Analysis of Private Sector Debt in Ireland March 2019 · 3. Analysis of household sector 10 3.1 Overview of household sector 10 3.2 Household debt indicators 12 4. Analysis of corporate

Department of Finance | Analysis of Private Sector Debt in Ireland Page |

Prepared by the Economics Division,

Department of Finance

finance.gov.ie

Analysis of Private Sector Debt

in Ireland

March 2019

Department of Finance | Analysis of Private Sector Debt in Ireland Page | i

Contents

Page

Contents i

Tables and figures ii

Executive summary iii

1. Introduction and background 1 1.1 Introduction 1 1.2 Macroeconomic importance of private sector debt 2 1.3 Macroeconomic Imbalance Procedure

3

2. Development of private sector debt in Ireland 4 2.1 Historical Irish debt levels 4 2.2 Debt-to-GDP ratio 4 2.3 Historical debt levels across the EU 5 2.4 Comparing consolidated and non-consolidated data 7 2.5 Effects of activities of multinational enterprises 8 2.6 The use of GDP vs GNI*

9

3. Analysis of household sector 10 3.1 Overview of household sector 10 3.2 Household debt indicators

12

4. Analysis of corporate sector 16 4.1 Decomposition of Irish NFC debt 16 4.2 Alternative NFC debt indicators

19

5. Alternative benchmarks for private debt 22 5.1 Fundamentals-based regression benchmarking 22 5.2 Prudential threshold 31 5.3 Summary of thresholds

33

6. Future outlook 34 6.1 Recent trends in lending 34 6.2 Future debt capacity

36

7. Conclusion 39

Department of Finance | Analysis of Private Sector Debt in Ireland Page | ii

Tables, figures, boxes and appendices

Page

Tables Table 1 Regression variables 24 Table 2 Prudential threshold estimates 32 Table 3 Summary of private debt threshold estimates 33 Figures Figure 1 Historical debt levels 4 Figure 2 Historical headline debt-to-GDP ratio 5 Figure 3 EU28 debt-to-GDP ratios, 2017 6 Figure 4 EU15 debt-to-GDP ratios over time 6 Figure 5 NFC debt-to-GDP, consolidated and non-consolidated 7 Figure 6 Total debt % of GDP and GNI* 9 Figure 7 Household debt ratios 10 Figure 8 Household debt ratios across the EU28, 2017 11 Figure 9 Household debt per capita across the EU28, 2017 (€) 11 Figure 10 Composition of household credit 12 Figure 11 Debt-to-gross disposable income 13 Figure 12 Household debt-to-assets 14 Figure 13 Household net worth (€bn) 15 Figure 14 Split of NFC debt, 2017 16 Figure 15 NFC debt foreign vs domestic split per cent of GDP and

GNI* 17

Figure 16 NFC debt % of GDP and GNI* 18 Figure 17 NFC debt ratios across the EU28, 2017 19 Figure 18 NFC debt % of gross operating surplus 20 Figure 19 Debt-to-investment (GFCF) 20 Figure 20 Debt-to-financial net worth 21 Figure 21 Benchmark annual change in nominal debt 23 Figure 22 Contributions of fundamentals to household debt 25 Figure 23 Contributions of fundamentals to NFC debt 26 Figure 24 Household debt benchmarks 27 Figure 25 NFC debt benchmarks 28 Figure 26 Total debt benchmarks 28 Figure 27 Household debt-to-GDP benchmarks 29 Figure 28 NFC debt-to-GDP benchmarks 30 Figure 29 Variations on the central benchmark estimate 31 Figure 30 Recent trends in household borrowing, annualised change 34 Figure 31 Recent trends in NFC borrowing, annualised change 35 Figure 32 Credit ratio trend 36 Figure 33 Household debt and debt ratio projections 37 Figure 34 NFC debt and debt ratio projections 38 Boxes Box 1 Fundamentals-based regression methodology 24 Appendix Appendix 1 Breakdown of total Irish debt 41

Department of Finance | Analysis of Private Sector Debt in Ireland Page | iii

Executive Summary

Despite a period of post-crisis deleveraging, Ireland’s stock of private sector debt,

typically measured by the debt-to-GDP ratio at 244 per cent, remains very high by

international and historical standards. In part, this is a result of a substantial

accumulation of debt by households and businesses in the lead up to the financial

crisis, some of which has been unwound, but also as a result of the activities of

multinational corporations. This paper analyses the components and dynamics of

Ireland’s private debt ratio to better understand the macroeconomic risks related to the

current level of debt.

The large multinational presence in the Irish economy creates difficulties in interpreting

both debt and GDP. Corporate debt is significantly inflated by the debt of large

multinational enterprises (MNEs) to foreign counterparties, very often within the same

group, with few linkages to the domestic banking or financial systems. As such, this

debt typically does not represent a significant risk to the domestic Irish economy. This

paper seeks to disentangle these MNE-related distortions to produce a ‘core’, or

underlying, Irish private debt ratio. It is also shown here that GNI* is a more appropriate

denominator for the ‘core’ Irish debt ratio than GDP. The core debt-to-GNI* ratio was

172 per cent in 2017, compared to a headline debt-to-GDP ratio of 244 per cent.

Another key issue with private debt is determining a sustainable level of private sector

debt for an economy. While the EU’s Macroeconomic Imbalance Procedure sets a

debt-to-GDP threshold of 133 per cent, this paper seeks to estimate alternative private

debt benchmarks against which to compare Ireland’s core debt ratio. In particular, a

regression-based methodology developed by the European Commission is used to

estimate bespoke benchmarks for private debt in Ireland, based on fundamental

economic factors, with appropriate adjustments to account for the distortionary impact

of MNE debt.

As the issues relating to household and non-financial corporation (NFC) debt differ

greatly, the two sectors are analysed in isolation as well as combined. For households,

it is found that the level of debt is below the fundamentals-based benchmark, however

Ireland’s households nonetheless remain among the most indebted in the EU, with

pockets of high debt still existing. For NFCs, ‘core’ Irish debt has been broadly in line

with the benchmark on average over the last two years.

The analysis suggests that the relatively high levels of private debt in Ireland that still

prevail after years of deleveraging may be attributable to structural aspects of the Irish

economy, for instance population growth, expected economic growth and equilibrium

unemployment. However, the higher base of private debt that now exists could still

pose a risk to the economy in the event of a future downturn. Indeed even modest

growth in nominal debt would still result in the debt-to-GNI* ratio remaining above the

MIP threshold out to 2023.

Department of Finance | Analysis of Private Sector Debt in Ireland Page | 1

Analysis of Private Sector Debt in Ireland

March 20191

Section 1 – Introduction and background

1.1: Introduction

Household and corporate borrowing plays a vital role in modern economies, facilitating

consumption and investment. In recent years, however, and particularly since the onset of the

financial crisis, private debt levels have soared across many developed countries, Ireland included.

While there has been much focus on the elevated public debt ratio in Ireland,2 particularly when

expressed as a percentage of GNI*, the private debt ratio is also an important economic indicator

to consider. Indeed, it comprises a much larger share of output than public debt (244 per cent vs

68 per cent of GDP, or 396 per cent vs 111 per cent of GNI* in 2017).

This paper takes stock of the current level of private sector debt in Ireland, and how this compares

both historically and internationally. The high levels of both household and non-financial

corporation (NFC) debt that continue to prevail in Ireland will be analysed from a macro point of

view, to assess whether the overall debt burden is high relative to appropriate benchmarks. The

focus here is on the stock of debt, which has significant medium to long-term real economy

implications, rather than flows of debt reflecting shorter-term trends.

To carry out this assessment, two key challenges must be overcome. Firstly, an issue with the

analysis of private debt in Ireland, along with a number of economic indicators, is the impact of

multinational activity on economic data. Disentangling the associated distortions to both corporate

debt levels (the numerator) and GDP (the denominator) is crucial to properly evaluate the domestic

economy debt ratio.

The second issue is the appropriate level of private debt for the economy. Clearly, some level of

debt is necessary, but there is mixed evidence on the level at which debt becomes problematic or

unsustainable. This paper will look at different approaches to estimating this threshold, in both a

country-specific and cross-country manner.

1 This paper was produced by Clíona McDonnell, an economist in the Department of Finance and member of the Irish Government Economic and Evaluation Service (“IGEES”). Unless explicitly referenced by Government decision, any proposal contained in this document does not represent Government policy and should not be represented as such. The analysis and views set out in this paper do not necessarily reflect the views of the Minister for Finance. The author would like to thank colleagues Brendan O’Connor, John McCarthy, Mike Fahy and Luke Rehill in the Department of Finance, as well as Christopher Sibley in the Central Statistics Office and Cormac O’Sullivan in the Central Bank of Ireland. The author particularly acknowledges the contribution of the European Commission’s DG ECFIN, in particular Leonor Coutinho, whose benchmarking methodology and code is utilised in this paper. 2 While this paper is focused on private sector debt, many of the issues also apply to public debt. The Department of Finance’s Annual Report on Public Debt in Ireland 2018 discusses the public debt ratio in detail.


The analysis here is undertaken in the context of the Macroeconomic Imbalance Procedure (MIP),

an EU-level process to identify potential economic imbalances in Member States, in which Ireland

is consistently flagged as having an imbalance in private sector debt. This paper will shed light on

whether this is a genuine imbalance posing a risk to the Irish economy, or simply a reflection of

the globalised nature of the Irish economy.

The remainder of the paper is structured as follows: firstly, this section will explain why private debt

is important to the functioning of an economy and its relevance to the MIP. Section 2 outlines the

developments in Irish private sector debt over time, as well as the problems with the private debt

ratio. Sections 3 and 4 analyse the household and NFC sectors in greater detail and consider

alternative sector-specific debt indicators. In Section 5, alternative benchmarks for appropriate

levels of private debt to those used in the MIP are considered, including regression-based

benchmarks. Recent trends in lending and the possible future development of the debt ratio will

be discussed in Section 6, before Section 7 concludes.

1.2: Macroeconomic importance of private sector debt

Debt has performed an important economic function for both individuals and businesses for

centuries, allowing them to spread and smooth their consumption across time. Debt, or lending,

from the point of view of a bank, creates financial depth. Consumers can purchase assets,

entrepreneurs can start up and established businesses can invest and expand. All of this promotes

economic growth, which means that debt has significant macroeconomic implications. There is a

wide range of literature showing the link between debt and growth. Amongst the most prominent

early examples is work by King and Levine (1993) showing that higher levels of financial

development stimulate economic growth (with financial development closely linked to debt levels).

The problem with high levels of debt is that there is an elevated risk the debt won’t be repaid. If

parties default on debt, banks’ balance sheets will suffer and they may reduce or withdraw lending.

This would then restrain consumption and investment, negatively impacting economic activity. To

avoid this, when debt reaches excessively high levels relative to repayment capacity, it may need

to be reduced. The debt-to-GDP ratio is generally used to measure debt relative to the capacity to

repay across the total economy. Deleveraging of the debt ratio can occur either actively or

passively. Active deleveraging involves a reduction in the nominal value of debt, i.e. be repaying

debt, which reduces the ratio. Passive deleveraging occurs when the nominal value of debt

remains broadly constant, or rises, but growth in GDP results in a reduction in the debt-to-GDP

ratio.

A substantial debt burden can make economies more vulnerable to shocks, for instance from a

global trade war or a high-impact event such as Brexit. It reduces the ability of both households

and corporations to weather reductions in income after a negative economic event, for instance to

maintain consumption and investment or to continue to service existing obligations. This can

magnify shocks and lead to larger swings in economic output.

It is clear that, at some point, debt can have a negative impact on economic growth. The threshold

at which the relationship becomes negative, however, remains under debate. At the low end of


estimates, Arcand et al (2012) estimate that private sector credit above 80-100 per cent of GDP

has a negative impact on growth. At the higher end, Cecchetti et al (2011) estimate that corporate

debt-to-GDP above 90 per cent and household debt above 85 per cent, i.e. total private sector

debt-to-GDP above 175 per cent, would reduce growth. The threshold used in the MIP falls in

between these at 133 per cent for households and NFCs combined.

1.3: Macroeconomic Imbalance Procedure

The Macroeconomic Imbalance Procedure was introduced in 2011 as part of the European

Semester.3 It seeks to identify potential macroeconomic imbalances and prevent their development

across all EU Member States, with the goal of maintaining economic stability in each Member

State, in the euro area, and in the European Union as a whole. A scoreboard of fourteen

macroeconomic indicators is published annually, covering external imbalances and

competitiveness, internal imbalances, and employment and social developments.4

Private sector debt is monitored by two internal imbalance indicators: the stock of private sector

debt and the annual flow of credit to the private sector, both measured as a percentage of GDP.

The threshold set for the stock of private debt, a breach of which causes the MIP scoreboard to

‘flash’ and thus indicate an economic imbalance, is 133 per cent. Ireland has been consistently

flashing on the scoreboard for its private debt ratio after building up high levels of debt in the run-

up to the crisis. This is despite active deleveraging by the private sector since then, with credit

flows well below their 14 per cent MIP threshold, and indeed negative since 2012. This points to

the slow-moving nature of stock variables and the length of the process to reverse such

imbalances. It is the stock imbalance that is the focus of this paper.

The 133 per cent threshold was set based on the 75th percentile of the private debt ratios of EU

Member States over the period 1995-2007, i.e. it was set such that three quarters of the debt ratios

of Member States would be below 133 per cent during those years.5 This is a purely statistical

threshold that, if not arbitrary, at least lacks economic theoretical underpinning. For example, if

there was some overheating in some economies during the relatively short period covered, the

133 per cent threshold would be higher than otherwise. It does not control for the economic cycle

or underlying structural or economic drivers of debt (‘fundamentals’). To address this issue, this

paper will look at alternative thresholds and regression-based benchmarks against which to

evaluate private debt ratios (see Section 6).

3 Further information on the MIP can be found at: https://ec.europa.eu/info/node/4320/ 4 The CSO produces a publication on the MIP scoreboard each year, which can be found at: https://www.cso.ie/en/releasesandpublications/ep/p-macip/macip17/ 5 The threshold was originally set at 160%, based on non-consolidated debt data. A switch to consolidated data was later made, along with excluding financial derivatives, and the threshold was reduced to 133%.

https://ec.europa.eu/info/node/4320/

https://www.cso.ie/en/releasesandpublications/ep/p-macip/macip17/


Section 2 – Development of private sector debt in Ireland

This section firstly examines the evolution of the private debt ratio in Ireland and sets it in an

international context. The Ireland-specific issues surrounding the interpretation of the private

sector debt ratio will subsequently be discussed.

2.1: Historical Irish debt levels

The outstanding nominal amount of private sector financial liabilities, which includes loans and

debt securities, is shown in Figure 1.6 The total value of debt is shown, as well as the breakdown

into the two private sectors, household and NFC. The financial sector is not included in the

analysis, as is typical when considering private sector debt.

Total private sector debt stood at €170bn in 2001, and has generally risen each year, with the

exception of 2009, 2010, 2016 and 2017. The rise in debt since the financial crisis has been driven

by rises in NFC debt due to the effect of multinational firms, most notably in 2015 as a result of

balance sheet relocations, with household debt falling each year since 2008. Developments in both

sectors will be discussed in more detail in Sections 3 and 4.

Figure 1: Historical debt levels, € billions

Source: CSO Institutional Sector Accounts.

2.2: Debt-to-GDP ratio

An examination of the nominal value of debt alone lacks economic context; instead, it is

internationally preferred to express debt as a percentage of GDP (as is the case for public debt).

The debt-to-GDP ratio for Ireland is shown in Figure 2. A comparison of the ratio and the monetary

6 The earliest-available data is from 2001, hence the majority of the analysis in this paper will date from 2001 to 2017.

59 72 88109

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194 203 198 185 179 174 169 159 150 143 140

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900

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Household NFC Total Debt


value of debt in Figure 1 can offer some insight into the drivers of the change in the ratio, namely

changes in debt stocks versus changes in GDP, for both households and NFCs.

The debt-to-GDP ratio follows a broadly similar trend to the absolute value of debt seen in Figure

1. The main differences are, firstly, that the NFC debt-to-GDP ratio declines up to the mid-2000s,

as strong GDP growth outweighed the proportionally smaller accumulation of NFC debt, before

the ratio began rising before the crisis. Secondly, the jump in total and NFC debt levels in 2015

related to the on-shoring of corporate balance sheets was accompanied by a large rise in GDP,

which tempered the growth in the ratios.7 Nevertheless, total debt-to-GDP rose by 28 percentage

points in 2015, and NFC debt-to-GDP by over 50 percentage points.

The chart also shows the 133 per cent debt-to-GDP threshold under the MIP. Ireland’s debt has

been breaching this threshold since the beginning of the debt data series in 2001.

Figure 2: Historical headline debt-to-GDP ratio


2.3: Historical debt levels across the EU

Assessing Ireland’s debt in a European context is instructive; this is done as both a snapshot of

the most recent data, and over time, in Figures 3 and 4, respectively. Figure 3 shows that Ireland

has the fourth highest headline debt-to-GDP ratio in the EU28, behind Luxembourg, Cyprus and

the Netherlands. Herein, however, lies part of the issue with Ireland’s headline private debt ratio:

Ireland appears heavily indebted by EU standards, and indeed compared to advanced economies

7 See Department of Finance (2018a) note on GDP and modified GNI for an explanation of the level shift in GDP that occurred in 2015.

48% 53%61%

70%83%

91% 99%108%

116%110%104% 99% 94%81%

57% 52% 48%

91% 85% 81% 79%88%

99% 100%

128%140%147%

169%181%174%

197%

249%

231%

196%

139%137%141%149%

170%

191%198%

236%

256%257%274%280%

268%278%

306%

283%

244%

133%

0%

50%

100%

150%

200%

250%

300%

350%

Household % of GDP NFC % of GDP


globally.8 It is also worth noting that the three most indebted EU nations above Ireland all face a

similar issue due to large multinational sectors in their economies. Overall, 12 Member States were

above the MIP threshold in 2017.

Further insight can be gleaned from Figure 4. In the early 2000s, Ireland was above the EU15

median private debt ratio, but within the interquartile range (the 25th – 75th percentile). Although

debt also rose across the rest of the EU in the build-up to the crisis, Ireland began to significantly

diverge post-2009 due to the activities of MNEs, creating a wedge between domestic and headline

debt. A more nuanced approach to evaluating private sector debt that adjusts for the impact of

MNEs is therefore warranted, as will be discussed in Section 2.5.

Figure 3: EU28 debt-to-GDP ratios, 2017

Source: Eurostat.

Figure 4: EU15 debt-to-GDP ratios over time

Source: Eurostat, Department of Finance calculations.

8 Amongst advanced economies, only Hong Kong has a higher debt-to-GDP ratio than Ireland in the IMF Global Debt Database.

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210

260

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EU Interquartile Range EU Median Ireland

MIP Threshold

(133%)


2.4: Comparing consolidated and non-consolidated data

One issue with examining private debt is the use of consolidated versus non-consolidated debt

data. The consolidation of debt figures excludes intra-group lending within companies within a

country, which inflates debt levels.9 In non-consolidated terms, if a subsidiary of a group borrows

from another company within the same group, this loan would show up as a debt owed by a

company in Ireland. In reality, however, this simply reflects company accounting rather than

borrowing from financial institutions and markets.

To address this issue, the MIP scoreboard moved from monitoring non-consolidated debt-to-GDP

with a threshold of 160 per cent to consolidated debt-to-GDP with a 133 per cent threshold in 2014.

It is worthwhile to highlight the extent of the impact of consolidation in Ireland, if only for the fact

that it points to the distorting impact of MNEs on Irish debt data. Figure 5 shows the divergence

between consolidated and non-consolidated NFC debt which became particularly apparent from

2008 onwards, as the multinational sector expanded in Ireland.10 This intra-group lending is so

significant that it accounts for almost 30 percentage points of debt-to-GDP in some years.

However, consolidated data still does not account for intra-group cross-border lending, which will

be elaborated on in the following section.

Figure 5: NFC debt-to-GDP, consolidated and non-consolidated


9 The consolidation issue therefore does not apply to households. 10 The jump in the gap between consolidated and non-consolidated debt in 2008 was also partially due to an additional data source on intra-group lending made available to the CSO.

91%85% 81% 79%

88%99% 100%

128%140%

147%

169%181%

174%

197%

249%

231%

196%

93%86% 82% 81%

89%101%102%

147%

165%171%

194%208%

198%

221%

271%258%

218%

0%

50%

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150%

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300%

Consolidated NFC Debt % of GDP Non-consolidated NFC Debt % of GDP


2.5: Effects of activities of multinational enterprises

It has become apparent in recent years that some internationally-accepted economic indicators do

not accurately reflect underlying Irish economic activity, amongst them GDP and the current

account, as the substantial level change in 2015 showed.

This issue is particularly salient in the realm of private sector debt. To make international

comparisons feasible and thus assess the scale of a country’s debt, absolute levels of debt must

be put in context, specifically in relation to the size of the country’s economy. GDP is typically used

as the scaling factor here, hence the private debt-to-GDP ratio is the most commonly-used

indicator for private sector debt. The problem for Ireland is that both the numerator, the nominal

value of debt, and the denominator, GDP, are distorted by the activities of multinational enterprises

(MNEs).

𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝐺𝐷𝑃 𝑅𝑎𝑡𝑖𝑜 = 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡

𝐺𝑟𝑜𝑠𝑠 𝐷𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑃𝑟𝑜𝑑𝑢𝑐𝑡

Firstly, the headline debt in the numerator is inflated as it includes the large levels of debt of MNEs

in sectors such as technology, pharmaceuticals and aircraft leasing. Due to their corporate

structures, many of these firms hold disproportionately large amounts of debt and assets on the

balance sheets of their Irish subsidiaries, relative to the scale of their Irish operations. Much of this

debt is intra-group, with overseas affiliates lending to Irish subsidiaries within the same corporate

group. This debt is not consolidated out as consolidation only removes within-country intra-group

lending. Other MNE debt is typically owed to foreign banks and financial markets, and does not

generally constitute a burden on the domestic Irish economy, whether to the operations of

companies in Ireland or to the domestic banking system.

Secondly, the GDP denominator is also inflated by MNE activity. Statistical issues including the

treatment of onshoring of intellectual property and contract manufacturing mean that GDP (and

indeed GNI) overstates domestic economic activity in Ireland. If domestic Irish debt were measured

against GDP, the inflated level of GDP would reduce the debt ratio and potentially mask underlying

vulnerabilities in the economy. Instead, GNI*, a modified measure of gross national income that

strips out most of the impacts of MNEs, is the preferred indicator to use as the denominator (as

long as the MNE impact can also be stripped out from the numerator); this will be elaborated further

in the next section.

In summary, both the numerator and denominator are inflated in Ireland’s private debt-to-GDP

ratio. However, it is clear that the distortion to the numerator far outweighs that to the denominator,

such that the headline ratio is much higher than would otherwise be expected. This paper will

attempt to disentangle these distortions in the discussion of the NFC sector in Section 4.


2.6: The use of GDP vs GNI*

GDP is used in the denominator as a proxy for the ability to repay debt, such that the level of output

generated by households and NFCs can essentially fund their debt payments. When considered

in this sense, GDP does not accurately reflect the ability of Irish households and businesses to

repay their debt, particularly in the case of households. To address this, GDP can be replaced with

GNI* to better reflect the output produced by Irish citizens and businesses.

Figure 6 shows the difference in the debt ratio when measured against GDP and GNI*. Looking at

debt on a GNI* basis shows a considerably higher burden, with the debt-to-GNI* ratio 152

percentage points higher than debt-to-GDP in 2017, at 396 per cent. Some of the cross-border

relocation of assets in 2015 led to the debt-to-GNI* ratio rising sharply and diverging even more

significantly from the debt-to-GDP ratio, before falling again in 2016 and 2017.11 This shows,

however, how much the debt-to-GNI* ratio is influenced and inflated by MNE activities; 396 per

cent would be an artificially high debt ratio.

It is clear that GNI* should be the preferred indicator by which to measure Irish debt, both public

and private, as discussed in Department of Finance (2018b). However, MNE debt must also be

excluded from the numerator to ensure that only domestic Irish economic activity is reflected in

both the numerator and denominator, in so far as possible (see Section 4).

Figure 6: Total debt % of GDP and GNI*

Source: CSO, Department of Finance calculations.

11 Revisions to GNI* and private debt by the CSO saw 2016 debt-to-GNI* rise from 405% to 440%, however, highlighting the sensitivity of the debt ratio and the caution that must be used when interpreting debt ratios in Ireland.

139%137%141%149%170%

191%198%

236%256%257%

274%280%268%278%306%

283%

244%164%166%166%176%201%

223%236%

283%

323%334%

370%387%

352%366%

498%

440%

396%

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300%

400%

500%

600%

Total Debt % of GDP Total Debt % of GNI*


Section 3 – Analysis of household sector

This section will consider the debt levels of the household sector in more detail, including the use

of alternative indicators. It is important to note that the discussion in this paper pertains to

aggregate levels of household debt; the distribution of debt across households is not the focus.

There are undoubtedly pockets of high debt amongst certain cohorts and households that are

hidden by the aggregate data. As such, any conclusions on the macro risks posed by household

debt should not be taken to imply that micro risks, where there are concentrations of high debt, do

not exist.

3.1: Overview of household sector

Figure 7 charts the evolution of household debt-to-GDP and GNI* over time. It is clear that for

households, debt should be benchmarked against GNI* rather than GDP, as the inflation of GDP

due to multinational activity is not relevant to the capacity of the household sector to repay its debt.

While both indicators can be seen to have peaked in 2009, household debt-to-GDP is now broadly

back to pre-crisis levels, with households actively deleveraging since 2009. Despite this, however,

debt-to-GNI* remains relatively high at 77 per cent.

Figure 7: Household debt ratios


Ireland’s household debt is also high relative to EU peers. Figure 8 shows Ireland has the 6th

highest household debt ratio in the EU, when measured on a GNI* basis. A similar picture is

48%53%

61%

70%

83%

91%99%

108%116%

110%104%

99%94%

81%

57%52%

48%

57%64%

71%

83%

98%

107%

117%

129%

147%143%141%137%

123%

107%

93%

81%77%

0%

20%

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60%

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100%

120%

140%

160%

Household % of GDP Household % of GNI*


portrayed in Figure 9, which shows that Ireland also has the 6th highest level of household debt

per capita in the EU, at €29k per person.

Figure 8: Household debt ratios across the EU28, 2017


Figure 9: Household debt per capita across the EU28, 2017 (€)


The composition of household debt is important to consider; the risks related to high levels of debt

depend, to an extent, on the quality of the debt, notwithstanding the legacy issue of non-performing

loans. Mortgages, as they are secured against property, are generally low risk, and as such carry

low interest rates for borrowers, while unsecured loans or consumer credit, for example for car

purchase or home improvements, are riskier and require higher interest rates. While macro data

on total household debt owned by Irish households is not broken down by loan type, data on credit

0%

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60%

80%

100%

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0

10,000

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70,000

EU Median

(50%)


extended by Irish financial institutions to Irish households offers a good proxy for total debt.12

Figure 10 shows that mortgages comprise the vast majority of household borrowing, 83 per cent

of household credit. This means that the majority of household credit is low risk and of a secured

nature, and therefore presenting a lower risk to banks and a lower debt servicing burden for

households, relative to other types of household debt.

Figure 10: Composition of household credit

Source: Central Bank Money and Banking Statistics, December 2018.

3.2: Household debt indicators

As GDP is an aggregate measure of all activity in the economy, it represents far more than the

household sector alone. As such, looking at household debt-to-GDP or GNI* ratios in isolation

does not give a full picture of the burden of debt on households. In the Irish case, this burden would

be understated. To better understand the possible strain on households, therefore, it is important

to also examine other metrics.

Disposable income is an obvious choice for a more representative denominator for households; it

speaks to the repayment capacity of households. Indeed, debt-to-disposable income is often used

as the primary indicator of household indebtedness. A high ratio of debt-to-disposable income

would indicate that households may, on average, have taken on more leverage than they can

service at their current income levels. This would also leave them exposed to rises in interest rates.

12 This would not include household borrowings from ‘other financial intermediaries’ (OFIs), which includes mortgages that have been securitised or that have been sold by banks to asset management companies, as well as any borrowings from NFCs, non-resident financial institutions and general government. Debt to OFIs comprises the majority of the difference between the €90bn of credit extended to households by domestic banks and the €140bn of debt owed by households in 2017.

Mortgage83%

Other2%

Consumer Credit <1 yr

3%

Consumer Credit 1-5 yrs9% Consumer

Credit >5 yrs3%

Consumer Credit15%

Mortgage Other Consumer Credit <1 yr Consumer Credit 1-5 yrs Consumer Credit >5 yrs

Total household credit from Irish credit institutions: €91bn


If debt and interest payments are absorbing a large proportion of households’ disposable income,

their consumption will be constrained, which in turn has consequences for the macroeconomy.

Figure 11 shows Ireland’s debt-to-gross disposable income (GDI) since 2001, and also sets it in a

European context.13 Debt-to-GDI peaked at 212 per cent in 2009 and has since fallen to 126 per

cent in Q3 2018, back to its 2003 level. However, it can also be seen that even in 2001, Ireland’s

debt-to-GDI was above the 75th percentile of EU Member States, and close to double the EU

median. Ireland currently has the fourth highest debt-to-GDI in the EU, behind Denmark, the

Netherlands and Sweden. Compensation of employees, i.e. wages, is the primary driver of

disposable income and follows a very similar pattern, both for Ireland and the EU.

It is apparent that Ireland’s household debt levels have been high by European standards for some

time. This begs the question of why. The high debt-to-income ratio shows that it is not the case

that Irish households have higher incomes and thus borrow more, but household debt levels can

depend on a number of other factors, including demographics, the pension system and culture

(including preferences for home ownership). Are there structural factors that have caused Irish

households to take on more debt, or does this simply reflect more risk-taking amongst Irish

households? Although this question is complex and beyond the scope of this paper to fully answer,

Section 5 will attempt to address it by looking at economic fundamentals that are generally

understood to determine the accumulation of household debt.

Figure 11: Debt-to-gross disposable income

Source: Eurostat, Department of Finance calculations. Q3 2018 data for Ireland taken from Central Bank Quarterly

Financial Accounts. Data for Bulgaria, Greece, Croatia, Malta, Poland and Romania is not available.

In the private sector, debt is generally used to finance the purchase of assets. In the case of

households, these assets are predominantly housing, and in the case of corporates, they can

include both tangible and intangible assets ranging from machinery and stock to intellectual

13 Household GDI is equal to gross income minus net current transfers, including taxes.

98%

112%

126%

147%

172%

192%203%201%

212%207% 208%

195%190%

177%

160%

147%

133%126%

0%

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200%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Q318



property. It is also true that solvency depends on more than simply income; overall financial wealth

is important. A household (or firm) facing a loss of income that is rich in assets may be able

maintain solvency, hence it is useful to look at debt relative to assets and overall financial net

worth.

Figure 12 shows that the debt-to-assets ratio in Ireland has also recently returned to 2003 levels,

having peaked in late 2011. Household net worth is charted in Figure 13 and paints a similar picture

in that net worth has also recovered from crisis-era levels, standing at €769bn in Q3 2018. The

problem with both of these metrics, however, is that they are both heavily influenced by house

prices. For instance, the 8 per cent rise in net worth in the year to Q3 2018 was almost entirely

driven by a 9 per cent rise in the value of housing assets. Most of the fall in net worth during the

crisis was due to the collapse of property prices, while much of the recovery in net worth is due to

the subsequent rise. While rising house prices are highly correlated with rising household debt as

households borrow primarily to purchase houses, house prices are also volatile. If house prices

fall, the value of household assets will fall, without a corresponding fall in the value of the debt they

owe, putting substantial downward pressure on household net worth, and thus solvency.

Figure 12: Household debt-to-assets

Source: Central Bank Quarterly Financial Accounts.

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Figure 13: Household net worth (€bn)

Source: Central Bank Quarterly Financial Accounts.

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3

Financial Assets Liabilities Housing Assets Net Worth


Section 4 – Analysis of corporate sector

Here, the debt of the non-financial corporation (NFC) sector will be explored further, particularly

the portion of debt attributable to non-Irish companies.

While some level of corporate debt is important as firms borrow to fund investment, over-

indebtedness of firms can be problematic, particularly during a downturn. Firm profits can be

consumed by debt and interest payments and firms’ ability to borrow to continue operating or invest

is constrained. In this section, NFC debt relative to measures such as firm investment will be

analysed, as well as relative to other Member States.

4.1: Decomposition of Irish NFC debt

In Section 2, the high levels of headline NFC debt were illustrated. As discussed, however, these

figures are heavily distorted by the MNE presence in Ireland.

Using recently available data from the CSO, the debt attributable to multinationals that represents

little risk to the real Irish economy can be stripped out to estimate an underlying Irish NFC debt

figure. Figure 14 presents this breakdown of NFC debt in Ireland by borrower and counterparty

location. The first two categories, ‘Irish Parent - Irish Debt’ and ‘Irish Parent - Rest of World (ROW)

Debt’ are indisputably part of ‘core’ Irish debt. They relate to borrowings of Irish companies from

both domestic banks and financial institutions and from international banks and financial markets,

respectively.

Figure 14: Split of NFC debt, 2017

Source: CSO Macroeconomic Scoreboard 2017, Department of Finance calculations. Figures represent

percentages of total NFC debt.

The next category, ‘Foreign Parent – Irish Debt’ is less straightforward. This debt predominantly

relates to foreign companies with (at least) two subsidiaries registered in Ireland, one performing

an operational function (e.g. manufacturing) and the other a corporate treasury function, e.g.

Irish Parent(Irish Debt)

15%

Irish Parent(ROW Debt)

15%

Foreign Parent(Irish Debt)

7%Foreign Parent

(ROW Debt)50%

Redomiciled PLCs13%

Total NFC debt: €576bn


managing the company’s cash and investments. In this case, the treasury is the Irish counterparty

and the debt is effectively intra-group lending, but is not consolidated out in the data as the two

subsidiaries are technically operating in different economic sectors (non-financial and financial

corporations). As such, this debt relates neither to Irish companies nor Irish financial institutions

and will be excluded from core Irish debt. The ‘Foreign Parent – ROW Debt’ category clearly relates

to the debt of multinational firms borrowing internationally or from overseas affiliates and is

excluded from core Irish debt. The same applies to redomiciled plcs, essentially firms with

headquarters in Ireland but without substantial economic functions here.14

Core Irish NFC debt should therefore only include the ‘Irish Parent – Irish Debt’ and ‘Irish Parent –

ROW Debt’ categories. This debt comprises less than a third of total NFC debt, or 59 per cent of

GDP in 2017. Benchmarking core Irish NFC debt against GDP would be inconsistent and

disingenuous, however, as the activities of MNEs would then be included in the denominator but

not the numerator.15 As GNI* is the preferred measure of Irish economic activity, the debt-to-GNI*

ratio of 95 per cent is the best estimate of the true core Irish NFC debt ratio. While it is possible

that this figure may not fully represent the debt of all firms that poses a risk to the Irish economy,

it is a close approximation and is far more informative than the headline NFC debt ratio.16

Figure 15: NFC debt foreign vs domestic split % of GDP and GNI*

Source: CSO Macroeconomic Scoreboard 2017, Department of Finance calculations.

14 Further information on redomiciled plcs in Ireland published by the CSO can be found here: https://www.cso.ie/en/releasesandpublications/in/rpibp/redomiciledplcsintheirishbalanceofpayments2017/ 15 Conversely, measuring headline NFC debt against GNI* would also be inconsistent, as MNE activity would be reflected in the numerator but not the denominator, and the debt ratio would be overstated. 16 For example, traditionally Irish large firms that are now headquartered abroad but which maintain substantial operations here would be classified as foreign parent firms.

49 50 43 38 33 29

11 15 18 16 26 30

42 30 3319 15 14

69 66 77147

12598

9 1325

2832

25181 174

197

249231

196

0

50

100

150

200

250

300

350

400

2012 2013 2014 2015 2016 2017

Debt % of GDP

Irish Parent (Irish Debt)

Irish Parent (ROW Debt)

Foreign Parent (Irish Debt)

Foreign Parent (ROW Debt)

Redomiciled PLCs Total NFC Debt

69 66 57 63 51 47

16 19 23 26 40 48

58 39 44 32 24 23

9687 102

239

195159

12

1733

46

49

41

250229

259

405

359

318

0

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150

200

250

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2012 2013 2014 2015 2016 2017

Debt % of GNI*

Irish Parent (Irish Debt)




Redomiciled PLCs Total NFC Debt

59% 95%


Figure 15 illustrates the split of NFC debt going back to 2012, the earliest available year for this

breakdown, in terms of both GDP and GNI*, while Figure 16 shows a longer historical context. The

rise in NFC debt ratios in recent years has been driven primarily by foreign debt that, broadly

speaking, is not a burden on the Irish economy. Core Irish NFC debt as a share of GNI* has risen

slowly in comparison, by 10 percentage points over the last five years. There has also been a shift

in its composition, with growth in Irish Parent – ROW debt accompanied by a reduction in Irish

Parent – Irish debt. This suggests that, while larger Irish firms with the capability of borrowing

internationally have increased their borrowing, smaller firms who must borrow domestically have

continued deleveraging. This supports the narrative and research that Irish SMEs continue to

deleverage, whether by choice or due to lack of access to bank funding, which in turn could be

constraining investment.17

Figure 16: NFC debt % of GDP and GNI*

Source: CSO, Department of Finance calculations. Note Irish-only NFC debt includes Irish Parent-Irish Debt and

Irish Parent-Foreign Debt, and excludes redomiciled plcs, Foreign Parent-RoW Debt and Foreign Parent-Irish Debt.

The range of NFC debt ratios that can be used to represent Ireland is shown in an EU context in

Figure 17: both headline and core Irish debt, measured against both GDP and GNI*. Ireland’s

performance relative to peers is vastly different depending on the measure chosen. Ireland has

the third highest debt ratio when looking at headline debt-to-GDP, but only the sixth highest using

core debt-to-GNI*. The other countries with the highest ratios also have large levels of international

17 Gargan et al (2018) find that one in five Irish SMEs are unsatisfied with their investment levels, while Lawless et al (2018) estimate that Irish SMEs are underinvesting by approximately 30%. Neither paper, however, finds lack of access to bank funding as the primary reason for this.

91% 85% 81% 79% 88%99% 100%

128%140%147%

169%181%174%

197%

249%231%

196%

108%102% 95% 94%103%

116%119%

154%176%

191%

229%250%

229%

259%

405%

359%

318%

61% 65% 61% 54% 59% 59%

84% 85% 80% 89% 91% 95%

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

NFC % of GDP NFC % of GNI*

Irish-only NFC % of GDP Irish-only NFC % of GNI*


financial or multinational activity, e.g. Luxembourg, Cyprus, Netherlands, and adjustments may be

required to their respective ratios, however that is outside the scope of this paper.

Figure 17: NFC debt ratios across the EU28, 2017


4.2: Alternative NFC debt indicators

A number of alternative metrics by which to measure NFC debt are presented here. With all of

them, however, the numerator issue remains: the headline NFC debt figure is inflated by MNE

debt. As such, where relevant, the indicators are shown here using both the headline and core

Irish debt figure for the available years from 2012-2017.

A sensible benchmark for NFC debt would be firm profits; very high debt relative to profit in normal

times would suggest that debt is unsustainable. Figure 18 shows the headline NFC debt as a

percentage of gross operating surplus (GOS), which approximates firm profits. The ratio in Ireland

rose substantially in 2008, resulting from a combination of a rise in debt and a fall in GOS. Prior to

that, Ireland was in line with the EU median, but since 2008 has been close to the 75th percentile

of EU Member States. The shift in NFC debt in 2015 was accompanied by a proportionately large

rise in GOS, keeping the ratio stable.

These figures, however, are obviously distorted by MNE debt. To attempt to disentangle them,

GOS is split into the profits of ‘large MNEs’ and ‘other NFCs’, with large MNEs comprising 65 per

cent of 2017 GOS.18 Foreign MNE debt (excluding redomiciled plcs, who would not contribute to

GOS) is then measured against large MNE GOS, while the remaining core Irish debt is measured

against other NFC GOS. This breakdown suggests that it is foreign firms, rather than Irish firms,

driving the high debt-to-profits ratio in Ireland relative to European peers, although the two series

18 This breakdown is provided by the CSO. Large MNEs include those companies covered by the CSO’s Large Cases Unit.

318

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209196

148127

10495 93 90 82 80 79 78 75 72 70 69 67 64 61 60 59 56 52 48 47 42 39 34 34

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converged in 2017. While GOS has been rising for both sets of firms, foreign NFC debt has been

falling and Irish NFC debt (borrowing from abroad) has been rising. However, the debt and GOS

categories here do not align perfectly, and it is possible that the Irish debt as a percentage of other

NFC GOS is understated.

Figure 18: NFC debt % of gross operating surplus


Figure 19: Debt-to-investment (GFCF)

Source: Eurostat, Department of Finance analysis.

150%

250%

350%

450%

550%

650%

750%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

EU Interquartile Range EU Median

Ireland Core Ireland Debt % of Other NFC GOS

Foreign Debt % of Large MNE GOS

0x

5x

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20x

25x

30x

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

EU Interquartile Range EU Median

Ireland Core Irish Debt to Other NFC GFCF

Foreign Debt to Large MNE GFCF


Comparing NFC debt to investment, as measured by gross fixed capital formation (GFCF),

provides another alternative. Figure 19 shows the rise in debt-to-GFCF from 2007, i.e. a rise in

corporate indebtedness relative to investment. Ireland was above the EU upper quartile as far back

as 2001, suggesting that Irish firms may be underinvesting in capital relative to the levels of debt

they are taking on. The volatility of this ratio in recent years shows, however, the distortions from

the activities of multinational enterprises. A similar breakdown as above of GFCF into large MNE

and other NFC is applied, with Irish debt as a percentage of other NFC GFCF indeed lower than

the EU median.

It is also useful to look at firms’ net worth, similar to that done for households in Section 3, to show

how solvent or well-capitalised firms are. Data on the stock of non-financial assets is not available

for NFCs, however, so only financial net worth can be considered here. Figure 20 shows the ratio

of debt-to-financial net worth over time and in a European context. Ireland has been above the

75th percentile of the EU since the beginning of the series. While this points to NFCs in Ireland

being heavily indebted, again, the distortions due to MNE activity that have occurred in recent

years could also be masking an improvement in the solvency of Irish firms.

Figure 20: Debt-to-financial net worth

Source: Eurostat.

0%

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100%

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140%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017



Section 5 – Alternative benchmarks for private debt

One of the key issues in the analysis of private debt is the difficulty in estimating the level at which

debt becomes ‘too much’. As previously discussed, the 133 per cent MIP debt-to-GDP threshold

is purely statistical. Benchmarks for private debt ratios based on economic factors would be

preferable, but are difficult to establish. This section looks at such available benchmarks,

particularly focusing on an economic fundamentals-based regression approach. Other

approaches include a prudential threshold which seeks to identify the level above which a banking

crisis is more likely.

5.1: Fundamentals-based regression benchmarking

The primary method considered in this paper for estimating debt benchmarks is the European

Commission’s fundamentals-based benchmarking regression approach.19 The Commission has

developed a methodology to estimate country-specific benchmark levels of private debt, based on

economic fundamentals in that country over time. Structural, or long-term average values, for

explanatory variables are used to strip out the impact of the business cycle and estimate a

fundamental level of debt appropriate to that economy across the economic cycle.

Box 1: Fundamentals-based regression methodology

The model estimates the annual change in the debt-to-GDP ratio in each country based on that

country’s economic fundamentals, starting in 1995. These annual changes are then accumulated to

estimate the benchmark private debt ratio in the current year. Data from a panel of 51 advanced and

emerging economies over the period 1988-2016 are used to perform a generalized least squares

regression (GLS).20 The annual change in the debt-to-GDP ratio is used as the dependent variable

in the regression, with a number of economic factors which would affect private debt used as

explanatory variables. Table 1 describes these variables.

There are two main steps in calculating the benchmarks. Firstly, the GLS regression is performed to

estimate coefficients for the magnitude of the impact each variable has on changes in private debt.

Once these coefficients (common for each country) are estimated, they are applied to underlying

values of the variable for the country of interest in each year. Adding these across all of the variables

gives the estimated benchmark change in debt-to-GDP for each year. To ensure cyclical factors do

not distort the benchmark, structural or average values of the explanatory variables are generally

used, e.g. the average budget balance from 1995-2016, the current account norm rather than the

actual current account value, growth in disposable income rather than actual house prices. The

19 This method was first presented at the Economic Policy Committee’s LIME Working Group in April 2017 (European Commission, 2017a) and updates to the methodology were subsequently proposed in June 2018 (European Commission, 2018). Results have been used in various Country Reports produced by the European Commission, including for Ireland. The prudential methodology was also developed at LIME. Further information on LIME can be found at: https://europa.eu/epc/working-group-methodology-assess-lisbon-related-structural-reforms_en 20 GLS is the preferred specification as there may be autocorrelation in the residual terms. Results for OLS and Prais-Winston (allowing for AR(1) autocorrelation) regressions are also reported in the paper.

https://europa.eu/epc/working-group-methodology-assess-lisbon-related-structural-reforms_en

https://europa.eu/epc/working-group-methodology-assess-lisbon-related-structural-reforms_en


differences between the standard variables used for the regression and the non-cyclical values used

to create the benchmarks are explained in Table 1.

Two main regressions are performed, to estimate benchmark changes in both household and NFC

debt. The results can then be added annually to the debt ratio in the starting period (1995) to create

benchmarks for total private sector debt.21

5.1.2: Predicted changes in private debt

The model predicts an accumulation of debt for each year over the period analysed, 1995-2017.22

Figure 21 shows the benchmark annual growth in the stock of debt compared to the actual change

in debt.23 Benchmark debt rose relatively quickly in the late 1990’s and early 2000’s for both

households and NFCs, with comparably low growth from 2010 onwards. This implies that, in

normal times, as would be expected, there would be no active deleveraging, although the private

debt ratio could still fall if GDP growth is stronger than growth in debt. The actual change in debt

is highly volatile in comparison to the benchmark.

Figure 21: Benchmark annual change in nominal debt

Source: European Commission, Department of Finance calculations.

21 As Irish private debt is only available back to 2001, the data is backcast to 1995 based on the growth of bank credit over the same period. 22 While the Commission’ model runs up to 2016, the benchmark for Ireland has been extended to 2017 in this paper. 23 The nominal change in debt has been calculated by multiplying the change in the debt-to-GDP ratio by GDP in each year.

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Household

Benchmark Change in Debt

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

NFC

Benchmark Change in Debt

Actual Change in Debt Level


Table 1: Regression variables

1. Estimating coefficients

2. Calculating benchmarks

General Description Source

Variable Expected

Sign (Non-cyclical) Variable

5-years ahead growth expectations

+ 5-years ahead growth

expectations Higher economic growth would lead to higher expected returns on investment and higher

house prices, thus more debt accumulation. IMF (WEO), EIU

Unemployment - NAWRU24 Unemployment reduces household income and the associated uncertainty would reduce debt

accumulation. Eurostat and WDI;

Ameco

Current account (CA) per cent of GDP

- Current account norm A CA deficit is associated with financial inflows from abroad that can fuel credit booms. CA norms are CA balances estimated by the Commission based on fundamental rather than

cyclical factors.

Eurostat and IMF; European Commission

Cyclically-adjusted budget balance

+ Cyclically-adjusted

budget balance, 1995-2016 average

A budget deficit is posited to crowd out private investment and thus private debt. Ameco, IMF (WEO),

OECD

Construction investment

+ Long-run equilibrium

value of deprecation and population growth

Captures increases in construction activity, which would increase debt accumulation, not related to property price increases. To remove cyclical effects, the long run value is assumed

to depend on population increases and the stock that needs to be replaced due to depreciation.

Ameco, OECD, UN

Real house price growth

+ Real disposable income per capita growth, 1995-

2016 average

Average growth in income is used as a proxy for house prices as in the long run, sustainable house price growth would be in line with income growth.

Eurostat, BIS; Ameco

Population growth + Population growth25 A larger population demands more housing and is thus associated with higher levels of

household debt. AMECO, IMF WEO, and World Bank WDI

Change in old age dependence

- Change in old age

dependence A higher proportion of the population aged 65+ is associated with less debt as pensioners

typically cannot borrow. Ameco

Credit regulation index

+ Credit regulation index An index capturing the deregulation of banks prior to the financial crisis and increased

regulation post-crisis. It increases as regulation loosens, facilitating more debt accumulation. Fraser Institute

database

Total stock market capitalisation

+ Total stock market

capitalisation, average 1995-2016

A proxy for the equity value of firms, with higher levels of equity allowing them to take on more debt.

World Bank Global Financial Development

Database

Stock market returns + Stock market returns, average 1995-2016

A proxy for the cost of equity versus debt financing for NFCs, with higher returns increasing the cost of equity. For households, higher returns increase financial wealth.

World Bank Global Financial Development

Database

Global risk aversion (VIX index)

- n/a Captures the impact of the global financial crisis. Deviations from the mean of the index are

used, with the mean expected to be zero when cyclical factors are stripped out. Risk aversion is used as a control variable to estimate coefficients but not to calculate the benchmarks.

CBOE VIX index

Source: European Commission, 2018.

24 The NAWRU is the non-accelerating wage rate of unemployment, that is, the unemployment rate at which wage growth is stable, or the structural rate. 25 A Hodrick-Prescott filter is used on population growth to remove short-term cyclical fluctuations.


The impact of each of the variables on the debt-to-GDP ratio each year is shown for households

and NFCs in Figures 22 and 23, respectively. For households, credit regulations, growth

expectations, population growth and unemployment are driving the benchmark changes in debt.

The lower growth in debt-to-GDP from 2010 onwards primarily reflects a rise in the NAWRU and

a fall in population growth. While these are generally regarded as structural rather than cyclical

factors, in the Irish case, they are also known to be linked with the economic cycle.26 Due to the

flexible nature of Ireland’s labour market and the high gross migration flows, which result in large

net inflows and outflows during expansions and recessions, respectively, the NAWRU tends to be

highly correlated with the actual unemployment rate, and the population rate with economic

conditions. The benchmark debt for Ireland thus grew by much less during the years of the financial

crisis, which shows the difficulty in abstracting from Ireland’s economic cycle to isolate

fundamental, across-the-cycle conditions, and the caution that must be exercised in interpreting

benchmarks.

Figure 22: Contributions of fundamentals to household debt-to-GDP (%)

Source: European Commission.

The main drivers of benchmark NFC debt accumulation are similar to those of households in that

growth expectations and unemployment are important. The other key factor is equilibrium

construction investment (not included in the household regression), while the government budget

balance is more important for NFC debt.27 Similar to households, the reduced growth in in

26 This has been noted, for example, by the IMF in its June 2018 Selected Issues paper, Business Cycle In Ireland: Accounting For Open Labor Market And Multinationals. 27 This is not surprising, as the model assumes government spending crowds out private investment, which can be expected to be more relevant for corporate than household investment.

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benchmark debt is partially due to a rise in the NAWRU, as well as a fall in construction investment

(driven by reduced population growth).

Figure 23: Contributions of fundamentals to NFC debt-to-GDP (%)

Source: European Commission.

5.1.3: Benchmark private debt ratio over time

The benchmark private debt-to-GDP ratio is estimated by cumulating the annual changes over

time. The following charts show these benchmarks for households, NFCs, and combined total

private sector debt, respectively, from 1995-2017, and compare them to the actual debt ratio. The

debt level is also shown as a percentage of GNI*.

Firstly, household debt is shown in Figure 24. The actual debt ratio rises much quicker than the

benchmark in the lead up to the peak household debt ratio in 2009, before subsequently falling

much faster than the benchmark. This highlights the fact that non-cyclical changes in debt, based

on fundamentals only, should generally be gradual. Indeed, the stronger rise in the benchmark in

2009 is primarily due to the fall in the denominators, GDP and GNI*. The strong GDP and GNI*

growth in recent years has led to falls in the benchmark debt ratios.28 The actual household debt-

to-GDP and debt-to-GNI* ratios are now both below the benchmark, with the debt-to-GNI* at 77

28 The model estimates benchmarks for changes in the debt stock scaled by GDP. From this benchmark, a benchmark for the change in the debt-to-GDP ratio is derived. As the benchmark debt flows are based on fundamentals, they are typically stable. This implies that large recessions (with a fall in GDP) would be associated with a natural leveraging (rise in the ratio), while large expansions would be associated with a natural deleveraging.

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per cent in 2017, compared to the benchmark of 93 per cent. This would imply that the existing

levels of debt are in line with a level associated with fundamental economic drivers. However, this

is only one method of estimating appropriate levels of debt, and should not be read as a definitive

answer to the question of whether households need to further deleverage.

Figure 24: Household debt benchmarks


The benchmarks for NFC debt are shown in Figure 25. While the actual headline debt ratios began

rising around 2005 and increased more sharply from 2008, the benchmark was relatively stable.

In 2017, the headline ratio remained substantially above the benchmark, however, core Irish debt

was below the benchmark since the beginning of that data series in 2012 until it rose marginally

above it in 2017. Core Irish debt-to-GNI*, the preferred representation of the Irish NFC debt ratio,

was 95 per cent in 2017, slightly above the benchmark of 93 per cent.29

The total debt benchmarks shown in Figure 26 are simply the sum of the household and NFC

benchmarks. Core Irish private sector debt is 13 percentage points below the benchmark, at 172

per cent versus a benchmark of 185 per cent, on a GNI* basis. Again, this suggests that the private

sector has deleveraged to a level that can be explained by fundamental factors.

29 This comparison is reasonable as the factors driving the benchmark are effectively all domestic, except the current account, which accounts for a very minor portion of the change in debt (on average, its impact over the period nets out to zero).

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Figure 25: NFC debt benchmarks


Figure 26: Total debt benchmarks


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5.1.4: Cross-country comparison

It was shown in Figure 8 that Ireland ranked 6th highest (on a GNI* basis) in the EU in terms of

2017 household debt ratios, behind Denmark, Cyprus, Netherlands, Sweden and the UK. These

countries also rank in the top 2016 benchmark estimates, as can be seen in Figure 27, showing

the correlation between benchmarks and outturns. Ireland ranks third on a debt-to-GNI* basis.30

This suggests that the underlying structure of the Irish economy, i.e. based on fundamental rather

than cyclical factors, has given rise to higher levels of household debt than other European nations.

The starting value of debt in 1995 is also shown: Ireland had a comparatively low ratio in 1995,

indicating that the benchmark has grown faster in Ireland than in other countries.31

The chart also shows how far countries’ debt ratios were from their benchmark in 2016 (the “gap

to benchmark”). The above-mentioned countries with high household debt are also notably above

their benchmark ratios. Ireland, in comparison, is below benchmark (along with Luxembourg). This

further suggests that the deleveraging process by Irish households has been more rapid in

comparison to European peers.

Ireland has one of the highest NFC debt benchmarks in the EU, shown in Figure 28, which also

suggests that the structure of the Irish economy, particularly the levels of underlying construction

investment and growth outlook, would lead to higher levels of private debt. Similar to the household

sector, however, Ireland stands out amongst a majority of its European peers, with actual core

NFC debt broadly in line with the benchmark in the last two years, following the adjustments

described in Section 4.

Figure 27: Household debt-to-GDP benchmarks

Source: European Commission, Department of Finance calculations. Ranked by 2016 benchmark.

30 Cross-country comparisons are done using 2016 data as the analysis was extended to 2017 for Ireland only. 31 This also allays the concern that countries with the highest starting levels of debt are simply the ones with the highest benchmarks now.

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Figure 28: NFC debt-to-GDP benchmarks

Source: European Commission, Department of Finance calculations. Ireland gap to benchmark is based on core NFC debt. Note Luxembourg gap to benchmark is off the scale at 195 per cent.

5.1.4: Variations in benchmark estimates

A number of robustness checks were carried out to assess the sensitivity of the benchmarks for

Ireland to changes in methodology or assumptions. This includes varying the starting year and

starting value of debt.32 The model is also run replacing the current account norm variable with

Ireland’s modified current account (CA*) from 2007, when the CA* data is first available, and using

an alternative estimate of Ireland’s NAIRU in place of the NAWRU. Finally, the starting value of

NFC debt is also reduced to adjust for the presence of MNEs in 1995.33

As can be seen in Figure 29, varying the model to produce a range of estimates does not have a

material impact on the household benchmark. While the NFC benchmark rises close to 80 per cent

debt-to-GDP in some of the scenarios, other variations lead to a negligible reduction in the

benchmark, at most. As such, the central estimate is also a conservative estimate, with variations

on the model suggesting the benchmark Irish debt could actually be higher.

32 As private sector debt data is not available as far back as 1995 and the starting point must instead be estimated, there could be a discrepancy between the benchmark and the actual ratio when the series begins in 2001. 33 15% of 1995 NFC debt is allocated as MNE debt, based on the 15% of 1995 gross value added contributed by foreign MNE-dominated sectors.

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Figure 29: Variations on the central benchmark estimate


5.1.5: Fundamentals-based benchmarking conclusion

The regression results suggest that Ireland’s household and core NFC debt ratios can be explained

by fundamental economic drivers and that further deleveraging may not be strictly necessary from

a macroeconomic point of view.

While this methodology adds much to our understanding of why debt levels can and should differ

across countries, this is not to say that it provides a definitive estimate of where private debt ratios

should be. If there is an omitted variable that also impacts the accumulation of private debt, whether

observed or unobserved, the estimates would be different. If one of the included variables were

actually influenced by cyclical factors, the estimates of a fundamental benchmark would also be

biased.

While the fundamentals-based method appears to be the best available at present, to address

such concerns as above, the next sections will consider other thresholds estimated by alternative

methodologies.

5.2: Prudential threshold

Another methodology used by the European Commission (2017b) to establish appropriate levels

of private debt is the so-called ‘prudential debt threshold’, beyond which the probability of a having

a banking crisis increases.

This takes a signalling approach to crisis detection, looking at the debt levels of countries that did

or did not suffer a banking crisis. The debt threshold chosen maximises the signal power, such

that the probability of a Type 1 error, that a crisis is missed, and a Type 2 error, that there is a false

alert in identifying a crisis, are both minimised. This method estimates a common cross-country

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threshold of 113 per cent private sector debt-to-GDP, 20 percentage points below the MIP

threshold. This is on a non-consolidated basis, implying the prudential benchmark for consolidated

debt would be lower still.

To estimate country-specific thresholds, debt must be interacted with another variable that would

impact the probability that high debt could result in a banking crisis. The variables interacted here

are banks’ regulatory capital, as well-capitalised banks reduce the probability of a banking crisis,

government debt, as high government debt reduces the government’s ability to boost the economy

with spending or to bail-out banks, and relative income per capita, as countries with lower average

incomes are generally associated with less stable financial markets. The estimated thresholds for

Ireland are outlined in Table 2 below.

Table 2: Prudential threshold estimates (non-consolidated)

Method NFC Debt Household Debt Total Debt

Common threshold (cross-country) 63 43 113

Irish threshold from bank capital interaction 142 84 213

Irish threshold from government debt interaction 32 24 48

Irish threshold from relative income interaction 87 51 146

Irish debt-to-GNI* (2017) 318 77 396

Irish core debt-to-GNI* (2017) 95 77 172

Source: European Commission. Note the thresholds for NFC and households do not sum to the total as all three

are estimated separately.

The predictive power of the threshold interacted with bank capital is the highest and thus is the

Commission’s preferred threshold, estimating a 213 per cent total private debt-to-GDP for Ireland.

This is among the highest thresholds for Member States, pointing to the fact that Irish banks are

now relatively well-capitalised and thus less susceptible to a banking crisis. Ireland’s core private

debt ratio was comfortably below this threshold in 2017 at 106 per cent in GDP terms, and 172 per

cent in GNI* terms. While the threshold interacted with government debt is substantially lower, and

Ireland’s debt significantly above it, the same is the case for the majority of other Member States.

Ireland is above the relative income threshold in GNI* terms only, but again has one the highest

thresholds among Member States given the relatively high GDP per capita in Ireland. However,

the inflated level of GDP in Ireland also means that the relative income threshold will likely be

overstated.

The problem with this methodology is that as crisis events are rare, it is difficult to obtain precise

estimates of the threshold for debt associated with them. The results are sensitive to the sample

and assumptions and, as such, should be treated with caution, a caveat which is also noted by the

Commission.


5.3: Summary of thresholds

Table 3: Summary of private debt threshold estimates

Method Total Debt Household

Debt NFC Debt Description

MIP threshold 133% - - Current threshold

Common prudential threshold*

113% 43% 63% Value that minimises false alerts

and missed crises

Country-specific prudential threshold*

213% 84% (24%) 142% (32%) Interacted with bank capital

(government debt)

Fundamentals-based threshold (GDP)

114% 57% 57% Estimated medium to long-term

debt level

Fundamentals-based threshold (GNI*)

185% 93% 93% Estimated medium to long-term

debt level

Estim

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from

litera

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Cechetti et al (2011)

175% 85% 90% Threshold beyond which debt has

a negative impact on growth

Arcand et al (2012)

80-100% - - Private sector credit above this

has a negative impact on growth

Irish Headline Debt-to-GDP

244% 48% 196% 2017 outturn

Irish Core Debt-to-GDP

106% 48% 59% 2017 outturn

Irish Headline Debt-to-GNI*

396% 77% 318% 2017 outturn

Irish Core Debt-to-GNI*

172% 77% 95% 2017 outturn

*Non-consolidated debt.

Source: European Commission, CSO. Note the prudential thresholds for NFC and households do not sum to the

total as all three are estimated separately.


Section 6 – Future outlook

This section considers recent trends in lending and potential future developments in the private

debt ratio.

6.1: Recent trends in lending

This analysis has looked at the current stock of private debt and whether its levels can be explained

by fundamental economic drivers. The issue, however, is that even if the current debt ratio has

fallen to a level consistent with fundamentals, it is now at a much higher base than it was pre-crisis,

analogous to public debt. Should the private sector begin to significantly accumulate debt again,

as would eventually be expected during an economic expansion, the debt ratio could quickly

become unsustainable again. Thus for Ireland to maintain a stable private debt ratio, debt would

need to grow at the same pace as the economy (or GNI*), but no faster.

Lending by domestic institutions to the Irish private sector has begun to grow recently after years

of negative growth due to active deleveraging post-crisis (although this does not include

repayments of loans that have been securitised or sold by banks). Growth in net lending from

domestic institutions to households turned positive in July 2017, while mortgage lending began

growing in November 2017, as can be seen in Figure 30. Although households saw an overall

marginal fall in their total borrowings from all sources in the first three quarters of 2018, the uptick

in lending from domestic institutions points to the rising momentum in credit markets.

Figure 30: Recent trends in household borrowing, annualised change

Source: Central Bank Money and Banking Statistics, Department of Finance calculations.

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Credit extended by domestic institutions to NFCs saw its first post-crisis growth in January 2018,

shown in Figure 31, with the growth rate strengthening since July 2018. Short-term lending to NFCs

continues to decline, with the uptick in medium-term (1-5 year) lending driving the growth. Total

lending to SMEs also continues to decline, albeit at a much slower pace than previously.

Figure 31: Recent trends in NFC borrowing, annualised change

Source: Central Bank Money and Banking Statistics, Department of Finance calculations.

This implies that Ireland is moving from active to passive deleveraging, i.e. relying on rises in GDP

(or GNI*) rather than reductions in the debt stock, or that the debt ratio could potentially begin to

rise again. Passive deleveraging has less negative impact on consumption or investment and thus

economic growth. However, it also means the pace of deleveraging is likely to be significantly

lower.

While this data on lending does not directly map onto private debt holdings, it serves as a useful

proxy (as previously discussed in Section 3.1). However, it is also true that the stock of debt is a

slow moving variable. As such, we will only see the impact of recent developments in lending

markets on the debt ratio with a lag.

An additional indicator of recent trends in lending is the credit gap analysis published by the Central

Bank. The credit gap is the difference between the actual credit ratio (credit issued to the private

sector measured against GDP or GNI*) and the estimated trend in the ratio based on historical

data. Figure 32 shows that the actual ratio for both GDP and GNI* is currently well below trend,

implying private sector debt is not at an unsustainable level. However, this metric simply uses a

statistical filter rather than underlying economic drivers, and the high levels of credit that built up

in the early 2000s would bias the trend upwards.

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It is also worth noting that the GNI* measure of national credit attempts to strip out the MNE impact

on headline credit / debt.34 Domestic NFC credit is proxied with credit from resident banks to

resident NFCs only, which would exclude debt borrowed by Irish firms from non-Irish or non-bank

institutions, and thus likely underestimate core NFC debt. Nonetheless, the fact that national credit-

to-GNI* has now returned to pre-crisis levels points to the fact that the private sector may now be

coming to the end of its deleveraging phase.

Figure 32: Credit ratio trend

Source: Central Bank Countercyclical Capital Buffer Data.

6.2: Future debt capacity

While forecasting private debt is inherently difficult and not commonly practised, a high-level

simulation of the debt ratio going forward is provided here. This is based on the Department of

Finance’s growth forecasts (for GNI*) and a ‘stylised’ path for debt based on recent lending trends.

Two scenarios are considered, one with the stock of growing modestly and one with the current

debt ratio maintained with debt growing accordingly. It is shown that, due to the high existing stock,

even a modest rate of growth in debt would result in a debt ratio in excess of the MIP threshold in

2023.

For the first scenario as reported in Figures 33 and 34, household and core NFC debt are assumed

to grow at the modest rates of 0.6 and 1.5 per cent respectively which were seen in the third quarter

of 2018, as reported in the Central Bank’s Money and Banking Statistics based on lending from

domestic institutions.

34 Creedon and O’Brien (2016).

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This illustration results in a debt-to-GNI* ratio of 59 per cent for households and 76 per cent for

NFCS by 2023. Thus even assuming very modest future growth rates, Ireland’s debt-to-GNI* ratio

would still be slightly above the 133 per cent MIP threshold by 2023 at 135 per cent.

A second scenario is also presented in both figures showing the nominal debt burden of the private

sector if the debt ratio were to be maintained at its current level. This essentially presents a

hypothetical scenario in which debt grows at the same rate as the economy, as measured by GNI*.

Maintaining the current 77 per cent household debt-to-GNI* ratio implies households taking on

approximately an additional €50bn in debt, with total household debt then rising to €195bn. This is

close to the pre-crisis peak of €204bn in 2008. A stable NFC debt ratio would imply an additional

€60bn of debt, with total NFC debt rising to €240bn.

Overall these scenarios show that the higher stock of overall private sector debt that now exists,

is likely to persist into the future and could still pose a risk to the economy in the event of a future

downturn.

Figure 33: Stylised household debt and debt ratio scenarios

Source: Department of Finance calculations. Scenario 1 assumes debt growth in line with recent trends in lending from domestic institutions and Scenario 2 assumes debt growth to maintain the current debt-to-GNI* ratio. Both scenarios use the Department of Finance’s Budget 2019 GNI* forecasts.

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Figure 34: Stylised core NFC debt and debt ratio scenarios

Source: Department of Finance calculations. Scenario 1 assumes debt growth in line with recent trends in lending from domestic institutions and Scenario 2 assumes debt growth to maintain the current debt-to-GNI* ratio. Both scenarios use the Department of Finance’s Budget 2019 GNI* forecasts.

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Section 7 – Conclusion

The contribution of this paper is threefold. Firstly, it identifies the need to benchmark Ireland’s

private sector debt against GNI* rather than GDP, as GDP significantly understates the underlying

debt ratio. Secondly, the impact of the activities of multinational enterprises on NFC debt has been

teased out to produce an estimate of underlying or ‘core’ Irish private sector debt. Thirdly, a range

of regression-based estimates against which Irish debt can be benchmarked are discussed. Using

these benchmarks, it appears that Irish debt may in fact be in line with levels predicted by the

economy’s underlying fundamentals (e.g. expected economic growth, population growth and

structural unemployment).

It is often cited as an underlying weakness of the Irish economy that private debt levels are highly

elevated. This paper makes it clear that to have a more nuanced discussion on private debt, the

household and NFC sectors must also be considered in isolation, as well as combined. Irish

households remain relatively indebted by European and historical standards, but the analysis

suggests that this may be explained by structural factors in the Irish economy. In the case of NFCs,

the underlying debt-to-GNI* ratio is much lower than the headline figure appears and is more in

line with EU peers, on average. However, there still exist pockets of high debt amongst certain

cohorts of households, and the higher stock of overall private sector debt that now exists could still

pose a risk to the economy in the event of a future downturn.


References

Arcand, J., Berkes, E. and Panizza, U. (2012). Too much finance? IMF Working Paper WP/12/161.

Cecchetti, S., Mohanty, M. and Zampolli, F. (2011). The real effects of debt. Bank for International

Settlements Working Papers No. 352.

Central Statistics Office (2018). Redomiciled PLCs in the Irish Balance of Payments 2017.

[Online]. Available from:

https://www.cso.ie/en/releasesandpublications/in/rpibp/redomiciledplcsintheirishbalanceofpayme

nts2017/

Creedon, C. and O’Brien, E. (2016). Indicators for Setting the Countercyclical Capital Buffer.

Central Bank of Ireland Economic Letter Series Vol 2016, No. 2.

Department of Finance (2018a). GDP and ‘modified GNI’ – explanatory note. [Online]. Available

from: https://www.finance.gov.ie/wp-content/uploads/2018/05/180504-GDP-and-Modified-GNI-

Explanatory-Note-May-2018.pdf

Department of Finance (2018b). Annual Report on Public Debt in Ireland. [Online]. Available from:

https://www.finance.gov.ie/wp-content/uploads/2018/09/Annual-Report-on-Public-Debt-in-Ireland-

2018.pdf

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regression-based approach.

European Commission (2017b). Note to LIME Working Group: Private sector debt thresholds: an

update.

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benchmarks: enhanced sample and robustness checks.

Gargan, E., Lawless, M., Martinez-Cillero, M. and O’Toole, C. (2018). Exploring Investment

Patterns for Irish SMEs: New Survey Evidence. ESRI Quarterly Economic Commentary August

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IMF (2018). Ireland Selected Issues June 2018. IMF Country Report No. 18/195.

King, R. and Levine, R. (1993). Finance and growth: Schumpeter might be right. Quarterly Journal

of Economics 108 (3), pp.717-737.

Lawless, M, O’Toole, C. and Slaymaker, R. (2018). Estimating an SME investment gap and the

contribution of financing frictions. ESRI Working Paper 589.

https://www.cso.ie/en/releasesandpublications/in/rpibp/redomiciledplcsintheirishbalanceofpayments2017/

https://www.cso.ie/en/releasesandpublications/in/rpibp/redomiciledplcsintheirishbalanceofpayments2017/

https://www.finance.gov.ie/wp-content/uploads/2018/05/180504-GDP-and-Modified-GNI-Explanatory-Note-May-2018.pdf

https://www.finance.gov.ie/wp-content/uploads/2018/05/180504-GDP-and-Modified-GNI-Explanatory-Note-May-2018.pdf

https://www.finance.gov.ie/wp-content/uploads/2018/09/Annual-Report-on-Public-Debt-in-Ireland-2018.pdf

https://www.finance.gov.ie/wp-content/uploads/2018/09/Annual-Report-on-Public-Debt-in-Ireland-2018.pdf


Appendix

Figure A1: Breakdown of total Irish debt


99 94 81 57 52 48

49 5043

38 33 29

11 1518

16 26 30

42 3033

19 15 14

6966 77 147

12598

913 25

2832

25

280 268 278306

283

244

0

50

100

150

200

250

300

350

400

450

500

2012 2013 2014 2015 2016 2017

Debt % of GDP

Households Irish Parent (Irish Debt)




Redomiciled PLCs

137 123 107 93 81 77

6966

57 6351 47

1619

23 2640 48

5839

44 3224 23

96

87 102

239

195159

12

17 33

46

49

41

387

352366

498

440

396

0

50

100

150

200

250

300

350

400

450

500

2012 2013 2014 2015 2016 2017

Debt % of GNI*

Households Irish Parent (Irish Debt)




Redomiciled PLCs


Tithe an Rialtas. Sráid Mhuirfean Uacht,

Baile Átha Cliath 2, D02 R583, Éire

Government Buildings, Upper Merrion Street,

Dublin 2, D02 R583, Ireland

T:+353 1 676 7571

@IRLDeptFinance

www.finance.gov.ie

Documents

Analysis of Private Sector Debt in Ireland March 2019 · 3. Analysis of household sector 10 3.1 Overview of household sector 10 3.2 Household debt indicators 12 4. Analysis of corporate