S&P upgrades forecast for Irish economy but warns of ‘two-speed recovery’

Ratings agency Standard & Poor’s (S&P) has upgraded its growth forecast for the Republic’s underlying economy to 5 per cent for this year and next year, noting that demand would benefit from pent-up savings and investments.

“Ireland’s diversified economy, flexible labour market and timely countercyclical policy measures underpin its recovery prospects,” the agency said in its latest assessment of the Irish economy.

However, it cautioned that “the asymmetric effect” that Covid-19 has had on the domestic and foreign-controlled sectors of the Irish economy implied “a two-speed recovery”.

Economy

It predicted that the underlying economy, as measured by modified gross national income (GNI*), will rebound by 5 per cent on average in 2021-22.

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“GDP [gross domestic product], the standard measure of economic growth, would grow much faster, as foreign-owned high-tech sectors like computer services and pharmaceuticals keep performing strongly,” it said.

The Department of Finance expects the economy – in GDP terms – to grow by 15.6 per cent this year.

“The stable outlook indicates that we do not expect the Covid-19 pandemic or its potential long-term effects to cause any lasting structural damage to Ireland’s credit metrics,” S&P said, suggesting Government debt would fall below 100 per cent of GNI* by end 2022 as the economic recovery takes hold.

On corporation tax, it said the implementation of the Organisation for Economic Co-operation and Development (OECD) agreement was likely to put some pressure on Government revenue, “but we do not expect it to alter our view of Ireland’s creditworthiness”.

"Over the past 10 years, Ireland has become increasingly reliant on corporation tax receipts," it said.

Tripled

“The increased profitability of some big multinationals, mainly in the computer services and pharmaceuticals sectors, has helped Ireland outperform its budgetary targets, even during the pandemic,” it said, noting corporate tax receipts tripled in 2010-2020 while their share of total tax revenue surged to 20.7 per cent from 12.4 per cent.

Even with the Government’s predicted €2 billion a year loss from the changes, which include a reallocation of tax rights to bigger countries and new minimum rate of 15 per cent, the agency said it still expected fiscal consolidation to resume.

“Ireland’s record of sound fiscal management has given the Government some leeway to mitigate the near-term impact of the OECD corporate tax agreement,” it said.

On banks, the agency said that while lenders here entered the Covid pandemic with good capital buffers and liquidity cushions and that actual losses to date had been “muted”, profitability remained poor.

“We believe the most significant risk to Irish banks is a potential failure to generate structurally sound profitability,” it said.

Cost

While the withdrawal of KBC and Ulster Bank would enlarge the market shares of remaining players, "profitability prospects remain constrained because it [the sector] lacks revenue diversification and stability of top-line results," it said.

“The persistently high cost base increases the pressure on profitability,” it said.

“Although banks are committed to their cost-reduction targets, achieving these targets remains difficult as banks continue to invest in business transformation and digital capabilities,” it said.

In its report, the agency said it expected tensions with respect to the Northern Ireland protocol to persist. While the free trade agreement signed between the EU and the UK reduces the adverse effects of Brexit, Brexit has increased trade barriers between Ireland and the UK, it said.

“We expect the NI protocol to continue to cause tensions between the different parties. We do not expect these to materially alter our view of Ireland’s creditworthiness,” it said.