Staff from the European Commission, in liaison with staff from the European Central Bank, visited Dublin from 16 to 19 May to conduct the seventh post-programme surveillance (PPS) review mission for Ireland.
Staff from the European Stability Mechanism also participated in the meetings on aspects related to its Early Warning System. The main objective of PPS is to assess the country’s capacity to repay loans granted under the former EU-IMF financial assistance programme and, if necessary, to recommend corrective actions.
While the outlook for the Irish economy remains bright, external risks are significant. Ireland has made substantial progress in addressing crisis legacies, including by repairing private sector balance sheets, reducing public debt and creating employment. Growth of the domestic economy remains robust, driven by positive developments in the labour market, consumption and core investment. However, some of the striking headline figures are heavily distorted by activities of multinational enterprises, including highly variable investment in intangible assets and aircraft. In this context, recent efforts to develop complementary economic indicators are welcome as they could improve the data available to policymakers. Risks to the economic outlook remain tilted to the downside. Uncertainty surrounds the final outcome of the negotiations between the UK and the EU under Article 50 of the Treaty on European Union. Moreover, possible future changes to international tax and trade policies are another potential source of asymmetric shocks.
High external uncertainty puts an even greater premium on prudent fiscal policy amid calls for a ‘recovery dividend’. The general government deficit continues to decline, yet the underlying fiscal effort diminished in 2016. This reflects the government’s policy of exhausting all available fiscal space, which received a boost from corporate tax windfalls in 2015-2016. In the future, it would be prudent to use such funds to accelerate deficit and debt reduction, in particular as many indicators suggest that the economy is already operating close to its potential. Moreover, prudent expenditure management remains essential also to ensure compliance with EU fiscal rules in 2017.
The resilience of public finances to economic fluctuations and adverse shocks could be strengthened by broadening the tax base. In particular, there is scope for a shift toward more sustainable and growth-friendly sources of revenue. The planned “rainy day fund” and the announced 45% public debt-to-GDP target go in the right direction, but will need to be spelled out in more detail. The ongoing spending review provides an opportunity to improve the efficiency of public expenditure and reorient it to address capacity constraints and promote inclusive and sustainable recovery.
The recovery of the Irish banks continues but is yet to be completed. Several years after the crisis, banks have deleveraged and their capital positions have significantly strengthened. The quality of the banks' assets has improved mainly as a result of ongoing restructuring, asset sales as well as rising collateral values. Non-performing loans continue to decline but the share of long-term arrears, especially mortgages is still significant. The strong initial take-up of the “Abhaile” aid-and-advice scheme for mortgage debtors in distress could lead to a broader use of personal insolvency. It is important to continue to ensure the adequacy of provisioning practices.
Subdued credit demand and the banks’ legacy issues are still a drag on their profitability, but the outlook for credit growth is improving. While new lending is picking up, on aggregate both households and firms are still repaying more than they borrow. So far, the growth in new lending has been largely confined to specific categories within mortgage and corporate loans. Irish banks are still vulnerable to market distress in the euro area, or possible spillovers from the UK following its decision to leave the EU. Concerns remain that the draft bill enabling the Central Bank of Ireland (CBI) to cap interest rates on variable rate mortgages, if enacted, could have negative implications for the transmission of monetary policy, financial stability and bank competition.
Residential property prices accelerated recently and will need to be closely monitored. On top of brisk economic growth, demand side policies may have exacerbated recent price trends, yet the fundamental issue remains insufficient housing supply. Completions of new residential housing units increased in 2016 but the supply of homes remains well below estimated demand fundamentals. The government has repeatedly and actively intervened in the residential property market but it will still take time to deliver an adequate supply of new homes. Certain building requirements still present a barrier to the construction of apartments, while the new National Planning Framework could facilitate a more stable housing market by enabling a coherent spatial distribution of housing and supporting infrastructure. Current price developments are not being driven by credit. The annual review of the macroprudential measures in the mortgage market provides an opportunity to ensure that the calibration of tools remains appropriate.
The mission would like to thank the Irish authorities for the helpful and open discussions.
The next PPS mission is planned to take place in the autumn of 2017.
19 May 2017