On February 2, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Post-Program Monitoring Discussion [1] with Ireland and considered and endorsed the staff appraisal without a meeting on a lapse-of-time basis. [2]

Despite risks to the outlook, Ireland’s capacity to repay the Fund is strong, given robust economic and fiscal performance, large cash buffers, manageable financing needs, and favorable market financing conditions.

Ireland continued to grow at a healthy pace in 2016, mainly driven by domestic demand. In the first three quarters of 2016, output expanded by 4.8 percent y/y with private consumption and investment, excluding the most volatile components, providing the largest contribution to growth. Broad-based employment gains brought the unemployment rate down to 7.2 percent in December. Despite strong domestic demand, headline inflation hovered in negative territory during most of the year, reflecting declining energy prices. The current account surplus widened somewhat in the first three quarters of 2016. Exchequer data for December confirmed the positive trend in public finances. The headline general government deficit is expected to end the year on target at 0.9 percent of GDP, while the debt burden is on a steady downward path. Credit to the private sector has continued to fall but at a declining rate. Balance sheet repair of domestic banks has continued but profitability remains weak. Property market conditions have tightened further, mainly due to a limited supply response.

Executive Board Assessment

The economic outlook remains broadly positive, notwithstanding risks, and the capacity to repay the Fund is strong. Robust domestic demand is projected to drive continued healthy growth, supporting further moderation in unemployment. Inflation, which turned slightly negative this year, is expected to edge up gradually. Brexit-related risks, a sustained low growth-low inflation environment in Europe, external political uncertainties and rising anti-globalization sentiment, as well as ongoing developments in corporate tax treatment at the international level add to uncertainty. The political context for the new minority government is challenging, but agreement on the 2017 budget represents an important milestone. Despite these risks, Ireland’s capacity to repay the Fund is strong, given robust economic and fiscal performance, manageable financing needs, and favorable market financing conditions.

The impact of operations by multinationals on headline GDP complicates the assessment of domestic activity essential to economic decision making. Staff welcomes the work underway, with support from the IMF and other outside experts, on alternative measures for domestic activity.

The government’s fiscal targets are broadly appropriate. Given Ireland’s strong track record of fiscal discipline, the moderate adjustment planned in 2017 strikes a reasonable balance between advancing deficit reduction and addressing public expectations for a growth dividend. Expenditure increases beyond those already programmed would need to be offset by tax increases or cuts in other spending to meet the deficit target, requiring difficult trade-offs. More broadly, still high public debt and risks to the outlook and to the revenue base, including from the concentrated corporate tax base, call for maintaining moderate growth in expenditures, saving any revenue windfalls, and ensuring that potentially temporary revenue gains are not used to fund permanent expenditure increases. In this context, staff welcomes the authorities’ commitment to reach their medium-term deficit target of 0.5 percent of GDP by 2018, establish a “rainy-day” fund beginning in 2019, and reduce debt-to-GDP to 45 percent within a decade.

Within a tight envelope, fiscal policy could be more supportive of growth. With capital expenditure already well below peers, well-targeted increases are needed to buttress Ireland’s competitiveness and support the population’s welfare, including through investments in economic and social infrastructure. The Housing Action Plan and related efforts to address the acute problem of housing shortages, high rents, and homelessness are welcome, but fiscal incentives related to housing should be limited and closely monitored to ensure they are well-targeted to assist those most in need and to reduce risks of fueling demand and price pressures. Plans for a phased elimination of the Universal Social Charge should not come at the expense of the breadth and stability of the tax base.

Irish banks continue to operate in a challenging environment. The capital and liquidity positions of domestic banks have improved, but, with low underlying profitability, they remain vulnerable to shocks. The UK’s decision to leave the EU could put further pressure domestic banks’ profitability. In the context of pending legislation on variable rate mortgages, loan pricing should adequately reflect market conditions to allow banks to build up capital and return to normal business profitability. The disposal of the government’s stakes in Irish banks, which would support public debt reduction, should continue once market conditions are supportive.

Nonperforming loans are declining overall, but resolution of deep mortgage arrears should be accelerated. Intensified supervisory oversight of banks’ internal management of NPL resolution should continue to ensure that prolonged mortgage arrears are tackled through loan restructuring where feasible. The “advice and arrears” scheme recently introduced by the government shows promise in improving borrower-creditor engagement, but further steps to make the legal proceedings more efficient are also critical to accelerate the resolution process.

Continued vigilance is needed to safeguard macro-financial stability, especially relating to the property market. The macroprudential measures introduced in 2015 serve an important role in strengthening the resilience of banks and household to adverse shocks. The recalibration of the macroprudential framework is reasonable given early experience with the framework and current dynamics in the housing market. Steadfast progress toward full implementation of the CCR and replacing the LTI limit with a DTI limit, which better captures the borrowers’ repayment capacity, remain key to ensure prudent lending.