Statement following the conclusion of the fifth 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 fifth post-programme surveillance (PPS) mission from 7 to 10 June. Staff from the European Stability Mechanism also participated in the meetings on aspects related to its Early Warning System.
The current economic and financial situation continues to benefit from a strong rebound of economic activity. Ireland remains the fastest growing EU economy. Real GDP growth was buoyant at 7.8% in 2015, surprising on the upside after 5.2% in 2014. Initially driven by net exports, economic growth is now more broad-based and primarily supported by domestic demand. Gross fixed capital formation has been the most dynamic component, driven mainly by the activity of multinational enterprises (MNEs). Despite ongoing deleveraging, private consumption has picked up too. Unemployment continues to decline and reached 7.8% in May, while inflation remains low. Residential property price rises have decelerated after the introduction of macro-prudential mortgage lending rules. Net private credit growth remains depressed though new lending is recovering and interest rates on new loans have declined somewhat, especially for households. Financing conditions, including interest rates on government bonds, remain favourable and are likely to remain so, also on account of the monetary policy measures of the European Central Bank (ECB). Profitability in the main domestic banks continues to recover amid improving asset quality and higher net interest margins. Economic growth is expected to moderate somewhat to around 5% in 2016 and a more sustainable rate of almost 4% in 2017. Both domestic demand and the external sector are expected to contribute to the consolidation of the economic expansion. Economic and financial risks are tilted to the downside by the uncertainty surrounding the UK referendum on EU membership and a possible downturn in global growth.
According to the Commission assessment, the government corrected the excessive deficit in 2015 by the deadline set in the Excessive Deficit Procedure (EDP) recommendation, as the general government deficit reached 2.3% of GDP and is projected to decline further. Tax revenues in 2015 were bolstered by strong economic growth and by a surge in corporate tax receipts mainly driven by MNEs. Budget 2016 included further tax cuts and expenditure increases worth 0.7% of GDP, but the budget deficit is projected to narrow to 1.1% of GDP in 2016. Under a no policy change scenario, it is forecast to narrow further to 0.6% of GDP in 2017, taking also into account the estimated budgetary impact from fiscal policy measures that have been specified in sufficient detail by the authorities. The public investment-to-GDP ratio in 2017 is projected to remain at historic lows, at 1.8% of GDP. Gross general government debt is forecast to continue falling from 93.8% of GDP in 2015 to 86.6% of GDP by 2017, owing mainly to the strengthened economic outlook. Spending pressures are emerging, raising the risk of a deviation from the recommended fiscal adjustment path. Recently announced upward revisions to the 2016 expenditure ceiling of 0.25% of GDP could increase the budget deficit unless they are matched by higher than anticipated revenues. Moreover, the new government plans further cuts to personal income taxes and VAT rates that remain to be specified in detail. Additional efforts are needed to make the tax system more efficient and growth-friendly through a shift towards less distortionary taxes. There is scope for broadening the tax base with a view to mitigating revenue volatility. Improving cost effectiveness in healthcare, especially in hospitals and pharmaceuticals, remains a challenge.
Bank profitability has improved, though in some cases it remains fragile or boosted by the write-back of impairments. It continues to be limited by the high amount of distressed loans, a significant amount of legacy assets (tracker mortgages) and subdued credit demand. The share of non-performing loans (NPLs) in the domestic banks continued to decline to 16.1% at the end of 2015, from a peak of 27.1% in 2013, but it remains among the highest in the euro area. The share of mortgages in long-term arrears has dropped, but is still high at about two thirds of total mortgage arrears. Banks need to continue with loan restructurings and with improving the sustainability of restructuring solutions. Efforts should continue to address insolvency and bankruptcy procedures, alongside difficulties in speedily accessing collateral. Proposed legislation aims to enable the Central Bank of Ireland (CBI) to periodically review the market for principal dwelling house mortgage loans and, if a “market failure” is identified, to introduce a cap on mortgage rates. The government has indicated in the Dáil Éireann (the lower house of the Irish Parliament) that there is an obligation to consult the ECB on this draft legislation.
The CBI implemented macro-prudential measures to regulate mortgage markets in support of its financial stability mandate. A first review of their effectiveness will be published by the CBI at the end of November 2016. A timely introduction of the credit register would contribute to improving lending standards. A new ministry for housing has been created to coordinate the broad array of proposed and existing housing policy measures. Still, the undersupply of housing remains a prominent issue and needs to be tackled using supply-side measures. Careful monitoring of the property market should continue, especially given the high foreign capital inflows into the commercial real estate market, coupled with strong demand.
Ireland's economic adjustment has been remarkable, and the challenge for the new government is to maintain the momentum, while mitigating the risk of a return to boom-and-bust cycles. Deleveraging of public and private debt has continued, facilitated by high nominal GDP growth and low interest rates. To sustain growth in the medium term, housing and infrastructure bottlenecks need to be tackled more ambitiously, including by better using existing resources or harnessing new ones for additional capital expenditure. Ensuring compliance with EU fiscal rules will help avoid the pro-cyclical policies of the past. The current favourable economic and financial conditions provide an opportunity to accelerate the reduction of the still high public debt. Sales of government-owned shares in the domestic banks would further reduce debt.
The next PPS mission is planned to take place in the autumn of 2016.
The mission would like to thank the Irish authorities for their helpful and open discussions.