflation has hovered around zero as low commodity and food prices more than offset rising cost of services, particularly housing rents. Taking into account negative spillovers, real GDP growth is projected to decline to just below 5 percent in 2016 and converge to its estimated potential over the medium-term on the back of more moderate export growth and investment activity.

Context

1. Ireland’s economy has rebounded exceptionally, but the recovery is incomplete and crisis legacies still pose challenges. Ireland’s growth outperformed that of its peers during 2014-15, bringing real GDP at end-2015 ten percent above its pre-crisis level. The robust economic growth was supported by favorable external conditions, and was accompanied by improved balance sheets, a strengthening banking sector, steady job creation, and rising incomes and asset prices. Policy implementation has been strong (Annex I). Nevertheless, the recovery is unfinished and has yet to benefit parts of the population. Moreover, elevated public and private sector debts and a large stock of banks’ distressed loans leave the economy susceptible to shocks.

uA01fig01

Real GDP

(Index, 2008Q1=100, seasonally adjusted)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Haver Analytics; and IMF staff calculations.
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Ireland’s Vulnerabilities in the Euro Area Context

(Rank, 1=best, 16=worst) 1/

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: BIS; Haver Analytics; WBDI; National authorities; and IMF staff calculations.1/ Based on the relative ranking of EA countries excl. the Baltics.2/ Ireland data excludes MNEs debt.3/ In percent of GDP.4/ In percent of gross disposable income.

2. The newly-elected government needs to maintain the economic policy course and tackle crisis legacies to achieve durable and inclusive long-term growth. The minority coalition that was formed in May 2016 following the February general election consists of the former incumbent party, Fine Gael, and independents. The importance of preserving economic recovery and safeguarding public finances is widely shared, and the broad policy course is likely to be continued. Nevertheless, the increased political fragmentation and reform fatigue may complicate policymaking and the fallout from the UK vote to leave the EU could do so too.

Exceptional Growth but Elevated Vulnerabilities

A remarkable growth performance is supported by favorable external conditions

3. The Irish economy has performed beyond expectations (Figure 1). Real GDP posted 7.8 percent growth in 2015 on the back of strong domestic demand and solid export growth. Gross fixed capital formation was mainly driven by investment in intellectual property by multinationals (MNEs) (Box 1), and a rise in machinery and construction investment.1 Private consumption expanded strongly as consumer sentiment surged, the drag from deleveraging moderated, wages and employment improved, and low inflation supported real incomes. Double-digit export growth benefited from favorable external conditions: a real effective depreciation of the euro reflecting continued monetary easing by the ECB and strong trading-partner demand. Yet the contribution of net exports to growth was only marginal as imports rebounded together with exports and investment.2 The recovery has been broad based, though the information and communications technology (ICT) and manufacturing (including pharmaceuticals) sectors have been particularly buoyant. High-frequency indicators suggest that the growth momentum has continued in 2016.

Figure 1.
Figure 1.

Ireland: Real Sector and Inflation Indicators, 2006–16

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Onshoring of Intangible Assets to Ireland

Partly in response to increasing multilateral efforts to combat aggressive tax planning and avoidance, including the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan, some MNEs have chosen to restructure their businesses and relocate their intangible assets, such as patents and copyrights, to countries with supportive business environment.

Consequently, Ireland, which maintains a competitive taxation environment, including for intellectual property-related activities (Knowledge Box), experienced a sharp increase in intangibles investment to 9½ percent of GDP in 2015 from about 5 percent of GDP in 2014. To the extent that investment in intangibles is related to patent onshoring, it is matched by imports, and thus is GDP neutral during the year of the transaction. Nevertheless, this investment adds to Ireland’s capital stock, and in the future, ceteris paribus, will contribute positively to net export growth (mainly due to lower royalty payments abroad).

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Contributions to Fixed Investment Growth

(Percentage points y/y)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Central Statistics Office.1/ Includes machinery & equipment, construction & other residential investment.
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Contributions to GDP Growth

(Percentage points y/y)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Statistics Office; and IMF staff calculations.1/ Excludes aircraft and intangibles.
uA01fig03

Contributions to Real GDP Growth

(Percent y/y)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Statistics Office; and IMF staff calculations.1/ GDP growth accounts for statistical discrepancy as well.
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Trade in Goods and Services

(Percent change y/y, real terms)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Statistics Office; and IMF staff calculations.

4. Labor markets continued to improve without inflationary pressures. The solid employment growth in 2015 helped reduce the unemployment rate to 7.8 percent in May 2016, and was reflected in a moderate increase in private sector’s real wages, though labor force participation has not recovered so far. Inflation hovered around zero owing to lower commodity and food prices, which more than offset the rising cost of services, particularly housing rents.

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Employment and Unemployment Rate

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Central Statistics Office.
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Contribution to Annual HICP Inflation

(Percentage points))

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

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

5. Public finances delivered a sizeable outperformance in 2015. Revenues significantly exceeded the initial budget profile, largely reflecting strong corporate income tax (CIT) receipts.3 Expenditures rose more moderately over the budget profile (but slightly below the supplementary budget envelope), as a lower-than-planned interest bill partly offset higher current primary spending. The general government deficit fell to 2.3 percent of GDP—well below the initial budget target of 2.7 percent of GDP and the Stability and Growth Pact (SGP) 3 percent of GDP threshold. As a result, Ireland exited the Excessive Deficit Procedure (EDP). The overperformance would have been even more sizeable (yielding an underlying deficit of 1.3 percent of GDP), if conversion of government’s remaining AIB preference shares to ordinary shares (equivalent to 1 percent of GDP), had been excluded from capital transfers.

Fiscal Performance

(percent of GDP)

article image
Sources: Department of Finance; Eurostat; and IMF staff calulcations.

In 2015, it includes the increase in capital transfers due to the conversion of the remaining AIB preference shares to ordinary shares (Eurostat decision).

6. Rising demand, partially fueled by global search for yield, and supply-side bottlenecks have stimulated property prices (Figure 2).

  • Residential real estate (RRE) prices and rents continued to increase. Nevertheless, following the abolishment of tax exemptions on capital gains in December 2014 and the introduction of new macroprudential loan-to-value (LTV) and loan-to-income (LTI) limits in February 2015 (see 2015 Article IV Staff Report), the market somewhat cooled off: RRE price growth decelerated in late 2015 and the number of mortgage approvals temporarily declined (Figure 3).

  • Commercial real estate (CRE) prices rose even more rapidly. Total returns of the Irish CRE sector outstripped those of other European countries, reflecting the confluence of strong equity investment largely financed by foreigners in search for high yield, and still limited new construction.

Figure 2.
Figure 2.

Ireland: Household Finance and Property Market Developments, 1995-2016

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Figure 3.
Figure 3.

Ireland: Housing Developments, 1990-2016

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

uA01fig09

Residential Housing Market

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Daft.ie; OECD; and IMF staff calculations.
uA01fig10

Commercial Real Estate Market

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: CBRE (Ireland); CSO; MSCI (IPD); and IMF staff calculations.
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Commercial Real Estate Total Returns

(Percent)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: MSCI/Invetsment Property Databank.

7. Financial conditions have been broadly supportive. As elsewhere, the UK vote to leave the EU has led to stock market losses but the sovereign bond market has been well behaved. The ECB’s quantitative easing (QE), together with Ireland’s favorable growth prospects, have kept the 10-year Irish sovereign yields very low, even if the spreads slightly widened temporarily following the UK vote to leave the EU. In line with other European countries, the Irish equity market partly reversed its last year’s gains and declined by about 17 percent in 2016H1. Reflecting the strong GDP growth, improved balance sheets and prudent fiscal policy, Moody’s upgraded Ireland’s sovereign rating to A3 (May 2016), following Fitch’s and S&P’s upgrades to A (February 2016) and A+ (June 2015), respectively. The recent issuance of a 100-year sovereign bond is an additional sign of market confidence.

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Ten-Year Sovereign Bond Yields

(Basis points)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Bloomberg.
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Stock Markets

(Index, Jan-2014=100)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Bloomberg.

Yet the recovery is still incomplete

8. Domestic demand and employment have yet to return to their pre-crisis levels. Private consumption, albeit recovering, is held back by the ongoing deleveraging process and the prevalence of households with low or negative equity. Disposable income is still some 5 percent below its peak, partly due to the higher tax burden. Investment in residential properties is lagging behind demand. With a still elevated jobless rate and sluggish labor participation, labor market slack persists and employment growth has been uneven across regions.

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Real GDP Components and Employment

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Statistics Office; Haver Analytics; and IMF staff calculations.1/ Excluding aircraft and intangibles.
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Regional Employment Growth, 2012Q1-2016Q1

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Statistics Office; and IMF staff calculations.

9. High public and private debt burdens leave the economy vulnerable to shocks. Public debt has declined to about 94 percent of GDP at end-2015 from a peak of 120 percent of GDP in 2013, but remains well above the pre-crisis levels. Despite falling debt, many households are susceptible to a drop in income or an interest rate increase. Nonfinancial corporates’ (NFC) profitability has improved significantly and deleveraging has continued in recent years. Nevertheless, many small firms are financially weak and vulnerable to shocks.

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Gross Public Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: IMF World Economic Outlook.
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Household Debt Burden 1/

(Percent of gross disposable income)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Bank of Ireland; Haver Analytics; and IMF staff calculations.1/ Total household loans in percent of 4 quarter gross disposable income.
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Debt of Nonfinancial Corporations 1/

(Percent)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Bank of Ireland; and IMF staff calculations.1/ Debt is equal to securities other than shares, loans, and financial derivatives and employee stock options.

10. The banking system repair continues, but challenges remain. The recent Financial Sector Assessment Program (FSAP) observed that liquidity indicators have improved as banks reduced their wholesale funding. Capitalization is also stronger, though deferred tax assets add substantially to the total. The banking sector as a whole returned to profitability in 2014-15 reflecting higher net interest income, better asset quality, and a reduction in operating cost, but also provisioning reversals as collateral values increased and loan restructuring continued. Yet, the underlying bank profitability remains subdued, bank balance sheets are still contracting despite a gradual pick up in new lending, and the high share of impaired loans poses fragilities, particularly given the increasing portion of mortgages in deep arrears (above 720 days) in the total stock of mortgage arrears (Figure 4). Provision coverage ratio remained broadly stable, and stood at about 52 percent of total nonperforming loans (NPLs) at end-2015.

Figure 4.
Figure 4.

Ireland: Credit and Deposit Developments, 2003-16

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

uA01fig19

Non-Performing Loans

(Percent of total loans, domestic banks)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Central Bank of Ireland.

The outlook is positive but risks are skewed to the downside

11. The positive economic performance is expected to continue, despite the fallout from the UK referendum result. GDP growth is projected just below 5 percent in 2016 on account of less vigorous domestic demand, mainly due to investment. Private consumption is expected to keep growing at a dynamic pace reflecting higher employment, lower household indebtedness, and positive wealth effect from rising property prices. Over the medium term, the Irish economy is likely to be affected by the consequences of the UK vote to leave the EU. The severity of the impact is however difficult to gauge at this stage. It will crucially depend on the future relationship between the UK and the EU, especially regarding trade, financial flows, and movement of labor. Taking into account some ensuing negative spillovers consistent with model-based calculations in the “limited” scenario outlined in the UK 2016 Article IV report and the accompanying Selected Issues paper, Ireland’s real GDP growth has been revised downward in 2017-18.4 Over the medium term, growth is projected to decelerate and converge to its estimated potential (about 3 percent a year) on the back of more moderate export growth and investment activity. As a result, the output gap is expected to virtually close and the current account surplus to moderate by the end of the forecasting period.

uA01fig20

Real GDP Growth Projections

(Percent change y/y)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Bloomberg; CBI, ESRI; EC; MoF; and IMF staff estimates.

Ireland: Macroeconomic Projections, 2015–21

(Percentage change unless indicated otherwise)

article image
Source: Central Statistics Office; and IMF staff projections.

Excluding multinational enterprises, see 2015 Article IV Selected Issues Paper.

12. Risks are tilted to the downside (Annex II):

  • External risks have worsened since the UK referendum result and now prevail. The recent UK vote to leave the EU, if accompanied by prolonged uncertainty over UK’s new relationship with the EU, larger-than-expected slowdown in the UK and in the rest of Europe, and higher financial market volatility, would have a significant adverse effect on Ireland. In these circumstances, a countercyclical fiscal policy together with the central banks’ commitment to provide additional liquidity, would help lessen the impact. Over the medium term, a possible relocation of EU-oriented firms from the UK to Ireland could partly mitigate some of these effects (Annex III). On the upside, the ongoing restructuring of operations by multinationals could reinforce Ireland’s attractiveness as a destination for FDI and increase the capital stock. A surge in financial market volatility in response to other shocks and disruptive re-allocation of assets as investors reassess global growth prospects or as geopolitical tensions intensify could further undermine confidence, with possible adverse effects on investment. At the same time, the ECB’s QE, the government’s limited financing needs, and sizeable cash buffers (3½ percent of GDP as of end-June 2016) would mitigate the impact on sovereign spreads. An extended period of low euro area growth could also hurt confidence, investment, and FDI. Finally, while Ireland benefitted from net immigration of highly-skilled European workers in the past, inflows of refugees are expected to be small, with a limited fiscal impact.

  • Domestic risks seem moderate. Rising incomes and lower deleveraging could lift private consumption and investment growth above the baseline, but continued rapid property price growth could generate new vulnerabilities. Reform fatigue combined with strong growth are fueling expectations of a recovery dividend among the Irish public, which together with political fragmentation could lead to some policy reversals. The impaired credit channel remains a medium-term risk if future demand for bank lending is not met with adequate supply.

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Ireland: Balance of Risks

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

13. Ireland’s external position is broadly in line with fundamentals and the economy remains competitive (Figure 5). The External Balance Assessment (EBA) methodologies suggest that the external position is broadly in line with fundamentals and desirable policy settings (Annex IV). The EBA Current Account approach indicates a slight undervaluation of the currency, but the current account gap can be—to a large extent—explained by undistributed profits of foreign companies that established their headquarters in Ireland. The External Sustainability and the Real Effective Exchange Rate approaches suggest minor overvaluation. Competitiveness continues to be strong in the services sector, and goods exports have also resumed robust growth, particularly in the pharmaceutical sector that appears to be less cyclical than global trade. In addition, Ireland’s traditional exports have performed strongly, benefiting from the depreciation of the euro. However, some trade losses could be expected following a depreciation of sterling and a reduction of UK demand (Annex III).

Figure 5.
Figure 5.

Ireland: Competitiveness Indicators, 1999-2016

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Authorities’ views

14. The authorities broadly shared staff’s assessment regarding Ireland’s economic outlook and risks. They saw prospects for robust real GDP growth, while somewhat decelerating over the medium term. Continuous progress in resolution of financial crisis legacies alongside increased market confidence should continue to support domestic demand, thus further reducing the unemployment rate. They concurred with the external sector assessment and predominant downside external risks reflecting the high degree of openness of the Irish economy. These include a significant slowdown in major trading partners and the ensuing adverse changes in the terms of trade, and heightened uncertainty regarding the prospects for many emerging market economies. However, this is mitigated somewhat by the fact that its exports are concentrated in sectors, such as pharmaceuticals, which are more resilient to external demand swings. Domestic factors, including tight housing markets and its adverse effect on labor mobility and competitiveness, as well as potential sectoral wage pressures could also pose downside risks. In addition, increased political fragmentation could complicate policy making. However, better-than-expected domestic demand and additional patent on-shoring represent potential upside.

15. The UK vote to leave the EU has added further uncertainty to the outlook and will adversely affect growth. The authorities’ initial estimate, based on the assessment in the government’s Summer Economic Statement (SES), is that growth in 2017 will be about ½ percent lower than previously expected, though the fiscal space for next year is largely fixed at this stage. The authorities will prepare a full macroeconomic projection in advance of Budget 2017 in October, and this will include updated estimates of economic growth, the public finances and the fiscal space, taking account of actual and prospective developments up to that time, including the estimated economic impact of the UK vote. The authorities have already published their contingency plans to deal with financial market volatility, potential effects on export industries, and FDI flows.

Rebuilding Resilience and Supporting Sustainable and Inclusive Growth

Ireland’s strong growth performance provides an opportunity to tackle the remaining crisis legacies, rebuild policy buffers, and increase the resilience of the economy to risks. Policies should focus on further reducing public debt while enhancing spending efficiency, lessening private sector vulnerabilities, improving bank balance sheets, and mitigating boom-bust cycles. Addressing structural weaknesses would support robust and inclusive medium-term growth and job creation.

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Ireland: Medium-Term Policy Priorities

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

A. Fiscal Policy

Continue rebuilding fiscal buffers, increase expenditure efficiency, and rebalance the tax mix

16. Ireland is on track to further improve its fiscal position on the back of strong growth (Figure 6). Some spending overruns, mainly in the health sector, are estimated to be more than offset by higher-than-expected tax revenues due to their solid performance in the first months of 2016. As a result, staff project the fiscal deficit to narrow to 0.9 percent of GDP in 2016 and the public debt to fall below 90 percent of GDP. Given that the global push for international taxation reform and greater transparency make durability of exceptional CIT performance uncertain, staff advocated saving any near-term unanticipated revenues and using them for debt reduction.

Figure 6.
Figure 6.

Ireland: General Government Finances, 2007-21

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

17. Fiscal policy should aim to rebuild buffers. The high degree of openness of Ireland’s economy increases its susceptibility to external shocks and the volatility of the business cycles (Annex V). Against this backdrop and in the absence of monetary policy independence, staff emphasized the need for continued reduction in public debt, thereby rebuilding room for counter-cyclical fiscal policy.5 To this end, staff argued that in the case of Ireland, mere compliance with the SGP rules might not be sufficiently prudent. Staff estimate that maintaining the medium-term objective (MTO) of a structural budget deficit of 0.5 percent of GDP, once achieved, would imply an unwarranted pro-cyclical fiscal policy given the positive output gaps estimated through 2021. Staff, therefore, advocated that the authorities overachieve the MTO, with primary balance surpluses, over the medium term. However, the inherent difficulties in correctly estimating Ireland’s cyclical position warrant extra caution.6 Avoiding periodic upward revisions of the three-year expenditure ceilings (thus compensating for possible overruns with other expenditure cuts) and saving potential tax windfall gains would also crucially help to rebuild fiscal buffers.

uA01fig23

Gross Government Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: IMF staff calculations.
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Successive Revisions to Triennial Departmental Expenditure Ceilings 1/

(Billions of euros)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Department of Finance; and IMF staff calculations.1/ Based on comprehensive expenditure reports and budgets.

18. In line with staff’s recommendations, the government plans to address social needs while ensuring sound public finances and durable debt reduction. In the Summer Economic Statement (SES) released on June 21, the government expressed the intention to achieve a structural budget deficit of 0.5 percent of GDP (MTO) by 2018. To this end, it allocates the fiscal room available under the SGP rules 2:1 toward expenditure increases and tax reductions during 2017-21. While the specific policies remain to be detailed, the fiscal plans include room to accommodate pent up spending needs, including those arising from demographic pressures. After 2018, as advocated by staff, the government intends to follow a countercyclical fiscal policy and save a portion of the fiscal space.7 On the basis of the outlined plans, staff estimate that the government’s objective of achieving the MTO by 2018 remains broadly within reach even under staff’s scenario of mild spillovers from the UK vote to leave the EU, which results in a more conservative growth outlook than that of the authorities which was published in April. Public debt is projected to remain on a downward trend reaching around 76 percent of GDP by 2021. In the event of a larger-than-expected fallout from the UK vote to leave the EU, the authorities should stand ready to take remedial actions, such as a countercyclical fiscal policy together with central banks’ commitment to backstop liquidity in euros and other currencies—if and when needed.

Ireland: General Government Statement of Operations, 2015-21

(Percent of GDP)

article image
Sources: Department of Finance; and IMF staff projections.

In percent of nominal potential GDP. Excludes one-off items.

19. Fiscal policy can be more supportive of job-rich growth. Priority should be given to rebalancing the tax mix and broadening the tax base, while improving spending efficiency and addressing infrastructure needs.

  • Rebalancing the tax mix would boost sustainable revenues and support job creation. Compared to EU peers, Ireland’s tax system has a higher reliance on more distortionary direct taxes, less on property and wealth taxes, while indirect taxes are about the EU average (Figure 7). In particular, personal income taxation (PIT and Universal Social Charge-USC) has a relatively narrow base (about 30 percent of households are exempted) and a relatively rapid progressivity (the top marginal rates are among the highest in the OECD).8 This places a large tax burden on middle-income households, undermines female labor force participation, creates welfare traps for low-skilled worker, and discourages high-skilled worker migration to Ireland.9 Consideration could thus be given to merging the USC into a more comprehensive PIT, with lower rates below the median wage and a broader base. Potential revenue losses could be compensated by decreasing the number of products with reduced and zero VAT rates and by faster scaling up the property tax.10 Income distribution concerns could be mitigated by means-tested allowances for low-income households.11

  • Enhancing spending efficiency would improve delivery of public services. By most metrics, Ireland is a low spending country (see Selected Issues on Public Expenditure Efficiency in Ireland). Moreover, expenditure is deemed to be generally efficient, especially for social spending where the impact on income inequality reduction is the highest in the EU (Figure 8). Nonetheless, there is scope for efficiency gains in the health sector. This would help generate resources needed to mitigate aging-related spending pressures. To this end, it is critical that ongoing reforms (strengthening of primary care, reform of hospital budgeting, lower expenditure due to greater generic drug use) progress as planned.12 Furthermore, improved targeting of social transfers would contribute to enhanced inter-generational fairness for the young.

  • Increasing capital expenditure would buttress Ireland’s competitiveness and support the population’s well-being. Ireland ranks last in the OECD for public investment as a share of government expenditure (see Selected Issues on Public Expenditure Efficiency in Ireland). Although the infrastructure quality remains above the EU average, it lags behind the “best in class” countries with which Ireland competes for high value-added exports. Technology infrastructure (broadband) and core infrastructure (power distribution and ports) need an upgrade, and maintenance of the existing insfrastructure stock is not fully met.13 Public capital expenditure should thus be scaled up and prioritized, thereby strengthening Ireland’s leading edge in the global export markets. Strengthening the evaluation framework for public investment would help maximize the growth impact.

Figure 7.
Figure 7.

Ireland: Key Features of the Tax System

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Figure 8.
Figure 8.

Ireland: Public Expenditure Efficiency

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

uA01fig25

Direct, Indirect and Other Taxes in EU-15, 2014

(Share of total tax revenue)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: AMECO; and IMF staff calculations.
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VAT Compliance and Policy Gap, 2013 1/

(Percent)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: EC “Study to quantify and analyse the VAT Gap in the EU Member States,” 2015.1/ The VAT compliance gap is defined as the difference between the amount of actually collected VAT and the amount of VAT that is theoretically collectable based on the VAT legislation and ancillary regulation (VTTL). The policy gap is defined as the ratio between VTTL and the amount of VAT that would be collected by applying a standard rate to final consumption.
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Government Investment, 2014

(Share of total government expenditure)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: OECD.

Authorities’ views

20. The government reiterated its broad objective to build a social economy based upon sound public finances. The authorities were in broad agreement with the staff’s analysis and agreed that Ireland’s high degree of economic volatility calls for adequate fiscal buffers to deal with potential negative shocks. They also stressed the importance of avoiding procyclical fiscal policy, hence the intention of establishing a rainy day fund. While the recovery is cementing, the authorities observed that new challenges are emerging, in particular regarding the growing demand for housing and the supply of critical infrastructure. The authorities indicated that the main gaps in public transportation across regions, as well as in large cities, need to be addressed in order to achieve a more regionally balanced economic growth. One of the key objectives of the government is indeed to create additional 200,000 jobs by the end of this decade, mostly outside Dublin. The authorities were mindful that demand pressures for healthcare ought to be addressed in an efficient way. Value-for-money considerations and the continued focus on reform of public services remain a key priority in the government’s policy agenda.

21. The authorities affirmed their intention to achieve a stable tax mix and entrench the progress made in recent years to broaden the tax base. Within this context, the authorities expressed their intention to reform the income tax system—including a phasing out of the USC—with a view to expanding the base while reducing the burden for lower and middle income earners. This reform is seen as a key element in promoting employment growth. On corporate taxation, the authorities recognized the wide uncertainty as to the transitory or more durable nature of the recent CIT upswing. They agreed with staff that future short-term revenue windfalls should be saved, but stressed that a better understanding of, inter alia, the structural drivers of corporate profitability was a pre-requisite to effective medium-term tax forecasting. While agreeing on the possibility of removing some VAT exemptions, the authorities highlighted the need to address them within a European context. As for the current house price valuation freeze for property tax, they emphasized the objective to maintain stable property tax revenues in the current upswing in the property market.

B. Macro-Financial Policies

22. Crisis legacies and property market swings need to be contained to enhance the resilience of the private sector. The FSAP concluded that the banking sector is tightly connected with Ireland’s real economy, but not with rest of the other financial sector.14 The FSAP also noted that the financial soundness of banks, households, and corporates has improved in recent years, but legacy issues amplify vulnerabilities to shocks. Solvency and liquidity stress tests under an adverse macroeconomic scenario indicate that the Irish banking system would be significantly impacted, with capital and leverage of several banks falling below certain hurdle rates (Annex VI).15 Policies should, therefore, focus on strengthening the banking sector’s resilience and its ability to sustainably support growth. Furthermore, the real estate market rebound raises concerns of potential emerging imbalances.

23. The recent UK vote to leave the EU could affect Ireland’s banking system through various channels. Given the large uncertainties involved, it is difficult to quantify the direct and indirect spillovers at this stage. However, there are a number of channels through which the banking system could be affected. The profitability of Irish subsidiaries in the UK could be adversely affected by the slowdown in the UK economy and the depreciation of the pound against the euro. Furthermore, the downturn may lead to deterioration in banks’ asset quality, reflecting in part a fall in UK property prices (particularly housing). In addition, Irish corporates that export to the UK may face lower demand and profitability, which in turn could hamper their debt repayment capacity. More broadly, slower economic activity in Ireland accompanied by higher unemployment could affect lending volumes, NPLs, and bank profitability, and slow the repair of private sector balance sheets. Heightened uncertainty and market volatility could increase bank funding costs, though the heavy reliance on deposits lessens this risk. Liquidity risks are mitigated by central banks’ commitment to backstop liquidity in euros and other currencies to deal with the market volatility following the referendum result.

Tackling crisis legacies

24. Raising banks’ profitability in a durable manner remains a key challenge. Despite progress, pre-provision profits continue to be modest. Prospects for further improvement are clouded by a number of factors, including low credit demand and ongoing system-wide deleveraging, limited scope for lower funding costs, prevalence of low-yield tracker mortgages, continued headwinds from unresolved distressed loans, and the need to upgrade technology infrastructure. More recently, the UK vote to leave the EU could further undermine profitability. Given these pressures, banks could lean toward riskier activities in an effort to boost earnings. While this could lead to higher internal capital generation, staff underlined the need to ensure that banks appropriately balance profit seeking and risk management. Staff encouraged conservative collateral valuations, and stressed the need for continued adequate provisioning.

Irish Banks: Key Financial Indicators 1/

(Percent)

article image
Source: Central Bank of Ireland; and IMF staff calculations.

Indicators cover the three main domestic banks: Allied Irish Banks, Bank of Ireland, and Permanent TSB. Figures are based on Q4 data.

Annual percent change in end period gross loans and advances.

Based on quarterly data and excluding nonrecurrent items, as a share of average total assets.

Provision stock to NPLs.

NPLs to sum of provision stock and CT1 capital.

Net loans to customer deposits, in percent.

25. Households’ balance sheets remain susceptible to shocks. Irish household indebtedness continues to be high by international standards, and about one-tenth of mortgage holders were in negative equity at end-2015. The FSAP’s analysis indicates that some mortgage holders are highly vulnerable, even those with loans that are currently performing. Specifically, households with high LTV ratios are more likely to default; and in an adverse scenario young borrowers and first-time buyers with variable-rate mortgages are particularly vulnerable (Annex VII).

uA01fig28

Households’ Debt

(Percent of gross disposable income)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: BIS; Haver Analytics; National authorities; and IMF staff calculations.
  • Reducing household NPLs would help improve banks’ balance sheets and reduce the drag on domestic demand. The share of distressed mortgages has moderated, but deep arrears (over 720 days) have remained stubbornly high on the back of limited borrower-lender cooperation and lengthy legal proceedings. In line with the FSAP’s recommendations, staff emphasized that continued efforts are needed to advance resolution of distressed mortgages with a particular focus on deep arrears. Staff, in this regard, underlined that further progress on loan restructuring—where feasible—should be complemented with efforts to ensure that the legal process supports timely enforcement of contracts and collateral.

  • Households’ repayment capacity must be safeguarded through prudent mortgage lending. Banks are increasingly extending fixed-rate mortgages, though the vast majority of the outstanding mortgages (90 percent of stock as of March 2016) is still at a variable rates. Staff welcomed these developments noting that fixed-rate products will reduce households’ vulnerability to interest rate shocks, and stressed the need to ensure that banks adequately price borrowers’ capacity to repay by using conservative assumptions on future interest rates and incomes, while taking into account the difficulties in enforcing collateral, the ongoing deleveraging process, and the legacy burden.

uA01fig29

Mortgages in Arrears

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Central Bank of Ireland.

26. Corporate sector vulnerabilities need to be addressed to enhance the economy’s resilience to shocks. Favorable demand conditions are supporting recovery in the nonfinancial corporate sector. However, with high NPLs (13 percent of corporate loans in 2016Q1) and tight credit conditions for SMEs, corporate vulnerabilities remain elevated. Furthermore, the ongoing deleveraging reflects demand side factors as well as supply side constraints faced by Irish SMEs, including higher borrowing costs and—albeit declining—elevated loan-application rejection rates compared to their European peers. The FSAP’s analysis suggests that small firms have a higher share of risky debt than larger enterprises, and that a decline in profitability and an increase in interest rates would likely push many firms into a vulnerable state and increase new defaults (Annex VII). Staff therefore called for continued pace of corporate NPL resolution, including through loan restructuring for the most vulnerable, yet viable, firms. This would enhance the corporate sector’s resilience to shocks and ability to support a durable expansion of economic activity. Staff also underlined that closing data gaps on firm-level balance sheets would help the Central Bank of Ireland detect and mitigate a buildup of new vulnerabilities at an early stage.

uA01fig30

Debt-at-Risk, 2013

(Debt of firms with ICR<1 relative to total debt, percent)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: BvD; and IMF staff calculations.
uA01fig31

Interest Rates on New Loans to SMEs 1/

(Percent)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: ECB; and Haver Analytics.1/ Amounts less or equal to €1 million. Data is as of April 2016.

27. The disposal of the state’s shareholding in the banking system should continue. The two state-owned banks—AIB and PTSB—made progress toward privatization in 2015. Following successful equity issuance, PTSB reduced the government’s stakes to 75 percent from 99 percent in April 2015, and covered the capital shortfall identified in the ECB’s 2014 comprehensive assessment. AIB redeemed €1.4 billion of government’s preference shares and converted the remainder (€2.1 billion) to ordinary shares in December 2015, thus clearing the way for additional equity sale. The government announced plans to reduce its stakes in AIB to 75 percent, and further lower its holdings in PTSB, but a specific timeline has yet to be set. Staff stressed that disposal should continue to further reduce public debt and contain contingent liabilities, but acknowledged that market conditions, including those resulting from the UK vote to leave the EU, could affect the process.

28. Further strengthening of banking supervision would help maximize the benefits of the Single Supervisory Mechanism (SSM). The FSAP observed that the financial regulatory framework has been significantly strengthened since the crisis and the Central Bank of Ireland has increased its resources and deployed them in a more proactive manner than in the past. The SSM, in which the ECB is responsible for direct supervision of the significant instititions that make up the bulk of the Irish banking system, is working well: the Joint Supervisory Teams (JSTs) for Irish banks operate effectively, and SSM methodologies, processes, and procedures are fully operational. In line with the FSAP’s recommendations, staff underlined that the recent supervisory gains need to be preserved, particularly in light of the possible changes to the banking industry landscape and business models. Staff encouraged supervisors to continue enhancing their already considerable stress testing capacity, which will help challenge commercial banks’ risk modeling. In view of the high turnover of supervisory staff, review of personel policies would be appropriate to attract and retain experienced supervisors.

Authorities’ views

29. The authorities agreed that the recovery in the banking system is ongoing, yet challenges persist. They noted that new lending is resuming and is helping to restore net interest margins. However, continued system deleveraging, the low interest rate environment, and remaining legacy issues present significant headwinds. The authorities concurred that lending rates should adequately price these factors, as well as the risks associated with the Irish economy, including the difficulties to realize collateral of distressed borrowers. The authorities pointed to the solid progress made in the workout of impaired loans across all portfolios and stressed that the resolution of the remaining NPLs is a key supervisory priority. In this regard, they indicated continued implementation of the Distress Credit Strategy, which sets out supervisory expectations for the resolution of mortgage arrears on a bank-by-bank basis while requiring banks to set quarterly resolution targets for their commercial/corporate books. Furthermore, the forthcoming introduction of a government funded scheme to allow distressed mortgage borrowers access to legal and financial advice should help increase borrower-creditor engagement. To accelerate the legal proceedings, the Programme for Government proposes to establish a special court to expeditiously handle mortgage arrears and other personal insolvency cases, with designated judges that will ensure consistent rulings. The authorities broadly agreed with the FSAP’s recommendations, and noted their plans to further develop their stress testing capacity, reduce data gaps, and engage with the various stakeholders on personnel policies to retain experienced staff. Finally, disposal of state shareholding in the banks will be pursued with a view to maximizing the return to the state.

Mitigating boom-bust cycles

30. Macroprudential measures should be maintained. The measures implemented in 2015 were designed to increase the resilience of banks and households to property market swings, thus reducing the risk of future bank credit and house price spiral. In addition, it appears that the transmission channels have been working, particularly via price expectations. Staff argued—in line with the FSAP’s recommendations—that the Central Bank of Ireland should retain the LTI and LTV limits as a permanent feature of the mortgage market and supported the intent to periodically assess their impact and effectiveness Staff stressed the importance of converting the LTI limit to a debt-to-income (DTI) limit, which better captures the borrowers’ repayment capacity, once the Central Credit Register (CCR) becomes fully operational.

uA01fig32

Expectations of Changes in Residential House Price

(Percent)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Central Bank of Ireland (Macro Financial Review, 2016:I).

31. A potential buildup of new imbalances in the CRE market needs to be prevented. Although CRE prices have surged since 2013, the buildup of new vulnerabilities in domestic banks appears limited to date, as demand is mostly funded by foreign investors and domestic equity, such as real estate investment trusts, compared to bank funding in the previous cycle (see Selected Issues on Commercial Real Estate and the Supervisory Response). New CRE lending is increasing from low levels, but the credit stock continues to decline. FSAP’s analysis of CRE prices provides inconclusive results, ranging between an overvaluation of 10 percent to an undervaluation of 8 percent, depending on the methodology and the choice of sample period (Annex VIII). In line with the FSAP’s recommendations, staff urged the authorities to closely monitor CRE market developments, address data gaps, ensure proper underwriting standards and property valuation both sector wide and in specific banks, and activate policy tools if early signals suggest a buildup of new imbalances. In this regard, staff welcomed the authorities’ recent initiative to establish a new comprehensive CRE market database.

uA01fig33a

Irish Private Sector Credit and CRE-related Credit

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Central Bank of Ireland.

32. Boosting the housing supply would help mitigate property price and rent pressures. The sluggish construction activity in recent years reflects the sector’s downsizing after the bursting of the property market bubble in 2008-09 and the ensuing limited access to finance for companies. High construction costs due to strict planning requirements have also been a factor. In response to mounting pressures in the housing market, the government introduced a package of measures in November 2015, including rebates for housing construction schemes that meet certain criteria, and new planning guidelines, which seek to reduce the building costs.16 Additionally, the National Asset Management Agency (NAMA), within its mandate, is to fund the delivery of 20,000 residential units by 2020. Staff stressed that additional policy actions should help expedite new construction, and welcomed the authorities’ intent to publish an Action Plan for Housing over the summer.

uA01fig33

Housing Market Indicators

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: Central Bank of Ireland.

Authorities’ view

33. The authorities confirmed their commitment to reduce the risk of a boom-bust cycle. The Central Bank of Ireland intends to maintain the macroprudential measures in place and launched the first annual review of their impact and effectiveness, to be completed by November 2016. The authorities concurred that transitioning from LTI to DTI limit would serve as a better instrument, but noted that the recalibration and implementation would require careful assessment of the data submitted to the CCR once it becomes operational. With regard to the CRE market, the authorities noted that the continued reduction in banks’ exposures to this segment limits the potential risks to the domestic economy. Furthermore, construction activity, which has responded to improving fundamentals, suggests that a large supply is in the pipeline, which will mitigate market pressures going forward. The authorities are working to reduce data gaps and closely monitor CRE developments. They stressed that resolving the housing shortage is of high priority. In particular, the forthcoming Action Plan for Housing aims at delivering 25,000 new houses per year by the end of this decade to better align demand and supply. In this context, they noted their intent to establish an infrastructure fund for local authorities to help develop the supply of new housing, and shorten the application process for new building permits. Additionally, the government has recently introduced a vacant site levy that will become effective by 2018 to deter land hoarding.

C. Achieving Sustainable Growth and Increasing Inclusiveness

34. Strong and sustainable economic growth is needed to reduce vulnerabilities. Staff project potential GDP growth to gradually stabilize at nearly 3 percent over the medium term, mainly due to the partly-cyclical rise in labor participation and capital accumulation largely driven by the multinationals’ activity. Total factor productivity (TFP) growth, however, is projected to remain modest just around one percent under current policies, falling short of the robust increases observed in the late 1990s and early 2000s.

uA01fig34

Growth Accounting

(Average cumulative percentage change)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: Central Statistics Office; Eurostat; Haver Analytics; and IMF staff calculations.

35. Addressing impediments to TFP growth would boost Ireland’s economic potential. Many advanced economies experienced TFP moderation, possibly due to spillovers from the US productivity slowdown and a resource shift toward lower-productivity sectors.17 Staff analysis of Ireland (see Selected Issues on Firm-Level Productivity and its Determinants: The Irish Case) indicates that, in recent years, TFP growth of SMEs has lagged behind that of large firms, and that medium and large-sized foreign-owned firms outperformed their domestic peers. Moreover, the analysis suggests that domestic firm-level factors, including limited access to finance, weak financial soundness, and low research and development (R&D) activity, may have also contributed to the slowdown in TFP growth. Staff encouraged the authorities to alleviate these potential impediments by broadening financing options for SMEs and advancing NPL resolution. As gross domestic expenditure on R&D is mainly financed by large enterprises and is below the OECD average, staff also stressed the need to encourage higher innovation activities among domestic SMEs, including through greater direct public sector’s support and by enhancing the partnerships of SMEs with education institutions.18, 19

uA01fig35

Expenditures on Research & Development, 2014

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: OECD.
uA01fig36

TFP by Firm Size and Ownership, 2014

(Median, 2007=100)

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Sources: BvD; and IMF staff calculations.

36. Job-rich growth would foster inclusion. Despite the robust recovery, some parts of the population have yet to feel its benefits. While the labor force is well educated, skill mismatches are relatively high in some segments, and youth and long-term unemployment rates remain elevated, the latter particularly among adults with lower educational attainment.20 Furthermore, female labor force participation is among the lowest in the EU. Staff therefore advocated strengthening incentives for women to enter the labor market, such as providing more affordable and high-quality child care and reducing the high marginal income tax rates for second earners. To increase the overall labor supply and boost youth employment, staff suggested upgrading labor skills and reducing skill mismatches by strengthening labor activation policies and expanding technical and vocational programs (see also Selected Issues on Public Expenditure Efficiency in Ireland).

Authorities’ view

37. The authorities agreed with the need to enhance productivity and job creation in order to support sustainable and inclusive growth They noted the recently-introduced policy initiatives to alleviate difficulties in SMEs’ access to finance, including the establishment of the Strategic Banking Corporation of Ireland in 2015, which provides low cost funding for SMEs. Furthermore, the expected implementation of the CCR would reduce firms’ informational asymmetry and hence the risk premia charged by banks. They acknowledged that higher public spending on R&D would enhance the business sector’s competitiveness and innovation capacity. They remain committed to increase Ireland’s R&D intensity, improve SMEs’ access to finance for innovation, develop research collaboration between enterprises and the public sector, and tailor support to meet enterprise needs, as outlined in the recently published Innovation 2020 strategy report. The authorities stressed their intent to foster reforms to improve the affordability and quality of child care. As outlined in their Action Plan for Jobs for 2016, efforts are being made to step up the skill supply by helping qualified workers to come to Ireland, and by establishing regional skills fora as a mechanism for enterprises and providers of education and training to work together in building the supply of skills for their regions.

uA01fig37

Ireland: Labor Market Conditions

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

D. Post-program Monitoring and Capacity to Repay the Fund

38. Ireland’s capacity to repay the Fund has strengthened further on the back of strong economic and fiscal performance, as well as favorable market funding conditions. Ireland has raised €13.4 billion in long-term bonds in 2015 and a further €6 billion in the first half of 2016. Revenue over-performance helped increase the government’s cash balance to about €8 billion as of end-June, 2016—almost twice the outstanding stock of Fund credit. The ECB’s QE is proceeding as planned at secondary market purchases of about €1.1 billion a month, which is broadly equivalent to staff estimates of average monthly gross financing needs in 2016-17.

uA01fig38

Government Gross Financing Need

Citation: IMF Staff Country Reports 2016, 256; 10.5089/9781475517675.002.A001

Source: IMF staff calculations and projections.

39. Medium-term financing needs appear manageable, and the falling public debt burden reduces risks going forward. Strong growth and fiscal performance have dramatically lowered the baseline public debt path, where further reduction is predicated on the authorities’ continued commitment to fiscal prudence. Gross public debt fell to about 94 percent of GDP by end-2015, and is expected to decline below 90 percent by end-2016—five years earlier than anticipated at the time of the 2015 Article IV consultation. Ireland’s funding strategy has significantly smoothed medium-term gross financing requirements, and it is likely that the projected hump in 2020 will be dealt with well in advance through debt management operations. Finally, the 2021–23 period—when the remaining liabilities to the IMF fall due—has relatively modest gross financing needs, further lowering risks to the Fund.

Staff Appraisal

40. Ireland’s economic rebound has been exceptional, but the recovery is incomplete. Robust domestic demand, particularly investment, and solid exports have supported the broad-based expansion. Unemployment has been steadily declining, and inflation has been subdued. Public finances are strengthening and the government’s debt-to-GDP ratio continues on a downward trend. Yet the recovery remains incomplete. Employment and consumption are still below their pre-crisis levels. Crisis legacies, such as elevated public and private debt burdens and a high stock of banks’ nonperforming loans, leave the economy vulnerable to shocks. The outlook remains favorable, but risks—mainly external—are tilted to the downside, especially after the UK vote to leave the EU.

41. Policies should strengthen further the foundations for sustainable and inclusive long-term growth. There is a need to lock in recent gains and build upon them while tackling the lingering crisis legacies, rebuilding policy buffers, and bolstering the resilience of the economy to shocks. At the same time, a recurrence of another boom-bust economic cycle needs to be avoided to allow strong, durable, and broad-based growth that will benefit all Irish people.

42. Continued steady reduction in public debt would increase the policy buffers in the event of potential negative shocks. Ireland has established a solid track record of fiscal rectitude and exited the Excessive Deficit Procedure. Building on this progress, and in light of Ireland’s high degree of economic volatility, adequate fiscal room for maneuver needs to be created to deal with possible adverse shocks. In absence of major economic repercussions from the UK vote to leave the EU, the policies outlined in the recent Summer Economic Statement appear broadly consistent with the attainment of the MTO of a structural deficit of 0.5 percent of GDP by 2018, and further improvement thereafter. This would prevent additional fiscal stimulus when economic activity is projected to remain above potential and allow general government debt to decline significantly. Should the repercussions from the UK vote to leave the EU be larger than anticipated, the authorities should stand ready to take remedial actions, such as a countercyclical fiscal policy together with central banks’ commitment to backstop liquidity in euros and other currencies—if and when needed.

43. Fiscal policy can be more supportive of job-rich growth. A rebalancing of the tax mix away from distortionary direct taxes, including by merging the universal social charge into a broader income tax with lower rates for below-median wage earners, would help reduce the tax burden on middle-income households, foster female labor force participation, and reduce welfare-traps for low-skilled workers. Implementation of a uniform VAT rate and faster scaling up of the property tax would compensate for lower revenues from direct taxes. Regressivity arising from these changes could be assuaged by means-tested transfers to low-income households. Enhancing spending efficiency, particularly in the health sector, would improve delivery of public services, while a better targeting of social transfers would improve inter-generational fairness. Capital expenditure, particularly in infrastructure and R&D, should be increased to safeguard Ireland’s competitiveness.

44. Recovery in the banking system is progressing, but challenges persist. Although banks’ financial soundness has improved in recent years, sensitivity analyses under the FSAP’s adverse macroeconomic scenario point to vulnerabilities amplified by crisis legacies. Furthermore, the fallout from the UK vote to leave the EU could undermine banks’ profitability and balance sheet repair. In the current low-interest environment, supervisors need to be even more vigilant to ensure that banks’ profit seeking is supported by appropriate risk management. Mortgage lending rates should adequately reflect market conditions, legacy burden, and credit risk, including difficulties in realizing collateral. Disposal of the government’s stakes in the banking system should continue. This would further reduce public debt.

45. The resilience of the nonfinancial private sector to shocks needs to be bolstered further. Intensified supervisory efforts should continue to resolve nonperforming loans, supported by the legal process to incentivize cooperation between borrowers and lenders. Further restructuring of distressed loans to the most vulnerable, but viable, firms would support a durable expansion of economic activity and reduce the corporate sector’s vulnerabilities. Closing data gaps on firm level balance sheets would enable detection and mitigation of a buildup of new vulnerabilities. Continued care is needed to ensure that provisions remain adequate.

46. A potential buildup of new imbalances in the property market should be prevented. Macroprudential limits on mortgage lending should be maintained as a permanent feature of the mortgage market to safeguard the resilience of banks and households against shocks. The Central Bank of Ireland intent to periodically assess the impact and effectiveness of these measures is welcome. Once the Central Credit Register becomes operational, the loan-to-income limit should be replaced with a debt-to-income limit, which better captures borrowers’ repayment capacity. As housing supply remains constrained, additional policy actions should help expedite new construction. Demand pressures in the commercial real estate market need to be closely monitored and policy tools activated if risks to financial stability emerge.

47. Residual structural weaknesses should be addressed to support a robust and inclusive medium-term growth and job creation. Policies should encourage broadening of the financing options available to SMEs and increasing direct public sector support of their innovation activities, including through closer partnerships with education institutions. Furthermore, enhancing labor activation policies and expanding technical and vocational programs would help retool skills and increase the likelihood of finding employment. Policies to address the high cost of child care and its variable quality, and reduce high marginal income tax rates on second earners would strengthen incentives for women to enter the labor market.

48. It is recommended that the next Article IV consultation with Ireland be held on the standard 12-month cycle.

Table 1.

Ireland: Selected Economic Indicators, 2011-17

(Annual percentage change unless indicated otherwise)

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

Contribution to growth.

Excludes bank restructuring costs.

Table 2.

Ireland: Medium-Term Scenario, 2011-21

(Annual percentage change, unless indicated otherwise)

article image
Sources: Central Statistics Office; Department of Finance; and IMF staff projections.

Contributions to growth.

In percent of GDP.

Excluding one-offs. For 2013, includes exchequer outlays for payments under the ELG scheme in the context of IBRC’s liquidation.

Table 3.

Ireland: General Government Statement of Operations, 2011–21

(Consistent with GFSM 2001; billions of euros)

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Sources: Department of Finance; and IMF staff projections.

Includes stamp duty, capital taxes, property tax and other taxes.

Includes imputed social insurance contributions. The 2011 downward jump in the series reflects the integration of health levy receipts into the universal social charge (now part of income tax).

Includes property income, sales of goods and services, current transfer revenue and capital transfer revenue.

Projections take into account the expenditure profile set out in the Summer Economic Statement, June 2016.

Includes financial sector support costs, license sales, and other non-recurrent revenue and expenditure items, such as the conversion of government’s remaining AIB preference shares to ordinary shares in 2015, that do not affect underlying fiscal position.

In percent of nominal potential GDP. Excludes one-off items.