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Global Economic Outlook
Ireland: September 2010 Outlook Update
By Katharina Jungen and Elisa Parisi-Capone
- RGE expects continued buoyant export growth over the next few quarters to drive Ireland’s recovery in 2010, but private consumption and investment activity remain impaired. We envisage GDP stabilizing in 2011.
- Sovereign risk is back at early 2009 highs given the uncertain costs of the banking sector bailout. Rising borrowing costs exert further deleveraging pressure on the highly indebted private sector.
- Ireland’s fiscal austerity agenda remains largely on track; however, the banking sector woes will require additional consolidation measures.
Outlook Update: Modest Expansion in 2010, Catch-Up Growth in 2011
The stronger-than-expected rebound in foreign demand for Irish exports is offset by renewed sovereign risk concerns and rising borrowing costs, which prompts us to leave the 2010 forecast unchanged at 0.2%. As indicated by business surveys, the external sector continues to provide the main impetus for Ireland’s economy, while a recovery in domestic demand remains elusive.
Figure 1: Real GDP Levels (€ millions, right axis) vs. GDP Growth Rate q/q (left axis)
Private consumption appears to have troughed, but investment activity is still registering sharp declines. Domestic demand is unlikely to see a notable recovery in 2010 as the ongoing need for aggressive fiscal consolidation measures will continue to weigh on economic activity. Hence, despite an impressive 2.7% q/q GDP expansion in Q1 2010 on the back of a similar contraction in Q4 2009, the likelihood of further negative quarters remains high. GNP, a more accurate indicator of Ireland’s economic performance (as it excludes repatriated foreign investment profits), will even see a renewed contraction of close to 1% this year, evidence of the sluggish performance of domestic demand. Following three years of negative growth, we expect GDP to stabilize and record bounce-back growth of 1.5% in 2011. The economic upswing will be held back by the expected slowdown in global demand in late 2010 and beyond. RGE expects consumer prices to fall by 1.4% in 2010 before registering modest growth of 0.5% in 2011.
Growth Dynamics: A Broader-Based Recovery Will Only Gradually Materialize in 2011
RGE expects the recovery in the external sector to have further strengthened in Q2 2010 given the rebound in global economic activity, with additional tailwinds provided by the economy’s trade-openness and the weak euro. Furthermore, the ongoing positive adjustment in Ireland’s external competitiveness in light of falling wages and declining consumer prices will give an additional boost to export growth. However, indicators suggest that the rebound in global economic activity peaked during the summer months and will start to moderate going forward. Particularly worrying are weak growth prospects for the eurozone and the U.S., Ireland’s most important trading partners next to the UK. Notably, Ireland’s manufacturing PMI, which has registered above the key 50 mark—indicative of output growth—since March 2010 as a result of strong foreign demand, weakened for the third consecutive month in August 2010.
We expect private consumption to make a positive —albeit small—growth contribution in 2010. Consumer confidence has improved drastically compared with levels 12 months ago, despite a small correction in July 2010. Retail sales received a temporary boost from the government-funded “cash-for-clunkers” program, which is set to expire at the end of the year. Still, headwinds remain in light of falling real wages, high unemployment, tight credit conditions and the ongoing need for households to deleverage.
Job-shedding unexpectedly accelerated in Q2 2010 with the unemployment rate reaching 13.8% in August despite earlier signs that the labor market is stabilizing. RGE expects employment levels to remain largely stable over the forecast horizon but the risks are tilted to the upside. The unemployment rate, however, will be slow to decline as the shrinking labor supply—given strong emigration flows and the large number of discouraged workers exiting the labor market—stabilizes and eventually reverses.
Investment, driven by the ongoing deterioration in the housing sector, will fail to make a positive growth contribution in 2010. While business investment will see a gradual improvement, the outlook for investment in the building and construction sector remains bleak, taking into consideration the ongoing weakness of new housing registrations, tight credit conditions, cuts to public infrastructure investment programs and the substantial housing overhang.
Figure 2: New House Registrations vs. House Completions
Source: Central Statistics Office Ireland
In 2011, Ireland will experience catch-up growth, partially a result of base effects. RGE envisages the Irish economy expanding by 1.5% for the year—well above the eurozone average—with the external sector driving GDP growth. However, in comparison with other leading economic research firms’ growth estimates, RGE’s GDP forecast is significantly more cautious, as we factor in slowing global demand growth in 2011, which will limit the positive impetus from the external sector. Still, a more broad-based recovery will materialize, with domestic demand registering positive—albeit weak—growth. With the housing market bottomed out, we even expect investment to make a positive growth contribution—following three years of negative growth—driven by a pick-up in machinery and equipment spending.
Risks: Demand for Irish Exports Will Determine the Strength of the Economic Recovery
Given the export-led nature of the current economic upswing, Ireland remains highly sensitive to developments in the global economy. A sharper-than-expected correction of growth prospects in the UK, U.S. and eurozone—Ireland’s key export markets—is likely to clip the wings of the economic recovery, while a renewed acceleration in global trade activity, coupled with a weak euro exchange rate, will positively influence the economic upswing. Since domestic demand will prove too weak to counteract any unexpected slowdown in export growth, the success of the Irish government’s fiscal austerity plan will also depend to a large extent on demand for Irish exports.
With tax revenue—which has stabilized in recent months—registering only slightly below target, the government’s fiscal consolidation agenda remained largely on track in H1 2010, but the risk still remains that additional austerity measures will prove necessary. Several upward revisions of the banking sector bill, higher debt servicing costs given the ongoing loss of market confidence and the uncertainty surrounding the turnaround in the housing market have exerted pressure on the government’s fiscal position. Furthermore, even though the rate of deflation has started to slow, consumer prices remain far below the eurozone average and the risk of a prolonged period of deflation cannot be excluded yet, which would add to the fiscal consolidation challenges
Figure 3: Annual Change in HICP vs. Core HICP
As a result, additional savings measures might be required in the 2011 budget proposal, posing a significant downside risk to RGE’s growth forecast.
Policy Implications: Banking Sector Woes Continue to Threaten Public Finances
In August 2010, negative news related to the Irish banking sector caused a sell-off in Irish bond markets with spreads over the 10-year bund widening to new record highs. Investors are growing increasingly concerned about the Irish government’s ability to absorb the escalating losses of the banking sector. Following several upward revisions, the government raised its cost estimate of Anglo Irish Bank’s bailout to €25 billion; however S&P, which recently downgraded Ireland’s sovereign rating to AA- with a negative outlook, expects the final bill to be significantly higher. To eliminate some of the uncertainty surrounding the final amount the government will present an official cost estimate of the banking sector rescue in late September; however, figures will remain preliminary since the final cost also depends on the discount applied to the third tranche of loans transferred to NAMA.
In early September, the government announced its plan to split Anglo Irish into a “funding bank” that will take over Anglo’s deposits and an “asset recovery bank” that will hold loans not transferred to NAMA, before slowly winding them down over the next 15 years. However, investors might not be too impressed by the move, as concrete plans regarding the timetable and final cost have not yet been presented.
Although the Irish government deficit will reach a staggering 20% of GDP in 2010 (factoring in this year’s capital injections into the banking sector), on a positive note, the Irish government has already fulfilled its funding needs until June 2011, giving it some breathing space in the next few months.