Mission Concluding Statement 

Ireland: Staff Concluding Statement of the 2022 Article IV Mission

May 5, 2022

Washington, DC:

Ireland’s economy has rebounded strongly from the pandemic and GDP surpassed its pre-pandemic trend. Growth is projected to remain strong, although there is substantial uncertainty due to the indirect impacts from the war in Ukraine. Energy and commodity prices will likely push average inflation above 6 percent this year. Covid-support measures are being appropriately unwound in line with the economic recovery. In the short term, two-way fiscal flexibility is needed to strike the right balance between supporting the economy and containing inflationary pressures. Several pre-pandemic challenges remain, including insufficient supply of housing; infrastructure, social, and green investment gaps; and the need to strengthen multinational enterprises (MNEs)’ inward linkages to make growth more inclusive. In the medium term, more high-quality spending is needed to facilitate the transformation of the economy while at the same time safeguarding fiscal sustainability. The financial sector has weathered the pandemic crisis well and remains resilient, but there is a need to address the legacy scarring effects of the Global Financial Crisis, tackle the factors contributing to high lending interest rates, and continue to strengthen and evolve supervision of the large and growing financial sector which is complex and globally interconnected. Further structural reforms should aim to remove bottlenecks, increase productivity, and reduce remaining inequities.

The economic outlook remains strong, but risks are tilted to the downside. Largely driven by MNEs, real GDP grew an impressive 13½ percent in 2021, surpassing its pre-pandemic trend. Household consumption increased by 5.7 percent. While direct financial and trade links with Russia and Ukraine are small, the impact of energy price increases is substantial. Hence, real GDP growth is projected to decelerate to a still robust 6 and 5 percent in 2022 and 2023, respectively. High energy and commodity prices, robust domestic demand, and tightening labor market are contributing to inflationary pressures. Headline inflation is projected to average 6.5 percent (with core inflation rising to 4.5 percent) in 2022 and 2.8 next year. Real GDP growth is projected to converge to its 3 percent potential over the medium term and inflation is expected to gradually decline to the 2 percent vicinity as energy and commodity prices are envisaged to subside. However, uncertainty is high and external risks are becoming more pressing including from further supply-chain disruptions, a worsening of external demand and confidence, and possible unanticipated financial sector exposures to sanctions. There are also uncertainties including the remaining details of corporate income tax changes and Brexit implementation.

In the near term, fiscal policy needs to strike a fine balance between countering the headwinds from the war in Ukraine and containing inflationary pressures. Strong tax revenue outturns and the tapering of the Covid-19 support have provided room for a swift response to mitigate the impact of high energy prices on businesses and households. Given inflationary pressures, future additional support, if needed, should be temporary and carefully targeted to better support vulnerable segments of the population while maintaining price signals to induce energy savings. The 2022 fiscal stance is broadly appropriate but in light of high uncertainty, fiscal policy should maintain two-way flexibility in response to evolving output and inflation developments.

The authorities’ medium term fiscal strategy aims to support investment needs while enhancing fiscal sustainability. Staff welcomes the planned medium-term fiscal strategy given that public debt is above 100 percent of GNI* and in view of the remaining uncertainties about changes in international corporate income tax (CIT) rules. However, with a fiscal balance approaching its pre-pandemic level and public debt expected to fall below 40 percent of GDP over the medium term there is scope for additional social and growth-enhancing and green spending while ensuring value for money. Priority should be given to education, training, health, and infrastructure to increase the productivity of the indigenous sectors and promote inward linkages of MNEs. Further progress in improving public investment quality will be key to maximizing returns. Remaining uncertainty regarding CIT and long-term demographic trends necessitate a broadening of the tax base, including by removing preferential VAT rates and gradually increasing the very low property tax rates while ensuring adequate social safeguards. Given the uncertainty, future CIT revenues should be treated with caution, allocating any windfalls to the Rainy-Day Fund.

The banking sector withstood the pandemic shock well thanks to strengthened regulation and supervision, but there is a need to address the legacy scarring effects of the Global Financial Crisis. Banks remain broadly resilient, thanks to high capital buffers, macroprudential measures and effective policy support. Nevertheless, retail banks’ profitability remains under pressure, lending interest rates are high, and credit to SMEs is low. It is important to resolve lingering issues from the GFC, especially addressing the challenges to the recovery of collateral, recognizing banks’ need to retain talent, and noting the importance of divesting government ownership.  Addressing the above-mentioned challenges would help reduce the cost of borrowing for households and SMEs and spur efficiency and innovation. Other risks that need to be carefully managed stem from Fintech, climate change, and the potential impact from the unwinding of pandemic-related support. Embracing Fintech also creates opportunities for consumers and SMEs, improving access to financial services.

Ireland is a host to a large market-based finance sector (MBF). The global and European regulatory framework, and its implementation in Ireland, needs to continue to keep pace with the large, complex, and globally interconnected financial system, growing non-bank lending, the dynamic Fintech sector, and AML/CFT issues. Investment funds hold primarily non-Irish assets on behalf of foreign investors, although they also have domestic interlinkages, primarily through property funds. The Central Bank of Ireland (CBI) has made significant strides in the monitoring and supervision of this sector. Addressing remaining data gaps and elucidating linkages is important for Ireland and the global community. The Irish Authorities should continue to work with European and International authorities to improve the regulatory framework and prioritize its guidance on the use of liquidity management tools.

Macroprudential measures have been effective but the framework needs to evolve to reflect the growing share of non-bank activity. The macroprudential measures on mortgages were effective in supporting resilience of borrowers and containing pro-cyclical credit dynamics. Going forward, the limits on mortgage debt should continue to be closely monitored, and, if warranted by developments in unsecured credit, be complemented by limits on total debt. Investment in CRE rebounded in 2021 with significant cross-border flows, often intermediated via IFs. While these flows provide diversification in funding, they may also act as a channel of contagion for global financial shocks. The CBI’s proposal to implement a leverage limit and provide liquidity management guidelines for Irish-domiciled property funds are essential steps forward to strengthen the system’s resilience to CRE shocks.

Housing supply policies should be further strengthened, with a focus on boosting productivity in the construction sector and improving zoning and the permits processes. The government has launched the “Housing for All” program, which includes measures such as improving zoning, planning, land availability, and provision of social housing. We encourage timely implementation of this program and placing further emphasis on policies aimed at enhancing productivity and competition in the construction sector, further improving dissemination of data on local zoning, and simplifying the process to obtain permits. While the “First Home” affordable purchase shared-equity scheme (part of Housing for All) aims to support first-time home buyers, it does not address the key issue, which is the supply bottlenecks. Therefore, it would be important to keep the scheme narrowly targeted and limited in size to prevent further upward pressures on prices.

Structural reforms are needed to facilitate post-pandemic labor reallocation and reduce labor shortages and skill-mismatches. Labor market outcomes exceeded pre-pandemic levels in both employment and participation, with the highest gains registered for female and young workers. However, employment in contact-intensive sectors is still lagging, and the construction and MNE sectors continue to report severe labor shortages. Policies should, therefore, focus on facilitating labor reallocation, including through upskilling and provision of affordable childcare programs. In this context, we welcome the strategy in the Economic Recovery Plan to strengthen access to training, including the measures aimed at increasing the take-up of training courses and apprenticeships.

Ireland is making progress in implementing its ambitious climate agenda, but more clarity is needed on measures to achieve the stated quantitative targets. Important steps towards achieving the new goals include a carbon tax path to €100 per ton by 2030, green policies in the National Recovery and Resilience Plan (including retrofitting of public buildings and railroad investment) and plans to boost investment in low-emission transport, energy-efficient housing, and renewable energy. The approval of a sector-specific carbon budget is a welcome step. To ensure its effectiveness it would be important to specify well-phased measures to achieve the quantitative targets. Furthermore, just transition measures should be a priority to support the affected groups.

An IMF mission, led by Khaled Sakr conducted meetings in Dublin, Ireland, during April 26– May 5, 2022. The mission worked closely with the Financial Sector Assessment Program (FSAP) team led by Paul Mathieu. The mission met with Minister of Finance Paschal Donohoe; Minister of Public Expenditure and Reform Michael McGrath; Governor of the Central Bank of Ireland Gabriel Makhlouf; other senior officials; parliamentarians; and representatives of labor unions, the business community, the banking sector, and industry. The mission would like to thank the Irish authorities for the close collaboration and to express appreciation for the candid and insightful discussions.