EUROPEAN COMMISSION Brussels, 22.2.2017 SWD(2017) 73 final COMMISSION STAFF WORKING DOCUMENT Country Report Ireland

Including an In-Depth Review on the prevention and correction of macroeconomic

imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP

2017 European Semester: Assessment of progress on structural reforms,

prevention on correction of macroeconomic imbalances, and results of in-depth reviews

under Regulation (EU) No 1176/2011



{COM(2017) 90 final}

{SWD(2017) 67 final to SWD(2017) 93 final}







Contents Executive summary1 1.Economic situation and outlook5 2.Progress with country-specific recommendations13 3.Summary of the main findings from the MIP in-depth review16 4.Reform priorities20 4.1.Public finances and taxation20 4.2.Financial sector26 4.3.Labour market, education and social policies36 4.4.Investment45 4.5.Sectoral policies51 A.Overview table58 B.MIP Scoreboard64 C.Standard tables65 References70 LIST OF Tables 1.1.Key economic, financial and social indicators — Ireland12 2.1.Summary table on 2016 CSR assessment14

3.1.MIP assessment matrix — Ireland 201618 4.1.1.Government's contingent liabilities22 B.1.The MIP Scoreboard for Ireland64 C.1.Financial market indicators65 C.2.Labour market and social indicators66 C.3.Labour market and social indicators (continued)67 C.4.Product market performance and policy indicators68 C.5.Green growth69 LIST OF Graphs 1.1.Gross value added from domestic production and foreignowned multinationals5 1.2.Core domestic demand and employment6 1.3.Consumer sentiment and business prospects6 1.4.Recent labour market trends7 1.5.Real effective exchange rate8 1.6.Goods exports and contract manufacturing8 1.7.Total investment and main drivers9 1.8.Core investment and its components10 4.1.1.Government gross debt evolution20 4.1.2.Debt servicing cost indicator21

4.1.3.Maturity profile of Ireland’s longterm debt (end December 2016)21 4.1.4.Change in final and planned expenditure allocation and revenue surprise23 4.2.1.Banks’ book quality and provisioning26 4.2.2.Forbearance levels — a euro area comparison27 4.2.3.Evolution of mortgage loans in arrears27 4.2.4.Net lending volumes and yearly growth rates28 4.2.5.International investment position by asset type (IFSC and nonIFSC)29 4.2.6.International investment position by asset type — excluding IFSC29 4.2.7.International investment position by institutional sector, nonIFSC30 4.2.8.Geographic distribution of FDI liabilities, immediate and ultimate ownership (2015)30 4.2.9.Direct investment abroad end year position by prior domicile location31 4.2.10.Current account balance, net components31 4.2.11.(Nonconsolidated) private sector debt to GDP32 4.2.12.Financial assets held by Irish households33 4.2.13.Total corporate loans by counterparty33 4.2.14.SME lending – total and new34 4.2.15.Financing sources for SME fixed investment35 4.2.16.Interest rates for SME loans35 4.3.1.Unemployment by duration36 4.3.2.Relative dispersion of employment rates by education level, 2010, 2014 and 201536

4.3.3.Main social indicators38 4.3.4.Gap between people living in jobless households and unemployment ratio38 4.3.5.Public expenditure on education41 4.4.1.Investment in intellectual property and aircraft45 4.4.2.Investment in dwellings and other construction45 4.4.3.Breakdown of unit labour costs48 4.4.4.Total value added per person employed Irish indigenous and foreign firms (2000-2014)48 4.4.5.Gross Value Added per hour worked, total economy (20062015)49 4.5.1.Overvaluation gap with respect to price/income, price/rent and fundamental model valuation gaps51 4.5.2.Housing completions and demand52 4.5.3.Trends in business R&D intensity and public R&D intensity, 2000201555 4.5.4.Difference between real growth in government budget appropriations for R&D (GBOARD) and real growth in GDP, 2007201555 LIST OF Boxes 2.1.Contribution of the EU budget to structural change in Ireland15 4.3.1.Selected highlights: Expert Group on Future Skills Needs42 Executive summary This report assesses Ireland’s economy in the light of the European Commission’s Annual Growth Survey published on 16 November 2016. In the survey the Commission calls on EU Member States to redouble their efforts on the three elements of the virtuous triangle of economic policy — boosting investment, pursuing structural reforms and ensuring responsible fiscal policies. In so doing, Member States should focus on improving social fairness in order to deliver more inclusive growth. At the same time, the Commission published the Alert Mechanism Report (AMR) that initiated the sixth round of the macroeconomic imbalance procedure. The indepth review, which the 2017 AMR concluded should be undertaken for the Irish economy, is presented in this report. Ireland’s economic prospects remain bright, but risks have heightened. GDP is estimated to have grown by 4.3 % in 2016 and is projected to further expand by 3.4 % in 2017 and 3.3 % in 2018. The activities of multinationals remain unpredictable but this does not disguise the fastpaced, broadbased and employmentrich recovery that has taken place in the country. Yet, the external environment has become increasingly uncertain. Ireland could be subject to external shocks linked to the referendum on UK’s membership of the EU and the international tax environment, through its impact on multinational location decision.

Domestic economic activity has expanded strongly. Gross value added in the ‘domestic’ sectors of the Irish economy expanded by 4.4 % in 2015, more than twice the rate in the euro area as a whole. Moreover, core domestic demand — a measure that strips investment components linked to the activities of multinationals — grew by approximately 5.4 % in 2015. Core domestic demand now stands 8 % above its 2010 level, reflecting the breadth of the Irish recovery, which has reached nearly all sectors. However, large differences prevail between the productivity growth of the indigenous firms and multinationals operating in Ireland. Unemployment has continued to fall but labour market and social challenges remain. Longterm unemployment has also declined further and the youth unemployment rate has fallen below the EU average. In 2016, the country experienced net inward migration for the first time since 2009. This is in addition to sizeable natural population growth of about 0.8 %. However, verylongterm unemployment (over two years) amounted to more than 40 % of all unemployment in 2015 and labour market participation has increased only marginally, despite the strong recovery. However, notwithstanding the progress so far, some households continue to experience poverty and social exclusion. Insufficient housing supply is a concern for both its economic and social reasons. House prices are increasing and supply constrains persist. This highlights the importance of coherent spatial planning and infrastructure investment. The government is intervening in the residential property market to support the recovery in supply. The stability of tax revenues in the medium term is a concern for public finances. The general government deficit has continued to drop, due largely to a surge in GDP and strong tax receipts. However, the increasing reliance on buoyant corporate tax receipts to finance permanent increases in current expenditure is a concern. This is because corporate tax receipts tend to be a volatile source of revenue in most economies and particularly in Ireland. The small tax base increases risks stemming from the still elevated levels of public debt and relatively high debt servicing costs. Although the domestic economy continues to grow at robust rates, there are uncertain times ahead. The external environment is increasingly unpredictable and internal risks also remain. Increasing spending pressures to fund current services are emerging, reducing the scope for public investment. Reorienting the fiscal policy mix towards growthsustaining capital expenditure and increasing the quality of current expenditure remain at the forefront of policy issues, also with a view to reducing the vulnerability of public finances to shocks. A number of factors continue to drag on bank profitability. These include the high stock of nonperforming loans and lowyielding tracker mortgages, weak credit demand, difficulties in accessing collateral, and continued pressure on net interest margins. Recent price and rent increases have drawn attention to persistent housing supply bottlenecks. These problems have greater implications for social stability than for financial stability at present. Overall Ireland has made some progress in addressing the 2016 countryspecific recommendations. Some progress was made regarding the quality of public expenditure which has improved, but Ireland has taken measures that are at odds with broadening the tax base. The use of volatile tax revenues to fund current expenditure makes public finances more vulnerable to the risk of future shortfalls in revenue. Some progress has been made regarding labour market. The rollout of labour activation programmes has continued but their effect has not yet been assessed by the government. Ireland has also taken steps to make childcare more affordable and improve its quality, but these efforts will need to be sustained over coming years to meet existing needs. Despite recent progress, incentives to work within the tax and benefit system remain a challenge. Ireland has also made some progress in tackling the still relatively high level of nonperforming loans. Although the level continues to fall, the longterm sustainability of restructuring solutions is uncertain. The central credit register has been delayed and is now only expected to be fully operational in late 2018. Regarding progress in reaching the national targets under the Europe 2020 strategy, Ireland is performing well on employment rate and early school leaving targets. More effort is needed in R&D investment, reducing greenhouse gas emissions, increasing the proportion of renewable energy, improving energy efficiency, reducing poverty and attaining the already extremely high and ambitious tertiary education goal. The main findings of the indepth review contained in this country report, and the related policy challenges, are as follows: Private sector indebtedness remains high. Nonfinancial private sector nonconsolidated debt stood at 322.3 % of GDP at the end of 2015. Trends in private debt, especially for nonfinancial corporations, are difficult to gauge due to the strong influence of the activities of multinationals on debt levels. However, there is evidence that domestic firms and households are continuing to reduce their debt. Strong economic growth, coupled with job creation, rising earnings and asset valuations are expected to support deleveraging in the future. Although there are indications of credit demand picking up in certain loan categories, existing debt repayments exceed new credit. Gross government debt is on a firm downward trend, but remains high. Public debt reached 78.6 % of GDP at the end of 2015, 32 percentage points below its peak level in 2012. The risks associated with high debt, such as its future refinancing, are mitigated by the longterm maturity of the Irish debt stock and its low interest rates. The government is studying the feasibility of a rainyday fund as a tool to alleviate fiscal risks while continuing to reduce public debt. Nevertheless, as Ireland is a small and very open economy, its public finances remain vulnerable to external shocks and changes in economic outlook. The net international investment position reversed its path in 2015. Ireland’s negative net international investment position had been falling rapidly before 2015, but it surged to 208 % of GDP in 2015 as a result of the transfer of large balance sheets into the country. In so far as it is observable, the external sustainability of domestic sectors does not appear to be deteriorating, although it is difficult to assess. The stock of nonperforming loans remains high. Banks’ asset quality is improving and profitability is recovering but remains fragile. The nonperforming loans ratio for domestic banks fell to 14.7 % at the end of June 2016, down from a peak of 27.1 % at the end of 2013. Nevertheless, this ratio is still among the highest in the euro area. The share of arrears in the total mortgage balance remains high at 14 %. The high ratio of nonperforming loans is expected to continue to weigh on domestic banks’ profitability — as well as on the economic activity of affected households and firms — in the short and medium term. Carefully balancing the push for credit volumes with prudent lending standards continues to pose a challenge for banks. Property prices continued to increase. Residential property prices remain below precrisis peaks and overall, current prices do not appear to be overvalued. Private rents increased 9.7 % in the year to December. Insufficient housing supply continues to be the prime driver of the increase in rents and house prices. House price increases are being tackled through supplyside and macroprudential measures but it will take time for housing completions to recover. Other key economic issues analysed in this report which highlight particular challenges for the Irish economy are as follows: Reforms of the fiscal framework have played a key role in repairing Ireland’s public finances. In recent years, comprehensive reviews of expenditure have primarily focused on reducing government spending to meet overall fiscal targets set over the crisis period. However, there has been little evaluation of the effectiveness and efficiency of expenditure programmes, which ultimately weakened the multiannual spending planning. Repeated discretionary changes to expenditure ceilings have characterised Ireland’s recent budget execution and weakened prioritisation of growthenhancing expenditure. The Irish economy is sensitive to changes in the international tax environment. The weight of multinationals in overall GDP and the growth in corporate tax receipts as a proportion of government revenue increase Ireland’s exposure to changes in international tax regimes. In response to the uncertain environment, the government is engaging in international tax reforms. More generally, relying on a broader tax base enhances revenue stability in the face of economic volatility. As a response to the uncertain environment, the government is engaging in international tax reform. The situation on the labour market continues to improve but social challenges remain, in particular for low workintensity households. There are large disparities in labour market outcomes for different skills groups. Recovery in the labour market has not yet reversed the prospects of lowskilled workers. Low work intensity for some groups persists, as aspects of the tax and benefit system lead to low work incentives. At the same time, the improving economy is resulting in skills shortages in several areas. The availability and cost of childcare remain barriers to female labour market participation and hinder efforts to reduce child poverty. Spatial planning and infrastructure provision have become increasingly important. There are a number of challenges for developing projects of an economically sufficient scale. These include coherent spatial planning and infrastructure provision, such as transport, water and energy, and in their efficient integration with public transport corridors in and around main urban areas. Regulatory issues and building permits are also slowing down the uptake of construction activity. The lack of affordable housing in urban areas may also be detrimental to Ireland’s continued ability to attract foreign direct investment, as firms have difficulties finding suitable accommodation for employees. Linkages between multinationals and indigenous firms remain limited. Their export performances and profiles are significantly different, while the productivity gap between them is growing wider. Public R&D expenditure remains low. Public R&D intensity has declined since 2009 and continues to cause concern. Fully implementing measures to improve R&D, in particular those to support the innovation capacity of indigenous SMEs, depends on the return to a trend of sustained investment.

The costeffectiveness and sustainability of the healthcare system continue to pose challenges. In view of a growing and ageing population, the costeffectiveness of the health system remains a priority. Public healthcare expenditure pressures persist which can have a negative impact in the medium term for fiscal sustainability. Specific strands of reforms are progressing gradually. Ireland has introduced some important efficiency measures, yet key costeffectiveness gains are still to be achieved, for instance by strengthening the role and use of primary care as a gatekeeper for Ireland’s overburdened hospitals. 1. Economic situation and outlook GDP growth The Irish economy has continued its rapid recovery but the risks have heightened. The very rapid growth in Irish GDP since 2014 reflects both the positive evolution of the domestic economy and the substantial contribution from global value chains, with limited impact on domestic economic activity. In 2014, the volume of Irish GDP was already at the precrisis level and just over 10 % higher than in 2009 — the lowest point in the aftermath of the crisis. GDP is estimated to have grown by 4.3 % in 2016 and is projected to further expand by 3.4 % in 2017 and 3.3 % in 2018. The large operations channelled through Ireland by some multinationals, do not disguise the fastpaced, broadbased and employmentrich recovery that has taken place in the country at the same time. In the next few years, Ireland’s domestic economy is expected to continue to expand at robust rates. But the risks have also increased, reflecting the referendum on the UK’s membership of the EU and the uncertainty surrounding future US tax policies. The value added recorded in Ireland by some multinationals has increased dramatically. In 2015, gross value added (GVA) — a measure of output net of the inputs used for its production — more than doubled in the economic sectors dominated by foreignowned multinationals (Graph 1.1) ( ). A small number of very large multinationals restructured their operations in 2015. This led to a bigger share of GVA from their global production chains being booked in Ireland but had a limited impact on domestic economic activity (European Commission 2016a, Box 2.1). The evolution of the international tax environment appears to have played a role in the changes to the operations of multinationals (Section 4.1.3). As a result, net exports contributed 18 percentage points (pps.) to GDP growth in 2015, driven by the production and sale of goods abroad on behalf of the Irish affiliates of some multinationals — known as contract manufacturing (see below). Graph 1.1:Gross value added from domestic production and foreignowned multinationals Source: Central Statistics Office of Ireland (CSO) Headline national accounts indicators therefore need to be interpreted with caution. Under current standards for compiling national accounts ( ), GDP captures not only domestic production but also the value of production and income accruing to domestic entities from their activities abroad. Observers should therefore look beyond headline indicators and into their disaggregation. There is also a direct arithmetic impact on any indicator expressed as a share of GDP — used to measure the burden of public debt or the intensity of research and innovation, for example. This report uses disaggregated and complementary indicators, whenever source data allow for their calculation. There is abundant evidence that the domestic economic activity has expanded strongly. GVA in the ‘domestic’ sectors of the Irish economy — those where the presence of foreignowned multinationals is not prevalent — grew by 4.4 % in 2015 (Graph 1.1), more than twice the average in the euro area. Moreover, core domestic demand — a measure that strips out investment components linked to the activities of multinationals — grew by approximately 5.4 % in 2015 (Graph 1.2). The upward trend reflects the breadth of the Irish recovery, which has reached nearly all sectors in the economy. Graph 1.2:Core domestic demand and employment Source: European Commission and calculations based on CSO data Overall, confidence in the economy remains high despite growing risks and uncertainty. Monthly indicators of consumer confidence, retail sales and business prospects have been close to or above precrisis levels since 2014 (Graph 1.3). However, the outlook has become more uncertain. Risks discussed in this report include exchange rate developments and wage pressures. Other sources of uncertainty relate to productivity developments, the volatility of certain sources of public revenue and the overall exposure of the economy to global value chains and taxation frameworks. Further depreciation of sterling and uncertainty surrounding the referendum on UK’s membership of the EU could weigh on consumer and business confidence and economic activity. However, there is also the upside potential from further investment in infrastructure and housing, and the continued attractiveness of Ireland as an entry point to the EU single market. Graph 1.3:Consumer sentiment and business prospects Source: Central Statistics Office of Ireland, KBC Bank of Ireland, Markit Group The longerterm impact of the referendum on UK’s membership of the EU on the Irish economy remains uncertain. It depends on the precise shape of the future relationship between the UK and the EU. The interdependence between the Irish and the UK economies declined following the intense period of diversification and growth that Ireland has undergone since it joined the EU. Several studies highlight potential downside risks for the Irish economy in relation to the referendum on UK’s membership of the EU. The fall in sterling has an impact on indigenous Irish exporters, in particular in the agrifood sector. In this regard, the National Competitiveness Council has identified the broadening of the export destinations for domestic firms as another challenge for Ireland. Labour market Unemployment has continued to fall but challenges remain. It stood at 7.3 % in Q42016, down from 15 % at the beginning of 2012 (Graph 1.4). Longterm unemployment also declined further and the youth unemployment rate fell below the EU average to 15.3 % in Q42016, almost halving from its 2012 peak. In addition to the expansion of the economy, a number of employment activation policies have played a role in improving labour market recovery. The rate for young people not in employment, education, or training fell further in 2015 but remains 2.3 pps. above the EU average. In 2016, the country experienced net inward migration for the first time since 2009 — with an estimated net inflow of 8 200 people in the 2544 age bracket. This is combined with sizeable natural population growth of about 0.8 %. Despite the strong recovery, labour market participation has increased only marginally. Graph 1.4:Recent labour market trends Source: European Commission More jobs and recovering pay levels have continued to support household consumption. High employment intensity is a continuing feature of the recovery of the Irish economy. Employment grew by nearly 2.7 % in the first three quarters of 2016, compared to the same period in 2015. Most new jobs are fulltime positions and the proportion of temporary employees remains far below the euro area average. At the same time, nominal earnings per employee grew by 2.8 % in 2015 and average hourly earnings continued to go up in the first three quarters of 2016. Both of these developments explain the high growth in household consumption (5 % in 2015), combined with the demand for durable goods, such as cars and home appliances, after the crisis. Social developments Income inequality is below the EU average, due to an effective taxbenefit system. In 2015, the income inequality as measured by the S80/S20 indicator ( ) stood at 4.5 compared to the 5.2 EU average. Ireland had one of the highest incidences of market income inequality — the inequality of income before taking into account taxes, social transfers and pensions — amongst Member States. However, the taxbenefit system is particularly effective at reducing inequality in Ireland, resulting in a performance in line with the EU average in terms of disposable income ( ). This effect was even more pronounced in the years immediately after the crisis (20112013). Ireland’s system remains effective at containing inequalities as measured by income . In terms of net wealth (difference between total assets and total liabilities), in 2013 many Irish households still owed more than they owned. Overall, households' net wealth inequality is relatively higher than income inequality and among the highest in the EU (ECB 2016). Inflation Consumer price inflation has been negative but energy prices are starting to recover. The harmonised index of consumer prices (HICP) declined by 0.2 % in 2016, even lower than the 0.0 % observed in 2015. Energy prices continued to drag down the headline inflation rate while services inflation was 2.5 % and remains the main source of upward price pressures. Nationally, private rents increased 9.7 % yoy in December and market participants report that private rents in Dublin have exceeded their precrisis peaks.

Competitiveness External competitiveness has improved. The improvement in Ireland’s external competitiveness can be seen by comparing the real and nominal effective exchange rates (EER) (Graph 1.5). In 2015, Ireland’s real EER was back to its 2002 level. Nominal exchange rates contributed the most to improving Ireland’s competitiveness in 2015. However, this has been partially reversed by the recent weakening of sterling. In addition, the overall improvements in these headline indicators hide large differences across sectors (Section 4.4). Graph 1.5:Real effective exchange rate Source: European Commission External position The external performance of the Irish economy has been very positive. In 2015, net exports contributed 18 pps. to GDP growth, driven by contract manufacturing activities of multinationals ( ). Up until 2014, the exports of contractmanufactured goods by Irishdomiciled firms were compensated by imports (royalty payments) to entities residing abroad. This resulted in an overall neutral effect on GDP. But since 2015, the volume of contract manufacturing has become significantly larger and without royalty payments matching the volume of exports. The net volume of contract manufacturing can be approximated by comparing customs and balance of payments data for goods exports (Graph 1.6). This is because contractmanufactured goods rarely enter the Irish territory. The differential between balance of payments and customs data narrowed significantly in the first nine months of 2016. The performance of indigenous firms in international export markets was also robust in 2015, as reflected by the customs data, and helped by positive exchange rate developments. However, indigenous exports have suffered from the weak sterling exchange rate since July 2016. Graph 1.6:Goods exports and contract manufacturing Source: European Commission Risks and vulnerabilities to Ireland’s external position have become increasingly difficult to ascertain. The headline net international investment position deteriorated markedly in 2015. A more detailed analysis shows that the risk to the external position of domestic sectors probably did not deteriorate. The international investment position of domestic banks improved. However, the position of domestic nonfinancial corporations cannot be fully determined, given the weight of multinationals and lack of disaggregated indicators. The marked deterioration in the external position of multinational companies, considered as a whole, does not appear to pose a threat to the domestic economy (Section 4.2.2). Financial sector Banks’ resilience to shocks has improved further but they continue to face considerable challenges. Their capital positions have continued to improve but there are persisting vulnerabilities (Section 4.2.1). The stock of nonperforming loans continued to decline but remains high. The high proportion of longterm arrears is still a concern. On top of legacy issues, weak credit demand and the low interest rate environment constrain the banks’ ability to improve their future profitability. Growing uncertainty in the external environment represents an additional challenge. New lending is growing only gradually, with measures in place to ensure it is prudent. Net lending for both households and companies remains negative. However, mortgage approvals are increasing, amidst increased competition and product offering by banks. New credit to nonfinancial companies, in particular SMEs, is also recovering (Section 4.2.5). The ability of banks to substantially reduce interest rates is however constrained by legacy issues, including the stock of lowyielding assets and persistent difficulties in accessing collateral. The government continues to pursue a broad range of initiatives to facilitate SMEs’ access to credit. Domestic firms and households remain highly indebted but continue to deleverage. The private debttoGDP ratio has been affected by both the surge in GDP and the debt stock that accompanied the relocation of multinationals’ balance sheets to Ireland. However, domestic firms and households continue to deleverage but their debt stock remains high compared to the rest of the euro area (Section 4.2.3). Most of the debt stock attributable to foreignowned multinationals consists of intrafirm loans or transactions in international capital markets. The exposure of domestic banks to the cluster of multinationals based in the country remains very limited in Ireland. Investment and housing market The surge in investment has been driven largely by the onshoring of intellectual property assets. Total investment (gross fixed capital formation) in the Irish economy grew by more than 30 % in 2015 and 70 % since 2010 (Graph 1.7). However, most of this growth can be explained by the redomiciliation of intangible assets, such as patents, by multinationals. Coming from abroad, these flows also count as Irish imports and have an initial neutral effect on Irish GDP growth. However, they also reduce the amount of royalties paid abroad for the use of patents — and therefore help to explain the surge in value added in Ireland in recent years (see above). Total investment has also been driven by aircraft imports (Section 4.4.10). Graph 1.7:Total investment and main drivers Source: European Commission Other investment components have also been strong. Excluding intellectual property and aircraft, the growth in investment components has been robust since their lows in early 2012. Construction investment has grown steadily since 2012 by over 30 %, albeit from low levels (Graph 1.8). More recent trends point to a deceleration in core machinery and equipment investment due to the recent completion of a large industrial project. Significantly higher growth in construction investment is expected in the next few years, given large unmet demand, in particular for housing in urban areas (see below). Public investment remains relatively low but continues to recover, given the resources available. After contracting sharply since 2008, capital expenditure by the general government is expected to recover gradually in the future (Section 4.4.1). A midterm review of the Capital Investment Plan 20172021is expected in 2017. Graph 1.8:Core investment and its components Source: European Commission Insufficient housing supply is a concern for both economic and social reasons. The recovery in construction activity is long in materialising, only picking up gradually and from low levels. At the same time, demand for housing is estimated at about 25 000 units per year or around 65 % above the completions expected in 2016, contributing to rising rents and houses prices (Section 4.5.2). Since the trough in prices in 2013, national residential property prices have grown by 50 %. Increases in residential prices have been moderate since the central bank introduced limits to mortgage lending. Rents have also increased rapidly and are now straining affordability. This supply shortage is also likely to have contributed to the growing number of homeless people (Section 4.3.2). It could also postpone the return of Irish migrants and weigh on foreign direct investment in Ireland, as firms have difficulties finding suitable accommodation for employees. Coherent spatial planning and infrastructure provision would support sustainable and balanced economic development. Delays in the pickup in construction activity after 2012 can be explained by a combination of factors — such as the collapse in construction production capacity after the bust of the property bubble, strategic behaviour by some firms (including land hoarding) and institutional hurdles (section 4.5.1). The government adopted a revised strategy to enable and promote construction in July 2016 (Section 4.5.1). Spatial planning and infrastructure provision have become all the more important — to enable the development of projects with sufficient scale, and their efficient integration with public transport corridors in and around main urban areas. In February 2017, the government launched a major national consultation for the preparation of a strategic planning and development framework for Ireland. Public finances

The deficit has continued to drop, alongside the surge in GDP and strong tax receipts. Ireland has shown a commitment to prudent fiscal policymaking since the onset of the property crisis, especially during the EUIMF financial assistance programme. The general government deficit has fallen by almost 10 pps. from its peak in 2010. Overall, the deficit reduction was mostly driven by expenditure restraint. More recently however, strong GDP growth and buoyant tax receipts have eased fiscal achievements. In 2015, the deficit fell to 1.9 % of GDP, down from 3.7 % a year earlier, partly due to the levelshift in GDP explained earlier. The fiscal effort lessened, as betterthanexpected revenue was used to finance additional current expenditure. The stability of tax revenues in the mediumterm is a reemerging concern for public finances. Past experience in Ireland, during the property bubble, demonstrates the dangers of overreliance on a small number of tax headings and narrowing the tax base. Cutting personal income taxes — if not adequately supported by a shift towards more growthfriendly sources of revenue — could significantly reduce revenue collection and have a regressive impact on income distribution which could increase inequality. Corporate tax receipts increased by 50 % in 2015 with multinationals accounting for approximately 80 % of total corporate tax receipts (Revenue 2016, p. 6). The increasing reliance on buoyant and volatile corporate tax receipts to finance additional permanent increases in current expenditure is also a concern (Section 4.1). The government debttoGDP ratio has fallen but the burden of public debt remains very significant. It fell to 78.6 % in 2015 from 105.2 % a year earlier, with the surge in GDP accounting for most of this reduction. The burden of gross government debt on public finances and the economy has declined more slowly than the debttoGDP ratio would suggest. Complementary indicators — such as the weight of the debt stock or debt servicing costs on total tax revenue — show that the burden of public debt remains significant (Section 4.1.1). Favourable market conditions and the longterm maturity of the debt stock are expected to ease future refinancing operations. Table 1.1:Key economic, financial and social indicators — Ireland Source: European Commission, ECB

2. Progress with country-specific recommendations Progress with implementing the recommendations addressed to Ireland in 2016 ( ) has to be seen as part of a process which started with the introduction of the European Semester process in 2014. The country has achieved considerable success in stabilising public finances and has been able to ensure a durable correction of the excessive deficit. The government balance has improved from a peak of 11 % in 2010 to 1.1 % in 2015, net of oneoff and temporary bank supporting measures linked to the financial crisis. The structural balance has also improved but more slowly in recent years. Limited progress has been made in broadening the tax base and repeated changes to expenditure ceilings remain a concern for budgetary execution. Measures have been taken to increase the costeffectiveness of the healthcare system but not all have been fully implemented. The fiscal sustainability of the health sector could be further improved. Public investment started to increase in 2014 and the government has outlined some of its priorities until 2021. The insufficient supply of housing, and related deficiencies in infrastructure and planning, have become more pressing for both economic and social reasons. The government has announced an array of measures to support supply including an increase of the provision of social housing units and a targeted infrastructure fund. The recovery in the labour market has also been supported by CSR implementation since 2014. Ireland has pursued a range of active labour market reforms over recent years. Two support programmes for jobseekers (Intreo and JobPath) have now been fully rolled out. Reforms of further education and training, aimed at promoting reskilling and upskilling, have also made steady and continuous progress. Ireland has also achieved some success in addressing child poverty by, for example, enhancing inclusion programmes. The Housing Assistance Programme and Family Income Supplement have reduced disincentives to return to work, while access to childcare has gradually improved. Efforts to implement the financial sector CSR, in place since 2014, are ongoing. Progress has been made in reducing nonperforming loans over the last three years, although their stock still remains high. Longterm impaired mortgages remain the most critical cohort to resolve. The Central Bank of Ireland has been closely monitoring the banks’ performance on mortgage arrears restructuring targets and their restructuring practices. Overall, the sustainability of restructuring solutions will only be validated over time. Several policy measures have been introduced to incite active engagement of debtors in distress, speed up legal procedures and increase the number of personal insolvency arrangements, but their takeup has been limited so far. Overall, Ireland has made some ( ) progress in addressing the 2016 CSRs. Since the publication of the CSRs, the quality of public expenditure has improved but the country has taken measures at odds with broadening the tax base. Thus some progress was made on CSR 1. As regards CSR 2, the roll out of labour activation programmes has continued but their effects have not yet been assessed by the government. Ireland has also taken some steps to making childcare more affordable. On CSR 3, Ireland has also made some progress. Nonperforming loans have continued to fall but the longterm sustainability of restructuring solutions is sometimes uncertain. The central credit register is now only expected to become fully operational from late 2018. Table 2.1:Summary table on 2016 CSR assessment Source: European Commission 3. Summary of the main findings from the MIP in-depth review The 2017 Alert Mechanism Report calls for further indepth analysis to monitor progress in unwinding the imbalances identified in the 2016 MIP cycle. In spring 2016, macroeconomic imbalances were identified in five areas. These relate to the high levels of private and public debt, the negative net external liabilities, the high ratio of nonperforming loans and the rapidly rising property prices and rents. This report provides the indepth review (IDR) of how the imbalances identified have developed. In particular IDRrelevant analysis can be found in the following sections: public debt in Section 4.1.1; financial sector imbalances in Section 4.2.1, external imbalances in Section 4.2.2, private indebtedness in Section 4.2.3, and property market in Section 4.5.1. 3.1 Imbalances and their gravity The debt stock of the private sector is high. Nonfinancial private sector nonconsolidated debt stood at 322.3 % of GDP at the end of 2015, up from the 301 % of GDP recorded at the end of 2014. However, it also represents a decrease from early 2015, when private debt surged as a result of the transfer of large balance sheets into Ireland. There is strong evidence that both domestic firms and households continue to reduce their debt. Although there are indications of credit demand picking up in certain loan categories, repayments of existing debt exceed new credit.

Gross government debt remains high. It stood at 78.7 % of GDP in 2015, 32 pps. below its peak in 2012. The ratio of debt servicing costs to tax revenue shows that the public debt still represents a significant burden. The risks associated with high debt, such as its future refinancing, are somewhat lessened by the longterm maturity of the Irish debt stock and its low interest rates. Nevertheless, being a small and very open economy, Ireland’s public finances remain vulnerable to external shocks and changes in the economic outlook. The net international investment position (NIIP) reversed its path in 2015. Ireland’s negative NIIP, which had been falling rapidly before 2015, surged to 208 % of GDP (Q42015) as a result of the transfer of large balance sheets into Ireland (see Table 3.1 for a split on various sectors). Insofar as they are observable, the external sustainability of domestic sectors does not appear to be deteriorating. Banks are facing a high stock of nonperforming loans (NPLs). Their ratio for the domestic banks fell to 14.2 % at the end of September 2016, down from a peak of 27.1 % at the end of 2013. The high ratio of NPLs is expected to continue to weigh on domestic banks’ profitability, as well as on the economic activity of affected households and firms, in the near and medium term. Achieving the right balance between supporting businesses’ access to credit and maintaining prudent lending standards remains a challenge Property prices continued to increase but there is little evidence of overvaluation in the market. Residential property prices increased by 8.6 % in November 2016 compared to the same month a year earlier but remain far below precrisis peaks. Overall, current prices do not appear to be overvalued and recent increases are not currently driven by an unsustainable expansion of bank credit. Over the same period, private rents increased by 9.7 %. Insufficient housing supply remains the prime driver of the increase in rents and house prices. An adequate supply of housing is essential to protect and expand Ireland’s economic future growth but the recovery of residential construction will take time. 3.2 Evolution, prospects and policy responses Deleveraging prospects are improving. Strong economic growth is expected to support deleveraging in the future. It is important to keep distinguishing between trends for domestic firms and multinationals. Government debt is projected to decline further but public finances remain vulnerable to shocks. The debt ratio is on a firm downward trend. According to the European Commission winter 2017 forecast, it is expected to fall to approximately 72.6 % of GDP by 2018, conditional on robust economic growth and primary budget surpluses. Risks to longterm debt sustainability relate mostly to changes to the economic outlook. Government contingent liabilities, mainly related to bank bailout operations, are rapidly declining. The government is also studying the feasibility of a ‘rainyday fund’ as a tool to mitigating risks while continuing to reduce public debt. The worsening in the NIIP appears to be driven by factors disconnected from the domestic economy. Analysis shows that the recent deterioration in the NIIP was driven by the activities of a few very large multinationals. The risks presented by the external liabilities of these companies are mitigated by a number of factors (Section 4.2.2.). Therefore, many of their operations have few implications for the external sustainability of the domestic economy. Regarding the banking sector, the NIIP of the Central Bank of Ireland (CBI) took an upswing in 2016, as domestic banks restored their access to market funding. Ireland’s headline NIIP will continue to be driven by the activities of multinationals. Measures to strengthen the banking sector have continued, and the stock of NPLs is declining. Banks’ asset quality is improving. and their profitability is recovering but remains fragile. New lending to the private sector is increasing gradually, albeit from low levels. While the progress made in loan restructuring is remarkable, the pace of the process has slowed and the sustainability of restructured loans in the long run requires constant vigilance. The legal procedures for mortgage arrears are still slow and cumbersome, while the use of insolvency and bankruptcy schemes remains limited. The central credit register is not expected to be fully operational until end2018. The government has actively intervened to address the issue of housing shortages but measures will take time to generate effects. The government is pursuing a range of measures to support the housing supply under its Action Plan for Housing and Homelessness. Housing completions remain well below the estimated demand as the construction industry continues to slowly recover. In this context, demandside policies, such as the ‘helptobuy’ scheme, could be counterproductive. The macroprudential measures ( ) introduced by the CBI in 2015 have reduced house price expectations. However, macroprudential rules remain important to enforcing prudent lending standards — mitigating the risk of a repeat of the dangerous property bubble of the 2000s. Supporting housing supply also appears to be the best policy to sustainably contain the increase in rents, while the government is also taking measures to alleviate the immediate social consequences of high rents (Section 4.5.1). However, proposed rent controls could provide a disincentive to further investment. 3.3 Overall assessment Ireland has broad based sources of imbalances linked to large stocks of external, public and private debt as well as a high level of nonperforming loans, all making Ireland vulnerable to adverse shocks. Strong productivity growth in past years has implied improved competitiveness, and a positive current account balance entailing a rapid reduction in the stock of net foreign liabilities ( ). However, even if the negative NIIP had been falling at a fast pace before 2015, it has reversed partly due to a level shift in 2015. The external sustainability risks for the domestic economy seem limited although difficult to assess. On the back of a strong growth recovery, private debt is falling at a rapid pace, as well as the NPL ratio, which remains however elevated. Government debt is also projected to remain on a downward trajectory. The stock of NPLs has been declining rapidly but slowing down somewhat by the end of 2016. Property prices continued to increase over 2015 but there is no significant evidence of overvaluation. Policy measures have been taken in recent years especially on the financial sector, debt restructuring, and the management of public finances. As regards the undersupply in the housing market the government has taken measures repeatedly but the measures will take time to generate effects. Table 3.1:MIP assessment matrix — Ireland 2016 (Continued on the next page) Table (continued) Source: European Commission 4. Reform priorities 4.1. Public finances and taxation 4.1.1.Fiscal policy*( ) (public deficit and debt developments)

The government gross debttoGDP ratio is firmly on a downward path. Ireland’s government debttoGDP ratio is projected to continue to decline, after peaking at 119.5 % in 2012. The European Commission winter 2017 forecast projects the ratio to fall further to 75.1 % in 2016 and to reach 72.6 % in 2018, contingent on still robust GDP growth and the realisation of sizeable primary budget surpluses (Graph 4.1.1). However, the burden of government debt on public finances and on the overall economy can no longer be assessed solely on the basis of GDP ratios. Despite being reflected in additional government revenues, the considerable impact of the foreign activities of multinationals on Irish GDP together with their inherent volatility (Section 1) calls for complementary debt indicators. In absolute terms, public debt is still high. The stock of debt remains at a historically high level. It has, however, one of the most longterm maturities in Europe and interest rates are relatively low. According to the 2017 Draft Budgetary Plan, government gross debt is projected to increase by nearly EUR 13 billion over 20162019, reflecting the projected increase in the funding requirement, owing primarily to large bond redemptions in 20192020. This could have an impact on borrowing conditions at that time. Alternative measures of repayment capacity show that progress has been relatively moderate. Revenuebased indicators — such as the stock of debt or debt interest expenditure as percentage of government revenue — can give a more accurate view of the state’s ability to generate resources to service its debt. These metrics are also more resilient to the effects of globalisation on Irish economic performance data. The proportion of government interest expenditure relative to its tax revenue has improved significantly since 2013 (Graph 4.1.2). However, it remains high compared with other highly indebted EU countries, also reflecting the low tax environment in Ireland. It is also twice the EU average in 2015. Comparing debt stock and tax revenue would give a similar picture. Graph 4.1.1:Government gross debt evolution Source: European Commission However, the sovereign’s financing situation remains healthy. Government bond yields have fallen sharply since the end of 2013 and continue to fall, reflecting Ireland’s progress on the economic and fiscal fronts, as well as ECB’s bond purchases under its quantitative easing programme. As of the end of September 2016, EUR 6.5 billion had been raised in bonds at a weighted average yield of 0.85 % and with a weighted average maturity of close to 10 years ( ). To date, Irish government bonds maturing up to 2023 are trading at negative yields. Graph 4.1.2:Debt servicing cost indicator Source: European Commission Long maturities and moderate interest rates ease refinancing operations. At the beginning of 2016, the average maturity of debt was close to 12 years — having improved by nearly one year after IMF programme loans were replaced with longerdated government bonds ( ). The next significant bond maturity (EUR 6.4 billion) is due in the Q42017. Other bond redemptions are significant over the medium term (Graph 4.1.3). The current outstanding balance on the six benchmark bonds maturing in 20172020 is around EUR 50 billion. Bilateral loans from the UK, Denmark and Sweden also begin to mature in 2019. The next IMF maturity, of EUR 2.9 billion, will be in 2021. Debt sustainability has improved. However, comparisons with previous debt sustainability analysis ( ) are very much affected by the level shift in nominal GDP in 2015, which carries over into later years. The latest debt sustainability analysis carried out on the basis of the Commission’s winter 2017 forecast projects that the general government debttoGDP ratio will fall steadily until 2024 to around 65.2 % and then increase slightly in the following few years, mainly on account of increasing ageing costs (Graph 4.1.1). These baselinescenario projections assume that existing policies will not change from 2018 on ( ). Graph 4.1.3:Maturity profile of Ireland’s longterm debt (end December 2016) Source: National Treasury Management Agency Yet, public finances remain vulnerable to shocks, while risks have increased. Risks to longterm debt sustainability relate mostly to changes to the economic outlook — since most of the outstanding stock of debt pays fixed interest rates. Adverse developments on real GDP growth — of a magnitude reflecting the country’s historical variability of output ( ) — would increase the public debttoGDP ratio by 22 pps. by 2027 to about 90 % ( ). A combination of adverse effects on growth, interest rates and primary balance — also comparable to past shocks in magnitude — would keep the debt ratio at around 80 % of GDP by 2021. Uncertainty may further postpone plans to sell bank shares. According to the most recent assessment, the government’s total stakes in the three major domestic banks is valued at about EUR 13 billion (around 5.1 % of GDP) ( ). The sale of these stakes, on which the debt sustainability analysis does not speculate, could accelerate debt reduction further. However, subdued bank profitability could further hinder government plans for early sales. Additional cash over the medium term can be expected from surpluses arising from the closing operation of the National Asset Management Agency and the Irish Banking Resolution Corporation. Government contingent liabilities are rapidly declining. State guarantees fell sharply to 4.9 % of GDP at the end of 2015, down from 13.2 % in the previous year (Table 4.1.1). The vast majority of contingent liabilities are linked to the support granted to financial institutions. The ongoing repayment of governmentguaranteed bonds of the National Asset Management Agency means that contingent liabilities are rapidly decreasing yet further. Other potential future payments (not reflected in the table below) might arise in connection with public private partnership projects — which the government estimates at around EUR 4.6 billion — and commitments to provide capital to international organisations ( ). Table 4.1.1:Government's contingent liabilities Source: Department of Finance (Ireland) 4.1.2.Fiscal frameworks and spending reviews Ireland’s budgetary and expenditure reforms played a key role in repairing public finances. In the past years, comprehensive reviews of expenditure have primarily focussed on reducing government spending to meet overall fiscal targets set over the crisis period. There has been little evaluation of the effectiveness and efficiency of expenditure programmes, which ultimately weakened the multiannual spending planning. Indeed, repeated discretionary changes to expenditure ceilings, which were decided with little or no explanations, have characterised Ireland’s recent budgetary implementation. These took advantage of upward revisions to GDP growth and government revenue projections (Graph 4.1.4) with insufficient prioritisation to growthenhancing expenditure. An appropriately designed review of expenditure could support both fiscal responsibility and growthenhancing structural changes in public expenditure by guiding a better allocation of expenditures, in particular in view of prioritising investment. Against this background, the ongoing budgetary reform could enrich the Irish fiscal framework further. The recent budgetary reform incorporates new procedures aimed at improving communication on expenditure targets, increasing stakeholder engagement and harnessing public support to improve the quality of expenditure ( ). A number of documents analysing the economic, fiscal and social implications of possible policy options, have now been presented in advance of budget decisions and are part of the final budget package ( ). Overall, these budgetary reforms aim at developing a ̔culture of spending̛ evaluation to, for example, increase responsibility across the public administration for assessing the efficiency and effectiveness of public expenditure ( ). However, some of these principles have not yet been fully embedded in the wider Irish budgetary process. Graph 4.1.4:Change in final and planned expenditure allocation and revenue surprise Source: Irish Department of Public Expenditure and Reform, European Commission In an economy featuring such volatility, the planned ‘rainyday fund’ could act as a shock absorber. The government’s proposal to create a specific fund after the country has reached its mediumterm objective would work as a reserve against future contingencies but could also divert resources away from faster debt reduction. Appropriately designed fund or buffers ( ) could facilitate counter cyclical fiscal policy and help to absorb future shocks ( ). Its design could, however, also face hurdles in the form of accounting and fiscal rules, which currently do not make specific provision for this type of funds ( ). The design of the fund would probably require domestic fiscal rules to specify a target value for the fund in normal times. It would also be important for a set of rules to define which revenue windfalls would be paid into the fund and under which circumstances withdrawals from the fund could take place and with which allocation rules across expenditures. This would help the fund play a balancing role also in the event of unanticipated revenue fluctuations. The experience with the National Pensions Reserve Fund, established in Ireland in 2001, is also worth taking into account. The Fund was heavily invested in equities with a longterm duration to prefund pension liabilities, but suddenly had to be repurposed, with significant losses, in the context of the 2008 crisis. 4.1.3.Taxation The Irish economy is sensitive to changes in the international tax environment. Some features of the Irish tax system have been used by multinationals for aggressive tax planning . Recent changes are a consequence of both public-policy initiatives to limit tax avoidance and growing corporate awareness of the reputational risks from aggressive tax planning. The weight of multinationals in overall GDP and the growing share of corporate tax receipts in public revenue make Ireland more exposed to changes in the international corporate tax framework. To date, however, Ireland appears to have benefitted from the changes that are taking place in the international tax environment in the form of windfall tax revenues.

In response to the uncertain environment, the Irish government is engaging in international tax reform. Ireland has been constructively engaged in the Base Erosion and Profit Shifting (BEPS) project (see OECD, 2015) and has been an early adopter of the country-by-country reporting for large companies (Action 13 of the BEPS project). Moreover, the Irish government has introduced additional measures to address tax evasion and avoidance. They include a new compliance programme to tackle offshore tax evasion and amendments to prevent certain funds from exploiting existing legislation for tax avoidance purposes. Administrative resources for audits and compliance procedures have also been increased. These measures build on similar initiatives in 2015 and 2016, including the decision to change the corporate tax residency rules that had been exploited by some multinationals. Nevertheless, the growing share of corporate tax in total tax revenue merits some consideration. The annual corporate tax revenue increased by approximately 50 % in 2015 compared to 2014. This brought the share of corporate income tax in total revenue to almost 10 %, with the top 10 payers accounting for over 40 % of net receipts. Corporate tax revenue in Ireland can therefore be characterised as highly concentrated and prone to volatility. A detailed examination of the risks linked to the composition of the Irish tax system could help to ensure that public finances have access to a broad set of revenue sources. The government has already launched an independent review of its corporate tax code, which will yield a set of recommendations by summer 2017. Relying on a broader tax base would support revenue stability in the face of economic volatility. Ireland has done very little to broaden the bases of its tax heads. Budget 2017 has introduced a range of tax expenditure measures which are likely to narrow the income tax base thereby increasing public finances’ exposure to shocks. Measures include a tax rebate for firsttime buyers of newlybuilt homes and increases to tax credits for the selfemployed and home carers ( ). Tax rate increases in limited areas, notably on tobacco, are unlikely to sufficiently compensate for the more significant cuts elsewhere. This comes on top of the decision to further delay the revaluation of selfassessed property values, used to calculate local property tax liabilities, to November 2019. There is still no systematic process for evaluating the costs and benefits of reduced VAT rates. This is in contrast with the regular reviews of other tax expenditures. However, in the context of the budgetary process, the Department of Finance released a report on selected VAT issues, including the rate of VAT for hotels and restaurants. The report found that bringing the 9 % VAT rate back to the standard reduced rate of 13.5 % would generate additional revenue of EUR 626 million. Despite this, and the fact that hotels and restaurants are performing strongly, the government has decided to keep the reduced VAT rate as a buffer for the sector against the weakness in sterling, which increases the cost of holidaying in Ireland for British tourists. Recurrent property taxation is considered one of the most growthfriendly revenue sources. However, Irish revenues from immovable property are below the EU average, amounting to 1.0 % of GDP in 2014, compared to the EU average of 1.6 %. The extension of exemptions for newly developed houses and the postponement until 2019 of the revaluation of selfassessed property values, used to calculate local property tax liabilities, contrast with the importance of broadening the tax base for the sustainability of public finances. The tax system can be used for environmental policy while also generating revenue. Overall, revenues from environmental taxes are in line with the EU average (2.43 % of GDP for IE compared to an EU average of 2.46 %). The differences in the taxation of diesel and gasoline for road use are environmentally unjustified. In Ireland, diesel is taxed at a lower rate, although it emits more air pollutants. The tax advantage in favour of diesel currently stands at 11 cents per litre. An equal treatment of transport fuels would lead to environmental improvements. 4.2. Financial sector 4.2.1.Banking sector* Bank profitability has recovered but remains weak. A number of factors will continue to drag on bank profitability in the near to medium term. These include the elevated stock of nonperforming loans (NPLs) and lowyielding tracker mortgages, weak credit demand, difficulties in accessing collateral and continued pressure on net interest margins. However, progress made in loan restructuring and portfolio sales, as well as rising collateral valuations, have led to the release of provisions, supporting profitability metrics (Graph 4.2.1). Graph 4.2.1:Banks’ book quality and provisioning Source: ECB Market uncertainties are expected to persist over time. Irish banks remain susceptible to spillovers from financial sector problems from across the euro area. Bank shares across Europe have generally been weak but the domestic Irish banks have traded below euro area market averages in 2016. Irish banks maintain adequate capital buffers but may face pressures in the coming years. The aggregate Common Equity Tier 1 (CET1) capital position of Irish banks diminished slightly in the first quarter of 2016. This was driven primarily by a reduction in the capital of the branches and subsidiaries of foreign banks. Nevertheless, the CET1 ratio for the sector as a whole remained high, at 20.5 % of risk weighted assets as of the end of June 2016, down from 22.3 at the end of 2015 (ECB). Part of this capital buffer will be used in the gradual phasing in of the Capital Requirements Regulation. The European Banking Authority stress test of July 2016 signalled continuing challenges. The average CET1 ratios of Allied Irish Banks (AIB) and Bank of Ireland (BOI) scored significantly below their European peers in the adverse scenario. This was primarily explained by their accumulation of deferred tax assets and high NPL stock, considered below. Overall, the results show the vulnerability of the Irish banking sector to a reversal in macroeconomic environment. Credit risk accounted for the majority of the losses for these two banks under the adverse scenario, highlighting their key weakness relative to their peers. The substantial stock of deferred tax assets (DTAs) is still a concern. Accounting and tax practices allow institutions that make losses — and thus pay no income taxes — to generate DTAs to reduce their future tax liabilities. As a result of severe losses in recent years, Irish banks have accumulated a substantial stock of DTAs, the value of which depends on the banks’ future profits. These assets will need to be gradually deducted in the calculation of regulatory capital under current rules. BOI and AIB had accumulated a stock of over EUR 4.4 billion of DTAs by the end of June 2016, representing over 20 % of their own funds. The high forbearance levels in Ireland are partly a reflection of the arrears restructuring process. According to the CBI, the average NPL ratio of the domestic Irish banks was 14.2 % as of September 2016. This is lower than its peak level of 27.1 % at the end of December 2013 but remains substantially above the EU average of 5.4 % ( ). Forbearance levels in Ireland remain comparatively high (Graph 4.2.2). The large volume of restructured accounts also explains part of this differential, given the significant lag between the conclusion of a restructuring solution and the reclassification of the loan as performing. Graph 4.2.2:Forbearance levels — a euro area comparison Source: ECB Although NPL ratios have declined, the substantial share of longterm mortgage arrears requires continued monitoring. Thanks to increasing asset prices and the loan restructuring solutions offered to customers, significant progress has been made in reducing mortgage arrears, although pace of improvement is slowing down (Graph 4.2.3). At the end of September 2016, about 14 % of the total balance of mortgages was in arrears at least for 90 days — down from a high of about 20 % at the end of September 2013. As of September 2016, around 70 % of all mortgage arrears are past due for more than two years, primarily due to the limited success that the lenders have had in restructuring these loans. This issue requires close monitoring, especially since loans that remain in arrears for longer periods tend to carry higher risks and greater expected losses. The key difficulties in accessing collateral are lengthy repossession procedures and the infrequent use of out-of-court arrangements, insolvency and bankruptcy. A large number of mortgage arrears cases are still at some stage of the legal process, due to repetitive adjournments. Late repossessions can result in higher collateral valuations, given the recovery of the property market. However, they are also holding up a significant portion of the property market in a context of insufficient supply (Section 4.4.2). Difficulties in collateral access can also deter potential new market entrants and investors. Formal repossession processes are still preferred to outofcourt arrangements between banks and borrowers. A substantial use of bankruptcy and personal insolvency arrangements is yet to happen. Graph 4.2.3:Evolution of mortgage loans in arrears Source: Central Bank of Ireland (CBI)

Corporate and commercial real estate (CRE) loans remain heavily impaired and are either being restructured or sold away. Approximately 25 % of these loans continue to be nonperforming. Their restructuring is usually more complex and takes more time than mortgage restructuring. Sales of the portfolios of CRE still owned by banks could be affected by the changes announced to the tax regime applicable to Irish real estate funds, which could make investment in Irish CRE assets less attractive. The National Asset Management Agency (NAMA) continues with the successful sales of its assets. This process has recently been clouded by allegations of wrongdoings during the sale of one of its portfolios. By October 2016, NAMA had redeemed EUR 26.6 billion or 88 % of its senior debt. A wellfunctioning central credit register is a crucial element for ensuring prudent future lending standards. After several delays, the central register will begin collecting lenders’ submissions on consumer lending in mid2017. It will cover all types of lending only in mid2018. Banks are expected to carefully balance the push to boost credit volumes with maintaining prudent lending standards. The legislative proposal enabling the Central Bank of Ireland to cap interest rates on variable rate mortgages, if enacted, could challenge the sustainability of bank lending in Ireland. Such measures could act as a deterrent to new entrants to the market and to lending overall. The Central Bank concluded its review of existing national macroprudential measures, and broadly left them in place. Crucially, as it is a main affordability metric, the loantoincome (LTI) ratio was maintained at 3.5 %. The loantovalue (LTV) limits were altered, but not substantially. A new helptobuy tax rebate also reduces the stringency of the loantovalue ratio — thought the availability of the rebate is restricted by its eligibility requirements. Negative net lending and growing deposit trends are unchanged but the outlook is more positive. Net lending for both households and firms is still negative (Graph 4.2.4). However, mortgage approvals and drawdowns are increasing, with the share of fixed rate mortgages growing as banks expand their product range. New credit for nonfinancial SMEs is also on the rebound, with an increase of almost 30 % in June 2016 compared to the same period a year earlier. Interest rates on loans have declined, but remain higher than the euro area average. The increase in new credit to SMEs has occurred on the back of a reduction in average interest rates of 60 basis points over the year (Section 4.2.4). Similarly, the interest rates for mortgages have declined by about 10 basis points (to 3 %) and 20 basis points (to 3.5 %) for variable and fixedrate mortgages respectively — but remained almost twice as high as the euro area average. This reflects legacy issues whereby new lending has to cover up for the lowyielding existing loan book. The small number of bank lenders in the market is not conducive to bringing rates down either. Graph 4.2.4:Net lending volumes and yearly growth rates Source: CBI 4.2.2.External sustainability* The risks to the external sustainability of domestic sectors seem to be contained. Official statistics recorded a very large level shift that led to a substantial deterioration in the net international investment position (IIP) in 2015. However, the analysis below presents evidence that this was primarily due to transactions by a small number of very large multinational enterprises (MNEs), probably arising from optimisation of their operations across their global value chains. The associated financial flows and positions altered neither the productive capacity nor the external liabilities of underlying domestic economic sectors. As such, they have limited implications for the domestic economy and do not increase the risk of Ireland’s external position becoming unsustainable ( ). Ireland’s headline external accounts indicators should be interpreted with caution. An accurate assessment of the external sustainability of the Irish economy requires a detailed examination of several factors that affect but do not directly explain the IIP of the Irish domestic economy ( ). These include the International Financial Services Centre (IFSC) and the largescale operations of MNEs — including redomiciled public limeted companies (PLCs) ( ), aircraft leasing and contract manufacturing (European Commission, 2016c, p. 29). The international orientation of these sectors means that investment in Ireland is heavily influenced by global value chains and the interplay between tax regimes and tax treaties. Graph 4.2.5:International investment position by asset type (IFSC and nonIFSC) Source: CSO The IFSC has very large gross positions but its net position is far smaller. The IFSC is a hub for international financial transactions, which have little connection to the financing of the domestic economy. If the IFSC is included, Ireland’s gross IIP assets and liabilities both exceeded EUR 4 trillion in Q32016 (Graph 4.2.5). When the IFSC is excluded, the gross positions held in Ireland are far smaller (Graph 4.2.6). Nevertheless, they remain large compared to nominal GDP of EUR 256 billion in 2015. The total net IIP was 177 % of GDP (EUR 465 billion) in Q32016. Of this total net IIP, approximately EUR 120 billion was attributable to the IFSC. As the IFSC gross positions largely cancel each other out, the majority of the negative net IIP is attributable to the other international factors mentioned, combined with the domestic sectors of the economy (EUR 345 billion). Graph 4.2.6:International investment position by asset type — excluding IFSC Source: CSO In so far as they are observable, the benign trends in the net IIP of the domestic sectors appear to have continued in 2016. The net IIP of the Central Bank turned positive in late 2015 while the net IIP for non-IFSC banks turned positive in 2016 (Graph 4.2.7). After reaching levels in excess of EUR −100 billion during the financial crisis, the CBI had a small positive (EUR 7.6 billion) net IIP (and Eurosystem Target II payment balance) in Q32016. This is explained by the restoration of domestic banks’ access to market funding. Domestic banks’ net IIP also turned slightly positive (EUR 3.8 billion), partly reflecting the switch to domestic deposits from international wholesale funding and the deleveraging process. Other financial intermediaries had a large positive net IIP of EUR 176 billion, partly due to the overseas investments of insurers and pension funds. The net IIP of the general government sector (EUR −129 billion) deteriorated since the ECB Outright Monetary Transactions announcement but this may partially reflect improved international investor appetite for Irish sovereign debt ( ). These positive developments are dwarfed by the net IIP of EUR −404 billion of nonfinancial corporations, a category that is heavily dominated by MNEs. Moreover, it represents a large increase from the EUR −190 billion net IIP recorded in Q42014. Graph 4.2.7:International investment position by institutional sector, nonIFSC Source: CSO Revisions to the 2015 balance of payments led to a very large deterioration in Ireland’s net IIP. The revisions to national accounts data announced by the CSO in July 2016 were accompanied by large revisions to the balance of payments and IIP. These comprised of a large level shift in the negative net IIP to a peak of EUR −410 billion in Q12015, compared to the previous estimate of EUR −51 billion (both exclude the IFSC). Between 2014 and 2015, the net IIP deteriorated by about EUR 300 billion which is comparable in scale to the increase in the total capital stock of approximately EUR 255 billion recorded in the national accounts. Much of the changes to the net IIP were recorded as large negative volume changes as the change in stocks greatly exceeded the flows in 2015 ( ). The increases in liabilities were concentrated in the foreign direct investment (FDI) equity, other capital (which includes intercompany loans) and portfolio investment (see also section 4.2.3). The behaviour of MNEs partly reflects the optimisation of their operations across their global value chains. Notably, this includes international corporate tax considerations. In this context, the geographic distribution of FDI liabilities becomes informative (Graph 4.2.8). On an ‘immediate owner basis’ ( ), offshore financial centres account for approximately EUR 100 billion of FDI liabilities. In addition to these centres, the US, Luxembourg and the Netherlands also appear to be substantial direct investors in Ireland, on an ‘immediate owner basis’. Furthermore, on an ‘ultimate ownership basis’, the vast majority of direct investment liabilities are attributable to the US. Graph 4.2.8:Geographic distribution of FDI liabilities, immediate and ultimate ownership (2015) Source: CSO

Graph 4.2.9:Direct investment abroad end year position by prior domicile location Source: CSO Ireland’s current account surplus is overstated due to a number of factors. The headline data presented in Graph 4.2.10 record a very large surplus in merchandise trade. However, much of the exports, including the very large upsurge in Q12015, were driven by contract manufacturing activities (Section 1). A more accurate reflection of Ireland’s merchandise exports can be obtained by looking at alternative data sources (Graph 1.6). This phenomenon also contributed to the services trade and primary income deficits. Notably, imports of research and development business services have tended to increase rapidly in recent quarters, and combined with royalties and licenses, accounted for approximately 56 % of total services imports in Q32016. In contrast, the IFSC continued to record a large services export surplus, which stood at over EUR 16 billion in the year to Q32016. Regarding primary income, it should be noted that the sharp increase in profit outflows observed in 2015 is due to companies other than redomiciled PLCs. The latter recorded large, albeit declining, net primary income flows that inflated Ireland’s current account balance by EUR 4.8 billion in 2015. However, the precise value of the underlying current account balance of domestic sectors remains unobservable. Direct investment income outflows also highlight the use of offshore centres by MNEs operating in Ireland. Closer examination of income outflows from foreignowned direct investment enterprises shows that they increased by EUR 44 billion in 2014, to just under EUR 60 billion in 2015. It also highlights the very large profits generated by some MNEs operating in Ireland. A large proportion of profits, EUR 25 billion, were directed to offshore centres, compared to EUR 22 billion to other euro area countries. Graph 4.2.10:Current account balance, net components Source: CSO Intrafirm trade data highlight the dominant role of MNEs in Ireland’s exports and imports. Intrafirm trade in Ireland accounts for 30 % of exports and 25 % of imports (Stehrer, R. 2016). The US accounts for about 70 % of the total number of intrafirm flows and 72 % of the total number of import flows, which can be explained by the large number of US multinationals located in Ireland. Germany and the UK are the next most important intrafirm trading partners. The top 10 products traded intrafirm are predominantly chemicals and pharmaceuticals, medical devices and electronics, reflecting the specialisation of multinational enterprises located in Ireland. In conclusion, much of Ireland’s external liabilities are not attributable to domestic sectors of the economy. The above evidence indicates that a substantial portion of Ireland’s external liabilities are attributable to entities whose ultimate domicile lies abroad. The many MNEs that have significant economic activities in Ireland can be broadly characterised as follows: They are highly profitable, have a large share of liabilities in the form of direct investment, and have offsetting overseas assets, while their debt liabilities are not owed to Irish investors. These factors limit the risks to the domestic Irish economy. In other cases, although the ultimate domicile is legally in Ireland, the MNEs involved have only limited connections to the domestic economy. This means that much of recorded financial inflows do not contribute to the productive capacity of the economy, but are instead a reflection of the tax optimisation strategies of large US corporations. However, precisely because of the absence of links to the domestic economy, they do not increase the risks to Ireland’s external sustainability. 4.2.3.Private indebtedness* The private debttoGDP ratio decreased since a surge in 2015, but remains high. This surge in GDP reflects the growth in value added booked by multinationals in Ireland (Section 1). At the same time, the transfer of large balance sheets into Ireland also resulted in large increases to the overall stock of private debt attributed to the country. Nonfinancial private sector debt stood at 310.1 % of GDP in March 2016. Deleveraging had followed a rather linear trend since early 2012 but, in late 2014, the debt stock surged by an amount equivalent to the size of the country’s GDP (Graph 4.2.11). Over the course of 2015, the debttoGDP ratio reduced substantially again but this reduction was primarily explained by the surge in GDP rather than the debt stock levels. Graph 4.2.11:(Nonconsolidated) private sector debt to GDP Source: European Commission Households keep deleveraging, but less strongly, as new credit demand reemerges. The stock of Irish household debt decreased to 56.7 % of GDP at the end of March 2016, from a high of 125.2 % at the end of September 2009. Expressed as a percentage of disposable income, Irish household debt has fallen to 144.8 % in Q3-2016, down from 225 % in 2008, as the strong recovery in GDP has not been matched by an equal increase in household disposable income ( ).However, deleveraging slowed down in 2016, as new lending for consumer and house purchases started to pick up. The improvement in household finances is supported by recovering asset values. Housing and financial assets held by Irish households keep increasing in value (Graph 4.2.12). The recovery of house prices helps mortgage holders, as it increases the value of the equity they hold. Approximately 15 % of mortgages remained in negative equity at the end of 2015, compared to 20 % a year earlier. CBI statistics indicate a concentration of debt in loans overdue for over two years (Section 4.2.1), making their restructuring efforts crucial for resolving the debt burden of households. Graph 4.2.12:Financial assets held by Irish households Source: European Commission The debt levels of nonfinancial corporations are heavily affected by the presence of multinationals. Only one third of total debt of these corporations can be attributed to indigenous firms an amount equivalent to approximately 62 % of GDP in 2014 (Graph 4.2.13). These are firms that are not foreignparent owned or redomiciled from abroad (CSO, 2015). However, even when discounting for that, the Irish private sector remains highly leveraged in comparison to the euro area average. Isolating the effect of multinationals on corporate debt is crucial because they do not rely on the domestic banks. In the aftermath of the 20082010 crises, domestic banks had limited access to credit but this did not stop the increase in corporate indebtedness, which almost doubled from 2011 to 2015. This implies that in Ireland many nonfinancial corporations, mostly multinationals, do not rely on domestic lenders for funding but finance themselves through intragroup lending ( ) or international financial markets (Graph 4.2.14). This type of lending is less vulnerable to a worsening of domestic credit conditions. Graph 4.2.13:Total corporate loans by counterparty Source: CBI The Irish domestic corporate sector, mostly small companies, remains in strong deleveraging mode. This is evidenced by the negative net credit numbers characterising the Irish banking sector in recent years, and in line with the behaviour of Irish households which keep reducing their debt. The total stock of SME credit is falling due to continuous repayments and the sale of banks’ loan portfolios. Between early 2010 and early 2016, it fell by over 50 %. There is an increase in new lending, but it is still very small compared to the overall SME debt burden (Graph 4.2.14). Firms default less often and more firms have no debt at all. In addition to the overall fall in the stock of SME nonperforming loans (see Section 4.2.1), fewer SME loans are entering arrears and more loans are exiting arrears. Indebted firms are now better placed to service their debt. This is reflected in the decline of the median debttoturnover ratio to about 4.5 % in March 2016, down from a peak of 10 % two years previously. Most defaults still occur in the construction sector and among loans linked to both SME and personal lending, i.e. loans for house purchases or other property investment. Encouragingly, 37 % of all firms had no debt outstanding at the end of March 2016. Graph 4.2.14:SME lending – total and new Source: Central Bank of Ireland Viable firms constrained by their debt burden can only resume growth by rapid restructuring. The Central Bank of Ireland’s Regulations for firms lending to SMEs, that apply since July 2016, are an important step in ensuring adequate engagement between distressed SMEs and their lenders. Where the viability of firms depends on their debt servicing capacity, the downsizing of debt is an option that can result in a better outcome for all. For a large portion of SME debt that has ‘personal’ characteristics (see above), the restructuring approach should be similar to mortgage resolution.

4.2.4.SME access to finance Most Irish SMEs report improved turnover. According to the most recent Department of Finance SME Credit Demand Survey, 88 % of Irish SMEs reported stable or increased turnovers in the six months to the end of September 2016 ( ). The AprilSeptember 2016 Survey on Access to Finance of Enterprises (SAFE) indicates that one third of Irish firms invest in fixed capital, such as land and machinery, which is higher than the EU average of 27 %. While internal funds remain overwhelmingly the financing choice, more bank credit is being sought. Some SMEs still have debt to repay and others delay credit applications due to the uncertain market prospects. This cautiousness is one of the factors explaining the continued dominance of retained earnings as the top financing source (Graph 4.2.15). Reliance on internal funds has increased over the past year, and remains stronger than elsewhere in the EU ( ). However, the recovery in SME bank lending continues, albeit from a very low base. Most new loans are being extended to construction, agriculture and manufacturing firms. While hurdles remain, it is getting easier for firms to borrow. As the SAFE Survey reports, Irish SMEs are becoming less concerned about their ability to obtain credit, as they believe that banks are more willing to lend. Rejection rates by banks have declined and the waiting time for a credit decision has decreased. However, collateral and/or personal guarantees are still required in about 30 % of cases. The low profitability of Irish banks, legacy issues affecting the quality of their balance sheets and a concentrated lenders’ market ( ) remain the main reasons for the elevated cost of credit in Ireland (Section 4.2.1). Graph 4.2.15:Financing sources for SME fixed investment Source: CBI A pickup in the use of nonbank sources for SME credit is yet to be observed. When not relying on own funds for investment, SMEs turn to bank loans and leasing financing (Graph 4.2.15), while alternatives such as equity financing remain little used. Of the government bank financing initiatives, the Strategic Banking Corporation of Ireland (SBCI) has achieved most success, accounting for 9 % of all SME lending in the period from March to December 2015. SBCI financing is obtained through bank and nonbank lenders ( ) and has a more pronounced focus on investment, rather than working capital purposes. It translates, on average, into a 1 % decrease in the interest rate for SMEs. In December 2016 it increased its funding capacity from the original EUR 800 million to EUR 1.25 billion. Graph 4.2.16:Interest rates for SME loans Source: ECB The European Investment Fund (EIF) and the SBCI are entering new partnerships to support SMEs. In December 2016, they signed an agreement aimed at supporting Irish SMEs over the next three years to the tune of EUR 100 million in loans. The first EU programme for the Competitiveness of Enterprises and Small and Mediumsized Enterprises (COSME) agreement in Ireland will enable the SBCI to back an estimated 2 000 firms through risksharing initiatives. Moreover, to mitigate liquidity challenges facing the agricultural sector the SBCI launched a EUR 150 million lowcost agriloan scheme. This temporary scheme, designed in partnership with the Irish government, will include an SBCI credit risk guarantee and subsidy to selected financial intermediaries to enable them to offer loans at a 2.95 % interest rate to farmers ( ). 4.3. Labour market, education and social policies 4.3.1.Labour market In parallel with the labour market recovery, longterm unemployment has continued to fall but remains a challenge. As a proportion of total unemployment, it was above or close to 60 % from 2011 to early 2015, when it started to decrease but remained around 5 pps. above the EU average in Q22016 (53 % vs. 47.8 %). At the same time, verylongterm unemployment (over two years) amounted to more than 40 % of all unemployment in 2015 — one of the highest rates in the EU (Graph 4.3.1). Graph 4.3.1:Unemployment by duration Source: Eurostat, LFS The labour market continues to be characterised by large disparities between the labour market outcomes of different skill groups. The disparities between the employment rates of low, medium and highly skilled workers were among the highest in the EU in 2015 (Graph 4.3.2). These discrepancies have decreased only marginally in Ireland since 2010, compared to faster falls in some other Member States. This suggests that the labour market recovery has not yet been able to reverse the relative deterioration of labour market prospects that lowskilled workers have experienced since 2008. Nevertheless, continued employment growth, including in the construction and services sectors, is expected to contribute to reducing this gap. Ireland has, however, fewer low-skilled adults than in the EU overall. The least educated represent about 20 % of the 25-64 population in Ireland, as compared with 24 % in the EU and 27 % in the euro area. Graph 4.3.2:Relative dispersion of employment rates by education level, 2010, 2014 and 2015 Source: Update of calculations by Kiss and Vandeplas (2015). European Commission (DG EMPL) calculations based on Eurostat data Skills shortages are intensifying in several areas. While international surveys (ManpowerGroup, 2016) indicate that skills shortages are less severe in Ireland than in most other countries, they do occur in some sectors and occupations. The National Skills Bulletin 2016 (EGFSN, 2016) highlights challenges in ICT, engineering, sales, logistics, health, business and finance. This could potentially constrain growth in the future and have an impact on competitiveness. Strong growth in the construction sector has led to an emergence skills shortage in categories such as project managers, surveyors and some technical professions. An increasing number of employers report that they are experiencing issues with attracting and retaining employees. This is particularly relevant in view of the large unmet demand for housing. The rollout of JobPath Service was completed in mid-2016. Ireland has taken important steps to address the integration of the longterm unemployed (LTU) in the labour market, though an established activation model, the provision of tailored support for LTU and a strong engagement with employers. The JobPath Service forms part of the Pathways to Work ( ) strategy and is aimed at integrating the longterm unemployed into the labour market. The programme results (it is important to note that the figures are based on a small initial cohort of participants only, those who have completed their 52 week engagement period with the service, and are subject to review) have been positive so far, with fulltime jobstarts for JobPath participants reaching a rate of 22.2 %. This exceeds the target jobstart rate set out in the contract with the service providers (14.8 %) by 50 %. In October 2016, JobPath participants who were in verylongterm unemployment were 42 % more likely to obtain employment than nonparticipants. Existing schemes continue to be evaluated but the large number of initiatives makes a comprehensive assessment difficult. A major evaluation of the Intreo ‘onestopshop’ service for jobseekers, making use of counterfactual methods, is currently being carried out. This is a positive development as it will better align the available programmes with the needs and employability of participants. The responsibility for delivering training initiatives lies with a number of organisations and departments, making it difficult to arrive at an estimate of total expenditure of activation training programmes. The 2016 Country Report also highlighted concerns regarding activation and employment support programmes, including the Back to Education Allowance (ESRI, 2015a), and some of the measures taken forward by authorities to improve effectiveness. It is difficult to draw conclusions on the effectiveness of other upskilling programmes (i.e. JobBridge, Springboard and Momentum) due to the lack of formal, rigorous evaluation. Labour market integration of people with disabilities represents a challenge for Ireland. The country has the lowest employment rate of people with disabilities in the EU — only 26.5 % against an EU average of 48.5 %. The gap between the employment rate of people with and without disabilities is the second widest in the EU (37.6 pps. against an EU average of 22.9 pps.). Addressing this issue is particularly relevant due to the high prevalence of disability in jobless households (Section 4.3.2). Disability, however, appears to be less prevalent in Ireland. Most recent LFS estimates from Eurostat show that 7 % of the adult population had a disability affecting work capacity, compared with 11 % in the EU. The government has adopted a new strategy and a number of measures. The Comprehensive Employment Strategy for People with Disabilities, published in October 2015 and covering the period up to 2024, aims at increasing the employment rate of people with disabilities to 38 %. The government has already taken a number of actions such as establishing an employer helpline and doubling the quota for people with a disability working in the public sector, from 3 % to 6 %. A group has also been established to examine the financial barriers to taking up employment, such as the loss of the free travel pass associated with the receipt of disability/illness income support payments. Finally, Budget 2017 announced an additional EUR 2 million of funding to be made available in 2017 for preactivation support for people with disabilities. 4.3.2.Social policy

While absolute poverty and joblessness have been falling since the labour market recovery took effect in 2012, social transfers continue to protect the most vulnerable. The proportion of people affected by severe material deprivation continued to decrease in Ireland in 2015 and while much higher than at the onset of the crisis in 2008 it is now slightly below the EU average (Graph 4.3.3). Both the overall and child atriskofpovertyorsocialexclusion rates fell slightly in 2014 but they remain higher than the EU average. Relative poverty among children and young people increased slightly in 2015. Overall, relative poverty remains below the EU average of 17.3 % and is significantly reduced by social transfers. The atriskofpoverty rate before social transfers stood at 46.3 % but the impact of social transfers reduced this rate to 16.3 %. There is a territorial dimension to this phenomenon as consistent poverty and joblessness continues to be highest in small and mediumsized towns than in cities or rural areas (OECD, 2016). Graph 4.3.3:Main social indicators Source: Eurostat, EU-SILC Lowwork intensity for some groups persists. The proportion of people living in households with very low work intensity continues to be high. The rate, which was already high at the onset of the crisis at 13.7 % in 2008 versus an EU average of 9.2 %, fell from 21.0 % in 2014 to 19.1 % in 2015, but it remains almost double the EU average. During the recession, joblessness became more common among multiadult households with children. In 2015, 12.4 % of adults and 14.5 % of children lived in jobless households, down from peaks of 16 % and 20 %, respectively, in 2011/2012. Persistent joblessness is more common for women, older adults, those with lower levels of education, adults with a disability and in oneadult households with children. The chance of someone in a jobless household getting employment is little more than half than that of someone in a working household. The presence of children is linked with a lower chance of getting a job and a higher chance of exiting employment, mainly due to the pattern of care for women and the prevalence of inactivity as a result of caring responsibilities (Watson, Maître and Russell, 2015). The gap between people living in jobless households and the unemployment ratio is greater in Ireland than in the EU on average. This is due to the Irish economy growing faster than the EU average and, while the rate of joblessness is generally falling (Graph 4.3.4), only about one in four job entries in Ireland removes households from joblessness (O’Rorke, 2016). Graph 4.3.4:Gap between people living in jobless households and unemployment ratio Source: Eurostat The government has announced policy measures to tackle low work intensity but further details have yet to emerge. The Programme for Government (Irish Government, 2016b) outlined plans to develop a ‘Pathways to Work for Jobless Households’ strategy, expected in the first half of 2017. Similarly, Budget 2017 announced plans for a new working family payment that would be in place for the next budget round. The content and scope of these initiatives is not yet known but they are expected to combat some of the barriers faced by low work intensity households, including the need to increase work incentives in some cases. Some aspects of the tax and benefit system lead to low work incentives. In particular, the effective tax rate when taking up a job remains very high for some groups. This means that the net material gain of accepting a job offer is low. Disincentives are highest for those on low incomes with inactive partners, with or without children. Calculations suggest that only about 3 % of those in receipt of unemployment benefits would be financially worse off in the short term when taking up work (Savage et al., 2015). But for others individuals (recipients of either unemployment or welfare benefits) the financial gain can be small. The disincentives are typically caused by lost benefits while the negative impact of labour