ECONOMIC HEALTH CHECK
After Deep Slump, Nascent Recovery for Ireland
IMF Survey online
July 14, 2010
- Ireland's economy is stabilizing, growth expected to resume this year
- Export sector driving nascent recovery
- Continued fiscal consolidation will be necessary to maintain confidence
After a severe decline in late 2008 and 2009—amounting to more than 15 percent contraction of the nominal GDP―the Irish economy has now stabilized, and growth resumed in the first quarter this year.
The Irish authorities were among the first in Europe to undertake serious fiscal consolidation, with the introduction of an income levy and sizeable cuts to public sector pay and social welfare benefits. This early action helped restore confidence, and a strong export performance has lifted growth prospects. But unemployment remains high at more than 13 percent of the labor force, and the country’s openness makes it vulnerable to the instability that has gripped financial markets in recent months.
Although the economy could grow again this year, a return to the high growth rates that earned Ireland the nick name of “Celtic Tiger” is unlikely, with the IMF expecting GDP growth to increase gradually to about 3.5 percent in 2015.
Every year, the IMF conducts reviews of its member countries’ economies. The analysis is subsequently discussed by the IMF’s 24-member Executive Board.
In this interview, Ashoka Mody, IMF mission chief for Ireland, speaks about the nascent recovery and the many challenges that still lie ahead.
IMF Survey online: Ireland took swift action to return the budget to solvency. But has it been worth it, given the severe downturn of the economy?
Mody: If the government had failed to take action, the budget deficit would have been much larger and the borrowing requirements would have started going up even faster. That would have put the country in a difficult position over the medium term.
Because the consolidation had to occur during a recession, it has inevitably dampened short-term growth prospects. But that needs to be traded off with the longer term confidence-building that is very much a goal of this consolidation process. To the extent that the Irish authorities can now legitimately claim broader policy credibility, some of that confidence-building is already occurring, offsetting, in part, the short-term contractionary effects on the economy.
IMF Survey online: How vulnerable is the economy to contagion from the European sovereign debt concerns?
Mody: Ireland is in the group of so-called “peripheral” economies that have been the focus of sovereign debt concerns in recent months. Irish sovereign spreads have risen along with spreads in these other economies. However, within this group, the Irish economy has been relatively insulated and there has been no sense of a disorderly rise. Of course, on some days, when the markets have been very tense, those tensions have been felt in Irish sovereign debt markets also. The evidence so far, therefore, suggests the likelihood of severe contagion to Ireland is limited.
IMF Survey online: What are the prospects for a return to growth?
Mody: The growth numbers for the first quarter of 2010 look very good. On that basis, a number of commentators have revised their short-term growth outlook upwards. However, we are somewhat more cautious. All the growth in the first quarter has come from the spectacular growth of exports produced and sold by multinationals.
Domestic demand actually contracted in the first quarter of 2010. And employment has continued to remain weak. So the strong performance of the export sector is a little isolated, an outcome that is consistent with the analysis in our staff report.
So we are now awaiting the results for the second quarter. In the past, a very substantial growth in exports has sometimes been followed by a contraction in the immediately following quarter. So it’s not yet clear that these short-term developments are on a sustainable footing.
More generally, we believe there are still forces at play that will cause a drag in the Irish economy. These reflect the legacy of overvalued property, overextended credit, and an unsustainable increase in wages and prices. Therefore, our view of the medium term is also more cautious than that of the authorities.
IMF Survey online: Will the export sector produce enough new jobs to reduce unemployment?
Mody: If recent evidence is any guide, then Ireland’s export sector is unlikely to be an engine of job growth unless the exporting activity broadens to include domestic exporters and they show a much more lively participation in exports than they have in the past.
Most likely, most new jobs will be generated when consumption starts growing again. Consumption growth will improve prospects for businesses, who will then start investing and hiring.
IMF Survey online: How real is the risk of deflation?
Mody: Ireland had one of the highest price levels in Europe during the boom years, so some adjustment had to occur. This adjustment is currently taking place. Along with weakness in domestic demand, this process will keep prices soft.
But we do not expect negative inflation or declining prices over a prolonged period. Based on current evidence, we believe that prices in Ireland will decline this year, an assumption that is widely shared. Prices probably also will decline somewhat next year, though less so than this year.
IMF Survey online: What is the state of play regarding Ireland’s banks?
Mody: Substantial rebuilding of the Irish banking sector is still needed. There are two immediate issues: recapitalization and liquidity.
If everything goes according to schedule, Ireland’s banks will have been recapitalized to a reasonable extent by early next year. The plan is to “over” capitalize the banks to enable them to deal with the continued losses they are expected to face in 2011. Hopefully, at the end of this process, the banks will still have adequate capital—core Tier 1 capital of 8 percent of risk-weighted assets. If the losses turn out to be larger than expected today, the issue will have to be revisited.
The second issue is one of liquidity. In the boom years, Irish banks came to rely considerably on market funding, a tendency that many banks worldwide shared. The recent market tensions have been felt particularly acutely by banks seeking funding for their operations. Later this year, Irish banks will need to roll over some of their funding, as some of their past obligations come due.
The Irish authorities can provide guarantees to banks seeking new funds from the market, which should help the rollover process. With that rollover completed, the planned capitalization by early next year should give the banks greater ability to obtain market funding on their own and be gradually weaned off public support. This process will unfold over the coming months and will be monitored carefully by the government.