Mission Concluding Statement 

Ireland: Staff Concluding Statement of the 2018 Article IV Mission

May 14, 2018

Ireland has made significant strides in recovering from the crisis and the ongoing rapid economic expansion is broad-based and job-rich. Crisis legacies are on the mend. At the same time, public and private debt remain elevated while severe housing shortages are fueling price hikes and stretching affordability. Growth prospects remain strong as robust domestic demand together with the global recovery continue to boost activity. As a result, the economy is rapidly approaching full employment with the prospective rebound of the construction sector adding to pressures. External risks include an escalation in global protectionism and a possible hard Brexit would have significant negative spillovers given strong trade, financial, and labor market linkages with the U.K. C hanges in international corporate taxation, including the recent U.S. tax reform and EU anti-tax avoidance measures, could affect investment decisions by multinationals and result in some erosion of Ireland’s tax base.

The policy challenge is to harness the strong economic momentum to avoid a new boom-bust cycle, address remaining crisis legacies, and bolster the economy’s resilience for the event adverse risks materialize. To this end, fiscal policy should become countercyclical, while making room for much-needed infrastructure investments. This would involve broadening the tax base, which is also prudent in view of the high dependency on possibly volatile corporate tax revenues. Further action should be taken to boost housing supply in a sustainable manner. Efforts to repair banks’ balance sheets should be stepped up and preparations in the financial sector for Brexit need to continue. Structural reforms should focus on fostering higher productivity and inclusiveness to promote high, sustainable growth.

Building Fiscal Buffers Remains a Priority

Public finances have continued to improve on the back of strong economic growth, but vulnerabilities persist . Although the general government deficit has been virtually closed, the pace of deficit reduction has slowed somewhat while public debt remains elevated when measured in terms of metrics that better reflect the size of the domestic economy than GDP. Moreover, corporate income tax receipts, while buoyant, are concentrated in a few multinationals and thus vulnerable to shocks, including from the U.S. tax reform and the EU and international anti-tax avoidance agenda. At the same time, expenditure pressures are intensifying to address infrastructure needs and population ageing.

Considering the strong cyclical upswing and the risks to the outlook, fiscal policy should be tightened to build buffers. Based on current policies, the fiscal stance would be broadly neutral in 2018 and 2019. The mission recommends pursuing a small budget surplus in 2019, while aiming at reducing the public debt ratio to close to 50 percent over the medium term. Initiatives to achieve that should include:

• Broadening the tax base in a growth-friendly manner. Streamlining the value-added tax structure by eliminating exemptions and preferential rates such as in the hospitality and services sectors, and better targeting of tax expenditures could provide significant resources. Additional revenue gains can be achieved by gradually aligning the property tax bases with market values and by increasing the excise rate on diesel. Income distribution concerns could be mitigated by means-tested allowances for low income households.
• Avoiding the use of temporary revenue gains to fund permanent measures. Tax windfalls emanating from the activities of multinationals should be used to reduce public debt or to increase the forthcoming Rainy-Day Fund.
• Maintaining moderate expenditure growth while improving its quality and efficiency. The ongoing spending review is a good step towards more efficiency but more could be done by introducing specific objectives, including in healthcare. The ambitious public investment plans are welcome but call for improving the integration between strategic planning and capital budgeting, enhancing evaluation of public private partnerships, prudently managing infrastructure assets, and fully factoring in future management and maintenance costs.

It is important to strengthen the financial soundness of the Social Insurance Fund (SIF). Population ageing is expected to significantly increase pension and other social expenditures in the coming decades. Measures should be developed, including a review of social security contributions, to safeguard the SIF’s long-run viability and avoid future government subventions. In addition, consideration could be given to moving toward a more comprehensive and evenly distributed tax on individual earnings to better reward work, while preserving resources to address priority needs in a sustainable manner.

Fixing the Housing Market

House prices have continued to increase, reflecting severe supply shortages . Favorable labor market conditions, higher incomes, and improved household finances have boosted housing demand while construction has only sluggishly recovered from its crisis. House prices have increased at double-digit rates and rents have surpassed their pre-crisis levels. While the mission does not see immediate financial stability risks, by some metrics housing prices appear modestly overvalued and expectations suggest that the strong momentum is likely to persist for some time. Measures to address this issue include:

• Boosting housing supply . Recent measures to ramp up housing supply are a step in the right direction. Further efforts should focus on streamlining planning processes, reducing skills gaps in the construction sector, and advancing debt restructuring of distressed but viable construction firms. The establishment of Home Building Finance Ireland would help financially-constrained developers, yet its operations should remain limited in scope and subject to robust governance and prudent risk assessment. Policies to bring vacant land and properties to market should be reviewed periodically to ensure their effectiveness.
• Continuing to deploy macroprudential policy proactively . The current calibration of the macroprudential framework appears appropriate. As the new lending cycle unfolds, it is important to ensure that bank and household balance sheets remain resilient to shocks. A switch from the loan-to-income limit to a debt-to-income limit would better capture household repayment capacity and should be considered once comprehensive data on household debt becomes available.
• Reducing homelessness. Efforts to expand social housing are welcome, yet it is important to ensure that eligibility is means-tested. The Help-to-Buy scheme should be strictly targeted towards low-income households, while the provision of loans to risky borrowers outside the banking system should remain limited and subject to stringent risk assessment. Administrative measures to stabilize rents should be reconsidered as these are likely to discourage the development of the rental market.

The upswing in the commercial real estate (CRE) market requires close attention. The recovery of the CRE market is supported by strong resident and nonresident investment. Domestic bank exposure has declined significantly in recent years. However, their legacy portfolio of CRE assets remains exposed to a possible reversal in foreign investment flows and a drop in collateral values. Enhanced monitoring of this market, including by closing data gaps, and application of prudent lending practices are critical to contain risks. Taxation measures should continue to be used to dampen the market’s high sensitivity to international CRE price developments.

Strengthening Financial Sector Resilience

Domestic banks further improved their resiliency to shocks but face several challenges. Banks have strengthened their capital and liquidity buffers while favorable economic conditions and sustained improvement in household and corporate financial health have supported a nascent credit recovery. Uncertainty, however, remains elevated, particularly from the direct and indirect effects of post-Brexit arrangements. Lingering crisis legacies, upcoming regulatory changes, and costs associated with the correction of missteps related to tracker mortgages continue to pose headwinds to bank profitability.

Further improving the asset quality of the banking system is necessary. Significant progress has been made in reducing nonperforming loans (NPLs) but the resolution of distressed mortgages has proceeded at a reduced pace. Resolutions could be sped up by accelerating the legal process, improving creditor-borrower engagement, and further enhancing supervisory efforts, including by increasing provisions and providing binding guidelines on NPL write offs. Pending legislation, which could affect the contractual relationship between borrowers and lenders and disrupt the mortgage market, should be reconsidered.

Preparations in the financial sector for Brexit should continue . Banks should ensure that their business models are suitable to respond to a material change in economic conditions. Material reduction of NPLs accompanied with conservative collateral valuation would improve their resilience to a possible slowdown of the British economy and deterioration in Irish companies’ repayment capacity. Close engagement with insurance companies is needed to ensure their readiness to a possible change in the regulatory landscape and mitigate contract continuity risk.

Promoting High and Sustainable Growth

Addressing structural impediments would promote high and sustainable growth, and strengthen resilience to shocks . Priority should be given to address the following challenges:

• Infrastructure gap. Public investment efficiency is lagging that in peers and the uneven distribution of infrastructure across regions hampers balanced growth. The government’s National Development Plan for 2018-27 is a step in the right direction as it seeks to ensure that investment is well-prioritized to best achieve value-for-money.
• Productivity gap. Promoting productivity growth of local firms, including through greater support for innovation and enhancing partnerships of SMEs with research institutions, would help reducing the productivity differentials with peers and large multinationals.
• Labor skills gap. Skills shortages have emerged in several sectors, and the proportion of young people not in education, employment or training remains above the EU average. Determined efforts to align educational paths with labor market needs and to make training programs accessible to young people from disadvantaged regions are important.
• Gender gaps. Ireland’s gender employment gap is above that in peers, reflecting in part disincentives for women to participate in the labor force. A forceful implementation of recent Pathway to Work Action Plan for Jobless Households would help address these impediments. Attention should be given to providing affordable childcare, reducing high second-earner marginal tax rates, and eliminating gender pay gaps.

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The IMF team would like to thank the authorities as well as representatives from the private sector and civil society for candid and productive discussions, and their hospitality.