Dublin, Ireland: Ireland’s
economy has shown remarkable resilience in the face of recent consecutive
shocks, achieving one of the highest growth rates in the euro area in
2021-22. Growth is projected to moderate in 2023-24 albeit remaining solid.
Inflation is expected to ease further. The fiscal position has strengthened
considerably on the back of strong tax revenues, but the headline numbers
mask some underlying vulnerabilities. The large and complex financial
system has remained resilient so far and will continue to be tested by
tighter financial conditions. Ireland’s positive outlook is clouded by
considerable external risks. Policies should focus on maintaining
macroeconomic and financial stability and strengthening resilience in a
shock-prone world. This will require: (i) maintaining fiscal prudence to
support disinflation and building buffers for future shocks and spending
pressures from aging and climate change; (ii) continuing heightened
vigilance of financial stability risks; and (iii) advancing structural
reforms to boost housing supply, strengthen productivity, and accelerate
the green transition.
Outlook and risks
Growth is expected to moderate, from a very high
base. Tighter financial conditions, supply side constraints, and
weakening external demand are expected to weigh on the domestic economy. At
the same time, a strong labor market, a recovery of real incomes as
inflation recedes, and a rundown of excess household savings accumulated
during the pandemic should support private consumption in the near term.
Staff projects real GNI* growth to moderate to 2½ percent in 2023-24. GDP
growth is projected to decelerate to 1½ percent in 2023 and 2⅔ percent in
2024, from an average of 12 percent during 2021-22. Inflation is expected to
average 5⅓ percent in 2023 and 3.2 in 2024 before converging to 2 percent
in late 2025, reflecting the impact of ECB’s monetary tightening and the
moderation of growth and labor market tightness.
The outlook is clouded by considerable external
risks.
Further weakening of external demand, a renewed surge in commodity
prices, an intensification of Russia’s war in Ukraine or the
Israel-Gaza conflict, and tighter-than-expected global financial
conditions pose risks to the outlook. Furthermore, Ireland’s highly
open, small economy would likely be significantly affected by
deepening geoeconomic fragmentation in the coming years
and changes in international taxation could have more consequences than
currently envisaged. Activities of multinational enterprises (MNEs) entail
risks on both sides—a retrenchment (expansion) of the MNE sector would lead
to lower (higher) employment growth, tax receipts, and confidence.
Fiscal policy
Fiscal policy should continue to support disinflation and avoid adding
to aggregate demand.
Despite signs that inflation pressures are abating,
capacity constraints in the economy have become increasingly binding, amid a
still tight labor market and elevated core inflation. Well-targeted fiscal
policy can support disinflation at a lower cost to growth and inequality,
by reducing the tension between price and financial stability, while
protecting the most vulnerable. Prudent fiscal policy to build adequate
buffers is also warranted, given Ireland’s large exposure to external shocks
and future spending pressures from aging and climate change. Given the
uncertain and volatile nature of corporate income tax (CIT) revenues,
excess CIT collections should not be used to fund permanent spending.
The 2024 budget entails a slightly expansionary stance.
Budget 2024 responded to elevated levels of inflation through a package of
permanent and one-off cost of living measures. A smaller and better targeted
package would have been less costly while still protecting the most
vulnerable. As inflation continues to recede, one-off cost of living
measures should be phased out. In the event downside risks materialize,
automatic stabilizers should be allowed to work fully, while any
additional discretionary support needs to be temporary and targeted to the
most vulnerable while preserving price signals. Any fiscal overperformance
should be saved.
Strengthening public investment efficiency and ensuring timely
execution of the capital budget will be critical to deliver on the
government’s ambitious goals in the National Development Plan while
ensuring value for money.
Ireland has large and growing investment needs. More efforts need to be
directed towards expediting the planning permission process and modernizing
regulations. Streamlining the judicial review process is also critical to
address large investment needs while reducing uncertainty for projects.
Broadening the revenue base should remain a key policy objective.
With a relatively low, narrow, and concentrated revenue base, there is
scope to expand and diversify tax revenues, including by improving the
personal income tax (PIT) system, reducing its administrative cost, and
simplifying the VAT system.
Staff supports the authorities’ decision to save part of excess CIT
revenues in two savings funds.
This would help de-risk public finances from the excessive reliance on a
temporary, narrow revenue source and build buffers in good times while
partly pre-financing future spending needs. It is important to operate the
funds within a strong fiscal policy framework. With the EU fiscal rules
unlikely to be binding for Ireland, the authorities should reflect on an
appropriate anchor for their longer-term fiscal framework, beyond the
current spending rule for 2022-26, and how the operation of the new savings
funds can be integrated within this framework. General principles
following international best practices should also be considered to ensure
the funds are appropriately structured and sufficiently large to
effectively mitigate the impact of shocks and meet future spending
pressures.
Financial and Macroprudential policies
Systemic financial risks have increased, although there are mitigating
factors.
Tighter financial conditions, persistent inflation, and rising
vulnerabilities in the commercial real estate market (CRE) and its linkages
with leveraged non-banks are key contributors to the higher risks. At the
same time, households have remained resilient to higher interest rates and
cost-of-living, and insolvency rates of domestic firms have increased only
modestly. Residential housing markets remain vulnerable to further
increases in interest rates, but the long-standing mismatch between housing
supply and demand is expected to mitigate the impact.
Ireland’s banking ecosystem is in transition, with a growing presence
of international banks.
Domestic banks have continued to strengthen their balance sheets, with
sound capital and liquidity indicators. Still, intensified supervision of
credit and liquidity risks should remain, given a possibly delayed impact
from high inflation, tighter financial conditions, and vulnerabilities
accumulated during a decade of low interest rates. Progress in reducing the
government’s shareholding in domestic banks is welcome. As recommended in
the 2022 Financial Sector Assessment Program (FSAP), it is important to
recognize the need for the domestic banks to retain talent and ensure a
level-playing field for them in the face of more nimble non-banks. Large
international banks rely on wholesale funding and have large off-balance
sheet liabilities with material inter-linkages with foreign non-banks.
Their vulnerabilities to funding stress and shocks from nonbanks warrant
continued close monitoring.
Staff encourages continued close monitoring of credit conditions and
financial stability risks to assess the need for future adjustment of
macroprudential policy settings and agrees that mortgage measures
should not be used to address broader housing affordability issues.
The Central Bank of Ireland’s (CBI) gradual increase of the
counter-cyclical capital buffer to 1.5 percent is welcome. Despite the
slight increase in loan-to-income (LTI) for first-time buyers (FTBs), the
limit remains restrictive and would unlikely lead to irresponsible
borrowing. However, the relaxation of the loan-to-value limit for second
and subsequent buyers is not advisable because they are riskier than FTBs,
even if the loosening effect may be constrained by the LTI limit and
changes to the allowances. These measures could be counterproductive from a
housing-affordability perspective were they to increase housing demand and
prices. The CBI should continue to carefully monitor the impact of the
changes to the measures to ensure they are achieving their objective of
ensuring sustainable lending standards in the mortgage market.
Links between
the market-based finance (MBF) sector and the Irish economy have been
growing and need to be closely monitored.
Notwithstanding considerable progress, work should continue to fully
elucidate the interlinkages between parts of the MBF sector and the rest of
the financial system, and with the domestic economy. As recommended in the
2022 FSAP, closing still significant data gaps in the “other financial
institutions residual” sector and conducting risk analysis at a granular
level remain a priority, which will require intensified international
collaboration. Furthermore, despite the authorities’ active efforts, data
gaps in direct cross-border exposures to CRE, which can only be closed
through international coordination, prevents a complete accounting of
potential financial stability risks.
Commendably, Ireland is at the forefront of developing and
operationalizing a macroprudential framework for non-banks.
We welcome the CBI’s introduction of a leverage limit and liquidity
management guidance on property funds in November 2022 and issuance of a
Discussion Paper laying out an overarching approach to macroprudential
policy for investment funds. As recommended in the 2022 FSAP, the
authorities should continue to closely monitor developments in the CRE
market and property funds and recalibrate the macroprudential measures as
needed in case of material shifts, leakages, or unintended procyclical
effects. They should also continue to work with regional and international
institutions and other countries to develop macro-prudential tools
targeting risks from non-banks. Staff also welcome the ongoing extensive
review of the funds sector which, as part of its terms of reference, will
consider the financial resilience and sustainability of the industry in
Ireland.
An improved understanding of cross-border money laundering risks
remains important to guide policy priorities at the national level.
The increases in supervisory resources and efforts to develop a
quantitative risk assessment framework are welcome. The authorities
should consider exploring potential impacts of money laundering events
on the stability of the financial sector.
Structural policies
Policies to increase housing density, remove rent caps, and improve
productivity in the construction sector are crucial to sustainably
boost housing supply, and in turn support sustainable growth.
To address affordability concerns and more durably manage housing market
imbalances, measures under the Housing for All plan need to be further
complemented by a broader set of supply-side policies that increase urban
density, improve land use, and enhance construction productivity. Measures
providing greater certainty to developers, such as improving the
transparency and certainty about approval processes, as well as
accelerating the process are also required. Furthermore, reducing the
complexity and restrictiveness of rent legislations, notably replacing rent
caps with more targeted housing support for poor households, would help
increase rental housing supply. Increased housing supply would help relieve
labor shortages and facilitate labor mobility, hence supporting long-term
growth.
There is scope to further the MNE sector’s inward linkages to the Irish
economy.
Facilitating links between MNEs and domestic small-medium enterprises
(SMEs) via supply-chain linkages, labor mobility, and innovation cooperation
could help raise productivity levels of SMEs. Supporting the digital
transformation of SMEs, promoting innovation through expansion of government
support for SME-driven R&D, and providing infrastructure to foster
industrial clusters could also help bridge the productivity gap.
Progress in achieving key climate commitments needs to speed up.
The government has rightly adopted ambitious emission reduction targets for
2030 and 2050. However, Ireland will likely fall short of the 2030 target.
The introduction of sectoral limits was welcome, but compliance is proving
challenging and almost all sectors are projected to exceed their emission
ceilings. The authorities have legislated an annual increase in carbon tax
to 2030, with revenues committed to be fully recycled to address the cost
of climate change. They will also need to implement additional policies
that deliver emission reductions across all sectors faster than expected.
>Ahead of theFit-for-55 package rollout in 2027–
28, options could include reduction/removal of
implicit fossil fuel subsidies, expansion of the national carbon tax to
sectors currently not covered by a form of carbon pricing (e.g.,
agriculture), higher and unified carbon taxation, and introduction of
sectoral feebates. Vulnerable households should be protected using part of
revenues from carbon taxation.
The mission would like to thank the Irish authorities and all other
stakeholders for their hospitality, productive collaboration, and
candid and open discussions. We are especially grateful to the
Department of Finance and the Central Bank of Ireland for assistance
with meetings and logistical arrangements.