Mission Concluding Statement 

Ireland: Staff Concluding Statement of the 2019 Article IV Mission

May 10, 2019

A decade after the global financial crisis, the Irish economy is one of the most dynamic in Europe. Economic growth is strong, unemployment is nearing historical lows, and public finances have improved. Ireland’s success story is broad-based with multinational enterprises playing an important role. The downsized banking sector is well capitalized and liquid, but profitability is under pressure while credit to the economy has only recently begun to expand. Investment funds and other financial intermediaries continue to grow rapidly, lifting the overall size of Ireland’s financial sector above its pre-crisis level.

The baseline economic outlook foresees continued robust growth and job creation with a further tightening of capacity constraints. External risks are increasing, however, as Ireland’s close ties with the U.K. make it uniquely vulnerable to Brexit. Also, an escalation in global protectionism and changes in international corporate taxation could have negative spillovers. Policymakers should manage these risks by focusing on building buffers and strengthening resilience of the economy, both to alleviate demand pressures and prepare for the possibility of a major external shock.

Key measures to consider include: (i) tightening fiscal policy somewhat by avoiding spending overruns and broadening the tax base in a growth-friendly manner; (ii) using any proceeds from the National Asset Management Agency and from sales of government stakes in the banking sector or any other windfalls to pay down the still high public debt; (iii) further reducing nonperforming loans of the banks and closely monitoring risks in the large and fast-growing nonbank financial sector; (iv) continuing to reduce the housing shortage and homelessness; and (v) supporting productivity growth in the domestic economy and closing the gender gap in the labor market.

Strengthening fiscal resilience

The government’s fiscal strategy is solid, but vulnerabilities are building. Budget 2019 aims to maintain fiscal balance, in part relying on buoyant corporate income tax (CIT) revenue. Accounting for nearly a fifth of total tax revenue, up from 7 percent in 2014, its increase can be traced largely to activities of multinational enterprises. Most of the additional CIT revenue has been used to cover spending overruns in healthcare and to offset reductions in income taxation. However, part of CIT revenue is at risk due to its high concentration, weak links to the domestic economy, and susceptibility to changes in the international tax landscape. At the same time, public debt remains high compared to European Union (EU) peers.

Considering these vulnerabilities and the economy’s advanced cyclical position, fiscal policy should be tightened to alleviate demand pressures and build buffers against potential shocks. Based on current policies, the fiscal stance would be broadly neutral in 2019-20. Assuming an orderly Brexit, the mission recommends pursuing a small budget surplus in 2019, which could be achieved by strictly adhering to budgeted expenditure ceilings and saving any unforeseen additional CIT revenue (either in the Rainy-Day Fund or to pay down debt). For 2020, the government should target a surplus of 0.5 percent of GDP, while aiming to reduce the public debt ratio below 50 percent over the medium term. Actions to achieve this could include:

• Broadening the tax base in a growth-friendly manner. The increase in the value-added tax (VAT) rate for the hospitality sector is a welcome step, but there is scope to further streamline Ireland’s five-rate VAT system. The Universal Social Charge (USC) in its current form largely duplicates the Income Tax but adds administrative costs. The USC could be folded into a reformed Income Tax with somewhat higher rates, broader base, and more tax bands to reduce disincentives to work, while preserving the overall yield and income redistribution features. Rather than postponing adjustments in the local property tax, implementation could be improved by adhering to the three-yearly valuation assessments and maintaining the tax rate, while capping the rate of annual tax base increases to smooth tax payments.

• Moderating expenditure growth while increasing its efficiency. It is crucial to continue to resist spending pressures and to avoid the use of temporary revenue gains to fund permanent measures. A thorough healthcare review is needed to halt continuous spending overruns, which undermine the integrity of public finances. The enlarged capital budget and introduction of the investment tracker are welcome, but improvements in planning, selecting, costing, and ex-post assessment, including of public-private partnerships, are needed to improve the efficiency of Ireland’s infrastructure investments.

• Using any proceeds from the National Asset Management Agency and from sale of government stakes in the banking sector for debt reduction, to reverse the large increase in public debt during the crisis to support the banking sector.

Ireland should continue its proactive approach to the international corporate tax reform agenda. The government’s commitment—as set out in Ireland’s Corporation Tax Roadmap—to continue implementing agreed reforms, including the EU Anti-Tax Avoidance Directives, is welcome. To safeguard its reputation, Ireland should engage constructively in multilateral efforts to address digitalization and tax avoidance. With a more level international taxation playing field, the impact on the economy of such measures would be mitigated by the country’s various other competitive advantages such as its welcoming business environment and qualified labor force.

The financial soundness of the Social Insurance Fund (SIF) should be ensured. Population ageing is expected to increase pensions and other social expenditures in the coming years and the SIF faces significant deficits starting in 2030. To safeguard the SIF’s long-term viability and avoid future pressure on the government budget, a review of social security contributions and benefits should be conducted. The planned increases in the state pension age are steps in the right direction.

Ireland should step up policy efforts to achieve its climate targets. Rising greenhouse gas emissions bring Ireland further away from its climate commitments. There is an urgent need to develop and implement a comprehensive and appropriately ambitious strategy to transform the carbon-based economic model, particularly through decarbonizing agriculture, transport, and housing. Such a strategy should include increasing the carbon tax.

Safeguarding financial sector stability

Domestic banks have improved their resilience, but profitability and in some cases business models remain vulnerable. Stress tests suggest that Irish banks could withstand sizeable shocks to the economy. Nonperforming loans (NPLs) are declining, helped by portfolio sales and improved economic conditions. But their level remains high and weighs on profitability, together with the sizable portfolio of low-rate tracker mortgages, regulatory requirements to build up loss-absorbing liabilities, and elevated operational costs. Further improving the banks’ asset quality should be achieved by intensifying borrower-creditor engagement, accelerating legal proceedings, strengthening supervisory guidelines on provisioning and NPL write-offs, and avoiding legislation which could discourage NPL portfolio sales. The banks should also improve their cost-efficiency and diversify lending.

The large and fast-growing non-bank financial sector calls for close surveillance. This sector—comprising investment funds, money market funds, and other financial intermediaries—receives most of its funding from abroad and invests mainly in foreign assets. While the non-bank financial sector in Ireland would mostly be a conduit of global financial shocks, links to the domestic economy are non-trivial and growing. For now, the risk of financial distress in the investment funds sector appears low, but vulnerabilities are emerging. The authorities should continue to monitor risks closely, including the use of leverage by investment funds, while further improving data collection and continuing intensive international cooperation. It is also important to develop the capacity to conduct system-wide stress testing.

Macroprudential policies appear to be appropriately calibrated, but the macro-prudential toolkit should be enhanced. Current limits on loan-to-value and loan-to-income ratios have become more binding while lending standards have been upheld, helping to prevent excessive borrowing in the housing market and dampening house price increases. The authorities should also introduce debt-based measures (e.g., limits on debt-to-income and debt service-to-income ratios) that better capture household repayment capacity. The increase in the countercyclical capital buffer to 1 percent, announced last year in view of the advanced business cycle, will come into effect in July. Given the openness of the economy and its vulnerability to external shocks, expanding the toolkit with a systemic risk capital buffer would bolster system resilience.

Progress is being made in getting ready for Brexit. Financial sector preparations for Brexit appear broadly adequate to mitigate major disruptions. Close cooperation with the EU and U.K. should continue to ensure business continuity and avoid cliff-edge risks. Given continued uncertainty, financial institutions should remain conservative in their risk assessments. The central bank should continue to devote adequate resources to guarantee a high-quality authorization process for U.K.-based financial firms seeking to migrate some of their activities to Ireland.

Ireland should continue to strengthen its anti-money laundering regime and ensure the integrity of its globally interconnected economy. The transposition into national law of the 4^th EU Anti-Money Laundering Directive, including establishing a legal basis for a central registry of beneficial ownerships and enhancing due diligence requirements particularly for politically exposed persons, is welcome. In view of the rapidly growing financial sector and Brexit-related relocations, an appropriate framework to mitigate any new risks is crucial. The authorities should ensure ongoing implementation of requirements regarding customer due diligence; transparency of beneficial ownership; and suspicious transaction reporting by banks, the real estate sector, lawyers, and trust and company service providers. 

Addressing bottlenecks to growth

Further efforts are needed to address the housing shortage. Housing prices continue to rise, albeit at a more moderate pace as the supply of housing has begun to respond to rising demand. Supply shortages in the rental market, meanwhile, have pushed rents well above pre-crisis levels. The government has taken several steps to facilitate housing development, including by establishing a state lender for financially constrained developers. In addition, spatial planning should be improved to support building houses in areas where demand is strong. Building regulations could be further rationalized, and the efficiency of existing tax measures could be improved to counter land hoarding in urban growth areas. Efforts to expand social housing are welcome. Measures to improve affordability should be targeted to low-income households and the homeless to avoid exacerbating housing price pressures.

Overall productivity is high in Ireland, but certain sectors are lagging. The multinational sector is highly productive, and small- and medium-sized enterprises are more productive on average than in the rest of Europe. However, productivity has been declining in transportation, accommodation, food services, and agriculture—the same sectors that are most exposed to Brexit. The government should seek to improve the enabling environment in these sectors, including through direct funding of research and development, training of workers, and quality infrastructure investment. More workers should be equipped with skills necessary to find employment in sectors such as finance, professional services, and information and communication technology, where jobs are difficult to fill.

Ireland has an opportunity to substantially raise its economic potential by closing the gender gap. Female labor force participation, though increasing, continues to lag the EU average. The high cost of child care is a major obstacle to greater female labor force participation, particularly for low-income families. The launch of the Affordable Childcare Scheme is therefore a welcome development. Further steps to address the large gender employment and pay gaps could include the promotion of flexible work schedules, equal employment opportunities for men and women, individualization of the income tax, and greater transparency of gender pay differentials at the company level.

Disorderly no-deal Brexit contingency

A disorderly no-deal Brexit would have significant and immediate adverse consequences for the Irish economy and reduce long-run output. In this case, the government should allow automatic fiscal stabilizers to operate and provide targeted, temporary, and effective support to help hard-hit sectors adjust to the new market configuration. It should also prepare for a fiscal stimulus and deploy the Rainy-Day Fund, depending on the severity of the downturn in the broader economy. The central bank should release the countercyclical capital buffer in case of a sharp contraction in bank credit.

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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 warm hospitality.