Data on the performance of the Irish economy continues to make for grim reading. Besides well publicised statistics such as unemployment data or GDP figures, April saw the first increase in interest rates in the Eurozone in 2 years. With the outlook for inflation skewed to the upside, the ECB have begun to raise interest rates. Their main objective is an inflation target of close to 2%. Eurozone inflation for March was 2.7% year-on-year and 2.8% in April.
This is not good for Ireland. When dealing with a recession, low interest rates are welcome as in theory they lower the cost of finance for businesses to borrow to expand. What makes interest rate increases more unwelcome in Ireland’s case is the amount of personal debt that exists, in particular mortgage debt. Interest payments have been kept unnaturally low over the past two years, lessening the pain to many mortgage holders who are on variable rates. This will change if the ECB continues to raise interest rates in response to inflation.
Source: CSO 2011
The inflation we are seeing across the Eurozone is not what could be termed ‘good’ inflation, instead being made up of rising energy and food prices. In Ireland, wage growth is constant or falling while food and energy prices are increasing. This all points to less discretionary spending by consumers which is not likely to increase growth in the domestic economy. More recently, the IMF lowered growth forecasts for Ireland.
Worryingly, interest rate differentials are likely to make our position worse off. The UK is our largest trading partner, and with the Bank of England likely to maintain low interest rates for some time, our exports will become more expensive to British consumers, which are priced in a more expensive Euro. This is a threat to our growing export sector. One caveat to a stronger Euro is potential weakness over Eurozone government bail outs.
GNP and GDP
While GNP continues to fall, GDP is expected to increase, albeit at a slow pace and only advancing from substantial falls seen in previous years. The previous falls in GNP and GDP were mainly due to the collapse of the property market and the knock on affects that resulted. GNP growth has lagged GDP growth because the former is dependent on the domestic economy in particular and excludes the profits of the multinational sector. The importance of US multinationals to the Irish Economy is evident in that roughly one-third of the annual corporation tax take each year comes from the sector. It also shows the importance of our low corporate tax rate which is a significant competitive advantage, one which some EU members want us to give up. It is debateable whether we can afford to increase our low corporate tax rate and still retain this advantage. But Ireland is not unique in the Eurozone in having a low corporate tax rate. Other competitive advantages Ireland has include speaking English as our first language, good geographic location and the youngest workforce in Europe, with 35% under 25 years of age.
Source: CSO 2011
Unemployment is perhaps the best indicator of how the economy is performing. While it is well established that unemployment is high, the trend is not reversing. Additionally, emigration has played a role in the somewhat stabilising of figures, particularly amongst recent graduates.
Source: CSO 2011
Where to from here?
With high debt levels, high unemployment, higher interest rates and an ongoing banking problem is there any hope for the Irish economy? Ignoring the banking problem, Ireland is still spending more than we are earning in taxes. There are three ways to bridge this gap – grow the economy, reduce spending or increase taxes. There are arguments for and against the later two points; however growth in the economy is likely to be anaemic for the foreseeable future. The biggest areas of expenditure are on public service pay and pensions and social welfare. There is now increasing talk from Europe that wage levels will need to be cut again in the public sector. This is not surprising given that 1 in 5 of us work for the Government. Besides bridging the gap between revenue and expenditure, an ever increasing proportion of additional revenues raised are being used to service debt. This leaves very little to be invested for the future – whether infrastructure, education or technology which will impact on us all. It’s a shame that after the success of the Celtic Tiger which ended in the early 2000’s the Irish State is now being bankrolled by Europe and the IMF, eroding much of the progress previously made.
It is difficult to see a way out of this downturn besides time, allowing people to deleverage. In our view, Ireland will experience a lost decade similar to Japan in the 1990’s after their property market crash. However for those who are not saddled with debt, there is more reason to be optimistic. On the positive side the downturn has taken a lot of excess out of the system and the Irish economy has the opportunity to come back leaner and meaner. As an example, Dublin now ranks the 42ndmost expensive city in the world, down from 16th in 2008. Positives for Ireland include our important location within the EU for a number of service sectors including computer software, IT and financial services and more recently our growing export sector. These sectors will be key drivers on our road to recovery and will hopefully focus policy back onto real activity in the economy.
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