European Commission

Directorate-General for Economic and Financial Affairs

Economic Adjustment Programme for Ireland

Winter 2012 Review

EUROPEAN ECONOMY Occasional Papers [XXX]

ACKNOWLEDGEMENTS

The report was prepared in the Directorate General for Economic and Financial Affairs under the direction of István P. Székely, Director and European Commission mission chief to Ireland, and Martin Larch, Head of Unit for Ireland.

Contributors:

Davide Lombardo, Quentin Dupriez, Gabor Koltay, Sven Langedijk, Martin Larch, Kristin Magnusson, Danila Malvolti, Jānis Malzubris, Marie Mulvihill, Nigel Nagarajan, Wolfgang Pointner, Graham Stull, Jacek Szelożyński, and Rada Tomova. Input and comments from Álvaro Benzo, Sean Berrigan, Marcin Cecot, and the financial crisis task force of the Directorate General for Competition are gratefully acknowledged.

Comments on the report would be gratefully received and should be sent, by mail or e-mail to:

Martin Larch,

European Commission,

Head of Unit responsible for Ireland, Lithuania and Poland

CHAR 15/187

B-1049 Brussels

E-mail: martin.larch@ec.europa.eu

Contents

Executive Summary 5

1. Introduction 7

2. Macro-fiscal and financial developments 7

3. Programme implementation 15

4. Macroeconomic outlook 17

5. Policy Discussions 21

5.1 Fiscal policies 21

5.2 Financial sector policies 32

5.3 Structural reforms 38

6. Financing issues 44

7. Risks 45

List of abbreviations 47

Annex 1: Debt sustainability analysis 48

Annex 2: Supplementary tables 50

Annex 3: Draft updated programme documents 57

Figures

Figure 1: Productivity, competitiveness, and rebalancing 8

Figure 2: Employment and real GDP growth 9

Figure 3: Fiscal performance in 2012 10

Figure 4: PCAR banks' funding developments 11

Figure 5: Covered bonds issued by select European banks, 2012 12

Figure 6: Evolution of key lending rates 13

Figure 7: PCAR banks' loan developments 14

Figure 8: Developments on the Irish government bond market 15

Figure 9: Labour market and contributions to potential growth 18

Figure 10: The wealth effect of the housing bust, aggregate and by cohorts 19

Figure 11: Gross value added by sector 20

Figure 12: Health spending as a proportion of national income (2010) 24

Figure 13: Total pharmaceutical expenditure per capita (2010) 25

Figure 14: Salaries of medical specialists in some EU countries 25

Figure 15: Changes in public wage bill 29

Figure 16: Reductions in gross voted expenditures, outturn vs. targets 31

Figure 17: Covered banks' funding gap 33

Figure 18: Mortgage arrears 34

Figure 19: Drivers of covered bank profitability 37

Figure 20: Actual and simulated population on live register by duration 40

Figure 21: evolution of legal services prices vs. other services 43

Figure 22: Debt-stabilising primary balance in baseline projections (% of GDP) 49

Figure 23: Government debt projections (% of GDP) 49

Tables

Table 1: Revised macroeconomic framework 21

Table 2: Fiscal adjustment commitments 2013-2015, EUR billion 27

Table 3: Financing requirements 45

Boxes

Box 1: Maximising efficiencies to achieve better health outcomes 24

Box 2: A significant unexplained wage gap between public and private sector wages? 29

Box 3: Experience with expenditure ceilings under the programme 31

Box 4: Restoring bank profitability 37

Box 5: Breaking the cycle of long-term unemployment: activation, re-skilling and job creation 40

Box 6: Increasing competition in the provision of legal services 43

Executive summary A joint EC-ECB-IMF mission visited Dublin during 16-25 October to conduct the 8th review of the EU/IMF financial assistance programme for Ireland. The mission updated the programme macroeconomic framework by revising down somewhat the forecast for real GDP growth in 2013, mostly as a reflection of the lower pace of economic activity now envisaged for Ireland's key trading partners and somewhat weaker domestic demand. Forecasts for key aggregates in nominal terms for 2013 have been kept broadly unchanged, however, reflecting higher-than-expected inflation. Unemployment is envisaged to remain broadly stable at around 14.8% in 2013, but is increasingly long-term in nature—a key policy concern. Programme implementation remains strong overall: · As regards fiscal consolidation, central government cash figures through September 2012 were better than profiled, mostly on account of over-performance in tax revenue and lower-than-profiled capital spending, but the social welfare and health budget lines recorded overruns. Despite weakening in tax revenue in the fourth quarter, the 8.6% of GDP deficit ceiling is within reach. Two pieces of legislation advancing the reform of the structural fiscal framework (one formalizing the fiscal council and enabling ratification of the fiscal compact and the other giving a legal basis to medium-term expenditure ceilings introduced last year on an administrative basis) were also published. · As regards banking supervision and financial sector reform, several pieces of legislation were introduced to the Dail by end-September as required. While their content was broadly in line with programme understanding, Commission services found that the unduly high EUR 3 million cap on eligible secured debt raises implementation risks for the new personal insolvency regime. Separately, the credit institutions resolution fund levy, which in some key respects (notably, the basis of the levy and the target size of the resolution fund) is not in line with the European Commission proposal for the EU directive establishing a framework for the recovery and resolution of credit institutions and investment firms will have to be reviewed when the EU legislation is published. An advisory service for distressed mortgage borrowers was also introduced. Banks continue to make progress towards their deleveraging targets and to advance operational restructurings, but concerns remain on the prospects for their profitability in the medium term and the scarcity of new lending to underpin economic activity. · Progress continued on: (i) reforming labour market activation policies, though the pace should be accelerated and their coverage extended to reach a greater share of long-term unemployed; (ii) putting water service provision on a sound footing, though implementation risks are important as meter installation has yet to start and the authorities are concerned that there might be resistance to introduce charges ahead of a full roll-out of meters; (iii) preparing select state assets for eventual disposal; and (iv) reforming the sectoral wage setting mechanisms (legislation for which has been passed). Policy discussions were, as usual, frank and constructive and underscored that key risks and challenges remain: · Authorities reiterated their commitment to observe the agreed fiscal consolidation path. In particular, they have committed to deal in a durable way with the spending pressures experienced in the health sector (estimated to have caused the health budget baseline to increase by EUR 700 million). The mission stressed the need to ensure that measures are durable and growth-friendly and that they minimise the burden of adjustment on the most vulnerable. The estimated 2012 outturn weakened somewhat as from October 2012 with higher expenditure overruns and somewhat lower-than-previously-expected tax revenue projections. Against this backdrop, the 2013 budget targets the agreed deficit ceiling of 7.5% of GDP in 2013 by introducing revenue and expenditure measures in the order of EUR 1.4 and 1.9 billion respectively, as well as increasing dividends from state-owned companies. The deficit target for 2013 is predicated upon a macro scenario that is slightly more optimistic than the one contemplated by the Troika. Revenue measures include the introduction of a value-based property tax, a broadening of the labour tax base, as well as increases in motor tax and excises. Expenditure savings are expected to be achieved by reducing child benefit rates, further reducing the number of public service employees, increasing student contributions and through other saving measures. The authorities also confirmed their commitment to reduce the deficit to 5.1% of GDP in 2014 and 2.9% in 2015, in line with the programme. · In the financial sector, key challenges include how to address the banks' growing arrears backlog and ensure that they can resume playing an active role in support of the recovery. While the pace of mortgage arrears' formation has decelerated in recent months, progress in dealing with long-term non-performing loans has been slow and needs to be accelerated under active supervision by the authorities. Failure to decisively act on the mortgage arrears would pose increased risks to banks' future capital positions. The mission also emphasised that, for the reformed personal insolvency regime and the mortgage arrears strategy to be effective, it is essential to remove the identified impediments to repossession of collateral as a last resort to dealing with unsustainable debts, while recognising that it is desirable to keep families in their homes wherever possible. There was broad agreement that bank profitability should be enhanced with continued progress on operational restructuring and a concerted exit from expensive liability guarantees amid growing market confidence in Irish banks. Another key policy priority is to ensure that potential obstacles to credit extension for SMEs are identified and addressed, given the importance of this sector for future job creation. · The increasingly long-term nature of unemployment is a particular source of concern. While there is scope to speed up the pace and expand the coverage of active labour market policies, the bursting of the real estate bubble has generated a structural shift in the labour market and rising skills mismatches. Averting a "lost generation" will require a convergence of efforts to improve the functioning of the labour market, re-skill the long-term unemployed, foster job creation, and ensure that an adequate incentive structure is in place to optimally benefit when economic recovery gathers pace. · As far as the sovereign funding outlook is concerned, in the course of 2013 the authorities intend to maintain a comfortable cash position covering broadly 12 months of future financing needs in preparation for the exit from the programme. Disbursement Successful completion of this review would trigger the release of EUR 0.8 billion from the EFSM/EFSF, EUR 0.9 billion from the IMF, and EUR 0.5 billion from the UK under its bilateral loan.

1. Introduction

This report covers recent macroeconomic and financial developments, programme implementation, and the main challenges ahead, as assessed by the joint EC/ECB/IMF staff mission to Dublin on 16-25 October 2012 in the context of the eighth review of the economic adjustment programme, as well as the associated policy discussions with the Irish authorities.[1]

Successful completion of this review would trigger the release of EUR 0.8 billion from the EFSM/EFSF, EUR 0.9 billion from the IMF, and EUR 0.5 billion from the UK under its bilateral loan. This would bring disbursements to EUR 56.6 billion, representing 84% of the total international assistance of EUR 67.5 billion under the programme.

2. Macro-fiscal and financial developments

Macroeconomic developments in the second quarter of 2012 were broadly in line with programme projections. There was essentially no quarter-on-quarter (q‑o-q) growth in real GDP in the three months to June in seasonally adjusted (sa) terms. Domestic demand continued to be weak, with declines both on q-o-q (sa) and annual terms in all of its components, and especially the volatile investment category. The 0.4% (q-o-q, sa) decline in private consumption represented a notable slowdown in the pace of contraction, in line with high-frequency indicators such as retail sales, which were essentially flat. Exports fell in quarterly terms, as goods exports were hit by weakening demand from trading partners as well as possible first signs of the recent strong growth of chemical exports reversing (the so-called "patent expiration cliff", Figure 1). The year‑on‑year (y-o-y) increase in export growth of 2.1% continued to be robust, especially in the services category, supported by some regaining of the competitiveness lost in the pre-crisis boom (Figure 1). Together with relatively weak imports, this led the balance of payments to record a surplus of about 8% of GDP, suggesting that Ireland is well on its way to a third year of surplus in the external accounts. The strong q-o-q increase of GNP (+4.3% , sa) was a welcome development, but mainly reflects factor inflows from Irish multinationals unrelated to the performance of the Irish economy. The net international investment position improved marginally, a reminder that the unwinding of external imbalances incurred prior to the crisis takes time. Competitiveness indicators continued to improve steadily, although not at the pace observed in the immediate wake of the crisis.

Figure 1: Productivity, competitiveness, and rebalancing

More recent high-frequency indicators have been somewhat mixed. The manufacturing and services PMI grew strongly in November and are at historically high levels, although the rates of increase slowed in manufacturing output and new orders. On the other hand, industrial production fell by almost 18% in annual terms in October after an unexpectedly large fall in September on an annual and monthly basis led by developments in the pharma-chemical sector. Early indicators of domestic demand showed a more coherent picture, with the services index expanding at an accelerating pace in annual terms in November. Although residential property prices are still down compared to last year's levels (by 8% on an annual basis as of October) there are emerging signs of stabilization, especially in urban areas, with a slowing pace of annual decline and some increase in rents.

Inflation has been moderating in recent months. With relatively strong price pressures from energy and services (especially insurance) earlier in the year and temporary VAT effects moderating, HICP inflation fell in October, bringing the annual average rate in January-October 2012 to 2.0%.

Despite a slight further deterioration of labour market conditions in the third quarter, the situation appears to have broadly stabilised. Employment fell by 0.3% on a quarterly basis (sa) in Q3, following similar declines in the first two quarters (Figure 2). The y-o-y rate of decline in employment decreased from 1.3% in Q2 to 0.2% in Q3. Declines in Q3 originated mainly from the public service, where the head count fell by 4.1% in annual terms on the back of retirements triggered by expiring favourable treatment of pensions and lay-offs of temporary Census workers.[2] Private sector employment appears to be stabilising with marginal declines in the last two quarters. Due to migration-driven decreases in the labour force, the unemployment rate was virtually unchanged at 14.8% (sa) for the third consecutive quarter in Q3 although the number of unemployed individuals fell for the first time since early 2005.

Figure 2: Growth in employment and real GDP

Source: CSO

Fiscal performance weakened in the second half of 2012. Tax revenue was better than expected in the first half of the year but underperformed later in the year and is estimated to be 0.4% of GDP below the 2012 budget plans (Figure 3). This shortfall is partly offset by higher-than-budgeted revenue from the sale of mobile telephony licences (0.2% of GDP). Spending pressures in social and health services continued into the second half of the year, on account of higher-than-budgeted unemployment numbers and continued slippages/delays in the implementation of planned health measures (these account for a large part of the health overruns—see Section 5 below and Table A1). The overruns in health and social protection (0.4% of GDP) are expected to be partly offset by capital expenditure savings (0.1% of GDP) and lower-than-planned spending by other departments (0.1% of GDP). While cash interest expenditure is expected to be lower than planned, an increase in negative interest cash-accrual adjustment implies a lower net effect on the general government balance (0.3% of GDP). Table A2 compares the expected 2012 fiscal outturn with the budget plans. The 2012 fiscal deficit outturn is estimated at 8.2% of GDP, compared to the target of 8.1% of GDP on a like-for-like basis[3].

Figure 3: Fiscal performance in 2012

Tax revenue performance against projections || Expenditure savings against plans

||

Source: 2013 Budget, Department of Finance and Commission service estimates Notes: Figures are consistent with the monthly projections published in May 2012 with corresponding adjustments for the previous months. Tax and expenditure items are adjusted for timing-related temporary factors, which in particular improved corporation tax outturn against profile in February-June and net health expenditure in July-August. Expenditure includes departments' own receipts (appropriations-in-aid), except for PRSI revenue, which is presented among tax revenue. Capital expenditure is showed separately from current departmental expenditure.

Banks continue to deleverage their balance sheets. BOI has already met its 3-year non-core asset disposal target and AIB achieved 83% of its original 3-year deleveraging target by end-October, (both banks have done so in line with PLAR-assumed discounts). PTSB's progress to date has been limited, with EUR 3.8 billion of net customer loan balance reduction and no material asset disposals completed by end-September. Following agreement with programme partners, in September the CBI informed the bank that it would await the outcome of ongoing discussions on its revised restructuring plan before it considers PTSB's future deleveraging requirements. As of end-September, total net loan balances at the covered banks[4] have decreased by almost EUR 50 billion from end-December 2010 (of which EUR 13.8 billion year to date), representing over 70% of the original 3-year programme deleveraging target.[5] An additional EUR 13.1 billion of deleveraging has been completed by IBRC over the same period. A further EUR 2 billion of asset disposals have been sale-agreed as of mid-November, and are expected to settle by year-end.

Figure 4: PCAR banks' funding developments

Deposit stock increased for fifth consecutive quarter despite recent outflows... || ...reducing reliance on central bank funding to its lowest level since programme inception.

||

Source: Department of Finance Note: Figures are consolidated and include deposit inflows/outflows for foreign subsidiaries of PCAR banks. || Source: Central Bank of Ireland, Department of Finance Notes: Data covers BOI, AIB/EBS, PTSB and IBRC; ELA is proxied by the CBI's "other assets" series through March 2012 and by "other claims on euro area credit institutions" thereafter; November data is through 7 November only.

These deleveraging efforts, continued deposit inflows and recent market issuance have contributed to a gradual decline in covered banks' reliance on central bank funding. Despite recent outflows (EUR 1.1 billion in August-September) their combined deposit stock was about EUR 11 billion higher in October than a year earlier, having recorded net inflows of EUR 14.7 billion since the third quarter of 2011. As a result, loan-to-deposit ratios at the pillar banks have steadily declined, with AIB's falling below 120% by end-October and BOI's below 130% in November. Reliance on central bank funding has reduced correspondingly, and was more than EUR 55 billion (36%) lower in early November relative to the February-2011 peak (Figure 4). In addition, in mid-November BOI issued a EUR 1 billion unguaranteed covered bond,[6] collateralised by Irish residential mortgage loans, the first such issuance since before the launch of the programme, followed by a similar issuance of EUR 500 million by AIB later in the month. The relatively competitive pricing (Figure 5) and strong (largely foreign) investor demand are important signs of improved market funding prospects for Irish banks.

Figure 5: Unguaranteed covered bonds issued by select European banks, 2012

Pricing on Irish banks' recent covered bond issues compare favourably with European peers'

Source: Bloomberg, Bond Radar Note: Spread and ratings indicated as at times of issue; all unguaranteed covered bonds issued by banks from vulnerable or programme countries through 5 December 2012 included.

Monetary conditions have broadly continued to ease. Interest rates on new loans to non-financial corporations (NFCs) have been on a declining path for the past 12 months, reflecting reductions in Euribor, as have interest rates on new mortgages. They remain volatile, however, and banks increased their variable rates by 21 bps on average in September to improve their net interest margins (Figure 6). Rates on consumer credit not related to house purchase have also been on a steady downward trend since the beginning of the year, with floating and up to one-year fixed rates lower by almost 80 basis points since January.

Figure 6: Evolution of key lending rates

New lending to NFCs, 3-months ma || New mortgages, 3-months ma

||

Sources: ECB, Central Bank of Ireland. Note: Loans up to EUR 1 million at floating rate or floating rate after a period of fixed rate for up to one year. || Sources: ECB, Central Bank of Ireland. Note: Loans for house purchase at floating rate or floating rate after a period of fixed rate for up to one year.

Yet the flow of credit to the economy remains weak. Net lending to households has continued to contract, though the flow of loans for house purchase in the third quarter of 2012—EUR 0.7 billion of new mortgages issued (drawn down)—was the largest since Q4 2010 and almost 27% more than in Q2 2012. Over 90% of these loans went to the first-time buyer and mover-purchaser segments (Figure 7). This is consistent with emerging signs of stabilisation in domestic residential property prices, although many transactions continue to be carried out in cash.[7] Net lending to NFCs also continues to decline, though this partially reflects lower demand for investment spending, the gradual shift to shorter-term facilities such as overdrafts (which continue to increase, albeit at a slower pace), and the sector's high leverage, including as a result of legacy real estate exposures. Credit to indigenous SMEs (excluding property and financial intermediation) is still contracting, though the annual rate of decline fell to 4.9% by end-September from 8.9% a year earlier. Profitability challenges and the still-sizeable funding gap might hinder banks' capacity to extend new lending, which could represent a downside risk for the recovery. Other constraints include the difficulty of disentangling viable SME activities from their legacy debts and the need for banks to enhance their capacity to assess SMEs' creditworthiness based on their cash flow rather than—as was often the case during the boom years—on their property collateral (see Section 6). Foreign-owned Irish-resident banks are also contracting their exposure to domestic agents.

Figure 7: Bank loan developments

Lending to households and NFCs continues to contract, though mortgage credit showing signs of stabilisation || First-time-buyers and mover-purchasers account for the largest share of new mortgage lending

||

Source: Central Bank of Ireland Notes: (i) Lending to NFCs includes SMEs which account for about 60%; (ii) lending to households includes mortgage, , consumer and other loans || Source: Irish Banking Federation Note: Figures relate to all new lending (flows) secured by residential property extended by IBF's members (95% of total market)

Despite recent signs of stabilisation, the increasingly long-term nature of mortgage arrears is a persistent source of concern. While arrears balances on owner-occupier mortgage accounts less than 90 days past due (dpd) contracted over the two quarters to end June 2012 (by 5.6% and 1.9% QoQ respectively), an increase was recorded in Q3 which however was reportedly due to a technical timing issue.[8] Excluding the impact of this, a decline of [1.3%] in arrears balances of less than 90 dpd is estimated for the quarter. The deceleration in the pace of formation of new arrears reflects a stabilisation in the macroeconomic environment and some initial effectiveness in covered banks' strengthened efforts to tackle arrears early on. However, arrears balances on accounts more than 180 dpd continue to increase reaching over 14% of the total stock of owner occupier and investment property mortgages at end September. This highlights the urgent need for banks to implement advanced loan modification options to their long-dated arrears' stock in earnest. Curing late arrears is of paramount importance for restoring profitability and minimising potential further loan losses.

Taking advantage of improved sentiment towards Irish bonds, the authorities have added to their cash buffers. Yields on Irish government bonds have declined steadily in recent months and markedly since the supportive statements from euro area leaders in June and July (the yield on the 2020 bond fell from 6.2% in July to 4.5% in December). While the ratings by the major credit rating agencies have remained unchanged since the downgrades at the beginning of last year, one rating agency upgraded Ireland's outlook to stable from negative in mid-November (Figure 8). After the summer issuances of short-term T-bills and long-term bonds, Ireland made two T-bill issuances in October and November, with further reductions in the yields (0.55% in November, down from 0.7% in October and 1.8% in July) and comfortable bid-to-cover ratios. The increased market appetite likely reflects the continuously strong program implementation and progress on European initiatives to strengthen the institutional architecture of EMU. These issuances enabled a significant increase in cash balances, which stood at EUR 23.4 billion at the end of September (see also Table 3 on page 45), with corresponding upwards revisions to the interest bill and gross debt.

Figure 8: Developments on the Irish government bond market

Irish bond yields have declined steadily in 2012… || …while ratings have stayed flat.

||

Source: Bloomberg, Fitch and S&P.

3. Programme implementation

Programme implementation remains strong

• Fiscal policy/framework. Cash figures through September showed a better-than-profiled central government balance (the IMF quantitative performance criterion on the cumulative primary exchequer balance for Q3 has been met by a sizeable margin, i.e. EUR 1.3 billion). Two Bills were published as per the programme requirement. The Fiscal Responsibility Act[9] places the Irish Fiscal Advisory Council on a statutory basis and implements budgetary rules and debt rule in line with the Treaty on Stability, Co-ordination and Governance in the Economic and Monetary Union, The other piece of legislation will provide legal basis for already operational medium term expenditure ceilings (Ministers and Secretaries (Amendment) Bill 2012)[10]. Health measures were specified to address the health overruns, although their implementation and effectiveness was not as anticipated (see section 5 below).

• Financial sector reforms. In recognition of the progress achieved towards the programme's deleveraging objectives discussed in section 2, the modified deleveraging monitoring framework[11] has been formally operationalised through official communications by the central bank to covered institutions, and the first report under the new monitoring arrangements was provided in accordance with programme requirements. The authorities have also provided their routine reports on banks' performance with the work-out of arrears and unsustainable mortgage and SME loans. The financial supervision framework continues to be updated. In line with programme requirements, two pieces of legislation were published to (i) strengthen the credit union legislative framework and (ii) establish a Central Credit Register. Further benchmarks were observed through the introduction of regulations to (i) require credit unions to maintain an amount in the Deposit Protection Account of the CBI and to (ii) institute a credit institution resolution levy to recoup EUR 500 million in Exchequer resources provisioned for the resolution of troubled credit unions. The latter is, in some key respects (notably, the basis of the levy and the target size of the resolution fund), not fully in line with the European Commission's proposal for the EU directive establishing a framework for the recovery and resolution of credit institutions and investment firms, and the authorities have undertaken to review it when the EU legislation is published. Individual banks' operational reorganisations also continue to progress, with an updated restructuring plan submitted by AIB's management to the European Commission for assessment under state aid rules.

• Structural reforms. Legislation reforming sectoral wage setting arrangements to increase labour market responsiveness to changing economic conditions was enacted in July, and the authorities have updated the Troika on the actions they are taking to strengthen their labour market activation policies, including in terms of data collection and provision (progress is being made, but the challenge is enormous and efforts could be stepped up accordingly, see section 7). A programme facilitating access to professional financial advisory services for distressed borrowers was put in place. Finally, progress continued in terms of bringing identified non-strategic state assets closer to the point of sale and detailing the implementation strategy for the reform of water services, although delays to the latter appear to be accumulating, especially as regards the metering programme (see section 7), and implementation risks correspondingly growing.

New conditionality milestones were agreed, and an existing financial sector benchmark was postponed by a quarter. New programme conditionality was introduced including to guide the process leading to the introduction of water charges, to monitor closely the banks' progress on resolving longer-dated arrears, to amend the Company act making for cheaper and easier debt resolution processes for SMEs, to assess the costs of health service provision in comparison with other countries, and to ensure that the new personal insolvency framework operates amid balanced incentives by restoring banks' ability to repossess their collateral as an appropriate last resort measure. Taking account of recent developments concerning the EBA stress test, now expected in the second half of 2013, and given prior understanding that the two exercises would be aligned in terms of timing, it was agreed to postpone the programme requirement to complete the next PCAR from the second to the third quarter of 2013 (see updated programme documents in Annex 3).

4. Macroeconomic outlook

The growth forecast underpinning the programme remains unchanged for 2012, albeit with a slightly different composition, but it has been revised down for 2013. The overall growth story for the coming years is unchanged, with net exports as the main driver of growth, although domestic demand is expected to be slightly weaker than previously assumed. As outlined earlier, data released since the seventh review continue to be broadly consistent with real GDP growth of 0.4% in 2012. The contributions from net exports have been revised up somewhat for 2012‑2013, however, mainly due to imports recently being weaker than expected. Private consumption has accordingly been revised down marginally for the coming years. Export projections for 2012 have been kept at previous levels despite the worsening external environment. For 2013 the downgrade of the external environment projections compared to the seventh review is expected to bring down export growth somewhat, although the resilience of exports (particularly services) in recent years will likely act as a buffer. A gradual slowdown of growth in goods exports as patents expire is built into the projections, as well as more modest growth rates of services exports than what has been observed recently. The contribution to growth from net exports is set to stay largely unchanged as further contractions are expected across all domestic demand components, which will dampen imports correspondingly. As a result, 2013 GDP growth has been revised down to 1.1% from 1.4% at the seventh review.

The outlook for nominal GDP growth in 2013 is, however, broadly unchanged. The HICP inflation forecast has been revised up to 2.0% for 2012 following relatively strong increases earlier in the year (even after taking the recent moderation into account). Inflation is expected to decline in the coming years as temporary price pressures are unwound, thus supporting continued gradual improvement in competitiveness relative to the euro area, before inching up again towards 2% by 2015 in line with expected developments in the euro area. Although recent terms-of-trade developments have partly offset the effects of higher inflation on the GDP deflator, the net effect is positive, which results in higher projected levels of nominal GDP in 2012-2013 compared to those underpinning the 7th review despite the lower real GDP growth rate in 2013.

Weak labour market developments and their knock-on effects on domestic demand are expected to weigh on real GDP growth into 2014. The anatomy of the shock to the labour market has been outlined in previous reports—massive job losses both in the construction and industrial sectors being followed by loss of services jobs (Figure 9)—but recent data again suggest that previous projections were somewhat optimistic as regards to when employment would start growing and unemployment fall substantially. As a result of weaker labour market projections, domestic demand and GDP growth for 2014 have also been reduced. Since the start of the crisis, potential growth has been driven solely by total factor productivity amid extensive labour shedding and extremely low levels of investment, in marked contrast to the prior period (Figure 9). The mission continues to believe that the Irish economy has the potential to grow around 3% per year towards the end of the projection period, although the continuous edging up of the share of long-term unemployed, the risk of cemented skills mismatches and the uncertain investment outlook are increasing threats to that assessment.

Figure 9: Labour market and contributions to potential growth

There is significant uncertainty around domestic demand projections from the private sector debt overhang and high precautionary savings, and possible profit-hoarding by some corporates. Property markets have just started to show signs of stabilisation and substantial deleveraging has so far hardly dented the elevated household debt to disposable income ratio, which at 200% is more than twice the euro area average. The link between mortgage payment discipline and labour market status is also strong according to a recent CBI survey. These are the factors underpinning the baseline scenario where balance-sheet adjustment due to the large hit to household net worth (see Figure 10) will continue to weigh on domestic demand. On the upside, positive surprises relative to the baseline could result from the unwinding of precautionary savings, which appear to be very significant at least among those cohorts (loosely, the very young and old—see Figure 10) where many households are without mortgages. Such unwinding of precautionary savings could unleash substantial pent-up demand once macroeconomic uncertainty dissipates or bequests are realized.

Figure 10: The wealth effect of the housing bust, aggregate and by cohorts

Change in net worth and non-financial assets as percent of nominal disposable income, 2007-2012 1/ || House ownership by cohort

||

1/ Last observation Q4 2010 for U.K. and U.S. Source: OECD, Goodbody. || Source: CSO

The non-financial corporate sector is not yet playing a growth-supporting role in line with its potential. Profit shares are back to pre-crisis levels and continue trending upwards, although their macroeconomic importance is difficult to assess due to transfer pricing issues by multinationals (which account for the bulk of growth in gross value added (GVA) in recent years, see Figure 11), and the partial decoupling of value added in the sector from aggregate employment and other domestic developments. Debt ratios have stabilized at twice the euro area average and investment rates continue to decline. Credit constraints, which appear to be especially binding for SMEs, are likely an important explanatory factor for the subdued credit growth, but so is the lack of confidence in future growth prospects.

Figure 11: Gross value added by sector

Source: CSO

The authorities expect somewhat stronger real GDP growth.[12] The Department of Finance is more optimistic on GDP growth than Commission services throughout the 2012-2015 period, with an annual average difference of 0.3 percentage points. This results in its projected level of nominal GDP being EUR 1.5 billion higher by 2015 despite very similar projections for the GDP deflator. The main drivers of the difference are larger contributions from domestic demand, especially through lower imports and higher investments, as well as somewhat stronger export developments. The differences on the labour market side are minor, with the Department of Finance projecting slightly stronger employment growth in 2012-2013.

Table 1: Revised macroeconomic framework

Source: Commission services' calculations.

5. Policy discussions 5.1 Fiscal policies

Putting fiscal policy gradually back on a sustainable base is a key objective of the programme. The authorities continue to make good progress in this respect, having met so far all the quarterly fiscal targets under the programme. Yet much still remains to be done—including to address new spending pressures, e.g. in the health area—to close the still large fiscal deficit, and ensure that the debt ratio peaks next year and then embarks on a declining path. The key challenges will be to ensure that the adjustment is as growth-friendly as possible and does not prejudice the quality of public services and that its burden is fairly allocated (the most vulnerable should be shielded as much as possible). The fiscal framework continues to be strengthened, and the legislation granting statutory basis to the multi-year expenditure ceilings should ensure that these act as a credible anchor for policies and expectations after the programme period.

The 2012 budget deficit ceiling is estimated to have been observed. The draft 2013 budget forecasts the deficit for 2012 at 8.2% of GDP, below the 8.6% programme ceiling. Despite weaker revenue in the fourth quarter, and expenditure overruns in health and social welfare, the programme's deficit ceiling is envisaged to be respected thanks to a one-off higher-than-budgeted revenue from UMTS licence sales, lower-than-planned debt servicing costs, savings in the capital budget and the positive effect of the higher nominal GDP base.

There have been overruns in the health sector, which require durable reforms to reduce the risks of future spending pressures in this area. In July the authorities announced a set of measures to offset the health overruns. They committed to deliver at least part of the savings for items planned in the 2012 budget and to take additional structural measures addressing spending pressures (see report on seventhh review). Discussions during the mission evidenced that those commitments have been only partly implemented, resulting in an estimated overrun of EUR 370 million through November 2012. Combined with additional spending pressures by year-end and the unwinding of temporary measures next year, the structural gap in the health vote is about EUR 700 million (see Table A1 in Annex 2).

To deal with this problem, the authorities presented a package of measures in the 2013 budget. The total effort addressing the 2012 overrun and ensuring the planned adjustment in 2013 amounts to EUR 780 million. The package includes already announced and new measures. The former include the October 2012 deal with the pharmaceutical industry (expected to yield savings of about EUR 145 million), further exploiting the scope for flexibility arrangements under the Croke Park Agreement and additional pay savings (EUR 308 million), and charging all private patients in public hospitals (EUR 65 million). The new structural measures under the Primary Care Reimbursement Service (PCRS) (EUR 163 million) include reducing fees payable to health professionals (EUR 70 million), tightening eligibility criteria and greater co-payments[13] (estimated to generate savings of EUR 90 million).

The mission stressed that the chosen measures must be swiftly and fully implemented in order to meet the estimated saving targets. Based on 2012 budget experience, the identified measures are subject to significant implementation risks mainly related to the delays in publishing the necessary legislation. This is the case, for example, for the provisions to charge all private patients in public hospitals, which is to be adopted by end 2012 and for which a clear implementation timeline is not yet available. The authorities have also begun an engagement with unions representing public servants, including health sector workers, to seek additional savings from the public service pay and pensions bill, along with additional productivity reforms (including in terms of hours worked). The mission took the view that all options should be kept on the table and that additional savings in the public sector paybill should be made in a manner that does not compromise the delivery of key public services, including the option to review pay scales and allowances besides relying on further reductions in payroll numbers.

Moreover, the mission pointed out that significant scope remains to increase the efficiency, cost-effectiveness, monitorability and sustainability of the health system, including by implementing key reforms announced in the 2012 annual output statement for health expenditures. These include, for example, the introduction of a unique patient identifier, the enhancement of primary care reimbursement services, the expansion of general practitioners' (GPs) after-hours services, fuller cost recovery of the costs of treating private patients in public hospitals, and the introduction of a financing mechanism based on the "money-follows-the-patient (MFTP)" principle to foster integrated health care, better cater health service provision to individual needs, increase transparency and improve cost control. The rationalisation of the hospital network can be speeded up and the drugs bill reduced further (Ireland currently spends 34% more in per capita terms than the EU average – Figure 12 in Box 1), including by promoting greater use of generic drugs and ensuring that they are procured at prices more in line with other jurisdictions, and further advancing towards performance budgeting and its integration with budget planning procedures. A key enabler of cost reduction would be a system of compulsory prescription by active ingredients and generic substitution from pharmacies, combined with regular monitoring of doctors' prescription behaviour to check their compliance with binding prescription guidelines. To ensure that outpatient pharmaceutical spending does not exceed the available annual financial envelope in the budget, the government could also consider putting in place a claw-back mechanism (i.e. a rebate to be charged on pharmaceutical companies on a quarterly basis), in line with practice in other Member States. A cost allocation formula/mechanism should be set up to ensure full recovery, from specialists and insurance companies, of the costs to the State arising from private fee-for-service practices carried out in public hospitals. Finally, the Government could review the fees and salaries paid to medical professionals (see Figure 14 in Box 1), increase co-payments for products and services, and tackle the unsustainable growth in medical cards, including through greater use of GP Visit Cards to substitute for more expensive medical cards.

Box 1: Maximising efficiencies to achieve better health outcomes Improving value for money is key While most indicators show Ireland close to average in terms of health outcomes, health spending, especially on a per capita basis, is relatively high, suggesting poor value for money (Figure 12). In the period 1997 – 2007, per capita increases in healthcare spending in Ireland outpaced almost all other OECD countries. In a 2010 report, the OECD found that Ireland had the greatest potential for efficiency savings in public healthcare spending, and that the potential gains in life expectancy which could result were the second highest in the OECD. Figure 12: Health spending as a proportion of national income (2010) As discussed in Section 5, the immediate focus for health policy is on achieving budgetary targets. But many of the factors behind the overruns (e.g., staffing costs, drugs spending) are also linked in the medium term to improving efficiencies. Raising the efficiency of spending towards EU benchmarks should allow for improving outcomes for patients over time while containing the level of spending. Better measurement is a first step A key first step is to put in place better measurement systems that are a) monitorable, b) internationally comparable and c) patient-focused. Within this context, the pilot Government-level performance measurement system under the Public Service Reform Plan (linking Government's high-level goals to outcomes and outputs) could be expanded to include Health, as originally planned. More could be done on the cost of Pharmaceuticals While all EU countries have seen substantial increases in drugs costs since the turn of the century, Ireland's increases have been among the sharpest, nearly tripling from 2000 to 2008 (Figure 13). In 2010, per capita spending on pharmaceuticals in Ireland was the highest in the EU, 34% above the average, while health outcomes are not better than the average for EU countries over a range of high-level indicators. This suggests a potential for savings well beyond the measures already announced. High drug prices is an important factor. In particular in the area of generics, prices of the same drugs vary considerably across EU Member States, and with the patents on many branded drugs approaching expiration (the so-called 'patent cliff'), renewed attention could be paid to maximising the benefits of lower cost generics. Cost savings from generics are greatest when the uptake follows quickly from patent expiry. Important savings could be achieved with a reform of the external reference pricing mechanism. At present, Ireland sets prices for drugs based on an average of a basket of reference countries. Significant gains could be made by: (i) expanding the set of countries in the reference list and (ii) moving benchmarks from the average to the lowest prices among reference countries. On the demand side, prescription by active ingredient rather than by name of drug (with exceptions allowed only for "non-substitutability" cases to be rigorously motivated by the prescribing doctor), electronic monitoring and financial incentives could be employed to ensure prescribers are seeking the most cost effective alternatives. Provisions to these effects would significantly increase the efficiency-enhancing effects of the (Pricing and Supply of Medical Goods) Bill 2012. The switch to prescription on the basis of International Nonproprietary Name (INN), where possible, will facilitate compliance with the forthcoming Implementing Directive designed to help recognition of prescriptions issued in another member state, which all Member States must transpose by 25 October 2013. Figure 13: Total pharmaceutical expenditure per capita (2010) Remuneration of medical staff should also be reviewed The high level of remuneration of doctors, in particular specialists, is another feature of Irish health spending which may warrant attention. OECD data show that Ireland's remuneration to medical specialists is well above the EU average (although some caution is required in making cross-country comparisons). Figure 14: Salaries of medical specialists in some EU countries As a ratio of average wage In EUR thousands Source: OECD Health Data 2012. Data are for 2010 except Estonia, Italy, UK and Ireland (2011); Germany (2012); Luxembourg (2005); Netherlands and France (2009); Portugal (2005). Source: For Germany, average of three increments for 2012, Grade Ä 4 (Western Germany only); for all other countries: OECD Health Data 2012. Data are for 2010 except Estonia, Italy, UK and Ireland (2011); Germany (2012); Luxembourg (2005); Netherlands and France (2009); Portugal (2005). The authorities indicated that negotiations between the Department of Health / HSE and Hospital Consultants to achieve more efficiency from existing contractual arrangements have been recently completed and that the pay rate for newly appointed specialists will be cut by 30%. A comprehensive review of the market for medical staff could be considered, however, a some of the problem may lie in the low number of specialists as a proportion of all doctors. There may be value in strategies to further open the supply of labour to suitably qualified specialists from other countries. For instance, from 2007 to 2011, Ireland recognised 151 intra-EU qualifications for doctors (per million inhabitants); for the UK it was 205 per million inhabitants. For doctors wishing to set up practice in Ireland, such recognition is a precondition. Outside the EU, even more potential exists to open labour supply; however, it is important that Ireland observes standards from the WHO's ethical recruitment code when pursuing recruitment from developing countries.

The 2013 budget targets a deficit of 7.5% of GDP – in line with the programme's deficit ceiling. While the previously announced aggregate consolidation commitment of EUR 3.5 billion in 2013 has not changed,its composition has shifted slightly more to revenue measures compared to the MTFS projections[14]: EUR 1.9 billion in expenditure and EUR 1.4 billion in revenue measures, as well as increased dividends from state-owned companies of EUR 0.1 billion. Earlier introduction of the property tax in mid-2013 has some effect on the split between new revenue measures and carry-overs. The valuation-based property tax is expected to yield EUR 250 million in 2013, when it will be assessed only on a half-year basis, and EUR 500 million on a full year basis. Additional revenue on accrual basis is expected from the property tax deferral option for asset-rich but income-poor households.[15] Other major revenue measures include the broadening of the base for social contributions (PRSI, yielding EUR 286 million), and increases in excise duties on alcohol and tobacco (EUR 205 million), as well as in the motor and vehicle registration tax (EUR 150 million).

The expenditure plans for 2013 are broadly consistent with an expenditure ceiling of EUR 54.3 billion. The reduction of EUR 1.7 billion in the gross voted current and capital expenditure from the 2012 level reflects expenditure saving measures of EUR 1.9 billion in an environment of increasing demand for social services, including unemployment benefits, education and health care. Current expenditure adjustment amounts to EUR 1.4 billion and capital to EUR 0.5 billion. The current expenditure measures include cuts in child benefit rates (EUR 136 million), further reduction in the public service paybill, including through reductions in the number of public sector employees (EUR 220 million), increase in student contributions, many smaller savings across the government departments, and measures to contain health-care costs (see above).

The authorities have also reiterated their commitment to bringing the government deficit below 3% of GDP by 2015. The adjustment effort for 2014-15 remains largely unchanged, as well as previously outlined broad consolidation measures, yet details on specific measures are not available. On the basis of the Commission services' lower macroeconomic projections, the planned adjustment effort over the forecast period may not be sufficient to reach the deficit targets. A new Comprehensive Expenditure Review will start in 2013 providing options for further fiscal adjustment in 2014-15 and reassessing government spending priorities.

Table 2: Fiscal adjustment commitments 2013-2015, EUR billion

Source: Budget 2013 and MTFS.

Public service reforms are ongoing. The implementation of the Public Service (Croke Park) Agreement 2010-2014 is progressing. According to the Implementation Body's Second Annual Progress Report, a substantial reduction in staff numbers (around 11,530) took place during the review period (April 2011‑March 2012). As of mid-2012, public service numbers were 292,000, i.e. 28,000 below the peak of 320,000 in 2008 and comparable to 2005 levels. The Exchequer pay bill has been reduced by 17.7% in nominal terms between 2009 and 2012 (18.7% in real terms), from EUR 17.5 billion (gross) to EUR 14.4 billion (net of the pension-related deduction), while the Exchequer pension bill has increased by 15.4% from EUR 2.6 billion (gross) to EUR 3 billion (gross).[16] The Implementation Body estimated that, during the first two years of the agreement, pay and non-pay savings of EUR 810 million and EUR 678 million were achieved, respectively. Over the period 2009-2015, the annual Exchequer pay bill is expected to fall by EUR 3.8 billion, or by EUR 3.3 billion net of expected increases in public service pension costs. The mission stressed once again the need to closely monitor the implementation of the agreement in order to ensure that the desired savings are achieved, and that all options should be kept on the table to ensure that the delivery of essential public services is not compromised. Furthermore, the mission reiterated that reductions in allowances and salary scales for some categories of workers could be considered as a way to better align pay rates with those other countries. This would also allow further savings in the pay bill to be made without compromising the delivery of essential public services. This is especially the case in the health sector where, as underlined by a recent WHO report,[17] substantial additional savings through efficiency gains cannot be made within the required timeframe without damaging patient care[18] unless high salaries and the high price of other inputs are seriously addressed.

The authorities have announced just before the eighth review mission a targeted voluntary redundancy scheme which they consider would facilitate meeting the 2015 target for public service staff numbers of 282,500 by 2014. The scheme would be made available for yet-to-be-identified public service areas with staff surpluses. The terms of the scheme are as offered to HSE employees in 2010, namely a statutory payment (2 weeks per year of service, with the per-week payment capped at EUR 600, plus an additional EUR 600) and an incentive payment (3 weeks per year of service), subject to an overall cap of two yearly salaries. The authorities argue that it would allow a substantial structural improvement in the deficit, in terms of payroll and pension savings, and that it will pay for itself in 3 years. Their stated objective would be to secure long-term structural adjustments by targeting groups of employees for whom they believe redeployment and training would not be cost-effective.

The mission considers that the scheme is costly and that using in full the scope for redeployment and retraining under the Croke Park agreement would allow a more efficient use of human and financial resources, especially as the scheme's intended target group of employees has considerable remaining working life. In addition, there is a real risk that the scheme fails to reach the intended target, as employees that have few outside options choose not to separate. Moreover, while the scheme would generate savings in the longer term (as less pension rights would be accrued), it is likely to imply additional cost pressures for the welfare budget in the near term. Finally, the extent to which the scheme would be compatible with protecting service delivery or would require outsourcing of activities is unclear, casting doubts on the sustainability of the estimated savings.

Full implementation of pension reform is a crucial component of long-term sustainability of public finance. The Public Service Pensions (Single Scheme and other provisions) Act 2012 came into effect on 28 July 2012. The Act caps, for existing members as of 1 November 2012, pension accrual at 40 years, abates the pensions of public service pensioners who re-enter the public service, and allows for money to be recovered from pension payments in certain cases of financial misconduct. Yet important provisions for new entrants, such as the increase in the pension age and the calculation of the pension on average lifetime income, have yet to be put in place, pending a commencement order to be signed by the Minister of Public Expenditure and Reform. Delays in the commencement of the scheme imply a permanent reduction in the structural savings in terms of pension liabilities. The mission sought an update on the process and the authorities confirmed that the bill should be fully commenced by 1 January 2013.

Box 2: A significant unexplained wage gap between public and private sector wages? Ireland' public service pay and pension bill grew sharply in the pre-crisis years through a combination of pay rises and increases in public service employment (Figure 15). The authorities cut public sector wages between 5% and 15% effective 1 January 2010 and introduced a pension-related deduction in 2009, with rates ranging from 0% to 10.5% depending on the income bracket. This resulted in a fall in average annual (gross) earnings in the public service by 7.5% between 2009 and 2010 (in the same period, the fall for private sector workers amounted to 4.5%). Since then, in line with the Croke Park agreement, there have been no further reductions in pay rates. Figure 15: Changes in public wage bill However, a recent study by the Central Statistics Office (CSO)[19] has found that a sizeable positive gap remains between public and private sector wages that cannot be explained by worker or workplace characteristics. The analysis takes account of educational attainment, gender, full-time status, total length in employment and supervisory status. Although the study does estimations for wages both with and without employer size taken into account, the CSO did not control for specific occupations/job types across the two sectors. The study covers 2009 and 2010 (i.e. the year of the wage cut), although 2010 data could only be derived from the 2009 National Employment Survey by using data on net incomes from the Revenue Commissioner. The pension-related deduction of 2009 is also excluded from the analysis, which applies to gross earnings. In spite of the academic debate surrounding the methodology,[20] the CSO analysis points out that a significant unexplained wage differential in favour of public sector workers persists, even following the pay cuts of 2010.[21] The analysis shows that the unexplained wage gap for permanent full-time employees (aged 25-59) was around 14-17% in 2010, down from 18-20% in 2007, if employer size is not factored in. Including size, with the caveat highlighted above, reduces the gap to around 7-8% in 2010, down from 12-14% in 2007. Further analysis indicates that the unexplained wage gap is highest at the low-income end of the distribution, and gradually falls to nil or negative (depending on whether size is included as a control variable) around the 80th or 95th percentile in 2010. In 2009, the gap remained positive throughout the income distribution.

The mission also discussed ongoing reforms of the public expenditure framework. As mentioned above, two Bills were published in the third quarter of 2012 to establish the Irish Fiscal Advisory Council as an independent body on a statutory basis and define its mandate and responsibilities, as well as enshrine its independence, and to provide a statutory basis to the existing multi-annual expenditure ceilings. As regards the latter, the Commission's services are engaging with the authorities to ensure that elements of the multi-annual budgetary framework are adequately binding and transparent so as to constitute a credible policy anchor in the post-programme period. While three-year rolling expenditure ceilings are envisaged under the domestic budgetary framework, the government has not committed to the expenditure ceilings for 2015 in the current budget, before the Comprehensive Expenditure Review in 2013.

Further improvements are necessary to the legislation on expenditure ceilings to ensure that the framework constitutes a credible anchor for fiscal policy (Box 3). Based also on the results of a comprehensive review of the national fiscal frameworks of all EU Member States carried out under the auspices of the Economic Policy Committee (EPC) during 2011-2012, Commission services and ECB pointed out that the current draft does not sufficiently narrow down the conditions under which the Government may evoke an escape clause and thus be allowed to diverge from expenditure ceilings. Rather, the Government enjoys significant latitude to increase the ceilings without adequate accountability, as it only requires a proposal of the Minister for Finance. Moreover, the current draft does not provide sufficient assurances that the current and capital expenditure ceilings are met in practice, since the Minister for Finance may only make recommendations to the competent Ministers but is not actually empowered to impose binding ceilings. The mission also noted that the de-facto current fiscal rule requiring local governments to have a balanced budget in the aggregate could be firmed through a binding act (e.g. a memorandum of understanding) ensuring that local authorities' contribution to general government will be held to zero as a rule as of 2013.

The provision of fiscal data has been improved, and efforts in this area continue. The CSO will be in charge of the EDP reporting as of March 2013 and will publish a quarterly government finance statistics publications from April 2013. To ensure more reliable and transparent public finance data, the authorities are working on a memorandum of understanding on data exchange between the competent authorities. The authorities published for the first time, at the end of September, an alternative presentation of the Exchequer Returns, which enhances budgetary reporting and transparency by showing voted expenditure (current and capital, including spending from departments, the Social Insurance Fund, and the National Training Fund) and all revenue (current and capital, including separately the monthly outturn for Appropriations-in–Aid) on a gross basis. Further efforts have to be made to complete the new format by reporting on all major Exchequer items, as compared to monthly targets. This will be an important step to further increase the credibility of the budgetary framework and will facilitate access to and understanding of the fiscal data for prospective investors and the public at large, especially after the end of the programme.

Box 3: Experience with expenditure ceilings under the programme The programme, which was largely based on the Irish authorities' 2010 National Recovery Plan, targeted a very significant reduction in nominal expenditure relative to their 2010 level as a key component of the necessary fiscal consolidation. This was underpinned by the multi-annual expenditure ceilings for gross voted expenditure introduced on administrative basis.[22] Much has been achieved in this respect, with 2012 gross voted current expenditure expected to be 4% lower than in 2010 (Figure 16). Alongside these significant cuts, a closer look reveals gradual slippages with respect to original annual targets on account of (i) changed macroeconomic conditions (e.g., greater number of people on the live register) and (ii) policy implementation (e.g., delayed/failed implementation of planned measures in health area). Figure 16: Reductions in gross voted expenditures, outturn vs. targets While the expenditure slippages vis-à-vis original targets have not impeded the achievement of the programme targets and, thus, the establishment of a track record of good policy implementation under the programme as regards the general budget balance to GDP ratio, they shift the burden of the remaining expenditure adjustment up to 2015 as the ceilings for 2015 have actually been tightened compared to 2010. It is important to ensure that the on-going reforms of the multi-annual expenditure framework result in more binding and specific rules for expenditure ceilings, so that they can act as a credible policy anchor especially for the post-programme period.

5.2 Financial sector policies

Important progress has been achieved across the three main components of financial sector reform under the programme: banks are well-capitalised, system deleveraging is ahead of plan, and the supervisory framework is being enhanced. However, challenges to restoring profitability and a sizeable funding gap may undermine banks' capacity to support the nascent economic recovery through new credit extension. Decisively dealing with increasingly long-term mortgage arrears, reducing overall funding costs, and completing ongoing operational restructurings are important pre-requisites for addressing these challenges. Robust implementation of the new personal insolvency regime and timely reform of the repossession framework, ensuring a delicate balance between debtors' and creditors' rights, are essential to effectively dealing with legacy unsustainable debts. This would also allow banks to normalise their business models and re-focus operations towards profitable new lending, which is essential for a sustained recovery and a reduction of unemployment. Another key policy priority is to enhance SME's access to finance.

The important improvement in banks' funding positions is welcome, but concerns remain regarding the funding gap at the end of the programme. As previously noted, deleveraging and stronger-than-expected deposit inflows have helped to significantly reduce the funding gap[23] of domestically-owned banks[24]. The loss of rating-sensitive non-resident deposits – which saw an outflow of almost EUR 70 billion between end-Q3 2010 and end-Q1 2011 – resulted in increasing reliance on central bank funding, which was already apparent before the start of the programme. Estimates at programme inception had factored in more than EUR 11 billion of wholesale funding which have not materialised to date (despite BOI's and AIB's recent return to the covered bond market), while banks' total assets are also higher-than-anticipated by some EUR 16 billion.[25]Despite these developments, a small outperformance (of about EUR 1 billion) versus original funding gap estimates is expected by end-2012, with the funding gap at end-October having decreased to about EUR 158 billion from a peak of over EUR 237 billion at end-March 2011 (Figure 17). However, given uncertain prospects for sizeable market funding (a challenge currently facing most euro-area banks), and considering that the remaining disposals may be more challenging (as outstanding non-core assets are relatively less liquid and of lower quality), the funding gap could remain considerable, though recent bilateral repo transactions by Irish banks (on Irish assets) with market counterparties and the recent covered bond issues by BOI and AIB are encouraging.

Figure 17: Covered banks' funding gap

The funding gap has gradually decreased as deposit inflows and deleveraging continue || Funding breakdown shows funding gap is largely covered via central bank financing

||

Source: Central Bank of Ireland || Source: Central Bank of Ireland

The continued deterioration in banks' asset quality, in particular the long-term nature of mortgage arrears, is a persistent source of concern. The outstanding balance on owner-occupier mortgage accounts in arrears of over 90 days reached EUR 16.8 billion (Figure 18), equivalent to 15.1% of the total owner-occupier mortgage loan book at end-September 2012. While the pace of mortgage arrears formation has decelerated, the amount of arrears of 180 dpd or more has continued to increase and now stands at over 80% of total arrears. Similarly for investment property mortgages, the outstanding balance of accounts in arrears of over 90 days reached EUR 7.9 billion, equivalent to 26% of the total value of this loan book at end-September 2012; 84% of these arrears are 180 dpd or longer.. While the volume of loan restructurings continues to rise, the focus to date has been on preventing accounts from falling in arrears and on applying often unsustainable short-term forbearance measures. Recently released data shows that almost 10% of the balances of all owner occupier and investment property mortgage loans are in arrears of more than 360 days. Due to considerable difficulties for borrowers to make up for long periods of non-payment and given the lower level of engagement by banks with those borrowers, these levels of arrears could have potentially adverse implications for future recoveries and expected losses on those portfolios. To address this issue the banks have developed a range of long‑term loan modification measures which are currently in the process of being rolled out, though the banks' focus on implementing their mortgage arrears resolution strategies needs to be intensified.[26] To avoid further delays with implementation, underpin institutions' efforts and monitor progress, the authorities agreed to introduce quarterly measurable bank-specific targets for reviewing new and existing individual arrears cases from end-2012.

Figure 18: Mortgage arrears, end-September 2012

Owner occupier mortgage arrears and restructures || Owner occupier and Investment property mortgages

||

Source: Central Bank of Ireland

Given continued loan losses and high funding and operating costs, prospects for restoring bank profitability remain fragile. Actions are underway to improve profitability, with banks continuing to re-price deposits and loan books and to reduce operating expenses in the context of their restructuring plans (Box 4). Reflecting the improved situation and sentiment towards the Irish banking sector, the authorities are prioritising actions for the withdrawal of the ELG scheme in 2013. Banks forecast that annual impairment charges and loan-loss provisions will start to decline from 2012, helping to restore some institutions to modest profitability by end-2014. This is very much dependent on an improving economic environment and decisive implementation of sustainable loan-modification options to treat long-dated arrears. Even if these factors materialise, and loan losses evolve in line with expectations, there are concerns about medium-term profitability given the level and distribution across different arrears' buckets of provisions the banks presently hold relative to the level and age of arrears in their portfolios. While banks have been sufficiently capitalised to an unlikely stress scenario, it is essential that unexpected loan losses are avoided if sustained profitability is to be achieved in the near to medium term, reflecting also banks' weak internal capital generation capacity. Work is ongoing on a detailed assessment of developments at the covered banks relative to PCAR 2011 base and stress scenarios, overall results of which will be published in January 2013.

The new personal insolvency regime should help facilitate a step-change in the resolution of unsustainable debts. The Personal Insolvency Bill, which is due to be passed by the Oireachtas by year-end and become operational from early February, seeks to strike a balance between protecting debt service discipline and creditors' rights. It provides a non-judicial alternative to bankruptcy and will assist in securing adequate protections for debtors' principal private residence, also safeguarding reasonable standards of living for the most vulnerable indebted households. From this perspective, Commission services raised concerns about the EUR 3 million cap envisaged in the legislation for eligible secured debt. This would appear to be unduly high, given that the average mortgage debt is around EUR 300,000 and could induce banks, lawyers, and insolvency practitioners to focus on big-ticket cases rather than process the smaller but much more numerous cases of average debtors, who are likely to be facing greater distress. The efficiency of the system could also be jeopardised if the Insolvency service is overloaded with large complex cases, which could involve a multitude of inter-connected debts concerning not only a debtor's principal private residence, but also those associated with investment properties or (sole-trader) businesses. The authorities noted that there are no monetary caps on either unsecured or secured debts in bankruptcy and that during the consultation process stakeholders and the relevant Oireachtas Committee argued that the cap should have been raised or eliminated.

A functional repossession regime should, however, also be part of the tool-kit to deal with unsustainable legacy debts. While repossessions should remain a measure of last-resort, maintaining balanced incentives between mortgage borrowers and creditors requires that the existing unintended legislative constraints identified by case law[27], which could hinder repossession of collateral in some cases of debtor default, is removed.[28] The authorities have committed to removing the unintended legislative constraints, and efforts in this direction will be monitored in future reviews. The issue is particularly pressing for loans related to investment properties, given the level of mortgage arrears in this segment. The mission stressed the desirability of keeping families in their homes wherever possible, and thus the need to ensure that adequate measures are put in place to achieve this.

Several initiatives have been launched to facilitate credit extension to SMEs. These include a EUR 90 million Microfinance fund and the Credit guarantee scheme, which is expected to provide an additional EUR 150 million in lending for small businesses per year. In addition, the authorities have agreed with the pillar banks specific targets for a cumulative amount of EUR 21 billion in SME lending (defined as the volume of new sanctions in each year during 2011-2013), which—while not corresponding to similar volumes of net new lending—has been an important anchor for bank policy in this area. However, given the continued decrease in the stock of credit to the sector, it is important that any potential impediments to SME access to finance be identified and removed in a timely manner.

Yet, in view of the importance of SMEs for growth and job creation, more needs to be done. The mission underscored the importance of the sector for future job creation, but also recognised the difficulty of correctly identifying whether low SME lending mainly reflects weak demand for credit in a low-growth/deleveraging environment or supply-side constraints. As previous reports have indicated, both factors appear to be at work. Furthermore, a particular issue facing many SMEs is adequate access to working capital (as opposed to investment capital) to overcome liquidity constraints which can be exacerbated by payment delays from customers. It is acknowledged that payment delays between businesses, and between businesses and public authorities, can add to business costs. Directive 2011/7/EU, which replaces Directive 2000/35/EC, will address this matter and has to be transposed into national law by March 2013. Survey evidence seems to indicate that Irish SMEs may be more credit‑constrained than their euro area counterparts.[29] However, unlike the latter, many Irish SMEs significantly increased their exposure to property during the boom years. High leverage and reduced value of their collateral impaired their creditworthiness. The mission discussed with the authorities the importance of exploring options to disentangle SME real estate loans from their core business activities, which may remain viable. In principle, this problem can be reduced as banks move away from collateral-based towards cash-flow-based lending. But a final concern is that banks' capacity to adequately undertake cash-flow analysis may be seriously lacking, particularly at the branch level. This reflects a legacy problem of the property bubble, where banks may have failed to adequately invest in ensuring that their staff possess such basic banking skills. The recent initiative by one of the pillar banks to speed up the loan-application procedure at branch level is, however, welcome. The mission expressed its concern that, unless the wider issue of access to credit for SMEs is addressed, the long-awaited revival in credit growth may encounter bottlenecks which might hinder the future recovery. The mission also called for carrying out a comprehensive study on regulatory, administrative and financial burdens for SMEs, but the authorities suggested that this may be more appropriately considered following completion of ongoing surveys. Welcome steps to support lending to the sector were made in Budget 2013 following publication of the 10 Point (SME) Tax Plan and the announcement that the NPFR will establish and invest in funds to provide equity, finance, restructuring and recovery investment funding for SMEs of up to EUR 400 million (0.2% of GDP).

Box 4: Restoring bank profitability[30] Bank profitability remains challenged by high funding costs, operating expenses and loan impairment losses (Figure 19). Despite the sizeable availability of low-cost Eurosystem funding, about half of covered bank assets are deposit-funded; hence their overall financing cost had been deteriorating due to deposit price distortions and increased ELG fees[31]. Net interest income at the covered banks decreased by over 40% since 2010 due to higher funding costs (also compressing margins on new business), the low interest rate environment and limitations on banks' capacity to re-price large portions of their back-books. Even though operating expenses have remained broadly stable, their share of banks' gross operating income increased to over 100% on average from about 70% in 2010. As loan arrears continue to increase (albeit at a slower pace), additional impairment provisions are expected, which will continue to weigh on bank profitability. Figure 19: Drivers of covered bank profitability Source: Covered banks' Annual reports and Interim Financial Statements Notes: (i) 2012 data is annualised; (ii)"Other" includes income from LMEs Reducing funding costs through both a withdrawal from ELG and further deposit rate decreases is essential to restoring profitability. ELG fees considerably reduce banks' pre-provision profits and a strategy for the phase-out of the scheme (already completed for the UK operations of covered banks) in early 2013 remains a key priority for the authorities. This could constitute aggregate 12-month savings of about EUR 0.9 billion[32], though the full impact on bank profitability is likely to materialise only in 2014, given the current maturity profile of covered liabilities. The intense competition for deposits observed in the second half of 2011 and in early 2012 has started to abate with retail deposit rates starting to normalise particularly in the short‑term product categories (e.g. redeemable at notice deposit rates down by 0.48% since January). However, further deposit rate reductions may be necessary to contribute sufficiently to reducing banks' overall cost of funding and normalise net interest margins. As adjustments of funding cost will take time as banks gradually replace low-cost Eurosystem financing with market-based funding, adequate volumes of new lending at appropriate spreads are also a necessary pre-requisite to fully restoring profitability. Operational rationalisation is also essential for reducing costs. The banks are advancing voluntary severance, redundancy and early retirement schemes, and pursuing other cost-saving initiatives, including outsourcing of non-core functions, the closure of branches (circa 80 branches have been identified for closure in 2012 and 2013) and adjustments to staff benefits and pensions. All these measures combined are expected to generate annualised reductions of operating expenses of over EUR 450 million by end-2013. Despite these important initiatives, cost bases at the covered banks would likely continue to remain large in relation to gross operating income, given the drag of low-yielding long-dated legacy assets, and limited new lending and prospects for increasing non-interest income. That said, the three covered banks plan to enhance their efficiency considerably in coming years through operational and funding cost reductions and profitable new lending, targeting cost/income ratios of 50-55% by 2015 (significantly below current levels of 90% - 115%). Serious risk to a sustained return to bank profitability in the medium term is posed by further increases in loan impairment charges. Encouragingly, the pace of mortgage arrears' formation has started to decelerate, as banks have enhanced the effectiveness of their collections and work-out functions and sought early engagement with customers in difficulty. This addresses a key near-term risk to bank profitability. However, concerns remain regarding low levels of cure in long-dated arrears, reflecting considerable challenges and unwarranted delays for banks' implementation of advanced loan modification options on sufficient scale. As a result, impairment losses can be expected to continue to increase in the near term as sizeable proportions of long-term non-performing loans may be unable to cure and may need to be written off. Provisions are also likely to increase further weighing on profitability in coming quarters, in light of further deteriorations of banks' mortgage portfolio, as well as SME and CRE portfolios (average coverage ratios have actually declined to 55% at end-June from 58% at end-September 2011) and taking account of revisions, where necessary, to existing guidelines with regard to the provisioning treatment of certain advanced forbearance options. In addition, some structural features of Ireland's regulatory framework, such as the existing legal impediments to collateral repossession in some circumstances, reduce the recovery value of collateral and thus, unless addressed, may require an increase in provision cover.

5.3 Structural reforms

Structural reforms to strengthen the economy in the medium term continue to progress broadly in line with programme objectives. Persistently high unemployment, increasingly of a long-term nature, is a major social and economic concern that needs to be addressed forcefully. The functioning of the labour market is being improved, including through more effective activation policies and greater flexibility in sectoral wage setting arrangements, with a view to ensuring a job-rich recovery in the future, but faster and deeper progress is needed. The process to transfer the ownership and operations of the water sector to a national public utility and introduce water charges for households is advancing, but at a slow pace. In turn, the competition framework continues to be strengthened, and the process to dispose of selected State assets is moving according to plans.

Labour market reforms are advancing and should improve Ireland's ability to generate a job-rich recovery in the future. The Industrial Relations (Amendment) Act 2012, adopted in July, imposes a stricter legal framework for the setting of the terms and conditions defined by Registered Employment Agreements (REAs) and Employment Regulation Orders (EROs), including sectoral minimum wages. The Act mandates the Labour Court or the Joint Labour Committees (JLCs) to examine a number of factors prior to registering an REA or submitting an ERO, including the impact on employment, the consequences in terms of competitiveness, and the relative wage levels in other EU Member States where relevant. In addition, REAs and EROs have become subject to Ministerial approval. Overall, these reforms should enhance labour market flexibility in the future and ensure that proper consideration is given to job creation and competitiveness issues in negotiating sectoral minimum wages and working conditions.[33] This, together with the measures envisaged and implemented under the Action Plan for Jobs, should help promote employment creation in the future and ensure that wages are adequately linked to productivity levels. The Act also makes it easier for a party to an REA to call for a renegotiation of its terms. The renegotiation process mandated by law remains relatively slow and burdensome however, and the impact of the amendment will have to be monitored in the year ahead.

The authorities launched Intreo in October as an integrated platform for labour activation services. Under the Pathways to Work initiative, the authorities aim to improve activation by increasing engagement with the unemployed, providing more training opportunities, ensuring proper incentives to taking up job opportunities, promoting the recruitment of the unemployed and reforming the institutional set up. Intreo has been designed as a one-stop-shop for job seekers and employers alike. Once fully phased-in, jobseekers will go to Intreo offices both to determine their entitlements and to receive employment services. Employers, in turn, should receive support in identifying suitable candidates to fill vacancies and obtaining eligible incentives. Four Intreo offices were launched in October. A few more should be opened by end-2012 and work is under way to expand the network throughout 2013 to reach the nationwide target of 70 offices by 2014.

Active engagement of the unemployed has improved, but remains insufficient. As of end-October, about 55,000 jobseekers had gone through group engagements (significantly ahead of target), while almost 42,000 had been individually profiled. Under group engagements, jobseekers with similar profiles are provided with general information on the options and support measures available to them. Individual profiling, in contrast, offers more tailored support and is an essential component of the labour activation policy. At this stage, individual profiling and group engagement are prioritised on new entrants on the Live Register because of resource constraints. It is crucial, however, that the long-term unemployed become engaged in labour activation measures rapidly as they are at an increasing risk of complete marginalisation from the labour market and as their numbers are bound to increase in the near future.

In order to address resource constraints, the authorities are taking steps to outsource some engagement activities to the private sector under a payment-by-results contractor model. While some progress has been made already, the authorities expect to finalise the contract design and initiate the tendering procedure only by the first quarter of 2013, with actual referrals to the contractor(s) commencing no sooner than the end of October 2013. As much as possible, this process needs to be speeded up to ensure timely engagement with a larger proportion of the long-term unemployed and reduce risks that emerging mismatches remain entrenched and human capital is forsaken. Partial outsourcing has been used successfully in a number of EU countries already and should usefully complement Intreo's services and enable the provision of employment services at the lowest possible cost. In order to ensure optimal outcomes, the procurement process will need to be as competitive as possible. The performance of providers should be monitored in the future, with the low-performing ones eliminated from the market.

The impact of labour market reforms on unemployment has remained muted so far but should pay off once the recovery gathers pace. Economic growth over the past two years has not been sufficient to generate net job creation, and activation policies alone will not be sufficient to bring about a sharp drop in unemployment. The authorities are aware of this and adopted the Action Plan for Jobs in an effort to promote growth through an improved business climate and sectoral initiatives. Significant progress has been achieved in implementing the Action Plan for Jobs, but higher growth will be needed to achieve significant cuts in unemployment. Addressing high and long-term unemployment will require a combination of growth-induced job creation, improved labour-market functioning, and a better match between the demand and supply for skills (Box 5).

The Competition Authority is finally receiving its scheduled staff boost, meant to ensure that the Competition (Amendment) Act 2012 translates into an improved monitoring and enforcement of competition rules. Three of the 10 supplementary professional staff members had been recruited by end-October, and applications were being received for the remaining 7 posts. The additional staff will represent a mix of economists and lawyers, who are all scheduled to work as case handlers.

Box 5: Breaking the cycle of long-term unemployment: activation, re-skilling and job creation Unemployment has ceased to increase in 2012, but this provides little comfort as the rate is stuck at a high of about 14.8% and as joblessness is increasingly long-term in nature. By September 2012, close to 60% of the people on the Live Register had been unemployed for more than a year. In addition, the majority of the long-term unemployed are at the low-end of the skill range, and their employability is further affected by the length of time they remain away from activity. Addressing the (long-term) unemployment issue is an increasingly pressing policy concern that requires a comprehensive reform strategy. Under a baseline scenario of a gradual return to pre-crisis exit rates, it appears that the number of people on the Live Register would decrease only very gradually to around 220,000 by end-2016, and that the long-term nature of unemployment would actually worsen further, with close to 65% of people on the Live Register for more than one year. While such a simulation needs to be taken with extreme caution when it comes to precise numbers, the main findings are robust regardless of the scenarios envisaged and highlight two key policy issues: (1) a job-rich recovery will be essential to make a sharp indent in unemployment levels; and (2) major efforts will be required to further improve labour activation policies and generate much higher exit rates for the long-term unemployed, including through re-skilling and training. Figure 20: Actual and simulated population on live register by duration Sources: Department of Social Protection and European Commission calculations. As indicated earlier, 50% of the population currently on the Live Register previously held occupations in craft, sales or plant and machine operations, i.e. towards the low-end of the skills distribution. The National Skills Bulletin 2012 by the Expert Group on Future Skills Needs, in turn, indicates that Ireland currently suffers from skills gaps in a number of areas, including science, engineering, IT and certain segments of sales and marketing, craft and transport. While it would be illusory to aim at fundamentally reshaping the skills of people currently on the Live Register on a large scale, a core element of the labour activation policy must be to offer additional or new training to the unemployed, particularly the long-term ones, on a timely and targeted basis. As such, a faster implementation of the establishment of SOLAS to better coordinate and direct the local Education and Training Boards (ETBs) is essential. Regularly reviewing ETBs' curricula and trainings offers to ensure they are relevant to employer's needs and demands will also be important in the future. The relevance and effectiveness of Intreo's services to job seekers and employers will need to be reviewed as offices are phased in nationwide in 2013. Reaching targets on the number of people to be profiled or sent to group engagement will not be sufficient. The quality and relevance of the individual profiling and group sessions will be at least as important, and Intreo will have to ensure that it adequately services the needs of job seekers in terms of guidance and training and the needs of employers in identifying and short-listing potential candidates to fill vacancies. Aside from forceful implementation of the labour activation policy defined in Pathways to Work, further action will be needed to improve the demand side of the labour market. The solid implementation record on the Action Plan for Jobs in 2012 should be continued looking forward. Efforts should also be made to ensure that the increased labour market flexibility intended to be achieved through the Industrial Relations (Amendment) Act 2012 actually materialises.

The Legal Service Regulation Bill, a programme requirement, has completed second stage and committee stage is planned for early 2013. Amendments are to be introduced to reflect concerns over the independence from government of the new Regulatory Body.[34] With the bill's passage, the authorities should work to ensure speedy and effective implementation of the reforms, which are important to competitiveness (Box 6).

Plans to transfer the ownership and operation of the water sector to a national public utility and introduce charges for households have firmed up.[35] Aside from settling on the public utility model, a number of important decisions have been taken, including that: (1) Irish Water will be an independent State-owned company under the Bord Gáis Group; (2) the water sector will be subject to the independent regulatory oversight of the Commission for Energy Regulation (CER); (3) water charges will be generalised to all consumers (residential as well as non-residential) by 1 January 2014; (4) a sustainable funding model for the sector will be established, with the aim to make Irish Water self-funded eventually; and (5) the transfer of ownership and operations of the sector from local authorities to Irish Water will be phased in gradually over a period of around 5 years extending to 2017.

The implementation of the water reform strategy has so far been slow. The reform has nevertheless been planned since the beginning of the programme and is critical on a number of counts, including: (1) to foster an efficient and rational use of a scarce and valuable resource; (2) to ensure the viability of the sector's business model; and (3) to enable the financing of essential infrastructure investments, including to reduce leakages and ensure adequate service provision to suit the needs of businesses. Making Irish Water mostly self-funded like any other public utility will also generate significant structural savings for the Exchequer as operating and capital costs represent around EUR 1.2 billion per annum, with revenues from charges to non-residential users accounting for only EUR 200 million. Yet, concrete steps have been taken slowly. Among other things, progress towards the installation of water meters has lagged. The procurement processes for the supply of boundary boxes and the installation contracts are yet to be completed, and the authorities recognise that actual installation of boundary boxes and meters will not start until the third quarter of 2013. The full roll-out of meters is likely to take years and extend well beyond the scheduled date for the introduction of water charges, which will create additional difficulties regarding the pricing mechanism.

Landmark decisions are needed in the coming months to achieve the commitment of introducing water charges for households by the end of the programme period. Given the delays experienced so far, a number of key steps and decisions will have to be taken rapidly, including: (1) the enactment of legislation to grant regulatory oversight to the CER; (2) the enactment of a comprehensive Water Services Bill; (3) the establishment of Irish Water first on an interim basis and later in its final form; (4) the installation of meters; (5) the determination of a pricing methodology for households and non-residential users (both before and after meters are in place, i.e. respectively on a presumptive and on an effective-consumption basis); and (6) a decision on the level of Exchequer funding in the years to come and until Irish Water is put on self-funded basis. The latter two issues are closely interconnected, as the level of Exchequer support required for Irish Water will depend on the revenues that can be collected through the introduction of water charges for households. These steps are reflected in the revised memorandum of understanding, and the authorities are committed to engage with the European Commission in developing the new legislative arrangements for the sector.

Box 6: Increasing competition in the provision of legal services Whereas other sectors of the economy have experienced considerable cost adjustments since the onset of the crisis, legal services remain expensive in Ireland (Figure 21). After rapid increases during the boom, the cost of legal services only adjusted slightly, and still remained 12.1% above their 2006 level. This contrasts markedly with the post-crisis development of other services, whose prices did not rise as much to begin with and have since adjusted quickly back to 2006 levels (Figure 21). The World Bank Doing Business 2012 report estimates that, as a percentage of the value of a standardised claim in a commercial dispute, the enforcement cost is 26.9% in Ireland, versus an OECD average of 20.1%. Of this, more than 2/3 (i.e. 18.8%) is accounted by attorney costs. Figure 21: evolution of legal services prices vs. other services The high cost of legal services continues to pose problems for Ireland: · Cost competitiveness, in particular for SMEs, for which the high level of legal costs can act as an impediment to business success, particularly in contentious contract law issues. Since non-tradables like legal services also feed into the cost base in the Irish export sector, high legal service costs also hamper external competitiveness; · Equity concerns, as low income households who cannot afford high legal fees may be locked out of equal access to justice; · Fiscal issues, as the State is the largest buyer of legal services, making high legal costs a further challenge in terms of meeting fiscal targets under the Programme. A 2006 study by Ireland's Competition Authority[36] identified anti-competitive practices in the market for legal services, such as