Back from recession
Continued Recovery for Ireland
March 2, 2012
- Irish economy on slow recovery path, led by exports
- Strong program implementation has helped restore confidence in the economy
- Financial sector reforms key to recovery in domestic demand and job creation
After three years of recession, Ireland’s economy is recovering, albeit slowly. Led by a pickup in exports, the country saw growth turn positive in the first half of 2011. Financial markets are drawing confidence from Ireland’s strong implementation of the European Union (EU)- and IMF-supported program and the signs of recovery.
As a result, Irish bond spreads have fallen markedly since they spiked in July 2011, and are now closer to the levels seen for Italy and Spain than for Portugal or Greece.
But the crisis is not yet over, not least because unemployment remains unacceptably high at more than 14 percent. The economic slowdown in other eurozone countries makes it more difficult for Ireland to fully recover from its housing bust in 2008. In an interview, IMF mission chief for Ireland Craig Beaumont discusses Ireland’s economic prospects.
IMF Survey online: Ireland’s export-led recovery has slowed recently, in part because of the ongoing problems in the eurozone. How big a risk does this pose for the Irish economy?
Beaumont: Ireland’s GDP fell for three consecutive years from 2008 to 2010 as the economy suffered a severe bust following the credit and property boom that preceded the global economic crisis. Welcome signs of recovery started appearing in the first half of 2011, with exports growing strongly enough to offset the continued decline in spending by the private sector and the government. Data available for the second half of the year suggest weaker economic activity, but we are still estimating overall growth of almost 1 percent in 2011.
Looking to 2012, lower growth in Ireland’s main trading partners is expected to slow exports somewhat. But because Ireland exports goods such as pharmaceuticals and IT services that are less sensitive to the economic cycle than typical consumer goods, it may escape a more pronounced slowdown.
For this reason, we are still expecting positive GDP growth in 2012, in the order of ½ percent. There are some downside risks to this scenario, linked mainly to developments in the euro area, but the scale of these risks appears to have eased recently.
IMF Survey online: Has the government succeeded in plugging the hole in its public finances?
Beaumont: Ballooning budget deficits were a nasty side effect of the economic collapse, and given the spiraling public debt, the government simply had no choice but to cut back. The government undertook consolidation efforts well before the EU- and IMF-supported program was agreed, raising income taxes and reducing public sector wages and social welfare rates. Still, by 2010, the deficit remained at almost 12 percent of GDP because of the severe down-turn.
The program aims to reduce this shortfall while minimizing the harm to the economy, protecting the poor, and devoting resources to job creation, which is an urgent priority for the government. A total package of 3.4 percent of GDP in budget measures was carefully executed by the government in 2011, reducing the deficit to about 10 percent of GDP, well within the EU/IMF program targets.
Going forward, the government is committed to reduce the fiscal deficit to less than 3 percent of GDP by 2015. The recently announced budget for 2012 includes 2.7 percent of GDP in spending and revenue measures (including the full year effect of 2011 measures), so the adjustment is being gradually adjusted to facilitate recovery.
IMF Survey online: With unemployment hovering at 14 percent, and with more than half of unemployed people having been out of work for more than a year, what are the long-term prospects for job creation in Ireland?
Beaumont: Reducing unemployment is a must for the success of the EU- and IMF-supported program. The export sector is creating jobs, including by attracting foreign investment, but the numbers are not large enough to create a significant decline in the rate of unemployment because most of the factories producing the goods for exports are highly automated.
This means that stronger domestic demand is needed to bring down unemployment significantly. Recent and ongoing bank reforms should help restore healthy lending to households and small and medium-sized enterprises. The government is also working to improve training, especially to help those who lost their jobs in the construction sector develop new skills that will allow them to move into other sectors.
Together, these efforts will pay off in terms of stronger job creation in the coming years, although this may be of little comfort to those who are still without jobs.
IMF Survey online: Housing prices have been almost halved compared to their peak in 2007. How much further will they have to go, and what can be done to arrest the decline in the housing market?
Beaumont: Irish house prices rose dramatically until 2007, when the crisis hit. They have since fallen by 48 percent from this peak, including by more than 17 percent during last year alone.
There is relatively little turnover in the market, as potential buyers worry that prices may fall further, and mortgages are more difficult to obtain. But indicators such as house prices relative to incomes are returning to more normal levels by historical standards. So while we expect some further decline in prices, this should bottom out when values become sufficiently attractive.
Reforms to strengthen the banking sector will eventually encourage more lending, which will also help stabilize housing prizes. Finally, the household insolvency law is being modernized, including new out-of-court procedures to address the debt distress of some households, and this should also facilitate a recovery in the housing market.
IMF Survey online: How much more work is needed on slimming down the banking sector?
Beaumont: The banking sector grew extremely large during the boom, with assets reaching the equivalent of about 5 times the size of Ireland’s GDP. So a downsizing to more normal levels was long overdue.
A major step in the downsizing was the decision to move €70 billion in property and land development loans that had gone bad from the banks into the National Asset Management Agency, to be realized over 10 years. Two failed banks have been merged into the Irish Bank Resolution Company, which is winding down their remaining assets, recently selling most of a $9 billion commercial loan portfolio.
Three domestic banks are undertaking their own deleveraging, with an asset reduction of €70 billion targeted by end-2013, focused on non-core assets which are mostly held offshore. Almost half of the total deleveraging target was reached during 2011, and the prices for the disposal of assets were higher than expected. This is very good progress. Since then, however, market conditions have become more challenging, as European banks have started disposing assets on a larger scale. This is why Ireland’s deleveraging framework includes protection against losses from fire sales.
IMF Survey online: Will the Irish government be able to return to the financial markets in 2013, as currently foreseen under the EU- and IMF- supported program?
Beaumont: Recent market developments are favorable, with the spreads on Irish bonds falling to about 450 basis points on 2-year bonds, down from a peak of 2200 basis points in mid-2011.
The government is in regular contact with market participants, and currently intends to return to the market by issuing treasury bills in the second half of 2012. So we think it’s reasonable at this stage to expect that the modest market financing projected for 2012 will be achieved, although we will keep developments under review.
There is a more substantial need for market funding in 2013. Whether the government manages to meet its financing needs next year will depend not only on continued strong policy implementation on its part, but also on developments in the euro area. Because of this uncertainty, the IMF is encouraging the European authorities to proactively take steps to reinforce the prospects of Ireland having adequate market access in 2013.
Such steps could help Ireland avoid ongoing reliance on official funding, and would also contribute to overall European economic stability.