Ireland: Risk Assessment

Country Rating¹

Rating: A4

Business Climate Rating¹

Rating: A1

Risk Assessment²

The recession may well continue in 2011 for a fourth straight year
The crisis, triggered by a severe correction in the property market and exacerbated by the global financial crisis, has resulted in a sharp contraction in GDP, down nearly 12% from 2008 to 2010. With the loss of confidence by investors (affected by the slippage in public sector finances), the upward revision in the losses suffered by the banks, and the flight of deposits, government authorities had no choice but to turn to the IMF and the European Union late 2010 (ultimate rescue package of €85 billion including a contribution by Ireland itself. To benefit from this support and avert the failure of its banks Ireland had to resign itself to accepting a new austerity plan, even more severe than its predecessors. The rise of unemployment, the negative wealth effect resulting from the fall of property prices, the pay-down of household debt, the collapse of the construction sector, and the credit crunch continued to depress consumption and investment in 2010. The economy performed poorly in the fourth quarter with exports sagging despite increased competitiveness. The recession is very likely to continue this year. Private consumption is even expected to suffer a more severe slowdown than it did in 2010 as a result of a sharp decline in household disposable income attributable to the reduction in pensions and wages in the public sector and a further increase in unemployment. Investment will continue to suffer from the slump in the construction sector even though capital goods purchases appear on the verge of recovery. Exports will likely remain the crucial economic engine. And further out, Ireland doubtless has the capacity to re-establish a relatively dynamic economy thanks to productivity gains and its specialization and high value-added sectors (pharmaceuticals, other chemical products, equipment and machinery, IT services)

Default risk warded off in the near-term
Ireland has above all been the victim of a property and banking crisis attributable to the low interest rate levels prevailing in the country since it joined the euro zone and to ineffective oversight of the financial sector. It was, however, the inflation of the public sector deficit generated in large part by the exceptional support granted to the banking sector that pushed the country to the brink: In 2010 that support represented nearly 2/3 of the total public deficit (32.4% of GDP). Starting from a low level, the public debt has been rising sharply and is expected to represent 115% of GDP this year. As things stand now, Ireland may still not be in a position to return to the bond markets even by 2013, which could prompt it to seek additional aid, or even a restructuring of its debt. Thanks to government intervention in the form of recapitalization of the banks and establishment of a defeasance structure for non-performing loans and to cash infusions by the ECB, the banking sector avoided a massive collapse. After the last capital injections, in amounts based on stress tests carried out in March this year, the domestic banking sector will henceforth be entirely nationalized. The foreign debt of banking and financial institutions is considered high even after subtracting the portion owed by the international financial centre in Dublin.  Were the financing difficulties to persist beyond 2012 the banks would also be faced with the crucial question of restructuring the debt.  The new government, set up jointly by Fine Gael and Labour, took office this past March. It hopes to obtain agreement on a lower interest rate set for the rescue plan but has made a commitment to honour the objectives of the programme negotiated with the IMF and EU by its predecessor. Although the coalition has been benefiting to some extent from a grace period, continuation of the austerity programme could ultimately erode the sense of common purpose currently binding the country.

A two-track economy
The persistent weakness of domestic demand has resulted in a decline in prices that has squeezed corporate margins despite reductions in wages. Their financial position has been severely undermined in many sectors that focus on the domestic market, like property (which is unlikely to recover before 2012), home furnishings, merchandise transport and car trade. Conversely, an export industry dominated by subsidiaries of multinationals has performed well. Pharmaceuticals, chemicals, food and the internet have benefited from the decline in wages and rent, their still advantageous tax regime and the buoyancy of demand from non-euro zone European countries and from emerging markets.

Strengths

• Flexible economy
• Dynamic demographics
• Business-friendly environment-fiscal, social and legal attractiveness
• Much foreign direct investment, especially American
• High value-added economic sectors such as ICT, life sciences, pharmacy
• Exports of pharmaceuticals and chemicals holding up well

Weaknesses

• Dependence on U.S. multinationals
• High exposure to markets abroad (United States, United Kingdom)
• Insufficient transport and education infrastructure
• Stricken banking system
• Severely deteriorated public sector finances
• High household indebtedness
• Insufficient price competitiveness    
• Bursting of a property bubble