Executive summary 1

1. Scene setter - economic situation and outlook 3

2. Imbalances, risks and adjustment 10

2.1. Indebtedness and deleveraging 11

2.2. Financial sector challenges 20

2.3. Competitiveness and external sustainability 25

2.4. Structural challenges in the labour market and skills mismatches 33

3. Other structural issues 40

3.1. Healthcare system 41

3.2. Improving access to finance and SME development 43

3.3. Taxation and fiscal framework 50

3.4. Legal services and justice reforms 54

3.5. Infrastructure and climate 56

3.6. Social policies 59

AA. Overview Table 62

AB. Standard Tables 70

LIST OF Tables

1.1. Key economic, financial and social indicators - Ireland 8

1.2. Macroeconomic Imbalance Procedure: Scoreboard - Ireland 9

2.1.1. Government contingent liabilities 19

2.2.1. Results of the comprehensive assessment 21

3.2.1. Overview of SME credit policy initiatives 49

AB.1. Macroeconomic indicators 70

AB.2. Financial market indicators 71

AB.3. Taxation indicators 71

AB.4. Labour market and social indicators 72

AB.5. Expenditure on social protection benefits (% of GDP) 73

AB.6. Product market performance and policy indicators 74

AB.7. Green Growth 75

LIST OF Graphs

1.1. Real GDP, Ireland vs euro area 3

1.2. Contributions to GDP growth 4

1.3. Retail sales in Ireland 4

1.4. HICP inflation 4

1.5. Real estate prices 5

1.6. Unemployment rates, employment growth 5

1.7. Bank profitability 6

1.8. Ten-year spreads over German bonds 7

2.1.1. Private sector debt 11

2.1.2. Debt build-up and deleveraging trends 11

2.1.3. Corporate leverage indicators 12

2.1.4. Components of the household deleveraging process 13

2.1.5. Household debt sustainability 14

2.1.6. Household net worth 14

2.1.7. Contribution to change in gross government debt 15

2.1.8. Breakdown of gross government debt (end of December 2014) 16

2.1.9. Average effective interest rates on government debt (2014) 16

2.1.10. Maturity profile of Ireland’s long-term marketable and official debt (end of December 2014) 17

2.1.11. Gross government debt projections 18

2.1.12. General government balance and real GDP growth 18

2.2.1. Loan-to-deposit ratio (LDR) 20

2.2.2. Eurosystem borrowing 20

2.2.3. Components of domestic bank profitability 21

2.2.4. Domestic bank capital positions 21

2.2.5. Mortgage arrears 23

2.2.6. Mortgage restructuring 24

2.3.1. Current account balances 25

2.3.2. Exports of goods and services 25

2.3.3. Real effective exchange rate, 2005=100 26

2.3.4. Demand composition of GDP and GDP growth 26

2.3.5. Exports of pharmaceutical products 27

2.3.6. Difference in net exports (balance of payments vs. customs) 27

2.3.7. Services exports, imports and balance 28

2.3.8. International Financial Services Centre and non-International Financial Services Centre trade in services, primary and secondary income flows 28

2.3.9. Current account balance 29

2.3.10. Net international investment position by institutional sector 29

2.3.11. Target 2 balances 30

2.3.12. External assets and liabilities of domestic banks 30

2.3.13. International investment position of non-financial companies and non-bank financial intermediaries (outside the International Financial Services Centre) 31

2.3.14. International investment position of non-financial companies 31

2.3.15. International investment position of International Financial Services Centre 32

2.3.16. International investment position of non-International Financial Services Centre sectors 32

2.4.1. Unemployment rate, long-term unemployment rate and youth unemployment rate 33

2.4.2. Working-age population, active and employed people 33

2.4.3. Nominal unit labour costs, total economy 34

2.4.4. Labour market participation rates (ages 15-64) 35

2.4.5. Employment by educational attainment 35

2.4.6. Unemployment rate by educational attainment (ages 15-64) 36

3.1.1. Public healthcare expenditure, Ireland and EU 41

3.2.1. Outstanding credit to SMEs 43

3.2.2. Bank products requested by SMEs 44

3.2.3. Interest rates on SME loans - comparative overview 44

3.3.1. Tax burden 50

3.3.2. Revenues from property taxes (2012) 52

3.3.3. Expenditure ceiling reconciliation for 2015 53

3.5.1. Public sector gross fixed capital formation by area 56

LIST OF Boxes

1.1. Economic surveillance process 7

2.4.1. Policy responses to labour market challenges and skills mismatches 38

3.2.1. Regulating loan origination by investment funds 46

The economic outlook has improved markedly. Exceptionally strong net exports made Ireland the fastest growing economy in the EU in 2014. Although the contribution from net exports is likely to moderate, strong investment growth and the recovery in private consumption should underpin real GDP growth of about 3.5% in 2015 and 2016. The recovery has been job-rich and unemployment fell to 10.6 % at the end of 2014. The better macroeconomic environment has buoyed tax revenue and helped achieve fiscal targets despite expenditure overruns compared to budget profiles. It has also helped improve bank performance and ease the deleveraging process. Market perceptions of Ireland have improved significantly amid a general improvement in financial market conditions. The spread over 10-year German bunds fell to about 80 basis points in early 2015, bolstering sovereign debt and banks.

This country report assesses Irelandʼs economy against the background of the Commissionʼs Annual Growth Survey which recommends three main pillars for the EUʼs economic and social policy in 2015: investment, structural reforms, and fiscal responsibility. In line with the Investment Plan for Europe, it explores ways to maximise the impact of public resources and unlock private investment. Finally, it assesses Ireland in the light of the findings of the Alert Mechanism Report 2015, in which the Commission found it useful to examine further the persistence of imbalances or their unwinding. These are the main findings of the in-depth review in this country report:

· Private sector indebtedness declined in 2014 but is still high and well above the EU average. Corporate debt levels are inflated by the presence of multinationals, and SMEs have borne the brunt of the deleveraging among corporates. Deleveraging needs vary significantly among SMEs. High levels of debt are concentrated in a relatively small proportion of firms, while the majority are now either debt-free or able to service their debt. Debt repayments by households still outpace new borrowing as they continue to actively deleverage against a backdrop of resurgent economic growth and rising property prices.

· Public sector debt remains above GDP, but is expected to fall pending continued budget consolidation efforts and sustained economic growth. One-off factors accounted for most of the 12.5 percentage point drop in the debt-to-GDP ratio to 110.8 % in 2014. Public debt is mostly long-term and carries low interest rates reducing refinancing risks.

· Financial sector challenges are diminishing as domestic banks have been restructured, downsized and recapitalised. Profitability is still a problem, but it continues to improve and the banks' strengthened position was reflected in the results of the European Central Bank's comprehensive assessment. The regulatory and supervisory systems have been strengthened. However, the high share of non-performing loans is falling slowly, in particular in the mortgages and commercial loans.

· The external accounts have strengthened considerably over the past few years. The economy has regained competitiveness and the rebalancing between the tradable and non-tradable sectors seems to be nearing completion. Irelandʼs external accounts need to be interpreted with care, however, and although the net international investment position is falling, it remains highly negative.

· The labour market situation has improved, but long-term unemployment remains a problem. While the unemployment rate is now below the euro area average, the share of structural unemployment risks increasing. The adjustment need is compounded by the skills mismatches that have emerged with the rebalancing of the economy between the non-tradable and tradable sectors and by the difficulties in re-skilling or up-skilling workers.

This country report also analyses other macroeconomic and structural issues and the main findings are:

· The healthcare sector is facing sustainability challenges. Expenditure overruns have been recurrent in the past few years, which shows that while efficiency gains have been achieved in recent years, the health system may have reached a point beyond which containing expected cost increases would imply deeper structural reforms.

· SME access to finance remains heavily reliant on bank lending and the use of non-bank financing options is yet to develop.

· The high proportion of people living in households with low work intensity generates social challenges. Limited access to affordable and quality childcare is a barrier to increased female labour market participation.

Ireland has made some progress in addressing the country-specific recommendations the Council issued in 2014. Some progress was made in the areas of fiscal consolidation, the labour market, and non-performing loans restructuring. Budget 2015 complies with the Stability and Growth Pact, but the 2015 and 2016 deficit targets could have been more ambitious given strong economic growth, and expenditure ceilings still need to be strengthened. The introduction of training and activation programmes is progressing. Initiatives have been put in place to improve the financing conditions for SMEs. The restructuring of SMEs and household loans in arrears is ongoing. Some progress has been made in the area of healthcare, including in reducing public spending on pharmaceuticals. Limited progress has been made in tackling the low work intensity of households, with no progress on improving access to affordable and full-time childcare. Limited progress has been made towards reducing the cost of legal services, but some progress has been made on improving data collection systems in courts.

The country report reveals the policy challenges stemming from the analysis of macro-economic imbalances:

· Private and public sector deleveraging has a further way to go. Further deleveraging is necessary to ensure that debt levels are sustainable and do not weigh on the growth prospects. Strict adherence to the planned fiscal adjustment under the Excessive Deficit Procedure and subsequent progress towards achieving the medium-term budgetary objective would ensure that public finances are firmly set on a sustainable path. Further growth-friendly tax reforms, including broadening the tax base, would support the adjustment process.

· Lowering the still high level of non-performing loans would imply further loan arrears resolution. In particular, this would entail a constant monitoring of the sustainability of the solutions agreed between lenders and debtors. Making the credit registry operational in 2016 as planned would be an important step towards enabling lenders to make informed lending decisions.

· Improving SME access to bank and non-bank finance is important for growth and promoting jobs and investment. Accessible information about financing options is crucial for an increased use of public support schemes.

· The labour market will continue to face adjustment needs for years to come, even though employment growth has been sustained lately. Tackling skills mismatches fully would avoid higher structural unemployment, contribute to the sustainability of Ireland's growth model and improve social indicators.

Other challenges are:

· Untapped efficiency gains can be reaped in the health system to meet future increases in demand for care. Such gains would enable favourable health outcomes at an affordable cost to society.

· The proportion of people living in low work intensity households is high. The improved labour market situation alone is unlikely to solve the problem.

· The cost of legal services remains high. A new regulatory framework is in Parliament. Its final design and implementation will determine its effectiveness.

· Weaknesses in network industries persist. Addressing them in the current environment could prove challenging, particularly as far as the water sector is concerned.

Growth and external position

Ireland becomes the fastest growing economy in the EU. The Irish economy reached a turning point in the latter part of 2013 and grew strongly in 2014, driven primarily by net exports and a strong recovery in investment (Graph 2.1 below). In the first three quarters of 2014, real GDP was up 4.9 % year-on-year, with net exports contributing 3.4 percentage points. Ireland’s current account surplus was 5.7 % of GDP in the first nine months of 2014, underlining the strength of the country’s competitiveness. The strength of these figures has taken observers by surprise. Both in bad and good times, Irish GDP has exhibited higher amplitude than the euro area. In 2015, Irish output could be back to its peak of 2007, one year earlier than that of the euro area as a whole.

Graph 1.1: Real GDP, Ireland vs euro area

Source: European Commission

Some uncertainty underlies net export figures and their contribution to the local economy. Economic dynamism remains reliant on multinational companies and connected exports. Competitiveness gains since the crisis coincided with a favourable business environment. Some of the strength in net exports is linked to a surge in contracted production ([1]), which has little impact on employment and tax revenues in Ireland. The future evolution of this form of production is uncertain, because it depends on the evolution of global value chains. This means that the exceptionally strong contribution from net exports may not be sustained.

Sustained growth is expected for 2015–16, albeit more moderate than the previous year. Real GDP growth is forecast to be resilient in 2015–16 at around 3.5 % each year ([2]). This will be lower than the exceptional growth rate achieved in 2014 but still above the EU average. Consumption is forecast to pick up from 2015, helped by rising employment, moderate wage growth and big drops in energy prices. However, exports and investment will remain important drivers of GDP growth over the period. Ireland will also continue to benefit from its strong trade links with the more dynamic US and UK markets and a weaker euro exchange rate.

Investment has picked up sharply as business confidence continues to recover. Real GDP growth has also been driven by the recovery in gross fixed capital formation. Aircraft purchases and intellectual property transactions by multinationals generate significant volatility in investment. Excluding these, investment has been strong across the board (up by 19.7 % year-on-year in the first three quarters of 2014) signalling improved business sentiment among small and medium-sized enterprises (SMEs) and continued expansion by multinationals. The purchasing managers index (PMI) has been above 55 since March 2014.

Consumption has remained subdued so far, in the context of ongoing deleveraging. Household spending, weaker than expected, did not pick up significantly in 2014 as high debt levels continued to weigh on the Irish private sector. However, some of this sluggishness is also explained by statistical effects on the split between volumes and prices. Positive trends in retail sales, tax receipts and employment all point to an underlying recovery in consumption — still limited but apparent in the nominal figures. Retail sales have been increasing since mid-2013 (Graph 2.2 below), and consumer confidence improved sharply to a historic peak in December 2014.

Graph 1.2: Contributions to GDP growth

Source: Central Statistics Office of Ireland

Graph 1.3: Retail sales in Ireland

Source: Central Statistics Office of Ireland

The Investment Plan for Europe should give Ireland additional opportunities. The implementation of the Investment Plan for Europe should provide an additional boost to investment and growth from 2016 onwards. The impact of the plan for Ireland will depend on a number of factors. They include the volume of any contributions of Ireland to the Plan, the degree of participation by private investors and the characteristics of the specific projects selected by the European Fund for Strategic Investments.

Inflation and asset prices

Inflation remains subdued. Inflation remained lower than in the euro area for the sixth consecutive year in 2014 at 0.3 %, compared to 0.4 % in the euro area. Low energy prices have also put downward pressure on inflation recently and the harmonised index of consumer prices (HICP) fell by 0.3 % year-on-year in December 2014 (Graph 2.4 below). The increase in domestic demand and moderate wage increases should dispel inflationary expectations. Core inflation is forecast to exceed somewhat the euro area average in 2015–16, marking an end to the process of internal devaluation. That said, changes to the expected evolution of oil prices and unconventional monetary policy measures could alter this outlook.

Graph 1.4: HICP inflation

Source: European Commission

House prices have increased significantly but are still far from pre-crisis levels. In the housing market, pent-up demand and the low level of new construction have pushed up prices significantly, especially in urban areas. Residential property prices rose by 16.2 % year-on-year in November 2014 (Graph 2.5 below), with greater increases in Dublin than in the rest of Ireland — although the number of transactions remains small. The national property price index remains 37.9 % below its 2007 peak but if supply constraints persisted, they could exert significant upward pressure on residential prices. Commencement notices for new works and house completions have begun to rise from low levels but are not yet sufficient to satisfy demand. High accommodation prices in Dublin could also ultimately affect Ireland's position as an international business hub.

Graph 1.5: Real estate prices

Source: Central Statistics Office of Ireland

Labour market and social inclusion

Growth has been rich in jobs although the unemployment rate remains high. The standardised unemployment rate has fallen steadily to 10.6 % in December 2014 from a peak of 15.1 % in February 2012. Long-term unemployment has also fallen significantly but remains very high at 46 % of all unemployment benefit claimants. Employment increased by 1.7 % year-on-year in the third quarter of 2014, with nearly 95 % of jobs created being full-time positions. This trend is expected to persist, albeit at a more moderate pace, given skills mismatches. SMEs and construction are expected to provide job opportunities for people with less sophisticated skills. Average unemployment is forecast to fall further to around 9.5 % in 2015 and remain above 8 % in 2016, putting a lid on wage inflation despite rising wage demands.

Graph 1.6: Unemployment rates, employment growth

Source: Central Statistics Office of Ireland

Social protection has helped to alleviate the rise in poverty that followed the crisis. Ireland is one of the countries where net social expenditure increased the most (as a share of the aggregate level of economic activity) following the 2007 crisis. In 2011, it amounted to nearly 22 % of GDP, according to the latest available data. As a result, the country did not experience the rise in inequality some other Member States did. Nevertheless, deprivation rates have continued to rise in the year to 2013, driven by sharp rises in rural areas. This suggests that improving labour market conditions in Dublin and other urban areas have yet to spread to the rest of the country. The risk of social exclusion is heightened by the high proportion of people living in households with low work intensity, which remains the highest in the EU.

Fiscal developments and taxation

Buoyant tax revenues have helped Ireland reach its fiscal targets despite expenditure overruns. The general government deficit is forecast to drop to 4.0 % of GDP in 2014, below the Excessive Deficit Procedure target for that year and down from 5.7 % in 2013. This reflects the effects of remarkable economic growth in 2014, additional windfall revenues and lower interest expenditure. Tax revenues increased by 9.2 % in 2014. Receipts from personal income tax and VAT also increased, mirroring improvements in the labour market and consumer confidence. While total government expenditure increased only very moderately in 2013, spending pressures intensified further at the end of 2014, mainly in healthcare, compared to the budget profile. Unlike in previous years, healthcare budget overruns were not offset by savings in other areas.

The fiscal position is expected to improve further in 2015, but some risks remain. Taking into account tax cuts and expenditure increases of around 0.5 % of GDP, the general government deficit is projected to bet 2.9 % of GDP in 2015. In 2016, it is forecast to be 3.1 % under a no-policy-change assumption. Risks associated with the deficit projections for 2015 and 2016 mainly relate to the sustainability of the favourable economic outlook and to persisting spending pressures linked to demographics and the public service payroll. The structural deficit is expected to decrease to around 2.4 % of GDP in 2016, from 3.5 % in 2013.

Public debt is high but falling. Gross general government debt is projected to fall to 106.6 % of GDP in 2016, down from 123.3 % in 2013. This marked improvement largely reflects the liquidation of the Irish Banking Resolution Corporation, along with ongoing economic growth. Starting in 2014, small primary surpluses should also help maintain the debt trajectory on a consistent downward path. Nonetheless, the high level of public debt continues to be one of the main vulnerabilities of the Irish economy.

Financial sector and credit supply

Bank performance has continued to improve but there are still considerable difficulties (Graph 2.7 below). Almost all of the participating Irish banks passed the asset quality review and the stress tests of the ECB’s comprehensive assessment. Only Permanent TSB (PTSB) had a EUR 855 million capital shortfall in the adverse scenario of the test, which it is expected to fill with private capital. The results of the comprehensive assessment were in line with expectations and PTSB remains now the only loss-making domestic bank. The reliance of domestic banks on central bank funding has continued to decline, down to 3.9 % in September 2014, near the euro area average.

Graph 1.7: Bank profitability

(1) RoE: Return on Equity, RoA: Return on Assets Source: IMF (refers to the whole banking sector in Ireland)

Net lending to the private sector remains weak, given mostly low demand for credit. Lending to businesses (non-financial corporations) declined by 8.1 % year-on-year in October 2014. Lending to households, for consumption and house purchases, also fell by 3.3 % year-on-year in the third quarter of 2014. Demand for credit remains subdued as deleveraging by the private sector continues. Though still at very high levels, private sector non-consolidated debt fell by 3.9 percentage points in the first quarter of 2014, to 298.3 % of GDP. In addition to demand issues, there might also be credit supply constraints, as lending rates are higher in Ireland than in the rest of the euro area.

The number of non-performing loans remains high but is gradually decreasing. In the three main domestic banks, it fell to 24.9 % of total loans in the third quarter of 2014, from a high of 27.1 % at the end of 2013. The number and value of mortgage accounts in arrears for over 90 days decreased by 4.5 % and 3.8 % respectively quarter-on-quarter. However, mortgage arrears stood at 19 % of total mortgage loan balances in Q3-2014. The increase in the build-up of longest-term arrears persisted, up to 9.6 % of total loan balances in Q3, from 9.2 % at the end of June.

Positive market conditions have bolstered the sovereign and the banks. Bank of Ireland successfully tapped the markets and raised EUR 750 million of tier 2 capital in June 2014. In January 2015, the yield on 10-year Irish government bonds hit new lows of 1.03 % and the spread over German bonds fell to 63 bps (Graph 2.8 below). In early November 2014, the sovereign issued EUR 3.75 billion of 15-year bonds, the first such issuance since 2009. The yield of 2.49 % was a record low for this issuance. Also in December 2014, Standard & Poor’s upgraded Ireland’s long-term sovereign credit rating to A (from A-). The rating agency also confirmed its ratings of the Irish banks, upgrading Bank of Ireland’s outlook to positive. In January 2015, amid strong demand, Allied Irish Banks issued EUR 750 million of a 7-year covered bond at a yield of 0.75 %, as funding costs for Irish banks continue to improve.

Graph 1.8: Ten-year spreads over German bonds

Source: iBoxx

Table 1.1: Key economic, financial and social indicators - Ireland

(1) Domestic banking groups and stand-alone banks. (2) Domestic banking groups and stand-alone banks, foreign-controlled (EU and non-EU) subsidiaries and branches. (3) Real effective exchange rate. (*) Indicates BPM5 and/or ESA95. Source: European Commission, 2015 winter forecast, ECB.

Table 1.2: Macroeconomic Imbalance Procedure: Scoreboard - Ireland

Figures highlighted are the ones falling outside the threshold established by EC Alert Mechanism Report. For REER and ULC, the first threshold concerns Euro Area Member States. (1) Figures in italic are according to the old standards (ESA95/BPM5). (2) Export market shares data: the total world export is based on the 5th edition of the Balance of Payments Manual (BPM5). (3) Current account balance has been revised downwards following methodological changes in the treatment of FDI investment income. Source: European Commission.

Private sector debt and deleveraging

Private sector debt started to decline but is still considerably higher than the euro area average. Private sector non-consolidated debt amounted to EUR 515.3 billion (283.5 % of GDP) in the third quarter of 2014, down 10.6 % from a peak of EUR 576.6 billion in mid-2012. The correction begun since 2013 follows the excessive build-up between 2002 and 2011, when private indebtedness rose from about 120 % of GDP to over 320 % of GDP (Graph 2.1.1). Most of this increase can be attributed to the corporate sector amid expanding activity of multinationals and a growing number of SMEs taking on property-related debt. It grew by almost EUR 300 billion between 2002 and 2012 (a 276 % increase), while that of the household sector increased by about half of that amount (a 218 % increase).

Graph 2.1.1: Private sector debt

(1) Quarterly Financial Accounts release on an ESA 2010 basis with reference from Q1 2012 to Q3 2014. Figures for the Non-Financial Corporation (NFC) sector are the sum of loans and securities other than shares. Figures for households are the sum of loans and other accounts receivable/payable. Data are non-consolidated. MIP threshold: threshold of the scoreboard used under the Macroeconomic Imbalances Procedure. Source: Central Bank of Ireland, Central Statistics Office, European Commission

The deleveraging process started earlier among private households than in the corporate sector. The household debt-to-GDP ratio started declining in early 2010 while corporate indebtedness continued to rise for another two years (Graph 2.1.2). By the end of the third quarter of 2014, household debt had fallen to EUR 171.1 billion, down 19.5 % from its peak in late 2008. In contrast, corporate debt amounted to EUR 344.4 billion, down about 11.7 % from its peak in the second half of 2012. Despite notable improvements, the Irish private sector remains highly indebted. The estimated remaining deleveraging need is above 30 % of GDP, with obvious implications for the speed of recovery of private consumption and investment ([3]).

Graph 2.1.2: Debt build-up and deleveraging trends

(1) Quarterly Financial Accounts release on an ESA 2010 basis with reference from Q1 2012 to Q3 2014. Source: Central Bank of Ireland, Central Statistics Office

Corporate deleveraging is accelerating but overall debt levels remain high, even excluding multinationals. Since Ireland’s economy has a large multinational corporate sector, intra-group cross-border lending inflates corporate debt-to-GDP levels. The difference between consolidated and non-consolidated debt reflects this. In Ireland’s case the difference is 26.3 % ([4]). According to the Commission’s analysis ([5]), multinationals account for over 50 % of the increase in corporate sector indebtedness. Since multinationals have access to international capital markets, they do not depend on domestic banks for financing. This decreases overall deleveraging pressure amid favourable market conditions and reduces economic and financial stability risk. However, even taking this into account, Irish corporate debt levels as a percentage of GDP continue to exceed the euro area average by about 80 %.

Improvements in corporate debt levels were achieved by reducing nominal debt and increasing the value of company assets. Among other things, the latter is due to valuation effects stemming from the surge in real estate property prices. Company assets measured by total liabilities ([6]) have increased by 20 % over the past two years, while the debt stock, albeit more volatile, has decreased by 4 % (Graph 2.1.3). Although falling, debt servicing costs are still comparatively high compared to the rest of the euro area, making further debt reduction difficult.

Graph 2.1.3: Corporate leverage indicators

(1) Total liabilities are used as a proxy for total assets. Source: Central Bank of Ireland

SMEs seem to have borne the brunt of the deleveraging in the corporate sector. This is because SMEs were under greater financial stability pressure than multinationals. In contrast with the Irish-resident multinationals that maintain their intra-group funding practices and market borrowing practices, Irish companies, in particular SMEs, are focusing on loan repayments.

Indebtedness levels vary considerably depending on SME type and exposure to the property market. With high levels of debt concentrated in a relatively small proportion of companies, most do not suffer from excess leverage. According to the Central Bank of Ireland, a third of domestic SMEs have no debt at all and over 80 % can comfortably meet their debt servicing requirements, as their reasonably low debt-to-turnover ratios show. This means that much of the further corporate deleveraging need will have to be undertaken by those SMEs with high levels of debt. These companies are often exposed to property-related risks. This makes them vulnerable and more susceptible to default, especially in cases of negative equity. Even though the main lenders have stepped up their SME loan resolution efforts in line with the country-specific recommendation, this loan portfolio remains heavily impaired. About a quarter of all SME loans are in default (the third highest rate in the euro area). The wholesale and retail sector is the most exposed to loans in terms of balance ([7]). Defaults occur most often in the construction and hotel/restaurant sectors. SMEs are now allowed to apply for creditor protection (“examinership” under Irish law) in the Circuit Court rather than the High Court, which lowers their procedural costs – albeit take-up has been low so far. The proposed Consumer Protection (Regulation of Credit Servicing Firms) Bill aims to include SMEs and ensure that their rights as borrowers are protected even in the case of loan portfolio sales to unregulated entities.

Investment growth is mainly financed by corporate foreign borrowing and retained profits, not domestic banks. The diversity of the corporate sector in Ireland means that different companies use different strategies. On one side, national account data show a strong recovery in investment over the past few quarters. On the other side, negative credit flows show that the financing is not coming from domestic banks. This means that most of the pick-up in investment so far can be attributed to the multinational sector that borrows abroad. In addition, since the turnaround in the economy has boosted business revenues, companies have also used growing profits for working capital purposes and to reduce debt.

Negative credit flow partly masks a pick-up in demand for new credit. In spite of the continued balance sheet repair, deleveraging pressures on the Irish non-financial corporate sector remain high due to the still elevated indebtedness levels. However, some domestic corporates seem to have stabilised their businesses and could be more likely to borrow for investment.

Household debt repayments still outpace new borrowing as they continue to pay down debt. Negative credit flows are the single largest contributor to household debt reduction (Graph 2.1.4). In spite of that, the sector remains among the most indebted in the euro area at 91.5 % of GDP. Survey data show that 56.8 % of Irish households are indebted, and 33.9 % of them have a mortgage on their main residence.

Graph 2.1.4: Components of the household deleveraging process

(1) D/GDP, change: change in the debt-to-GDP ratio Source: European Commission

The impetus to further reduce household debt should continue with continued improvement in economic growth. Households have increased their savings to reduce debt. Household liabilities have been decreasing slowly but constantly since the onset of the crisis. At the end of 2014 they were at EUR 176 billion, a 19 % drop since their peak at the end of 2008. However, this was not matched by an increase in disposable income: as it remains subdued and consumption is still recovering, overall debt levels remain high (Graph 2.1.5). This is partly because average earnings remain relatively flat. Two thirds of all Irish mortgage holders continue to benefit from favourable ’tracker’ interest rates that keep the cost of mortgage servicing low.

Graph 2.1.5: Household debt sustainability

(1) Debt - to total loans of households. GDI - gross disposable income of households including non-profit institutions serving households. Source: Central Bank of Ireland, European Central Bank

Cooperation between lenders and borrowers on debt restructuring improved. Initiatives such as the Central Bank of Ireland’s Mortgage Arrears Resolution Targets and the regulatory reforms introduced during the programme helped improve cooperation between banks and debtors. Ambitious targets for concluded restructuring solutions for mortgages in arrears have been set for banks. Agreements continue to be monitored to ensure their sustainability. The restructuring solutions that banks have proposed generally offer more favourable repayment conditions and sometimes partial debt write-offs. The debt solutions offered by the Insolvency Service of Ireland represent another useful avenue for the most distressed debtors. However, little use is still being made of personal insolvency procedures and the reformed bankruptcy system, possibly on account of enhanced cooperation between debtors and lenders.

The increase in residential property prices increases households’ net worth. Houses make up almost 53 % of the total value of all household assets. In 2014 national house prices, as measured by the residential property price index, increased by 16.3 % compared to the previous year. This upward trajectory brought household net worth to EUR 574 billion in the third quarter of 2014 (Graph 2.1.6), rising for the ninth consecutive quarter (an increase of 5 % over the quarter).

Graph 2.1.6: Household net worth

(1) Net worth is measured as the difference between the households’ assets (housing and financial) and their liabilities. Source: Central Bank of Ireland, Central Statistics Office

The recovery in property prices is particularly strong in Dublin. Residential property prices in Dublin rose 22.3 % in the year to December 2014, with sharp price rises in Dublin slowly spreading to the rest of the country. Supply shortages are driving these price rises. Household formation rates suggest an equilibrium level of new house construction of approximately 25 000 units a year ([8]), with demand strongest in Dublin. Only an estimated 11 000 units were completed nationally in 2014. New measures have been introduced by the Central Bank of Ireland to increase the resilience of the financial and household sectors to future credit-fuelled property price rises. Failing a stronger supply response however, prices look set to increase further. This could hamper competitiveness and make it difficult to afford housing. In May 2014 the authorities launched Construction 2020, a strategy for the construction sector. It addresses aspects such as planning, financing, taxation, standards and enforcement. Legislative proposals include a special levy on vacant sites in urban areas and ’use it or lose it’ planning permissions for developers. The government has also released additional funding to increase the supply of social and affordable housing and committed itself to earmarking EUR 2.2 billion for this purpose in the next three years. The introduction of real estate investment trusts ([9]) as investment vehicles whose shares can be traded freely also seems to have attracted new funds. This provides additional liquidity for the commercial real estate sector.

General government debt and deleveraging

Government gross debt is very high but has started to decline. For the first time since 2007, gross general government debt is estimated to have fallen to 110.8 % of GDP in 2014, down from 123.3 % of GDP a year before. The sharp drop is largely due to the liquidation of the Irish Bank Resolution Corporation ([10]). Based on the European Commission winter 2015 forecast, the debt-to-GDP ratio is projected to further decrease to around 110.3 % in 2015 and to 107.9 % in 2016 (Graph 2.1.7). This assumes robust economic growth of more than 3 % and a sizeable primary surplus of around 0.9 % of GDP in 2015 and 0.8 % of GDP in 2016. The debt projections are sensitive to variations in economic growth and to the expected size of the budgetary adjustment. Interest rate risks are low due to prudent debt management and low future refinancing needs.

Graph 2.1.7: Contribution to change in gross government debt

(1) Stock-flow adjustments include Irish Bank Resolution Corporation consolidation, banks supports funded by the National Pension Reserve Fund and bank support measures Source: European Commission

Gross government debt is largely long-term and at low interest rates. Of gross government debt, 89.3 % has a residual maturity of more than one year. Around 33.4 % of that represents official loans from the EU-IMF programme partners (Graph 2.1.8). As of the end of 2014, average debt maturity was about 12 years ([11]). The average effective interest rate on government debt is estimated to be around 3.5 %. Compared to that of other EU Member States, this low rate reflects the high share of official debt and the currently very favourable market conditions in combination with long-dated government bonds at floating interest rates.

Graph 2.1.8: Breakdown of gross government debt (end of December 2014)

(1) Short-term debt is debt with a residual maturity of less than one year Source: Irish Department of Finance

The maturity profile and the interest burden are expected to improve further with the refinancing of IMF loans. In 2014, the Irish authorities requested a waiver of the proportional early repayment clause in its loan agreements with the IMF and EU lenders to make an early repayment of XDR 15.7 (EUR 19.6 billion) of IMF loans. The request was motivated by the fact that market rates had fallen well below the interest costs on existing IMF loans (Graph 2.1.9). The EU lenders granted the waiver in December 2014. Ireland repaid EUR 9 billion of IMF loans in December 2014 and EUR 3.5 billion in February 2015. The Irish authorities expect to conclude the planned reimbursement by the end of 2015.

Graph 2.1.9: Average effective interest rates on government debt (2014)

Source: European Commission

The authorities estimate savings on interest expenditure to be over EUR 1.5 billion over the lifetime of the reimbursed IMF loans, including hedging costs. The IMF loans are being replaced by government bonds with longer maturities (Graph 2.1.10). The National Treasury Management Agency raised EUR 3.75 billion from a new 15-year bond in November 2014 and EUR 4 billion in 30-year bonds in February 2015, at a yield close to 2 per cent. It plans to issue an additional EUR 8-11 billion of long-term bonds in 2015, including provisions for the remaining early repayment of IMF loans.

Graph 2.1.10: Maturity profile of Ireland’s long-term marketable and official debt (end of December 2014)

(1) *Bilateral loans were provided by the United Kingdom, Sweden and Denmark. **European Financial Stability Facility loans reflect the maturity extensions agreed in June 2013. ***European Financial Stabilisation Mechanism (EFSM) loans are also subject to a seven year extension. It is not expected that Ireland will have to refinance any of its EFSM loans before 2027. However, the revised maturity dates of individual EFSM loans will only be determined as they approach their original maturity dates. The original EFSM maturities are reflected in the table above. Source: NTMA

Sustained economic growth and further improvement of the budget balance are needed to keep the debt-to-GDP ratio on a firm downward path. The European Commissionʼs latest debt sustainability analysis ([12]) shows that in the absence of further consolidation measures in 2016 and beyond, the general government debt-to-GDP ratio would stabilise at above 107 % (Graph 2.1.11). Under the Stability and Growth Pact scenario ([13]), i.e. assuming that the Irish Government complies with all the requirements of the Pact, gross government debt is projected to decline to around 80 % of GDP by 2025. Though still high, this is an improvement on earlier forecasts, mainly because of a stronger growth outlook and higher primary budget balances.

Long-term sustainability of public debt implies achieving significant primary surpluses. The Stability and Growth Pact scenario under the debt sustainability analysis is contingent upon Ireland sustaining structural primary surpluses of about 3 % of GDP (Graph 3.1.12). A robust fiscal framework would support such a path. While it did much to improve the fiscal framework and the quality and timeliness of fiscal data under the EU-IMF financial assistance programme, multi-annual expenditure ceilings are still open to discretionary changes (Section 4.3).

The sustainability of government debt remains vulnerable to macro-shocks. The European Commission’s debt sustainability analysis also assesses the sensitivity of debt projections to changes in key economic variables. It shows that a negative shock to nominal GDP growth of 0.5 percentage points would increase the public debt-to-GDP ratio to about 114 % by 2025 under the no-policy-change assumption. By contrast, the sensitivity of government debt to a rise in interest rates on new borrowing is estimated to be low, given low future refinancing needs.

Graph 2.1.11: Gross government debt projections

(1) The Stability and Growth Pact scenario assumes a structural adjustment path in accordance with the fiscal effort recommended by the Council until the excessive deficit is corrected, and then an annual structural consolidation effort of 0.6 percentage points until the medium-term objective is reached. Source: European Commission

Graph 2.1.12: General government balance and real GDP growth

(1) The Stability and Growth Pact scenario assumes a structural adjustment path in accordance with the fiscal effort recommended by the Council until the excessive deficit is corrected, and then an annual structural consolidation effort of 0.6 percentage point until the medium-term objective is reached. Source: European Commission

Costs associated with demographic trends will put pressure on public finances. A progressively ageing population will be a feature of the next few decades. The proportion of Irish people aged 65 and over is expected to almost double by 2045. The combination of higher numbers of older people and falling numbers of people entering the working-age population should result in an increase in the old-age dependency ratio, even though the ratio will be sensitive to migration trends that are difficult to predict in the long run ([14]). These projected changes in the composition of the population could put pressure on public finances, with increasing demands to finance pensions, healthcare and long-term care needs. Pension reforms ([15]) have been implemented since the last age-related expenditure projections carried out jointly by the European Commission and the Economic Policy Committee. They are likely to have a positive impact on the long-term sustainability analysis, which will be updated later this year.

Government contingent liabilities remain significant but are declining. State guarantees were still substantial at 41.4 % of GDP in 2013, compared to the EU average of 9.8 % of GDP. Of these guarantees, 31.1 % of GDP in 2013 were contingent liabilities of the general government related to support granted to financial institutions (Table 2.1.1), compared to 6.4 % of GDP in the EU as a whole. Nonetheless, the ongoing repayment of the government-guaranteed bonds the National Asset Management Agency issued means that contingent liabilities are decreasing.

Table 2.1.1: Government contingent liabilities

Source: Irish Department of Finance

Overall, while the debt-to-GDP ratio has started to decline there are still challenges to the long-term sustainability of public finances. Based on current information, the Irish Govermentʼs budgetary targets for 2015 and beyond are in line with the Council Recommendation, and would ensure a declining debt-to-GDP ratio. However, debt projections are fairly sensitive to growth shocks and possible deviations from the fiscal adjustment path. An ageing population is also projected to increase health care and long-term care costs.

Banking sector restructuring

Ireland has made good progress in restructuring, downsizing and recapitalising its domestic banks. It has made good progress in addressing the significant imbalances in the banking sector. Since the end of 2010, two banks were merged and two others resolved. The European Commission has approved the restructuring plans of the two largest main domestic banks, Allied Irish Bank (AIB) and Bank of Ireland (BOI). All the domestic banks fulfilled stringent conditions to downsize their balance sheets to sustainable levels under the EU-IMF financial assistance programme which ended at the end of 2013. Their total assets have come down from around 220 % of GDP at the end of 2010 to about 158 % of GDP in 2014, with a greater focus on the domestic market. Average loan-to-deposit ratios have decreased from 155 % in late 2010 to 99.5 % in November 2014 (Graph 2.2.1). As a result, banks’ funding profiles have normalised, with stable deposits, full access to markets funding and less reliance on central bank funding (Graph 2.2.2).

Graph 2.2.1: Loan-to-deposit ratio (LDR)

Source: Central Bank of Ireland

Graph 2.2.2: Eurosystem borrowing

(1) Data up to December 2014 (for ES and EL: data up to Nov 2014) (2) *related to monetary policy operations denominated in EUR **total to domestic monetary financial institutions or not further specified Source: National central banks

The profitability of domestic banks continues to improve. In the first half of 2014, Allied Irish Banks and Bank of Ireland became profitable, with post-provision profits of EUR 437 million and EUR 399 million respectively. Over the same period, Permanent TSB reduced its losses before one-off exceptional items to EUR 172 million. Tracker mortgages ([16]) continue to weigh on the bank’s profitability however. Impairment charges have decreased; while operating expenses stayed relatively flat (Graph 3.2.3).

Graph 2.2.3: Components of domestic bank profitability

(1) 2014 figures are annualised Source: Annual and semi-annual reports of Irish domestic banks

The results of the ECB’s comprehensive assessment reflected the domestic banks’ strengthened position (Graph 2.2.4). All the Irish banks passed the asset quality review and the three-year baseline stress tests scenario of the assessment (Table 2.2.1). Only Permanent TSB showed a EUR 855 million capital shortfall in the adverse scenario of the stress test. The adjustments identified in the asset quality review for the Irish banks were modest, since the banks’ balance sheets had already been assessed towards the end of the EU-IMF financial assistance programme. Nevertheless, despite recent declines, the high share of non-performing loans and incidence of mortgage arrears continues to weigh on the Irish banking sector.

Table 2.2.1: Results of the comprehensive assessment

(1) *Static balance sheet approach **Dynamic balance sheet approach (2) CET stands for Common Equity Tier Source: Central Bank of Ireland

Graph 2.2.4: Domestic bank capital positions

(1) CT1 Ratio: Regulatory Core Tier 1 capital to risk-weighted assets Source: Central Bank of Ireland

The restructuring of Permanent TSB continues. To fill the capital gap the comprehensive assessment identified, the bank submitted its capital plan to the Single Supervisory Mechanism for review. Permanent TSB has nine months from the date of publication of the results of the comprehensive assessment to implement the capital plan. The bank has publically stated that recapitalisation will draw on private sources. The Commission is also currently reviewing the bank’s updated restructuring plan. Permanent TSB, 99.2 % state-owned, is taking advantage of the existing strong demand for Irish assets to attract private investors. It is improving its lending margins and prospects for write-backs as the Irish economy continues to recover ([17]). Nonetheless, the bank will have to pay back some of its EUR 2.3 billion of state aid over the coming years and its structural balance sheet issues, with a large amount of low-yielding tracker mortgages, will be difficult for the bank’s management to deal with. Overall, it is expected to tap into the private capital markets in the first half of 2015. However, unlike the other large Irish banks, Permanent TSB’s capital structure will not be very much affected by the gradual phasing out of existing capital instruments such as preference shares or deferred tax assets.

Banking regulation and supervision

The regulatory and supervisory systems have been reformed to address imbalances in banks. In addition to many other key regulatory reforms implemented under the EU-IMF financial assistance programme, 2013 legislation gave the Central Bank of Ireland extensive powers to source information, conduct on-site inspections, issue regulations and take direct remedial and enforcement action. The Central Bank Supervision and Enforcement Act 2013 also gave the Central Bank power to request an independent auditor assessment on banks’ financial accounts. Under the Single Supervisory Mechanism, joint supervisory teams will do the routine supervision of major institutions. The teams will be made up of staff from the ECB and the Central Bank of Ireland.

The phasing in of new capital requirements will challenge the main domestic banks. This is due to their low profitability and the fact that Bank of Ireland, and particularly Allied Irish Banks, have large holdings of deferred tax assets and government preference shares that will gradually be deducted from capital ([18]). Rapid improvements in profitability will be crucial to enable banks to use their deferred tax assets and generate internal capital. Converting existing preference shares into common equity tier 1 (CET 1) eligible instruments (i.e. common shares) could also improve Allied Irish Banks’ and Bank of Ireland’s fully-loaded Basel III capital ratios.

New prudential measures by the Central Bank of Ireland aim to contain mortgage and housing risks. While the national property price index remains 37.9 % below its 2007 peak, house prices are increasing rapidly in Ireland (by 16.2 % year-on-year in November 2014), and especially in Dublin. This is mainly due to supply shortages. The number of loans issued at high loan-to-value ratios has also been increasing recently. The amount of loans issued at over 80 % loan-to-value has increased to 50 % of new loans issued in 2013. Against this background, the Central Bank of Ireland introduced proportionate limits on the amount of new lending at high loan-to-value and loan-to-income levels. It did so to make banks and households more resilient to potential future credit-induced housing bubbles and reduce the risk of borrower default. Following extensive consultation, the final set of rules made certain concessions to first-time buyers ([19]). In the short-term these measures may curtail lending volumes and thus possibly keep bank profitability down. However, over the medium to long term, the housing market should adjust and credit risk should decline.

The setting up of a central credit register continues and will help supervision and credit decisions. The lack of a statutory central credit register in Ireland makes supervision, credit underwriting and internal risk management more difficult in the run-up to a crisis, contributing to the build-up of severe imbalances. The planned introduction of a central credit register continues to progress, albeit slowly. The Credit Reporting Act 2013 was enacted in December 2013. The current timeline envisages the register’s being operational in the latter part of 2016. It will enable lenders to carry out a more thorough evaluation of a borrower’s ability to pay back by providing a database on the total amount of individual and SME debt. The availability of borrowers’ total indebtedness data would also enable the potential introduction of macro-prudential measures involving debt-to-income and debt-service-to-income ratios.

Non-performing loans

The high stock of non-performing loans is slowly declining. They fell to 24.9 % of total loans of the three main domestic banks in the third quarter of 2014, from a high of 27.1 % at the end of 2013. The decrease reflects the improved macroeconomic environment, in particular reduced unemployment, better GDP growth prospects and the improved net wealth of households and companies amid growing asset prices, especially property prices. These variables are generally considered to be the main drivers of non-performing loans.

Mortgage arrears continue to fall steadily. Central Bank of Ireland data for the third quarter of 2014 show that the number of accounts in arrears for over 90 days decreased by 4.5 % quarter-on-quarter. Their value decreased by 3.8 % quarter-on-quarter. However, mortgages in arrears stood at 19 % of total mortgage loan balances in the third quarter of 2014, down from 19.9 % in the third quarter of 2013 (Graph 2.2.5). The persistent increase in the build-up of longest-term arrears (over 720 days) continued, increasing to 9.6 % of total loan balances in the third quarter (from 9.2 % at the end of June 2014). The buy-to-let sub-category remains more problematic with 30.8 % of total balances in arrears in the third quarter. This is higher than principal dwelling houses arrears that stood at 15.7 % in the same period. After recent increases, however, buy-to-let accounts in arrears decreased by 0.4 % quarter-on-quarter in the third quarter of 2014.

The banks continue to meet their mortgage arrears resolution targets. In September 2014, all banks had met and exceeded the target of proposing sustainable restructuring solutions to at least 80 % of mortgage holders in arrears of more than 90 days and concluding 40 % of them. More than the minimum required, in 75 % of concluded solutions, mortgage holders were meeting the terms of the new arrangement. Half of the proposed solutions involved restructuring, while the other half involve legal proceedings that may end in repossession. The number of restructured accounts increased in the third quarter of 2014 by 7.8 % quarter-on-quarter for principal dwelling housing, and 4.8 % quarter-on-quarter for buy-to-let. The number of repossessions in the third quarter increased by almost 7.5 % quarter-on-quarter to 2027 properties (Graph 2.2.6), but remains relatively low, with a greater proportion of buy-to-let properties than primary dwelling housing being repossessed.

Graph 2.2.5: Mortgage arrears

(1) PDH: primary dwelling housing; BTL: buy-to-lets; dpd: days past due Source: Central Bank of Ireland

Ireland has made progress in implementing sustainable restructuring solutions. There are still some discrepancies in the way banks classify restructured loans. An audit was carried out on the Q4-2013 arrears resolution targets outcomes and another audit is being carried on the Q2-2014 outcomes of two banks. They show that there has been a reliance on standard forbearance techniques involving rescheduling principal or interest payments rather than lowering both. Examples include temporary switches to interest-only mortgages, extending the term of the mortgage and arrears capitalisation. The latter type of restructuring has displayed a high propensity to re-default. Banks continue to rely heavily on legal proceedings in concluded solutions as a way of convincing customers in arrears to engage with them. As a result, there have been indications that the courts system is experiencing some backlogs, as shown by the more frequent adjournments and prolonged proceedings. Finally, rising rents have led to more use of rent receivership solutions for buy-to-let loans in arrears.

Graph 2.2.6: Mortgage restructuring

Source: Central Bank of Ireland

Commercial loan restructuring and disposal continue, though they still make up most non-performing loans. The banks are making progress in reaching their non-public commercial loan (including SME) restructuring targets. They aimed to have had almost all of them restructured by the end of 2014. Lenders have noted a recovery of cash-flows in certain SME sectors. The distressed commercial portion of the banks’ loan books is slowly decreasing, through a combination of asset sales, restructures and write-offs. The National Asset Management Agency (the bad bank tasked with the work-out of distressed commercial real estate exposures transferred by banks) is ahead of schedule with EUR 18.7 billion of assets disposed of at the end of December 2014 (about 28 % of which are Irish), taking advantage of strong market demand. The Consumer Protection (Regulation of Credit Servicing Firms) Bill was published in January 2015. The bill aims to address concerns regarding the protection of borrowers when loans are sold to entities unregulated by the Central Bank of Ireland. Under the discussion in the Irish Parliament, the bill would extend the existing protection of borrowers by regulating credit servicing firms. These firms would need to manage or administer the credit agreement with the consumer or SME on behalf of the unregulated buyer.

Overall, Ireland has made some progress in the implementing the Council Recommendations, including those on non-performing loans. As described above, Ireland has made considerable progress on mortgage arrears resolution. However, it has made less progress in developing guidelines on the sustainability of solutions and publishing data on banks’ SME/commercial arrears. Ireland has also yet to develop a strategy to address the issue of commercial real-estate arrears ([20]), although progress with restructuring some of these is being monitored under the commercial loan resolution targets ([21]). The National Asset Management Agency is accelerating asset disposals, taking advantage of strong market demand. The introduction of a central credit register is underway.

Current account and competitiveness

Large current account surpluses have become the norm. The major external imbalances that characterised Ireland in the 2000s seem firmly behind it. Following substantial deficits since 2000, the current account balance has turned positive again since the second half of 2010, driven mostly by increasingly large trade surpluses (graph 2.3.1). A number of underlying factors explain the sharp turnaround, with the large presence of multinational companies in Ireland complicating the understanding of the external accounts. Headline numbers therefore need to be interpreted carefully.

Graph 2.3.1: Current account balances

Source: Central Statistics Office

Competitiveness gains and demand shifts have contributed to external rebalancing. Ireland has long had a very open economy, with exports exceeding 80% of GDP as far back as the late 1980s (graph 2.3.2). The economic boom of the 2000s, however, led to a significant decrease in the export ratio as domestic demand surged to unsustainable levels and the non-tradable sector boomed, undermining the countryʼs competitiveness. The adjustment process of the past few years entailed a significant reallocation of resources away from an oversized construction sector to the tradable sector, a sharp contraction in domestic demand and renewed impetus in exports as a result of competitiveness gains.

Graph 2.3.2: Exports of goods and services

Source: Central Statistics Office

The rebalancing process between the tradable and non-tradable sectors seems to be nearing completion. Indications are that the reallocation of resources has reached a ‘natural’ limit ([22]) sufficient to put Ireland on a sustainable path. Ireland's unit-labour-cost-based real effective exchange rate is now moving broadly in line with Germany but still outperforming the euro area's rate (graph 2.3.3). This contrasts sharply with the period between mid-2008 and mid-2012 when Irelandʼs adjustment was much faster than that of other euro area Member States. With investment and private consumption having now passed their turning point, domestic demand has stopped contracting and the share of net exports in GDP has stabilised at around 22 % (graph 2.3.4). This remains very high by historical standards and could indicate that there may have been some overshooting in the rebalancing process between the tradable and non-tradable sectors.

Graph 2.3.3: Real effective exchange rate, 2005=100

Source: European Commission

Graph 2.3.4: Demand composition of GDP and GDP growth

Source: Central Statistics Office

Ireland continues to draw investments by large multinational companies. The strong export performance over the past few decades owes much to Ireland's ability to attract multinational companies. Exports of pharmaceuticals, information technology, business and financial services for example, represent a large proportion of total exports and are almost entirely driven by multinational companies. However, data on net foreign direct investment inflows need to be interpreted carefully because certain transactions do not generate new operational investments in Ireland. Foreign investments in Ireland have regained momentum in the past couple of years. This is reflected in the number of projects completed with support from IDA Ireland, the entity responsible for attracting and facilitating foreign investment.

Shifts in multinational companiesʼ operations greatly affect Ireland. Business decisions by multinational companies in Ireland are determined not only by country-specific factors, but also by the dynamics of global value chains and regulatory determinants, including in particular the interplay between tax regimes and bilateral tax treaties. Evolutions in global value chains have significantly affected Ireland's economy in the past and will continue to do so in the future, at times bringing about significant changes in the structure of output in a short period of time. ([23]) Multinational companies drive Irleandʼs export performance, provide a significant amount of high-skilled employment and generate a substantial share of national value added, particularly in manufacturing. Their activities also impact Ireland's balance of payments and international investment position to such an extent that it is difficult to disentangle underlying trends from specific issues.

The ʽpatent cliffʼ has been bridged. There were concerns in 2012 and 2013 that the expiration of patents on certain blockbuster drugs could trigger a general decline in the pharmaceutical industry, causing a sharp and sustained fall in exports. The patent cliff did in fact generate a steep drop in exports between their peak in Q2-2012 and the trough in Q3-2013. However, renewed investment and diversification put pharmaceutical exports on a rising trend again throughout 2014, allaying earlier fears (graph 2.3.5).

Graph 2.3.5: Exports of pharmaceutical products

Source: Central Statistics Office

Contracted manufacturing inflates recent export figures. A small number of multinational companies appear to have used contracted manufacturing more in recent quarters. Under such contracts, products manufactured overseas for Irish-resident firms are accounted as Irish exports once shipped to a third country, even if they never transit through Ireland. Although such operations should result in a countervailing service import, they increased the contribution of net exports to GDP in 2014, artificially inflating the current account surplus. This recent development has resulted in a disconnect between customs-based trade data and balance of payments-based data. The difference between net merchandise exports on balance of payments and customs bases, which used to fluctuate around zero, has become significantly positive since the first quarter of 2014 (graph 2.3.6).

Graph 2.3.6: Difference in net exports (balance of payments vs. customs)

Source: Central Statistics Office

The full and medium-term impact of contracted manufacturing remains unclear. The business decisions underlying the rise in contract manufacturing are not entirely known. The extent to which a boost to current account and national accounts data through merchandise trade could/will be counterbalanced by rising services imports is also unclear at this stage. Neither is it known if this situation will be long-lasting or if it could extend to a wider set of companies. In any case, it will be an issue to monitor when analysing future trends in the current account balance, in addition to the impact of re-domiciled public limited companies. ([24])

Services exports have surged, but so have imports. Services export growth has far outpaced goods exports growth in the past few decades as large multinational companies have increasingly used Ireland as a base for providing ICT, business and financial services. Imports of services, however, have increased nearly as rapidly in the same period, with rising payments on royalties and licences. As a result, Irelandʼs balance on services remains in deficit, even though it is now close to balance compared to sizeable deficits during most of the 1990s and 2000s (graph 2.3.7). Its strong merchandise trade performance therefore remains the driving force behind the current account surplus.

Graph 2.3.7: Services exports, imports and balance

Source: Central Statistics Office

Offshore financial services are a strong generator of net exports. Irelandʼs rise as a services exporter must also be considered in the light of the International Financial Services Centre. More than 500 companies operate in the International Financial Services Centre, directly employing over 30,000 people. ([25]) It generated net services exports of around EUR 10 billion in 2012 and 2013, and EUR 7.8 billion in the first three quarters of 2014. In contrast, non-International Financial Services Centre companies generated net imports of services of EUR 16.5 billion, EUR 10.4 billion and EUR 10.8 billion, respectively, in the same periods. Similarly, while International Financial Services Centre companies generate broadly balanced net primary income, the rest of the Irish economy is a large net payer of primary income to the rest of the world. Net non-International Financial Services Centre primary payments represented an average of around EUR 25 billion in 2012–2014, reflecting the high profitability of multinational companies (graph 2.3.8).

Graph 2.3.8: International Financial Services Centre and non-International Financial Services Centre trade in services, primary and secondary income flows

Source: CSO

Irelandʼs current account position is strong. The rebalancing and regained competitiveness of the past few years, together with the economyʼs sound fundamentals in terms of the business environment, the regulatory framework and skills, have led to a robust and lasting turnaround in the current account position (graph 2.3.9). Despite the rise of Ireland as an international services platform, merchandise trade continues to be the driving force behind the current account surplus. Multinational companies also continue to vastly dominate flows in the current and financial accounts. The nature of some of their operations also makes it hard to identify underlying patterns and economic impacts. They also make Ireland more susceptible to potential swings than most other economies.

Graph 2.3.9: Current account balance

Source: Central Statistics Office

External assets and liabilities

Net external liabilities remain large. Ireland had a negative net international investment position of EUR 176.5 billion (about 96% of estimated 2014 GDP) at the end of Q3-2014. This was down from a peak of EUR 204.4 billion (118% of GDP) in Q1-2012 (graph 2.3.10). Although the official sector (government and central bank) accounts for most of this net position, the countryʼs international investment position has developed in contrasting ways in recent quarters. The large multinational companies sector and Irelandʼs International Financial Services Centre also have large gross asset and liabilities positions liable to generate significant swings in the net international investment position, including through valuation effects

Graph 2.3.10: Net international investment position by institutional sector

Source: Central Statistics Office

Public sector debt remains the main reason for Irelandʼs negative net international investment position. A large proportion of government debt is held abroad, either by foreign bond holders or as debt owed to official creditors, mainly the European Financial Stabilisation Mechanism, European Financial Stability Facility and the International Monetary Fund. As of Q3-2014, general government gross external liabilities represented about 73% of estimated 2014 GDP. Although foreign assets partly compensate for this, the general governmentʼs negative net international investment position is significant enough that it accounts for most of the overall position.

General government external liabilities are stabilising. Given the openness of Irelandʼs economy, including in terms of access to financial markets for government funding, the general governmentʼs large negative net international investment position is unlikely to be reduced at an accelerated pace in the years ahead. Yet, it has stabilised in recent quarters on the back of declining government deficits and the emergence of a small primary surplus in 2014. It is expected to fall only gradually in the coming years, in line with Irelandʼs efforts to ensure long-term fiscal sustainability and put public debt on a firm downward trajectory (Section 3.1.1). The composition of this debt, however, will again shift towards liabilities towards private creditors. The early repayment of XDR 15.7 billion of loans to the International Monetary Fund will speed up the process this year.

Target 2 balances fall. In contrast with the general government, the Central Bank of Ireland has sharply reduced its net and gross external liabilities, mainly Target 2 balances ([26]).This was made possible by the end of the emergency liquidity assistance provided to domestic banks, the conversion of promissory notes, the near-completion of the deleveraging process of domestic banks and regained access to international financial markets for the government and domestic banks alike. As of the end of 2014, Target 2 balances amounted to EUR 40.9 billion, down from a peak of EUR 162 billion at the end of 2010 (graph 2.3.11).

Graph 2.3.11: Target 2 balances

Source: Central Bank of Ireland

The net international investment position of domestic banks is stabilising. Before 2007, domestic banks had accumulated large external liabilities that enabled them to fuel the housing market boom and acquire assets abroad. The restructuring of the banking sector in recent years has caused a rapid fall in the external assets and liabilities of domestic banks, including by transferring some positions to the public sector. The external liabilities of domestic banks stabilised in the first three quarters of 2014 at around EUR 110 billion, a third of their position at the end of 2009. External assets also stabilised and shrunk in similar proportion, from EUR 251 billion to around EUR 85 billion (graph 2.3.12). Once an important force behind the evolution of Irelandʼs international investment position, domestic banks have therefore become significantly less so.

Graph 2.3.12: External assets and liabilities of domestic banks

Source: Central Statistics Office

Business entities outside the International Financial Services Centre have broadly compensating net international investment positions. Non-bank financial intermediaries outside the International Financial Services Centre, including insurance companies, owned net external assets worth EUR 75 billion at the end of Q3-2014. This position has been relatively stable in the past few years, with external liabilities typically small. In contrast, the net international investment position of non-financial companies (mainly multinational companies) has been negative in the past few years (graph 2.3.13).

Graph 2.3.13: International investment position of non-financial companies and non-bank financial intermediaries (outside the International Financial Services Centre)

Source: Central Statistics Office

The external positions of multinational companies are very large. The net international investment position of the corporate sector outside the International Financial Services Centre (mainly multinational companies) has been negative in the past few years, but decreased to EUR 54 billion at the end of Q3 2014. This is mainly because multinational companies finance most of their Irish operations abroad, including through intra-company loans and reinvested earnings. In contrast to that of non-bank financial intermediaries, their net position hides much larger assets and liabilities, amounting to almost 300 % of GDP (graph 2.3.14). The size of their liabilities relative to the Irish economy, together with their large external assets, also show that multinational companies use Ireland to finance operations in the rest of the EU. It is therefore not possible to distinguish the amount of net liabilities that are directly related to Irish-based operations only.

Graph 2.3.14: International investment position of non-financial companies

Source: Central Statistics Office

The nature of the external assets and liabilities of multinational companies differ. As of Q3-2014, resident entities outside the International Financial Services Centre held most of their assets abroad in the form of direct investments (64.9 % of the total), including intra-company loans. The re-domiciliation of public limited companies contributed to increasing resident holdings of direct investment abroad, but the situation now appears to have stabilised. Portfolio investments, in turn, accounted for another 20.3 % of resident's external assets. Direct investment accounted for only 25.9 % of total liabilities, with more volatile portfolio investments and other forms of instruments accounting for 59.9 % and 34.7 % of the total, respectively. This type of mismatch between assets and liabilities could potentially expose Ireland to risks related to the transactions of multinational companies.

The gross positions of the International Financial Services Centre swamp those of the rest of the economy. External assets and liabilities of the International Financial Services Centre are exceptionally large in relation to the size of the Irish economy. As of Q3-2014, gross external assets and liabilities each represented almost 1500 % of GDP, by far exceeding even the positions of non-International Financial Services Centre multinational companies. The net position has nevertheless remained relatively small over the past few years, hovering around plus and minus 15 % of GDP (graph 2.3.15). As a result of the type of activities by International Financial Services Centre companies, external assets and liabilities are mainly held as portfolio investments. ([27]) The nature of portfolio holdings makes asset price variations more likely and potentially larger than for other types of assets. The size of gross positions means that relatively modest variations in asset prices are susceptible to have a significant impact on Irelandʼs overall net international investment position. However, the Irish economy and its external accounts are by and large sheltered from such variations as assets and liabilities refer to foreign entities.

Graph 2.3.15: International investment position of International Financial Services Centre

Source: Central Statistics Office

Graph 2.3.16: International investment position of non-International Financial Services Centre sectors

Source: Central Statistics Office

The core net international investment position has strengthened recently. Abstracting from the holdings of the International Financial Services Centre, Ireland's net international investment position strengthened significantly over the past few quarters, falling from a negative position of 124.2 % of GDP in Q2-2012 to 76.7 % of estimated GDP in Q3-2014 (graph 2.3.16). This is consistent with the significant rebalancing of the economy in the aftermath of the crisis and the remarkable shift from a current account deficit of EUR 10 billion in 20007–2008 to a surplus of EUR 7.7 billion in the first three quarters of 2014. The remaining sizeable negative net international investment position is mostly due to the legacy effects of the economic and banking crisis on government external debt. It should fall in parallel with Irelandʼs efforts to reduce fiscal imbalances by moving back towards the 60 % of GDP debt rule under the Stability and Growth Pact.

The labour market continues to adjust. The crisis caused large-scale unemployment with associated adverse social consequences. The rebalancing between the tradable and non-tradable sectors has created skills mismatches that risk increasing structural unemployment. The authorities have dealt with the situation by putting active labour market policies in place, revamping the further education and training sector and stimulating job creation.

Labour market challenges and rebalancing

The collapse of the property market and the ensuing financial and economic crisis led to a sharp deterioration in labour market indicators. Unemployment surged from an average of 4.1 % in 2000–07 to a peak of 14.9 % in early 2012.

The labour market reached a turning point in 2013 with renewed job creation in the private sector, modest rises in participation levels and modest falls in the unemployment rate. These improvements continued in 2014 with the employment rate (15-64 age group) at 62.2 % in Q3-2014, up just over 1 percentage point from 2013. The unemployment rate (15-74 age group) fell from 13.1 % in Q3-2013 to 11.4 % in 2014. Long-term unemployment has fallen gradually with the strengthening of the labour market, although it remains high at 7 % in 2014. Youth unemployment (15-24 age group) has fallen significantly from its peak of 33 % in mid-2012 to 21.9 % in Q4-2014. The number of young jobseekers (15-24) with very low skill levels has also fallen from 50.4 % in 2012 to 40.8 % in 2013 is a positive development. The situation is also improving for young people not in employment, education nor training, with the rate dropping from 18.7 % in 2012 to 16.1 % in 2013. These improvements in labour market indicators are encouraging signs that the policy measures put in place over the past few years are paying off. At 10.7 % (15-74 age group) in Q4-2014, however, the unemployment rate is still more than double its pre-crisis level (Graph 2.4.1).

Graph 2.4.1: Unemployment rate, long-term unemployment rate and youth unemployment rate

Source: European Commission

The adjustment of the Irish labour market has been supported by both migration and wage developments. In the run-up to the crisis strong labour demand attracted significant labour migration. In contrast, the proportion of foreigners born in another Member State in the working-age population decreased between 2008 and 2013. Partly as a result of this, the total working-age population has decreased since 2009 (Graph 2.4.2).

Graph 2.4.2: Working-age population, active and employed people

Source: European Commission

Wage developments also supported labour market adjustment. While in the pre-crisis period Irish wage increases were among the highest in the EU, its post-crisis adjustment has also proceeded rapidly. As a result, the accumulated growth of Irish nominal unit labour costs between 2000 and 2014 matches the euro area average (Graph 2.4.3).

Graph 2.4.3: Nominal unit labour costs, total economy

Source: European Commission

Long-term unemployment remains a serious concern, with the risk that cyclical unemployment could become structural. Long-term unemployment has fallen with the strengthening of the labour market, but it remains high at 6.6 % in Q3-2014, representing almost 60 % of total unemployment. Almost 5 % of the workforce has been out of work for more than 24 months. This partly reflects the difficulties that redundant workers with construction-sector skills have in transferring to other types of employment. It is also a mechanical consequence of the gradual nature of the recovery following a period of severe job-shedding during the downturn. The high prevalence of long-term and very long-term unemployment means that the workers affected are at great risk of losing tangible and intangible skills. This could have a lasting effect on their ability to regain employment.

Despite recent improvements, important challenges remain in relation to youth unemployment. The youth unemployment rate and the rate of people who are not in employment, education or training are still very high and above the EU average. Additionally, among those who are not in employment, education or training, a rising proportion is also not active in the labour force ([28]). A worrying trend in the Irish youth labour market is the increase in involuntary part-time work, which stands at 41.4 % of those aged 15-24 in temporary employment (compared with 37.5 % in the EU as a whole). This trend, along with a 20 percentage points increase in part-time employment as a percentage of total employment for those aged 15-24 ([29]), points to increasing labour market segmentation for young people.

Unemployment figures understate the effect of the crisis on the labour market since many workers who lost their jobs, especially men, became inactive. The activity rate of men fell by 4 percentage points from its pre-crisis peak to about 78 % in 2014. The activity rate of women held strong through the same period, but its pre-crisis growth has come to a halt. Overall, the number of economically active people has decreased slightly since 2009 (Graph 2.4.4). This partly reflects the decline in the working-age population, but also the withdrawal of some workers from the labour market through discouragement effects.

Graph 2.4.4: Labour market participation rates (ages 15-64)

Source: European Commission

Both the crisis and the recovery affected sectors and skill groups differentially. The crisis hit the construction sector disproportionately. In the first two years of the crisis, some 200 000 jobs were shed in the construction sector. It also affected the public sector, with employment falling by 24 500 (6.2 %) over three years to Q3-2014. A drop of 6 000 jobs occurred in the year to Q3-2014, bringing the total number of employees in the public sector to 370 300. Conversely, the number of employees in the private sector increased by 67 800 over the three years to Q3 2014 with an increase of about 26 000 over the last four quarters of the period. High-skilled sectors of the economy fuelled this growth. The ICT sector in Ireland grew, year-on-year, at a rate of 16 % during the 12 months to July 2014. Professional, scientific and technical activities increased by 5.9 % in the same period.

Skills mismatches have emerged with the rebalancing of the economy. Since the recovery was strongest in skill-intensive sectors, it opened up job opportunities mostly for high-skilled workers. While total employment of those with tertiary education has continued to increase, total employment of those with less than tertiary education has only stabilised during the recovery (Graph 2.4.5). The unemployment rates also show how the different effects of the recovery across skill groups. For those with at most lower secondary education, the unemployment rate was at 21.2 % in Q3 2014. It fell below 14 % for those with upper secondary education and below 7 % for those with tertiary or a higher level of education (Graph 2.4.6).

Graph 2.4.5: Employment by educational attainment

Source: European Commission

Ireland has digital skills gaps. Some 42 % of the workforce has few or no digital skills. Ireland suffers from a shortage of skilled ICT professionals. Demand is high, with over 30 % of companies employing ICT professionals. Supply is not keeping pace with demand. In 2014, over 50 % of companies that recruited or tried to recruit ICT professionals reported difficulties doing so, one of the highest rates in Europe ([30]). Ireland has nevertheless been proactive in addressing its digital skills gaps. With the help of relevant stakeholders, it has developed an ICT Skills Action Plan for the period 2014–18. The three main aims of the plan are to increase graduate numbers, enhance ICT capacity, improve awareness in the education system and attract foreign talent.

Graph 2.4.6: Unemployment rate by educational attainment (ages 15-64)

Source: European Commission

There have been positive developments in basic and tertiary education in Ireland. In the 2012 Programme for International Student Assessment (PISA) tests Ireland scored below the EU benchmark of 15 % for low achievers in reading and science (9.6 % and 11.1 % respectively). It scored slightly above the benchmark in relation to mathematics (16.9 %). Early school leaving has been falling consistently since 2009 (11.7 %) to a rate of 8.4 % in 2013, over 3 percentage points below the EU average of 12 % in 2013. Tertiary education attainment also continues to rise. Ireland’s tertiary education attainment rate for 30-34 year olds was 52.6 % in 2013, up from 51.1 % in 2012. While this represents the highest rate in the EU28, it is still short of Ireland’s Europe 2020 target of 60 % of the 30-34 year old population with a tertiary education qualification by 2020. Enrolments are projected to continue to increase over the next decade as the number of students grows and the national strategy to improve access, flexibility and lifelong learning is rolled out.

At the same time, re-skilling and up-skilling are a challenge for the education and training system. The further education and training system has been ineffective in providing the types of skills that the rebalanced Irish economy needs. It also failed to give the unemployed valuable and relevant re-skilling and up-skilling opportunities. Traditionally, the apprenticeship system in Ireland has been heavily geared towards the construction sector. The authorities have recognised the need to reform further education and training. Reforms have been put in place to ensure the creation of a system that is more responsive and relevant to labour market needs (Box 2.4.1).

It is difficult for lower socio-economic groups to access tertiary education. Young people from a lower socio-economic background are less likely to attend university given poor educational attainment at secondary school. A number of studies ([31]) have looked at the impact of social class on higher education participation. They have found persistent evidence of social inequalities in higher education participation and that financial constraints are a major explanatory factor. The abolition of fees for higher education has not been enough to narrow the social class-related gap in higher education participation.

Policy responses

There are concerns about the effectiveness of existing activation policies and training programmes. The effectiveness of some of the training programmes available to the unemployed is unclear. There is evidence that the largest programme, the Community Employment Scheme, is ineffective. Past participation on Community Employment was found to increase a claimant’s probability of falling back into long-term unemployment ([32]). With respect to JobBridge, existing evaluation evidence points to some positive effects, particularly where training is heavily focused on existing labour market demand ([33]).

Activation policies are underachieving due to limited capacities in the employment service. There are currently around 500 jobseekers per caseworker in the Public Employment Service, a ratio well above what is considered best practice. Allocation of additional resources and efforts to tackle long-term unemployment, through the roll-out of the JobPath initiative, will see the caseload fall closer to 200 cases per member of staff. This will also help to reduce the high rates of households with low work intensity, given 52.7 % of the total unemployed come from such households.

It will still take some time before the first effects of JobPath have an impact on the labour market. Referrals to the providers are expected to start only in the beginning of the second half of 2015. Since a comprehensive monitoring and evaluation framework is being put in place only now, it is difficult to assess ex ante the programme’s effectiveness. It remains to be seen how the private sector approach will differ from that of the Public Employment Services, what profile of claimants they will be working with, and their ability to harness links with employers and provide more effective services (with both activation and social inclusion components). The effective rolling out of the programme to tackle long-term unemployment will be necessary to meet ambitious numerical targets.

More measures need to be implemented, within the Youth Guarantee, to improve the situation of young people. Currently, there is a nine-month waiting period for young people who have been assessed to have a medium or high probability of exiting unemployment. The Council Recommendation on establishing a Youth Guarantee recommends young people receive a good-quality offer of employment, continued education, an apprenticeship or a traineeship within four months of becoming unemployed or leaving formal education to avoid scarring effects. Ireland also lacks a more comprehensive outreach strategy regarding, specifically, people not in employment, education nor training who are not active in the labour force. The data on involuntary temporary employment as a result of employer uncertainty arising from the financial and economic crisis also shows the importance of providing good-quality offers of employment or education, traineeships or apprenticeships relevant to labour market needs and leading to permanent jobs.

Further education, training and apprenticeship reforms are progressing in the right direction. The Further Education and Training Authority, SOLAS, has put a strategy in place to ensure programmes are efficient and relevant, link the provision of training to labour market needs and facilitate the movement of the long-term unemployed back into work. This includes setting up referral protocols between education and training boards and Intreo offices (single points of contact for all employment and income supports). A sound oversight system has been put in place to ensure that the rollout of the strategy and services plan is successful.

Ongoing reforms to the apprenticeship system will continue to be employer-led and should ensure the alignment of education and training provision with the needs of the labour market. The Apprenticeship Council has been given the task of extending apprenticeship opportunities to new sectors of the economy. Currently only a limited number of trades provide apprenticeship opportunities. Carrying out a ‘sustainability test’ that takes into account the evidence of labour market needs and future strategic economic priorities, future demand for apprenticeships and the progression routes for apprentices, should help enhance the labour market relevance of proposals. The first results of this initiative will not be seen before the end of 2015.

Given continued efforts to strengthen the skills base, the implementation of the new Junior Cycle would be a major development in school education. Current proposals would gradually replace the Junior Certificate Examinations with a combination of central assessment and school-based model of assessment with an emphasis on the quality of students’ learning experience. Schools will be expected to deliver a programme that enables students to develop a wide range of skills. These include critical thinking skills and basic skills such as numeracy and literacy. Major changes have been made to initial teacher education programmes, with literacy and numeracy units now part of the national teacher induction programme. School self-evaluation has been rolled out and new requirements have been introduced on standardised testing, including the return of aggregate data to the Department of Education and Skills.

A new national access plan for higher education to increase the participation of disadvantaged students is being drawn up. Due to be finalised in early 2015, it will identify new targets for broadening access and contain recommendations on helping disadvantaged students participate in higher education. They include targeted interventions in disadvantaged neighbourhood schools to increase the numbers of their students attending university and helping those who do make it to university when they get there.

The labour market situation has improved recently. Overall, Ireland has made some progress in addressing the Council Recommendation and the authorities’ efforts to address labour market challenges have started to pay off. Unemployment is on a firm downward trend. The institutional mechanisms are being put in place that should contribute to adequate labour market activation policies and provision of re-skilling or up-skilling training opportunities to address skills mismatches.

Irelandʼs healthcare sector is atypical among EU Member States. Health insurance and the delivery of healthcare are organised under a two-tiered structure of public and private systems. The private system covers the highest share of the population among EU countries for supplementary health services. All residents are eligible for a core set of public services, including hospital care, but full public health coverage is means-tested and restricted to a subset of the population. There are also intermediate levels of public coverage depending on circumstances. This complicates the rules defining entitlements to health services. In addition, there are numerous interactions, both intended and unintended, between the public and private systems. For example, doctors can treat both public and private patients in public hospitals.

Public expenditure on healthcare is comparatively high in Ireland. In spite of the relatively favourable demographics, public healthcare expenditure represented 8.7 % of gross national income in 2012, compared with the EU average of 7.3 %. ([34]) This ratio was down from a peak of 10.0 % in 2009 after years of increases in the 2000s and following efforts to contain healthcare costs as part of the measures to restore the sustainability of public finances (graph 3.1.1). Nevertheless, public healthcare expenditure remains fairly dynamic. In the past several years, outturns regularly exceeded the profiles set out in successive government budget plans.

Graph 3.1.1: Public healthcare expenditure, Ireland and EU

Source: European Commission

Population health outcomes are comparable to those of the rest of the EU. In spite of higher public expenditure on health, population health status indicators such as life expectancy and infant mortality are by and large no better than in the rest of the EU. The number of hospital beds and doctors per resident is comparatively low. A number of observers ([35]) have also independently pointed out that while efficiency gains have been achieved in recent years, the Irish health system may have passed an ʽinflection pointʼ making deeper long-term structural reforms necessary in order to contain expected cost increases.

Demographic trends are set to put additional pressure on health expenditure. While Ireland's demographic structure is currently favourable, its population is ageing rapidly. This will put significant pressure on healthcare expenditure between now and 2060, as recognised in the governmentʼs Comprehensive Expenditure Report 2015 - 2017.

Ireland has begun to implement a wide range of reforms in the healthcare sector. Initial reforms focused on securing savings as part of the fiscal consolidation efforts. In November 2012, the authorities published the Future Health strategy, an ambitious medium-term plan to reform the sector based on four pillars: (1) health and well-being; (2) service reform through an integrated model of care; (3) structural reform; and (4) financial reform. Future Health set an end-goal of transforming the two-tiered system into a system based on universal health insurance partly supported by general taxation.

The transition towards universal health insurance is being slowed down. A White Paper on the subject was published in April 2014, stating the governmentʼs aim to complete the reform by 2019. Since then, the authorities have decided to postpone the introduction of universal health insurance without announcing a new target date. They are still moving ahead with other reforms and the progressive completion of the building blocks for universal health insurance. These include the e-health strategy ([36]), financial reforms, the ʽmoney follows the patientʼ activity-based funding model for hospitals and making savings on public pharmaceuticals expenditure through structural measures. All of these reforms were launched under the EU-IMF financial assistance programme.

Universal health insurance postponement could have consequences for the private insurance sector. There m