Statement following the conclusion of the fourth post-programme surveillance mission to Ireland
Staff from the European Commission, in liaison with staff from the European Central Bank, visited Ireland to carry out the fourth post-programme surveillance (PPS) mission from 9 to 13 November. This was coordinated with the International Monetary Fund's fourth post-programme monitoring mission. Staff from the European Stability Mechanism also participated in the meetings on aspects related to its Early Warning System.
The on-going rebound in economic activity is exceptionally strong, testifying to the successful adjustment of the Irish economy in the past several years. While external risks are tilting to the downside and Irish quarterly national accounts are volatile, Ireland remains the fastest growing EU economy. Initially driven by net exports, growth is now supported by strong domestic demand. The latest budgetary decisions are likely to add to the already very strong growth momentum. Unemployment continues to decline and is now well below the euro area average. While supply shortages persist in large urban areas, residential property price rises have decelerated after the introduction of macro-prudential mortgage lending rules. Financial sector repair continues to progress well amid favourable market conditions. With the recent announcement of Allied Irish Bank's partial redemption of preference shares, the authorities have taken welcome steps to continue their disengagement from the domestic banks.
Helped by much better-than-expected growth, Ireland is well on track towards a timely and sustainable correction of the excessive deficit, and the gross government debt is set to decline to well below 100% of GDP next year, from a peak of 120% in 2012-13. At a time of strong economic growth, the government approved extra permanent spending of around 0.7% of GDP for 2015 which carries over into 2016. The increase is being financed by much higher-than-expected government revenue. However, the factors underlying the very buoyant and generally volatile corporate tax receipts still need to be ascertained.
Budget 2016, which targets a deficit of 1.2% of GDP, includes additional tax cuts and expenditure increases worth 0.7% of GDP. The deficit target would have been significantly lower had the strong growth in revenues been fully allocated to deficit and debt reduction. On the expenditure side, new measures in 2016 mainly consist of higher public wages and social benefits. The government investment-to-GDP ratio will further decline in 2016 after having been compressed considerably during the crisis. The Capital Investment Plan 2016-2021 would stabilise this ratio well below current euro-area average levels. The European Commission is currently undertaking a full assessment of the 2016 Draft Budgetary Plan with reference to EU fiscal rules and will present its Opinion shortly.
Financial sector and property market
The profitability of domestic banks continues to recover due to improved asset quality and higher net interest rate margins. It will be important to sustain profitability as capital requirements are becoming more stringent. Non-performing loans of domestic banks fell to 19.8% of total loans in mid-2015, down from a peak of over 25% in 2013. Nevertheless, they remain among the highest in the euro area and the share of long-term mortgage arrears continues to increase. This still weighs on the ability of banks to support economic growth with new credit at more favourable interest rates. Bank net lending to the private sector, especially SMEs, remains subdued though there are early signs of new lending picking up. Banks need to continue with loan restructurings and with improvements in the sustainability of restructuring solutions. Delays in the legal process that continue to hamper the success of restructurings should be reduced. Introduction of new Court Rules designed to improve case management may impact favourably on the level and success of restructures.
The implementation of the central bank's mortgage lending rules this year should underpin financial stability. A more timely introduction of the credit register would contribute to improving lending standards. The government has agreed an extensive set of measures in an attempt to deal with problems in the housing market, in particular the lack of supply in urban areas and in the rental sector. Careful monitoring of the property market should continue, especially in light of substantial foreign capital inflows to the commercial real estate sector.
Labour activation reforms are being finalised and there has been good progress with the reform of further education and training. More structural efforts are needed to improve cost effectiveness in the delivery of healthcare, especially in hospitals and public spending on pharmaceuticals. Adequate funding of water infrastructure needs to be ensured. Following renewed delays, the near-term enactment of the legal services regulation bill is critical to the reduction of high legal services costs.
Overall, the adjustment process of the Irish economy has continued, though the strong rebound of economic growth is set to moderate to more sustainable rates. To underpin growth in the medium term, housing and possible infrastructure bottlenecks will need to be addressed. The current very favourable economic and financial conditions give the government an excellent opportunity which should be taken to accelerate the reduction of the still high public debt.
The next PPS mission will take place in the spring of 2016.
The mission would like to thank the Irish authorities for their helpful and open discussions.