IMF Executive Board Concludes 2021 Article IV Consultation with Ireland

Washington, DC: On June 14, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Ireland.

The Irish economy was on a favorable path of high growth and declining vulnerabilities in the runup to the pandemic. COVID-19 outbreak had a large impact on Ireland. The high infection rates led to one of the most stringent containment regimes. The economic impact has been highly asymmetric. The domestic sectors contracted by about 10 percent while the export-oriented IT and pharmaceutical sectors, which are dominated by multinationals, grew by 18 percent in 2020, resulting in the overall GDP growth of 3.4 percent in 2020. The "COVID-adjusted" unemployment rate (including short-term pandemic-related unemployment) registered 20 percent for the year. The strong growth in CIT intake and resilient PIT revenues, helped contain the fiscal deficit at 5 percent of GDP despite the large expenditure measures. The annual average rate of inflation for the year was -0.5 percent. Future CIT revenue could be impacted by a possible adoption of an international minimum tax that is higher than Ireland's 12.5 percent although it would be mitigated by Ireland's non-tax comparative advantages that are likely to continue to attract FDI.

Irish banks have entered the crisis with strong capital levels but high level of legacy NPLs and low profitability. Lending to households and non-financial firms declined by about 4 percent year-on-year during the second half of 2020. Both households and firms, particularly SMEs, have significantly benefited from the payment breaks, limiting their vulnerabilities to the reductions in earnings and consumer spending. While impairment charges and NPLs have slightly increased, arrears in banks' mortgage portfolios have continued to decline and capital levels remain solid. Delays in construction during the COVID-19 crisis have exacerbated the shortage of affordable housing. After a small decline in H1:2020, house prices started to grow as demand exceeded supply.

GDP growth is projected at 4.6 percent in 2021, with the negative impact of prolonged lockdown counterweighted by an improved external outlook and increased adaptability to remote working. Private consumption is projected to recover quickly following mass vaccination and easing of restrictions. With a no-deal Brexit avoided, and a vaccine rollout underway, the outlook for investment will begin to improve. Indigenous exporting firms should benefit from a post-COVID international recovery, notwithstanding uncertainties surrounding implementation of some aspects of the EU-UK Trade and Cooperation Agreement (TCA). It is expected that export growth of pharmaceuticals, medical devices, and IT products remains resilient through 2022.

Executive Board Assessment [2]

The highly asymmetric impact of the pandemic on the Irish economy suggests a two-speed recovery. The domestic sector, which is more labor-intensive, contracted by about 10 percent in 2020, but the strong growth of MNEs softened the blow to the economy and public finances, making Ireland the only EU country with positive growth last year. GDP growth for 2021 is projected at 4.6 percent, with the domestic sector partly recovering as containment measures are gradually eased and adaptability to remote working continues to increase.

The swift and unprecedented policy response has been effective in mitigating the crisis impact and protecting households and firms . With a total envelope of around 10 percent of GDP (18 percent of GNI*) for 2020-21, the fiscal package was similar to that of other European countries but included a larger share of direct support. Notwithstanding the large direct support, the overall deficit for 2020 was contained at about 5 percent of GDP due to the strong revenue growth from corporate income taxes.

There is significant uncertainty over the near- and medium-term outlook. Risks are dominated by the pandemic dynamics, the execution of post-Brexit trade arrangements, and likely changes in international corporate taxation. While there are some downside risks for the rest of the year given the ongoing third wave, recent progress in vaccine rollout is promising and provides a significant upside risk. The authorities' comprehensive Brexit response has helped acquaint firms in the sectors most exposed to Brexit with customs procedures, thus reducing their vulnerability. Nevertheless, uncertainties around the non-tariff trade impediments remain a risk given Ireland's strong linkages with the U.K. Changes in international taxation can also affect both the Irish economy and public finances. Ireland should therefore continue to build on its strong non-tax comparative advantages, such as its qualified labor force, strong and stable legal and policy environment, and favorable business climate.

Fiscal policy should continue to be supportive in the near term to avoid cliff-edge effects, especially in view of remaining vulnerabilities . As the recovery takes hold, it will need to be adjusted to sustainably boost growth and support social cohesion. After the recovery is complete, the tax base should be broadened to help finance productivity-enhancing investment in human and physical capital, and to resume the reduction in public debt in relation to GNI*. There is also a need to further improve expenditure efficiency, including by enhancing the implementation of infrastructure projects and maintenance of public assets.

Further progress should be made in the period ahead to build on the regulatory actions taken in response to the pandemic, which helped stabilize credit conditions. The CBI complemented the ECB's policy support by releasing the countercyclical capital buffer for banks and set out clear expectations around how the industry-led debt moratoria should operate. Lenders should continue to engage constructively with borrowers in financial distress to put in place appropriate and tailored solutions to those borrower's circumstances. It is also important that supervisory focus remains on the timely recognition of problem assets and developing capacity to resolve rising NPLs. The insolvency and bankruptcy systems should be kept under review and enhanced as needed. Over the medium term, cost reduction and greater use of digital technologies could help raise banks' low profitability and reduce lending rates. Non-bank lenders are expected to increase their presence in the market in the period ahead, but strategic initiatives recently announced by two smaller banks are likely to lead to their withdrawal from the Irish market. This further highlights the need for supervisors to focus on the sustainability of banks business models, in particular on banks actions to achieve greater cost efficiency.

Continued strengthening of the regulatory framework for investment funds will help mitigate any spillover and potential reputational risks. Although sizeable redemption pressures at the onset of the crisis receded quickly, and direct exposures to the domestic economy remain limited, the large absolute size of the investment fund sector relative to the domestic economy calls for constant vigilance. We therefore welcome the CBI's plan to further improve data collection, strengthen risk management across the sector, and develop the macroprudential framework in close coordination with other European regulators.

Withdrawal of policy support should be carefully tapered to minimize economic scarring and facilitate an inclusive and sustainable recovery. It is important to adapt and gradually withdraw temporary support measures as the recovery takes hold to incentivize transformation and resource reallocation. Active labor market policies should be further strengthened as support measures are withdrawn, including in areas such as re-training and employment placement services, with special focus on youth employment. Income support measures should become increasingly conditional on re-skilling and further shift toward subsidizing new hiring in the expanding sectors to minimize the increase in long-term unemployment. Business support measures should also be increasingly targeted to affected but viable firms.

The authorities also need to strike a balance between providing targeted support to hard-hit sectors and vulnerable groups and addressing Ireland's medium-term challenges. This will require raising productivity through better education and vocational training. It is also important to empower women to raise their low labor participation, including by increasing the availability of affordable childcare facilities. Reducing affordable housing shortages requires a comprehensive multi-pronged approach across government institutions and levels. More public investment in social and physical infrastructures as well as affordable housing calls for greater spending efficiency and raising additional public revenue after the recovery is complete given the still high public debt in relation to GNI*. In addition, recently legislated higher carbon tax, with a trajectory to 2030, will help finance this effort, and sector-specific policies will help protect vulnerable groups in the transition to greener and more sustainable growth.