2012 Article IV Consultation with Ireland--Concluding Statement of the IMF Mission1
July 18, 2012
WORKING TOWARD SUSTAINED RECOVERY
The Irish authorities have made steadfast efforts to address an exceptionally deep banking crisis, establishing strong credibility in policy implementation despite an adverse external environment that has tested confidence and delayed recovery. Key medium-term priorities are enhancing financial sector health to help revive lending, putting the budget on a sound footing, and advancing structural reforms to facilitate growth and job creation. Difficult challenges remain in the context of persistent euro area uncertainties, and a further strengthening of European support to Ireland is required to weaken bank-sovereign linkages and improve the sustainability of the well-performing adjustment program, thereby facilitating a durable return of the sovereign to market financing.
1. The Irish authorities have made impressive progress to restore stability in the face of an exceptionally deep banking crisis. Determined actions have been taken to restructure and downsize banks, and the recapitalization exercise in early 2011was rigorous and transparent. Budgetary efforts have been substantial in recent years, containing the fiscal damage from the severe economic collapse in 2008-10 while maintaining social cohesion. These and other steps have together helped rebuild confidence, as seen in declining spreads on Irish bonds, the recent successful return to the Treasury bill market, and continuing substantial inflows of foreign direct investment. The underlying strengths of Ireland’s highly open economy delivered export-focused GDP growth of 1.4 percent in 2011, although domestic demand and GNP continued to decline.
2. Yet major challenges remain. At around 40 percent of GDP, the cumulative cost of supporting the financial sector accounts for half of the sharp increase in net public debt in recent years. The sustainability of public debt—expected to be 116 percent of GDP by year end on a gross general government basis—depends heavily on continued economic recovery. Real GDP growth is, however, expected to slow to about ½ percent in 2012 owing to weak trading partner activity. A rise in growth in coming years must overcome the drag from the ongoing fiscal consolidation and high private sector debt burdens, and must also serve to reduce unemployment, which at 14.8 percent, is at levels not seen since the 1980s.
3. Ensuring a lasting recovery will require further strong policy action. Financial sector health needs to be strengthened so that domestic demand can be supported by sound lending. Phased fiscal adjustment must be completed in a growth-friendly manner. Continued reforms are needed to head off structural unemployment.
4. Success will hinge on euro area stability and recovery, and strengthened European support is also required. Ireland’s small open economy has regained much of the competitiveness lost during the boom. Yet prospects for recovery, and for the resumption of market financing for the sovereign, rely on a revival of trading partner growth and calmer euro area financial conditions. Against that backdrop, euro area leaders have recently made welcome commitments to break the vicious circle between banks and sovereigns by enabling the ESM to recapitalize banks directly, to treat similar cases equally, and to examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment program. These commitments represent key stepping stones towards the mutually beneficial goals of ensuring Ireland’s economic recovery and its durable return to the bond market, thereby avoiding continuing dependence on official financing.
Reviving Sound Lending
5. Reforms of the banking sector have made substantial progress. A comprehensive strategy was adopted in March 2011 to return to a fully functioning banking sector that serves the needs of the Irish economy. A rigorous analysis of capital needs at that time gained market credibility through independent loan loss estimates, stringent scenarios and capital thresholds, and transparent reporting. Downsizing of the banks has proceeded on schedule while avoiding fire sales.
6. However, a number of interrelated challenges need to be addressed to restore banks’ ability to support Ireland’s economic recovery. In particular, arresting deteriorating asset quality and restoring profitability, together with regaining access to market funding, are each central to a resumption of lending:
Arresting the deterioration in bank assets is essential. As residential mortgage arrears rose during 2011, the Central Bank of Ireland identified banks’ operational weaknesses in distressed credit operations and required the banks to develop mortgage arrears resolution strategies. Banks are now accelerating work to build their credit collection and workout functions. Similar supervision of workout efforts for loans to SMEs should continue to proceed apace considering the importance of this sector for job creation. The authorities also recently introduced to parliament a reform of the personal insolvency framework to help address borrower financial distress while maintaining debt service discipline. Consistent implementation and close monitoring of these combined efforts should enable a much needed transition toward long-term solutions that are tailored to borrowers in difficulties. In parallel, it will be important to ensure that the repossession framework complements the personal insolvency reforms.
Regaining profitability is necessary for banks to sustain new lending. At present, interest margins are compressed by high deposit interest rates and fees on the Eligible Liabilities Guarantee (ELG) scheme. The authorities’ intention to phase out the ELG scheme in an orderly manner, while preserving access to funding, is appropriate. Moreover, banks’ remain burdened by cost structures that are too high; plans to reduce operational expenses will need to be fully implemented.
In common with banks in other euro area countries, accessing material volumes of secured market funding to support new lending faces difficulties. The Irish deposit base has recovered somewhat recently, and banks have obtained repo funding secured on UK collateral. However, looking ahead, the banks face further bond maturities that may increase their reliance on Eurosystem funding, which results in substantial encumbrance of their assets. These circumstances undermine prospects for a revival of lending, and a sustainable solution to this problem will need to be found.
Completing a Growth-Friendly Fiscal Adjustment
7. Ireland has implemented substantial fiscal consolidation since the onset of the crisis. Cumulative budget measures during 2009-12 strengthened the structural primary balance by just over 8 percent of GDP. This effort has been expenditure-led, including cuts in public wages, social welfare rates, personnel numbers and capital spending. Revenue contributions have included income tax base broadening, higher taxes on capital and savings, and an increase in the standard VAT rate. Careful design has enabled this consolidation to be achieved during a deep economic slump without compromising social cohesion or key public services.
8. However, with the deficit still in excess of 8 percent of GDP, significant further medium-term consolidation is required. After five years of consolidation, few low-hanging fruit remain, especially on the expenditure side. A strategic approach focused on the efficiency and fairness of measures, that keeps all high-quality expenditure and revenue options on the table, is needed to complete the consolidation in a durable manner. While avoiding imposing excessive fiscal drag in any particular year, the multi-annual expenditure ceilings and the Comprehensive Review of Expenditure provide confidence that the medium-term targets will be achieved despite implementation risks associated with large expenditure adjustments, demographic pressures, and risks to the macroeconomic baseline.
9. Comprehensive targeting of spending is needed to deliver immediate reductions combined with reforms to underpin savings in the medium term. Maintaining expensive universal supports and subsidies is difficult to justify under present budgetary circumstances. Better targeting of the child benefit, medical card spending, the household benefits package and the expenditure on non-means tested pensions can generate significant savings while protecting the poor. The Croke Park Agreement has facilitated personnel reductions and efficiency savings, and has helped maintain the industrial peace needed to achieve broader reform goals. Continued monitoring of the adequacy of savings in the net pay and pensions bill, and of public service provision, is necessary. Deeper reforms in health and higher education are needed to identify service priorities and deliver them efficiently.
10. A base-broadening approach to raising revenue will mitigate adverse growth effects. Ireland’s combination of high personal and indirect tax rates, and relatively narrow tax bases, provides considerable scope for this approach. In this context, income tax reliefs could be better targeted to low-income taxpayers, and options to broaden the base for Pay- Related Social Insurance could be examined. The planned introduction of a value-based property tax in 2013 will provide a progressive and stable source of revenue. A suitably high level for this tax would maximize these benefits, while care is needed regarding collection modalities and lead times.
Thwarting Structural Unemployment
11. The growing problem of long-term unemployment requires firm implementation of a broad based approach. Although economic recovery will be the main vehicle to reduce unemployment, it is also important to ensure that jobseekers are willing and able to fill jobs when they become available. The Pathways to Work initiative sets a sound direction for engaging with and supporting the unemployed to get back into the workforce. Jobseekers’ adherence to the principle of mutual obligation should be ensured. Realizing the full benefits of this reform will take time and will require enhanced training for case workers. Involving private sector firms in the provision of activation services, especially for the long-term unemployed, could also play a useful role if well designed. Given the need to re-skill jobseekers to enable their mobility between sectors, the creation of SOLAS and the Education and Training Boards is a priority to provide regular monitoring of training outcomes and effective delivery of further education and training.
12. Reforms of social benefits can support this strategy. The flat structure of unemployment payments results in replacement rates for the long-term unemployed that are high by international standards, contributing to low exit rates from the Live Register. The highest replacement rates affect those also receiving housing benefits. To avoid unemployment and inactivity traps for this cohort, it is important to integrate the systems of social housing provision and rent supplement for those with long-term housing needs into a new means-tested Housing Assistance Payment.
We are grateful to the authorities and our counterparts for their hospitality and open and constructive discussions.
1 As part of its mandate to oversee the international monetary system, the IMF periodically has an in-depth discussion with each of its member countries about their economic policies. This exercise, known as an Article IV consultation, involves a detailed examination of fiscal, financial sector and other key policies from a medium-term perspective. It is separate from the regular quarterly reviews of Ireland’s IMF-EU supported program. The IMF’s last Article IV consultation with Ireland was conducted in July 2010.