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Ireland: Weak Growth Poses Risk to Fiscal Plan
By James Mason and Pamela Reyes
The Irish economy is facing a tough 2011. Back in December, our forecast was for 1.0% y/y growth in real GDP. Since then, others have lowered their forecasts to something similar to ours as they factor in lower domestic consumption and greater headwinds from fiscal austerity than they previously expected (Figure 1). Our initial forecast for 2012 is 2.1% as we expect these headwinds to abate somewhat.
Figure 1: Selected Irish Real GDP Forecasts (% y/y)
Source: National recovery plan, Irish central bank, IMF, European Commission, OECD, ESRI
Domestic and external demand will continue to diverge (Figure 2). Exports will be supported by improved competitiveness, through lower real wages, and growth in key trading partners, such as the U.S. However, spillovers from the substantially foreign owned export sector to the domestic economy will remain limited because of heavy reliance on imports, high capital intensity and repatriation of profits. Investment will continue to contract due to weak government investment in infrastructure and high levels of unsold/vacant real estate. Massive drags on domestic consumption remain, due to fiscal austerity, continued weakness in credit growth, property prices and wages, high real debt burdens and high unemployment (the rate will remain above 10% for years due to structural unemployment in the construction and consumer services sectors).
Figure 2: Irish Real GDP Growth (% y/y) and Expenditure Components (contributions to quarterly growth)
Source: RGE and Central Statistics Office Ireland
This bleak economic outlook calls into question the viability of the National Recovery Plan 2011-2014, that assumed “Real GDP will grow by an average of 2.75% in the years from 2011 to 2014” in order to achieve an annual fiscal deficit of 3% of GDP by 2014. The European Commission extended by one year the deadline for meeting the 3% Stability and Growth Pact deficit threshold to 2015. However, given the economic outlook presented above, achieving even the new target is unlikely, so something has to give. The question for the new government in March is what?
So far, the political debate has focused on how to divide a smaller fiscal pie, complemented by some disappointingly vague talk about renegotiating the external support program. Irish politicians want a lower interest rate, they may well get it, but at what cost? German plans, to be proposed under a new "pact for competitiveness,” may well include a harmonized corporate tax rate, which would seriously lessen the possibility of an export-led economic recovery in Ireland. Imposing haircuts on senior creditors of Irish banks remains a possibility, but as corporate deposits continue to evaporate, the benefits may not justify the costs. Indeed, only Sinn Féin, political outsiders who will do well in the upcoming election but stand very little chance of forming part of a coalition government, have had the courage to explicitly advocate haircuts on senior bank debt. (See related RGE coverage on Ireland.)