Mission Concluding Statement 

January 27, 2015

An International Monetary Fund (IMF) mission visited Dublin during January 20–27 for the 2015 Article IV consultation discussions, part of the IMF’s regular surveillance of all member countries. At the end of the visit, IMF Mission Chief Craig Beaumont thanked the Irish authorities for the candid and constructive discussions, and issued the following statement:

Ireland’s recovery is off to a good start. But sustained solid growth and job creation over a number of years is needed to repair the damage from the crisis. The durability of the recovery will benefit from three main ingredients: putting the public debt burden on a firmly downward path, tackling the most entrenched private debt distress, and reviving lending while avoiding renewed vulnerabilities. A joined up strategy of steadily completing Ireland’s fiscal adjustment, together with financial and property market policies that support investment while mitigating boom-bust risks, is therefore needed.

1. Ireland’s recovery is robust yet crisis legacies persist. Surging exports and investment lifted growth to about 5 percent in 2014. Growth of 3½ percent is projected in 2015, aided by strong trade links with the U.K. and U.S., euro depreciation, and declining oil prices. Ireland’s medium-term prospects are positive, yet euro area stagnation poses downsides. Nonetheless, the ECB’s quantitative easing mitigates risks that favorable financing conditions could unwind. Unemployment has declined notably, to under 11 percent, but youth and long-term joblessness remain unacceptably high. Some 25 percent of bank loans are still classified as nonperforming.

Medium-Term Fiscal Policy

2. Ireland has proven its commitment to putting its budgetary position on a sound footing. Consolidation efforts over eight years are expected to bring the fiscal deficit to just below 3 percent of GDP in 2015. To protect the adjustment progress in 2015 it remains essential to avoid a repeat of recent expenditure overruns, especially in healthcare, and to save gains from revenue overperformance, asset disposals, and interest bill reductions.

3. Looking ahead, a balanced budget over the cycle is a sound fiscal goal for Ireland. Fiscal balance will put Ireland’s high public debt on a firmly downward path, reducing uncertainties and supporting investment and job creation. Declining debt will also rebuild the fiscal space needed to allow Ireland to cushion shocks going forward. Moreover, achieving budget balance over the cycle reduces the risk of the fiscal stance amplifying economic fluctuations, as was historically common in Ireland, but allows automatic stabilizers to play a counter-cyclical role in cushioning shocks.

4. The adjustment toward balance after 2015 should be phased and steady. As the economy still operates below its potential, a deficit just below 3 percent of GDP in 2015 translates into a structural deficit—excluding cyclical effects and one-off items—estimated at just over 2 percent of GDP. Phasing the closing of that structural deficit over a three year period would limit the drag on annual growth rates. Pacing this adjustment evenly, at no less than ½ percent of GDP annually, would enhance economic stability.

5. The policy mix to achieve steady adjustment should protect Ireland’s growth potential. The mission sees scope for both the expenditure and revenue sides to support adjustment, which could help create room to rebuild capital spending over time. Revenue measures could also be needed if evolving international tax standards impact the tax base. Expenditure and revenue reforms with the least adverse effect on Ireland’s growth potential should be favored.

6. Achieving the spending path in the government’s Comprehensive Expenditure Report 2015–17 will require broad based efforts:

• Public wage bill. Savings in this area made a major contribution to Ireland’s fiscal consolidation. Any future developments must recognize the very tight fiscal constraints in coming years. Implementing the Public Service Reform Plan 2014-16 to increase efficiency and improve service delivery remains a priority.

• Social protection. A large expansion in social protection spending was essential in the crisis and it is important that this spending now declines as the economy recovers. Further means-testing of benefits, or taxation of universal benefits, could generate significant savings while ensuring those on lower incomes are protected.

• Healthcare. Cost efficiency in this key sector should be improved, building on existing initiatives. In particular, high use of costly acute care should be reduced through expanded access to primary care, and further savings on pharmaceutical outlays should be sought.

• Education. Higher education funding reforms are needed to control growth in public spending while protecting low income students.

7. Capital spending needs should be reviewed carefully. Once the fiscal position is closer to balance, a gradual rebuild of currently low capital spending may be required to ensure adequate maintenance and avoid growth bottlenecks. Structural reforms that boost growth can benefit the fiscal position in the medium term, yet may have up-front costs including investment needs. It would be appropriate to explore scope for well specified structural reforms with credible timelines and growth benefits to qualify for the flexibility now available within the Stability and Growth Pact (SGP).

8. Revenue policies should protect the important progress in broadening the tax base in recent years. Maintaining up to date housing valuations will protect the property tax base and also help lean against housing cycles. The large fall in oil prices creates an opportunity to raise environmentally friendly taxes. Tax expenditures have been reduced and they should be reviewed over time in line with the authorities’ new guidelines. In the medium term, VAT reforms could bolster revenues without higher rates.

9. The rules of the SGP’s preventive arm will support adjustment to structural balance while countering fiscal pro-cyclicality. The Expenditure Benchmark and Structural Adjustment Rule will apply to Ireland after it exits the Excessive Deficit Procedure, as expected in 2015. Importantly, strong revenue performance will no longer permit additional spending in the same year, averting fiscal stimulus when growth is strong, because the Expenditure Benchmark will set a firm ceiling on annual spending on the basis of Ireland’s potential growth.

10. Yet, Ireland-specific technical issues in applying the rules should be addressed. The common EU methodology appears to understate cyclical swings in Irish unemployment and hence also in output. Ongoing work by the Irish authorities on refining technical aspects of the methodology is therefore welcome, to help ensure that the application of these rules will in practice underpin a prudent fiscal policy consistent with economic stability.

Financial and Property Market Policies

11. Financial and property-related policies should foster sound lending while tempering cycles to facilitate a recovery that endures. Ireland’s recovery calls for rising investment with growing needs for financing over time. Yet it is essential that past boom-bust patterns be avoided. Given the strong momentum in property prices and an emerging rise in mortgage lending, coupled with large international financial flows in search of yield, it is appropriate to move forward now to keep macro-financial risks in check.

12. Loan resolution has made progress and must now tackle the most entrenched cases. Total distressed loans are falling and further declines can be expected should restructures continue to perform. However, the value and number of residential mortgages past due by two years or more continue to rise and buy-to-let loan arrears remain very high. It is important to secure borrower re-engagement on lasting restructures where feasible, including through timely legal proceedings. Supervision should press banks to restructure or dispose of loans in prolonged arrears including those under legal proceedings. Close monitoring of the ongoing workouts of troubled SME loans also remains vital. Progress should be supported by a high level of transparency on the scale and quality of distressed loan resolution.

13. Supervision should encourage banks to be ahead of the curve in addressing capital quality issues. Deferred tax assets and preference shares are to be phased out as eligible regulatory capital under the new EU rules. Early steps to build high quality loss absorbing capital would better safeguard lending capacity than relying primarily on internal capital generation over time.

14. Nonbank financing can usefully complement bank lending. Recent experience with real estate investment trusts (REITs), authorized since 2013, highlights the positive role that appropriately regulated nonbanks can play. By bringing in fresh equity, REIT financed investments entail lower macro-financial risks than high reliance on bank loans. SMEs and the construction sector also need external risk capital and structures to facilitate such financing for these areas should be explored.

15. State sponsored financing vehicles can play a supportive role but fiscal risks should continue to be contained. The Irish Strategic Investment Fund should be carefully managed given its recent entry into a venture capital role. The Strategic Banking Corporation of Ireland could enhance credit availability for SMEs and modestly ease lending rates, yet monitoring of loan portfolio risks is needed given state funding guarantees.

16. An integrated micro- and macro-prudential approach is needed to protect financial stability and mitigate risks to recovery. The CBI has developed a macro-prudential framework with a range of policy tools available which it should apply proactively as risks evolve. Nonetheless, given uncertainties around the impact of these tools, banking policies must also maintain financial resilience through the cycle.

17. Strengthening the regulation of residential mortgage lending is therefore welcome. The CBI’s proposed policies on loan-to-value and loan-to-income ratios will increase the resilience of households and banks to financial shocks and help dampen the property cycle. Any differential treatment of borrower categories should ensure their financial resilience remains as strong as other borrowers, and should be kept under review based on default experience. Given widespread expectations of continuing house price rises, a phase in period could pose risks from front-loaded borrowing. The credit register will eventually provide valuable information on borrowers’ credit records and total debt, helping to limit circumvention.

18. Bank exposures to new commercial real estate risks must be contained appropriately. Losses on commercial property accounted for over half of bank capital needs in the crisis. Commercial property prices are again rising rapidly, partly due to international investments. Supervision should focus closely on banks’ risk management, underwriting standards, and valuations in this sector. Deployment of macro-prudential tools, such as loan-to-value rules and capital add-ons, should be kept under review.

19. Addressing the weakness in housing construction would over time help dampen price increases. Housing construction falls well short of demand in some areas, fueling price and rent increases. Restraints on construction include high costs—where local building codes and development levies are contributors—and a slow transition to an increased use of equity financing. The authorities’ steps to bring equity providers and developers together are welcome. Incentives to complete developments should be strengthened through use-it-or-lose-it building permits and a vacant site levy. Timely implementation of other Construction 2020 actions, including a streamlining of planning procedures, would also enhance the performance of this sector.

20. A more developed rental market would support labor mobility, help moderate property cycles, and reduce household exposure to such cycles. Rented properties are a low share of Irish housing. The framework for landlord-tenant relations should be reviewed with a view to attracting investment and professional management into the sector, which could in time expand the supply of rental property and moderate rents. With tight rental supply disproportionately impacting low income households, the increased social housing allocation in Budget 2015 is welcome.