May 12, 2021

Washington, DC: The pandemic has had a highly asymmetric impact on the Irish economy. The domestic sector, which is more labor intensive, contracted by about 10 percent in 2020, unemployment reached 30 percent at the peak of the first wave, while the multinational enterprises (MNEs) continued to grow strongly, driving overall GDP growth to 3.4 percent. A swift and comprehensive policy response has been effective in mitigating the crisis impact and protecting households and firms. The recovery is expected to take hold this and next year, but downside risks remain. A premature withdrawal of support should therefore be avoided. However, economic policy needs to strike a balance between providing targeted support to hard-hit sectors and vulnerable groups and facilitating transition to a greener and more digital recovery that limits scarring and addresses Ireland’s medium-term challenges. An inclusive and sustainable recovery will require raising productivity through upskilling and effective active labor market policies, especially for the youth and female workers. Sustained growth will also require more investment in the social and physical infrastructures and alleviating the shortage of affordable housing. These expenditure needs, as well as population aging and the still high ratio of public debt to Modified Gross National Income (GNI*), call for raising additional public revenue after the recovery is complete. It is also important to adapt and gradually withdraw temporary support measures as the recovery takes hold to incentivize transformation and safeguard fiscal sustainability.

The strong growth of MNEs softened the blow to the economy and public finances , making Ireland the only EU country with positive GDP growth in 2020. This was, however, due to an 18 percent growth of MNEs-related activities in the IT and manufacturing sectors (mostly pharmaceuticals). GDP growth for 2021 is projected at 4.6 percent, with domestic activities partly recovering from its sharp decline as containment measures are gradually eased and adaptability to remote working continues to increase. A two-speed recovery remains likely, and there is a need to minimize medium-term scarring and reduce income disparity.

Risks to the outlook stem from uncertainties surrounding the pandemic, execution of post-Brexit trade arrangements, and likely changes in international taxation. The Irish authorities' comprehensive preparations have reduced the vulnerabilities of the sectors most exposed to Brexit. Nevertheless, uncertainties around the non-tariff trade impediments remain a risk given Ireland's strong linkages with the U.K. Changes in international taxation can also affect both the Irish economy and the public finances. Ireland should therefore continue to build on its strong comparative advantages, such as its qualified labor force, strong and stable legal and policy environment, and favorable business climate. Policy action should also focus on enhancing social capital, particularly in education, training, health, housing, as well as digital and other physical infrastructure in order to retain FDI and amplify its positive domestic spillovers.

The comprehensive fiscal policy response made good use of the policy space that was built prior to the pandemic. The fiscal package, with a total envelope of around 10 percent of GDP (18 percent of GNI*) for 2020-21, was similar to that of European peers but had a significantly larger share of direct support. The package included unemployment benefits, wage subsidies, grants, tax deferrals, tax cuts, and loan guarantees. Notwithstanding the large direct support, the overall deficit for 2020 was contained at about 5 percent of GDP (8.4 percent of GNI*) due to the strong growth in corporate income tax intake and resilient personal income tax revenue, thanks to the high progressivity of Ireland’s income taxation. The comprehensive fiscal package was essential to mitigate the fall in incomes of households, improve their debt sustainability, and reduce SMEs’ financial distress. Withdrawal of the support measures should be tapered and gradual to avoid cliff-edge effects. Income support measures should become increasingly conditional on re-skilling and further shift toward subsidizing new hiring in the expanding sectors. Business support measures should also be increasingly targeted to affected but viable firms. Eventually, the tax base will need to be broadened to help finance productivity-enhancing investment in human and physical capital. In this context, we welcome the establishment of the Commission on Taxation and Welfare. The ongoing Spending Review and Performance Budgeting processes , along with the establishment of the National Investment Office, have helped improve spending efficiency. There is a need to further this progress, including by enhancing the implementation of infrastructure projects and the maintenance of public assets.

The CBI's regulatory actions taken in response to the pandemic helped stabilize credit conditions. The CBI complemented the European Central Bank's policy support by releasing the countercyclical capital buffer for banks and set out clear expectations around how the industry-led debt moratoria should operate. Lenders should continue to engage constructively with borrowers in financial distress to ensure that appropriate and tailored solutions to those borrower’s circumstances are in place. Supervisory focus should remain on the timely recognition of problem assets and developing capacity to resolve rising NPLs. The insolvency and bankruptcy systems should be kept under review and enhanced as needed. Over the medium term, cost reduction and greater use of digital technologies could help raise banks' low profitability and reduce lending rates. In the meantime, strategic initiatives recently announced by two banks are likely to lead to their withdrawal from the Irish market. The sustainability of banks business models should continue to be a key supervisory focus, in particular on banks actions to achieve greater cost efficiency.

Continued strengthening of the regulatory framework for investment and money market funds will help mitigate any spillover and potential reputational risks. Although sizeable redemption pressures on investment funds at the onset of the crisis receded quickly, and direct exposures to the domestic economy remain limited, liquidity mismatches and the large absolute size of the sector relative to the domestic economy calls for constant vigilance. We welcome the CBI’s plan to further improve data collection, strengthen risk management across the sector (including a system-wide liquidity risk management), and develop the macroprudential framework in close coordination with other European regulators.

An inclusive and sustainable recovery will require raising labor participation and productivity through better education and vocational training. To minimize the increase in long-term unemployment, active labor market policies should be further strengthened as support measures are withdrawn, including in areas such as re-training and employment placement services. Initiatives such as the online educational portal introduced this year have the potential to efficiently provide upskilling and retraining opportunities. It is also important to empower women to raise their low participation in the labor market, including by continuing to increase the availability of affordable childcare facilities .

Reducing shortages in affordable housing requires a multi-pronged approach . The government’s effort in this regard is welcome but more needs to be done by (i) releasing more land for development; (ii) streamlining approval processes for permits and re-zoning; (iii) assessing incentives to build rental properties; and (iv) increasing supply, including of social housing.

Continued effort is needed to meet the ambitious National Development and Climate Action plans . The recently legislated higher carbon tax, with a trajectory to 2030, will help finance this effort, and sector-specific policies will help reduce the costs and protect vulnerable groups in the transition to greener and more sustainable growth. Policy evolution during the post-COVID recovery provides an opportunity to accelerate the adoption of climate-friendly policies such as (i) boosting public investment in transportation networks and renewable energy; (ii) subsidizing building renovation to achieve greater energy efficiency; and (iii) supporting low-emission agronomic technologies and carbon sequestration including through the restoration of peatlands.

An IMF team conducted virtual meetings during April 26– May 7, 2021. The mission was led by Khaled Sakr and met with Minister of Finance Paschal Donohoe; Minister of Public Expenditure and Reform Michael McGrath; Governor of the Central Bank of Ireland Gabriel Makhlouf; other senior officials; parliamentarians; and representatives of labor unions, the business community, the banking sector, and industry. The mission would like to thank the Irish authorities for the close collaboration and to express appreciation for the candid and insightful discussions.