OREANDA-NEWS. February 08, 2016. Fitch Ratings has upgraded Ireland's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'A' from 'A-'. The Outlooks are Stable. The issue ratings on Ireland's senior unsecured foreign and local currency bonds have also been upgraded to 'A' from 'A-'. The Country Ceiling has been affirmed at 'AAA' and the Short-term foreign currency IDR and short-term commercial paper 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 upgrade of Ireland's IDRs reflects the following key rating drivers and their relative weights:

HIGH
Public debt dynamics continue to improve, reflecting a combination of strong growth and a return to a primary budget surplus in 2014. Fitch now estimates gross general government debt/GDP at 96.6% at end-2015, compared with 105% in our previous review and from a high of 120.2% in 2012. The revision is partly the result of a much higher than expected GDP deflator in 2015, with Ireland benefiting substantially from positive terms of trade. According to our baseline scenario (which does not include any positive stock-flow adjustments from the banking sector), public debt will continue to fall steadily to 70% by 2024, although this is still well above the 'A' median of 44.5%.

MEDIUM
Ireland's economy continues to expand at a brisk pace, with real GDP growth averaging 7% in the first three quarters of 2015, the highest figure among developed economies. Although investment growth remains volatile, the Irish economy is exhibiting much more solid fundamentals that will help sustain momentum in the short term. Stronger balance sheets, a continued strengthening of the labour market and rising household consumption should underpin robust domestic demand growth in 2016. Fitch expects the economy will expand by around 4% this year, compared with 2.4% in our previous review.

Fiscal consolidation accelerated in 2015, in line with strong headline growth and favourable financing conditions. Total revenue over-performed by EUR3.5bn (1.7% of GDP) on the back of higher corporate tax income. This allowed the government to increase expenditure by an additional EUR1.2bn in 2015 while still exceeding fiscal targets. The budget deficit fell to an estimated 1.5% of GDP, well below the original target of 2.7%, with Ireland expected to exit the Excessive Deficit Procedure this spring, as scheduled.

Ireland's 'A' IDRs also reflect the following key rating drivers:

Fitch expects the fiscal deficit to continue narrowing over the medium term, in line with the positive macroeconomic outlook, but the pace of consolidation is likely to slow as expenditure demands rise. In the 2016 budget the government authorised tax cuts and spending increases of about EUR1.5bn (0.7% of GDP). A key downside risk is the increased dependency on corporate tax income to drive total revenue growth, especially since the bulk of corporate tax is concentrated in a small number of companies.

The upcoming legislative election also represents a potential source of downside risks. Polls show that the result is likely to be inconclusive, with the ruling Fine Gael and Labour coalition falling short of a majority, while the main opposition Fianna Fail is trailing far behind. A protracted period of political uncertainty and/or the reliance on more radical political elements to sustain a coalition risks weakening of reforms. That said, throughout the crisis, Ireland has shown strong fiscal commitment and credibility, supporting our forecast that the next government will remain broadly compliant with EU and national fiscal rules.

Fitch maintains its view that the medium-term growth potential of the Irish economy is around 2.0%-2.5%, well below the average growth of the pre-crisis period. The need for further deleveraging, made more difficult by the very low inflation environment, as well as supply constraints on infrastructure, will remain a drag on domestic demand. A stronger recovery in the labour market and/or higher private investment would be supportive of stronger long-term growth. Conversely, a decision by the UK to leave the EU ("Brexit" scenario), could carry significant downside risks for trade, investment and the still-weak Irish financial sector.

Ireland's external rebalancing continued in 2015, with net external debt/GDP falling for the sixth consecutive year to an estimated 60.8% from a high of 97% in 2009. Fitch expects it to continue falling gradually over the medium term, although it will remain one of the highest ratios in the EU. A weaker euro has also helped sustain export momentum, particularly in the services sector, where Ireland now accounts for almost 3% of the world total. We forecast a comfortable current account surplus averaging 4.8% of GDP in 2016-17.

Financial indicators point to ongoing improvements in terms of banking sector performance, capital ratios and asset quality. However, challenges still remain, in particular high levels of impaired loans (19.4% of total in 1H15), and finding reliable sources of profitability. Property prices saw a modest recovery in 2015, with demand strengthening in the commercial sector. The Central Bank of Ireland have sought to moderate property price increases via the implementation of macro-prudential measures but lack of supply will continue to exert upward pressures.

Ireland has retained many of its structural strengths over the past seven years. It is a wealthy, flexible economy, with a per capita gross national income of USD41,000 compared with USD25,500 for the 'A' median. It also ranks the highest in terms of human development and governance indicators in the 'A' category.

RATING SENSITIVITIES
The following factors may, individually or collectively, result in positive rating action:
-Further reduction in the general government debt/GDP ratio.
-Further reduction in net external indebtedness.

The following factors may, individually or collectively, result in negative rating action:
-Divergence from the fiscal targets that halts the decline in the GGGD/GDP ratio over the medium term.
-Weaker economic performance, particularly if accompanied by a prolonged period of deflation, resulting in a substantial deterioration of banks' existing loan portfolios or a negative impact on the fiscal stance.

KEY ASSUMPTIONS
The ratings are based on the assumption that political uncertainty will not contribute to a deterioration of the sovereign credit profile.

We assume Ireland and the eurozone as a whole will avoid long-lasting deflation, with the ECB's asset purchase programme helping to underpin inflation expectations, although deflation risks could intensify in the case of further economic shocks.