OREANDA-NEWS. Fitch Ratings has affirmed Ireland's Long-term Issuer Default Ratings (IDRs ) at 'A-'. The Outlooks are Stable. The issue ratings on Ireland's senior unsecured foreign and local currency bonds have also been affirmed at 'A-'. The Country Ceiling has been affirmed at 'AAA' and the Short-term foreign currency IDR at 'F1'.

The rating of National Asset Management Ltd's (NAMA) guaranteed issuance has also been affirmed at 'F1', in line with the sovereign rating.

KEY RATING DRIVERS
The affirmation and the Stable Outlook reflect the following key rating drivers:

The general gross government debt (GGGD) to GDP ratio is forecast to have declined in 2014 by 13 pp from a peak of 123% in 2013 to 110%. The sharp decline was mainly driven by one-off factors, in particular the liquidation of Irish Bank Resolution Corporation (IBRC), a defeasance vehicle, and depleting cash balances, but faster than expected economic growth also helped the decline. While the debt level is still very high compared with the 'A' rating median of 49%, the lower debt improves shock absorbing capacity and will lead to lower interest expenditure.

GDP growth in 2014 likely reached 4.7%, an outstanding performance compared with other eurozone members and the weakness of the Irish recovery in previous years. To a large extent, growth was driven by temporary, sector-specific boost to net exports in 1H14, while the recovery of domestic demand was more moderate. Nevertheless falling unemployment, a pick-up in private investment and household consumption stabilising after five years of contraction confirms the successful adjustment of the domestic sectors.

Fitch maintains its view that the medium-term growth potential of the Irish economy is around 2%. The need for further deleveraging combined with the very low inflation environment weighing on the real value of debt burdens will constrain domestic demand growth for a prolonged period. Economic growth will slow to 2.9% and 2.5% in 2015 and 2016, respectively, as the temporary boost from net exports driven by contract manufacturing fades. Unemployment is forecast to decline close to 10% during this year and reach 9.6% in 2016.

The better macroeconomic performance had a positive spill-over to the fiscal stance. The budget deficit in 2014 was around 4% of GDP, compared with the 4.8% target. Tax revenues grew by 9.2% in 2014 and interest expenditures benefited from the benign financing conditions, more than compensating an increase in current expenditure of EUR807m, mainly in the health sector.

GGGD/GDP ratio will continue to decline gradually from the 110% level reached in 2014. The primary surplus, assumed to reach 2% of GDP by 2017, will contribute to the declining trend, while the nominal growth of the economy will slow in 2015-16. Fitch forecasts the GGGD/GDP ratio to fall below 100% in 2019. Ensuring a declining debt path will require substantial primary surplus given the still high debt level and the expected subdued nominal growth.

The Viability Ratings of Irish banks (Bank of Ireland (bb-) and Allied Irish Bank (b+)) are sub-investment grade. This illustrates the fundamental weakness and remaining vulnerabilities in the financial sector, notably banks' persistently high (25%) NPL ratios. However, falling unemployment and increasing house prices improve the outlook for the sector and the results of the ECB's comprehensive assessment in October 2014 confirmed that the Irish banking sector is sufficiently capitalised. Bank of Ireland and Allied Irish Bank, the two largest banks, passed the stress test without any additional capital requirements, while the capital requirement at the 98% state-owned Permanents TSB is maximum EUR455m (0.3% of GDP), taking into account the EUR400m CoCo instrument provided as part of the 2011 recapitalisation.

Both headline and core inflation (-0.3% and 0.6% in December 2014 in Ireland) are close to the eurozone average. The flexible Irish economy could cope with a deflation period during 2010-2012 and gained competitiveness within the monetary union through real price adjustments. In the current very low inflation environment there is no further improvement in relative competitiveness, but the adverse effect on real debt burden is similar. Fitch forecasts inflation to be zero in 2015 and increase only slowly, to 1% in 2016.

External debt sustainability will continue to benefit from large current account surpluses. The current account surplus reached 4.4% of GDP in 2013 and likely widened further in 2014 to 5%. Fitch forecast the current account surplus to remain broadly stable until 2016, albeit uncertainty is particularly high due to the large and hardly predictable intercompany flows. Nevertheless, Ireland has high net external debt at 68% of GDP (end-2014) and a high net international investment liability position of 103% of GDP (end-2013).

The government yield curve has reached new historical lows at most maturities and Ireland issued its first 30-year bond in February 2015 at 2.1% yield. This has enabled Ireland to start the early repayment of its IMF loan, which carries a higher interest rate. The Irish central bank's current holdings of sovereign securities will not constrain Ireland from fully benefiting from the ECB's sovereign asset purchases, as the 33% limit on maximum holdings will not be binding before the end of 2016.

The outstanding senior bonds of NAMA, a contingent liability to the sovereign, had declined to EUR13.6bn (7.5% of GDP) by the end of 2014. NAMA repaid EUR9.1bn senior debt in 2014 after EUR7.5bn in 2013, bringing cumulative repayments of senior debt issued to the participating institutions to EUR16.6bn.

Ireland has retained many of its structural strengths throughout the crisis. It is a wealthy, flexible economy, its per capita gross national income is USD36,000 in purchasing power parity terms, well above the 'A' median of USD24,500.

RATING SENSITIVITIES
The Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could individually or collectively result in positive rating action include:
- Continuation of the declining trend of the GGGD/GDP ratio.
- Further reduction in financial sector vulnerabilities and contingent liabilities for the sovereign.

The main factors that could lead to negative rating action are:
- Divergence from the fiscal targets that reverses the declining trend in the GGGD/GDP ratio.
- Weaker economic performance, particularly if accompanied by a prolonged period of deflation, resulting in a substantial deterioration of banks' existing loan portfolio or a negative impact on the fiscal stance.

KEY ASSUMPTIONS
Fitch assumes that the budget deficit will fall below 3% of GDP this year and Ireland will exit the Excessive Deficit Procedure, in line with the government's stability programme and the original Troika programme announced in December 2010. Fitch also assumes that fiscal consolidation efforts will continue beyond 2015 to ensure 2% primary surplus over the medium term.

The European Central Bank's recently extended asset purchase programme should help underpin inflation expectations, and supports our base case that, in the context of a modest economic recovery, the eurozone will avoid prolonged deflation. This is particularly relevant for highly indebted members, like Ireland as its high GGGD ratio and long average maturity of 8 years makes its public finances more exposed to deflation risks than countries with lower debt levels.

Fitch also assumes gradual progress in deepening financial integration at the eurozone level and that eurozone governments will tighten fiscal policy over the medium term.