## _cr04348

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### Background and Outlook
- Over the last half of the 1990s, incomes in Ireland grew quickly and converged to the EU average as output and employment expanded; output growth averaged 10 percent a year in 1995–2000.
- A sound macroeconomic policy framework encouraged large inflows of FDI that served as a catalyst to growth.
- Growth slowed in 2001 with the world economy; the downturn was relatively mild, particularly in employment, and the economy began to recover in 2003.
- Inflation, which had been running well above the euro area for several years, converged to the average euro area rate in early 2004.
- House price inflation continues to significantly exceed sustainable rates.
- Indicators point to a continued rebound in growth to rates above those in many other industrial countries, but significantly lower than those experienced during the late 1990s.

### Key Diagnostics and Projections
- Recovery is well underway and growth in 2004 and 2005 will be between 4 percent and 5 percent, the range that appears to be sustainable over the medium term.
- Staff’s baseline forecast: GNP growth picking up to 4½ percent in 2004, with a slightly higher increase in GDP.
- Staff forecasts GNP growth to rise to 5 percent in 2005.
- Medium-term potential: staff estimate medium-term potential GNP growth at the mid-point of the typically cited range of 4–5 percent.
- Inflation and wages:
  - HICP inflation fell from around 5 percent in February 2003 to 1¾ percent in April 2004, then picked up to 2½ percent most recently reflecting higher oil prices.
  - Staff view: underlying or “core” inflation remaining in the vicinity of 2 percent on a HICP basis.
  - Wage growth eased from an average of around 9 percent in 2001 to some 5 percent in 2003.
- Output and labor:
  - GNP growth decelerated from around 10 percent in 2000 to 1½ percent in 2002; overall GNP growth was 2.8 percent in 2003.
  - Unemployment rose from a low of 3.7 percent in January 2001 to 4.8 percent by July 2003.
- Housing:
  - The rate of house price increases rose to around 15 percent in 2003 and is running just below this presently.
  - Staff benchmark: recent house price increases of 12–15 percent are out of line with medium-term income-growth prospects of 4–5 percent in real, and 6–7 percent in nominal terms.

### Risks and Challenges
- Risks from further euro appreciation threaten competitiveness.
- Rapid house price increases pose risks of an abrupt unwinding; a disorderly correction risk increases the longer house-price inflation remains high.
- Competitiveness has deteriorated; absent wage moderation, further deterioration is possible.
- Large infrastructure needs and strong demand for higher quality public services create pressures on public finances.
- Expectations in product, labor, housing markets, and fiscal policy may not have fully adjusted to slower growth.

### Policy Recommendations (summarized)
- Implement a modest tightening in the structural fiscal balance in the next budget to avoid a procyclical fiscal policy; staff argued for beginning modest longer-run fiscal tightening in the next budget (Budget 2005).
- Authorities should continue to communicate concerns about potential overheating in the housing market to help achieve a soft landing; staff strongly supports the Central Bank’s public expressions of concern.
- Remove subsidies to housing over the medium-term to help moderate house-price cycles in the future:
  - Strong case for removing interest-deductibility of mortgage payments on primary dwellings.
  - Strong case for introducing a market-value-based wealth tax on property.
  - Tax second homes at higher rates given scarce infrastructure.
- Shorten the duration of the wage component of the social partnership agreements to increase flexibility in nominal wages; staff argued for maintenance of the new sub-period structure to provide flexibility, authorities noted practical difficulties.
- Continue to strengthen financial supervision and pursue efforts to improve public expenditure efficiency, control public sector wages, and increase domestic competition.
- Adopt an overall multi-year spending framework and extend rolling multi-year spending envelopes to current spending.

### Near-term outlook (2004) and 2005 (selected)
- 2004:
  - Staff baseline: GNP growth 4½ percent in 2004.
  - Authorities anticipate full-year GDP growth of the order of 4¾ percent (GNP 4¼ percent).
  - Domestic demand: consumer confidence recovering; household spending expected to rise with disposable incomes and employment; residential investment could well exceed last year’s vigorous pace.
- 2005:
  - Staff forecasts GNP growth 5 percent in 2005.
  - Authorities’ official projections at time of December 2003 budget: around 4 percent (acknowledged would need revision).
  - Key risk: extent to which consumption will be restrained by higher debt-servicing costs as interest rates begin to normalize; staff emphasized implications of rapid run up in household debt levels.
- Inflation/labor market:
  - Core inflation around 2 percent (staff); headline buffeted by oil prices.
  - Staff estimates limited slack dissipated under baseline by next year.

### Competitiveness, wages, and structural policy
- Price/exchange rate observations:
  - Nominal effective exchange rate essentially reverted to its level during 1995–98 after euro strengthening in 2002–03.
  - Consumer-price-based real exchange rate stands some 15 percent above its level during 1995–98.
- Manufacturing competitiveness:
  - Employment-weighted real exchange rate index for manufacturing has appreciated by some 15 percent over 1995–98 levels.
  - Deterioration reflected in increases in wages in excess of productivity since slowdown began in 2001.
- Wage agreements:
  - Recent wage increase negotiated: 5½ percent over 18 months (averaging 3⅔ percent a year).
  - Three-year national wage agreements have been useful, but tradeoff with flexibility suggests shortening duration could help.
- Market structure:
  - Ireland compares well on labor market regulation and administrative burden for start-ups but ranks poorly on competition legislation and intensity of local competition.
  - Improving competition in the non-traded sector is essential to contain input-cost growth into the traded sector.

### Housing market: characteristics, vulnerabilities, and policy
- Drivers of the boom: large increases in disposable incomes and employment during the Celtic Tiger era, demographic factors, migration flows, lower and less volatile interest rates following EMU, financial liberalization, strong preference for owning property, and tax changes (re-introduction of interest tax deductibility for residential investment mortgages in the 2002 budget).
- Credit and debt:
  - Mortgage credit pace reached 27 percent recently.
  - Household debt risen to 100 percent of after-tax income, up from 60 percent in 1998.
- Supply:
  - Some 69 thousand new homes were built last year, representing 17 new houses per thousand of the population (compared with 6 in the US, less than 5 in Europe, and less than 3 in the UK).
- Indicators of exuberance:
  - Some 40 percent of new houses being purchased as second or buy-to-let properties.
  - Buy-to-let transactions account for 20 percent of all new mortgages.
  - Building has accelerated despite rents and rental yield on new construction falling sharply.
- Vulnerabilities:
  - Predominance of variable-rate mortgages and increased household debt make housing market vulnerable to sharp interest-rate increases.
  - Staff benchmark: recent house price increases of 12–15 percent exceed sustainable paths tied to medium-term incomes.
- Policy tools:
  - Near term: public communication by the Central Bank to tame expectations; increase borrower and lender awareness of interest-rate prospects and debt-servicing impacts.
  - Medium term: remove mortgage interest deductibility, introduce market-value-based wealth tax on property, tax second homes at higher rates.
  - Authorities noted political difficulties likely insurmountable for removing interest deductibility or introducing property taxation.

### Banking sector resilience and housing exposure
- Bank loan-book composition related to property:
  - residential mortgages 34 percent
  - commercial property 12 percent
  - construction 4 percent
- Strengths:
  - High profitability and capitalization bolster capacity to withstand shocks.
  - Low bad/nonperforming mortgage rates of 1 to 20 basis points.
  - Low effective loan-to-value ratios imply prices would have to fall considerably before negative equity is widespread.
- Stress tests:
  - Strong capitalization levels provide a significant cushion against sharp declines in property prices combined with simultaneous increases in unemployment and interest rates.
  - Rating agencies share view that capitalization is strong.
- Staff recommendation: greater attention to effects of normalization of interest rates and increased borrower awareness of interest-rate prospects and debt-servicing impacts.

### Fiscal policy, public investment, and efficiency
- Recent fiscal developments:
  - Nominal expenditure growth: 18 percent in 2001, 12 percent in 2002, lowered to 7 percent in 2003.
  - 2003 outturn: nominal surplus of 0.2 percent of GDP, almost 1 percent of GDP better than budgeted.
  - 2004 Budget envisaged a small improvement in the cyclically-adjusted balance of about ¼ percent of GDP and a nominal deficit of 1.1 percent of GDP.
  - Staff revised projections to a nominal fiscal deficit of ⅓ percent of GDP in 2004 and, excluding one-offs, projects a structural/underlying deficit in 2004 of about ½ percent of GDP.
- Medium-term fiscal objectives:
  - Authorities committed to the SGP and achieving a zero structural balance over the medium term; staff supports this.
  - Given staff’s estimate of this year’s underlying deficit of ½ percent of GDP, a modest adjustment is required over the next few years to reach the medium-term objective.
- Public investment and value for money:
  - Government capital spending targeted at 5 percent of GNP.
  - Faster increases risk bottlenecks and inefficiencies; past excesses led to double digit rates of associated price inflation.
  - Popular dissatisfaction with quality in health, education and infrastructure despite double-digit spending growth suggests inefficiencies or inadequate output information.
- Staff recommendations:
  - Shift focus from inputs to outputs; emphasize quantified performance targets.
  - Improve monitoring and measurement of public outputs.
  - Extend rolling multi-year spending envelopes (already extended to public capital spending) to current spending to avoid procyclical pressures.

### Public finances: projected indicators and stress tests (selected)
- Macroeconomic projections (annual percent change):
  - GDP: 9.9 (2000), 6.0 (2001), 6.1 (2002), 3.7 (2003), 4.7 (2004), 5.0 (2005, Proj.).
  - GNP: 10.1 (2000), 3.8 (2001), 1.5 (2002), 2.8 (2003), 4.5 (2004), 5.0 (2005, Proj.).
- Fiscal balances (percent of GDP):
  - General Government Balance: 4.4 (2000), 1.1 (2001), -0.2 (2002), 0.2 (2003), -0.3 (2004), -0.5 (2005, Proj.).
  - Primary balance: 6.4 (2000), 2.6 (2001), 1.2 (2002), 1.6 (2003), 1.1 (2004), 0.8 (2005, Proj.).
- General government debt (percent of GDP):
  - 38.3 (2000), 35.9 (2001), 32.7 (2002), 33.2 (2003), 32.5 (2004), 32.0 (2005, Proj.).
- Current account (percent of GDP): -0.4 (2000), -0.7 (2001), -1.3 (2002), -1.4 (2003), -1.6 (2004), -1.3 (2005, Proj.).
- Balance of payments — current account balance (millions of euro): -379 (2000), -757 (2001), -1,617 (2002), -1,894 (2003), -2,250 (2004), -2,077 (2005, Proj.).
- Baseline debt projection: gross general government debt declines gradually from about 34 percent in 2003 to slightly below 31 percent in 2009.
- Stress-test outcomes (public sector debt in percent of GDP):
  - B1 (real interest shock): 32.5 (2004 baseline), 33.2 (2005), 34.0 (2006), 33.6 (2007), 33.3 (2008), 33.1 (2009).
  - B2 (real GDP growth shock): 32.5 (2004 baseline), 33.3 (2005), 34.6 (2006), 35.3 (2007), 36.2 (2008), 37.0 (2009).
  - B6 (10 percent of GDP increase in other debt-creating flows in 2005): 32.5 (2004 baseline), 42.0 (2005), 41.4 (2006), 40.9 (2007), 40.5 (2008), 40.1 (2009).
- Worst stress-test outcome described: a rise in the debt ratio from 32½ percent in 2004 to around 40 percent in 2009 under the assumption of a 10 percent of GDP increase in other debt-creating flows in 2005.

### Data, statistics, and authorities’ views
- Data reporting and gaps:
  - Quarterly national accounts on an ESA 1995 basis are published within 4 months of their reference period.
  - Real sector data sometimes published with a lag of 3–6 months; some non-SDDS series published with a lag of one and a half years (example: household disposable income).
  - Lags of 3–7 months for employment, earnings, unit wage costs, and national income and expenditure data.
  - Ireland does not have an overall earnings index or comprehensive sectoral balance sheet data.
- Core statistical indicators (as of August 12, 2004) — selected:
  - Date of Latest Observation: 8/12/2004.
  - Consumer Price Index: July 2004 (Monthly).
  - GDP/GNP: 1st Quarter 2004 (Quarterly).
  - Exchange Rates: 8/12/2004 (Daily).
- Authorities’ stance:
  - Authorities broadly share analysis and conclusions of the Staff Report.
  - Authorities agree medium-term growth potential is in the 4-5 percent range and expect annual per capita growth potential in the 3-3 ½ percent range.
  - Authorities insist wage increases be limited at minimum to those negotiated under the social partnership agreement.
  - Authorities emphasize improving efficiency and effectiveness of public service and infrastructure delivery rather than raising tax and expenditure ratios.
  - Authorities support Central Bank communications to curb housing expectations and are heightening awareness of household indebtedness implications.

### Staff appraisal: outlook, priorities, and concluding advice
- Near-term: Ireland’s performance has been enviable despite global shocks; recovery strengthening; inflation converged to euro area rates; near-term prospect stronger and broader-based growth with underlying/core inflation expected in vicinity of 2 percent.
- Medium-term: medium-term GNP growth forecast 4½ percent; key challenge is managing transition of expectations to slower growth and ensuring adjustments are structural.
- Priorities:
  - Extended period of wage restraint and increased wage flexibility.
  - Engineer a soft landing in housing via Central Bank communications and heightened borrower/lender awareness.
  - Start modest, front-loaded fiscal consolidation beginning in Budget 2005 to attain medium-term structural balance (underlying deficit in 2004 estimated at ½ percent of GDP).
  - Improve delivery and value for money in public services; extend multi-year spending envelopes to current spending; continue health-sector reforms and public service modernization.
  - Strengthen financial supervision and pursue competition-enhancing reforms in non-traded sectors.

*IMF staff executive summary as presented in the source document.*

### Executive Summary ......................................................................................................

### _cr04348 - Executive Summary ......................................................................................................

### Background and Outlook
- Over the last half of the 1990s, incomes in Ireland grew quickly and converged to the EU average as output and employment expanded; output growth averaged 10 percent a year in 1995–2000.
- A sound macroeconomic policy framework encouraged large inflows of FDI that served as a catalyst to growth.
- Growth slowed in 2001 with the world economy; the downturn was relatively mild, particularly in employment, and the economy began to recover in 2003.
- Inflation, which had been running well above the euro area for several years, converged to the average euro area rate in early 2004.
- House price inflation continues to significantly exceed sustainable rates.
- Indicators point to a continued rebound in growth to rates above those in many other industrial countries, but significantly lower than those experienced during the late 1990s.

### Key Diagnostics and Projections
- Recovery is well underway and growth in 2004 and 2005 will be between 4 percent and 5 percent, the range that appears to be sustainable over the medium term.
- Inflation will remain close to the ECB’s target as resource constraints have abated and the catch-up of the Irish price level to key trading partners appears complete.
- House-price inflation continues to run well above sustainable rates; the longer it takes for them to moderate the greater the risk of a disorderly correction.
- Competitiveness has deteriorated; although there is little evidence that this has yet had a significant negative impact, wage moderation going forward will be important to avoid further deterioration.
- GNP growth decelerated from around 10 percent in 2000 to 1½ percent in 2002; overall GNP growth was 2.8 percent in 2003.
- HICP inflation fell from around 5 percent in February 2003 to 1¾ percent in April 2004, then picked up to 2½ percent most recently reflecting higher oil prices.
- Wage growth eased from an average of around 9 percent in 2001 to some 5 percent in 2003.
- The rate of house price increases rose to around 15 percent in 2003 and is running just below this presently.
- Unemployment rose from a low of 3.7 percent in January 2001 to 4.8 percent by July 2003.
- Fiscal consolidation reduced public debt from over 100 percent of GDP in 1988 to 36 percent by 2001.
- Real GNP and GDP cycles have diverged due to the substantial contribution of multinationals and associated profit flows; GDP and GNP measures are not synchronized.

### Analysis of Recent Policy Responses and Structural Issues
- Fiscal policies were expansionary in 2000–02, contrary to Fund advice; beginning with the 2003 Budget the authorities took steps consistent with Fund advice toward consolidating the public finances and the 2004 Budget held the line.
- No new temporary fiscal initiatives have been introduced that attempt to fine tune the housing market.
- The 2003 social partnership agreement offered no fiscal concessions; the latest wage agreement presents a considerable degree of wage moderation relative to the past.
- Financial supervision has been strengthened in line with the 2000 FSAP recommendations.
- Progress has been more limited in improving public expenditure efficiency, controlling public sector wages, and increasing domestic competition.
- Domestic demand was supported by the ECB’s easing of monetary policy and expansionary fiscal policy during the slowdown; net exports remained a significant positive contributor to growth as import growth fell.
- With many factors accounting for the boom being one-off by nature (increased employment rate, productivity catch up), medium-term growth prospects are decidedly lower than in the Celtic Tiger era.

### Risks and Challenges
- Risks from further euro appreciation threaten competitiveness.
- Rapid house price increases pose risks of an abrupt unwinding; a disorderly correction risk increases the longer house-price inflation remains high.
- Competitiveness deterioration could have delayed negative impacts; absent wage moderation, further deterioration is possible.
- Large infrastructure needs and strong demand for higher quality public services create pressures on public finances.
- Expectations in product, labor, housing markets, and fiscal policy may not have fully adjusted to slower growth.

### Policy Recommendations
- Implement a modest tightening in the structural fiscal balance in the next budget to avoid a procyclical fiscal policy.
- Authorities should continue to communicate concerns about potential overheating in the housing market to help achieve a soft landing.
- Remove subsidies to housing over the medium-term to help moderate house-price cycles in the future.
- Shorten the duration of the wage component of the social partnership agreements to increase flexibility in nominal wages.
- Continue to strengthen financial supervision and pursue efforts to improve public expenditure efficiency, control public sector wages, and increase domestic competition.

*IMF staff executive summary as presented in the source document.*

### 7.      In the near term, the shared prospect is for the recovery to strengthen and

### _cr04348 - 7.      In the near term, the shared prospect is for the recovery to strengthen and

### Near-term outlook (2004)
- Staff’s baseline forecast: GNP growth picking up to 4½ percent in 2004, with a slightly higher increase in GDP.
- External demand: continues to improve though the euro’s appreciation last year will be a restraining influence.
- Domestic demand:
  - Consumer confidence recovering; household spending expected to rise along with disposable incomes and employment.
  - Recovery in equipment investment expected to strengthen.
  - Residential investment could well exceed last year’s vigorous pace.
- Authorities: Department of Finance’s recent update of prospects for 2004 is largely in line with staff’s forecasts.

### Outlook for 2005
- Broad agreement on prospects: Staff forecasts GNP growth to rise to 5 percent in 2005.
- Authorities’ official projections at the time of the December 2003 budget: around 4 percent (acknowledged would need revision).
- Key elements of the outlook:
  - Residential investment widely expected to at least decelerate from its extraordinary pace.
  - External demand projected to slow as excess capacity in the world economy gets utilized and growth falls to trend rates.
  - Household spending supported by increasing incomes and a tightening labor market.
  - Key risk: extent to which consumption will be restrained by higher debt-servicing costs as interest rates begin to normalize; staff emphasized implications of rapid run up in household debt levels.
  - Equipment investment expected to rebound strongly from substantially depressed levels.

### Inflation and labor market (near term)
- Shared outlook: inflation to remain moderate.
- Staff view: underlying or “core” inflation remaining in the vicinity of 2 percent on a HICP basis, though headline rates will be buffeted by oil prices.
- Authorities saw a somewhat higher average rate.
- Cyclical assessment: staff estimates build up of slack during the slowdown was limited and is dissipated under the baseline by next year with little implication for inflation.
- Authorities: share assessment of limited slack but saw faster prospective tightening in the labor market and greater potential for wage inflation picking up.
- Secular viewpoint: agreement that the “catch up” of the Irish price level to other developed countries appears complete and should not be a factor.

### Risks to outlook
- Near-term: risks broadly balanced.
  - Downside risks to external demand from the euro area offset by upside risks elsewhere, particularly the UK.
- Medium-term/downside risks emphasized by staff:
  - Significant further euro appreciation in response to global imbalances.
  - Potential unwinding of booms in house prices and construction.
- Inflation risks:
  - Slow adjustment of expectations to lower productivity growth and inflation prospects.
  - Potential feed-through of oil price increases to wages and services inflation tilting risks to the upside.

### Medium-term potential growth
- Strong agreement: medium-term growth prospects decidedly lower than in the second half of the 1990s.
- Staff estimate: medium-term potential GNP growth at the mid-point of the typically cited range of 4–5 percent.
  - Such rates are less than half the average experienced in 1995–2000.
- Factors:
  - Many 1990s boom factors raised the level rather than the growth rate of output.
  - Potential growth in Ireland is endogenous to a greater degree than in other advanced countries because capital accumulation is affected importantly by FDI (and competitiveness), and labor supply increases depend on migration flows and increasing participation rates.
- Authorities’ methodology:
  - Budget and official projections use estimates from the methodology agreed between EU countries and the European Commission.
  - That methodology currently yields estimates of current potential growth significantly above the 4–5 percent range due to weight given by filtering techniques to the boom period.
  - Authorities did not disagree that the methodology likely overstated potential growth over the medium term and noted limited slack in the labor market presently.

### Competitiveness and incomes policy requirements
- Inflation convergence: rapid reduction and convergence of inflation is encouraging, but concerns about erosion of competitiveness have grown.
- Price and exchange rate observations:
  - With strengthening of the euro during 2002–03, nominal effective exchange rate essentially reverted to its level during 1995–98.
  - With inflation persistently in excess of partner countries for six years, Ireland’s price level has risen well above main trading partners and the consumer-price-based real exchange rate stands some 15 percent above its level during 1995–98.
- Manufacturing competitiveness:
  - Traditional output-weighted real exchange rate for manufacturing suggests only a pause in trend real depreciation.
  - Employment-weighted real exchange rate index for manufacturing has appreciated by some 15 percent over 1995–98 levels.
  - Deterioration reflected entirely increases in wages in excess of those in productivity since the slowdown began in 2001.
- Export and FDI performance: encouraging recent performance has allayed some concerns but risks remain:
  - Firms may temporarily absorb declines in profit margins; lagged adverse response of output and employment possible.
  - Need for composition of FDI flows to move to higher value added activities; proactive industrial policy effective but necessary upgrading of skills must keep pace.
  - High rates of services inflation may deter labor supply (e.g., slowdown in female labor force participation as childcare costs rose).
  - Anecdotal evidence of high relative house prices deterring inward migration.
- Wage agreements:
  - Recent wage increase negotiated in second phase of the Sustaining Progress agreement: 5½ percent over 18 months (averaging 3⅔ percent a year).
  - Agreement seen as in line with lower prospective core inflation and productivity developments; strong case these agreements should not be exceeded.
  - Three-year national wage agreements have served Ireland well but tradeoff between greater wage flexibility and costs of renegotiation likely to shift.
  - Present three-year agreement is first to break up wage negotiations into two sub-periods; staff argued for maintenance to provide greater wage flexibility; authorities noted logistical and practical difficulties and heavy burden on social partnership process.
- Market structure and competition:
  - Ireland compares well on indicators of labor market regulation, regulatory burden, levels of bureaucracy, and administrative burden for start-up firms, but ranks poorly on competition legislation and intensity of local competition.
  - Improving competition in the non-traded sector, public and private, is essential to contain growth of input costs into the traded sector and maintain external competitiveness.
  - Authorities reported steps taken (reviews of restrictive practices in the professions completed for two professions with removal of major restrictions identified).
  - Staff noted slow progress on reviews of remaining six professions and resistance from public sector unions to steps toward improving efficiency in public transportation.
  - Overall results limited and scope for hastening progress considerable.

### Continued ebullience in the housing market
- Character of the boom:
  - Rapidly rising property prices in face of slow growth is a feature in many countries, but extent, scale and duration of the boom in Ireland set it apart.
  - Fundamental reasons for bigger boom in Ireland: enormous increases in disposable incomes and employment during the Celtic Tiger era, demographic factors, change in direction of migration flows, lower and less volatile interest rates following EMU, financial liberalization and innovation increasing supply of lending, and strong preference in Ireland for owning property.
  - Tax changes affected dynamics (re-introduction of interest tax deductibility for residential investment mortgages in the 2002 budget).
- Credit and debt:
  - Mortgage credit pace reached 27 percent recently.
  - Household debt risen to 100 percent of after-tax income, up from 60 percent in 1998.
- Supply response:
  - Last year, some 69 thousand new homes were built, representing 17 new houses per thousand of the population, as compared to 6 in the US, less than 5 in Europe, and less than 3 in the UK.
- Assessment of fundamentals vs exuberance:
  - Staff presented empirical evidence last year suggesting price increases had exceeded those suggested by traditional demand-side factors (disposable incomes, demographics and interest rates).
  - Authorities and other observers argued adding supply-side factors (price of building land, building costs, availability of mortgage loans) can sufficiently explain price developments.
  - Staff view: price of land, building costs and expansion in mortgage lending largely endogenous to the real estate cycle.
  - Staff sees elements of exuberance beyond fundamentals, reinforced by indicators:
    - Some 40 percent of new houses being purchased as second or buy-to-let properties.
    - Buy-to-let transactions account for 20 percent of all new mortgages.
    - Building has accelerated despite rents and rental yield on new construction falling sharply.
- Sustainability and vulnerabilities:
  - Agreement that recent rates of price increase are running above sustainable rates dictated by medium-term growth prospects; longer failure to moderate increases vulnerability to disorderly correction.
  - Staff benchmark: recent house price increases of 12–15 percent are out of line with medium-term income-growth prospects of 4–5 percent in real, and 6–7 percent in nominal terms.
  - Predominance of variable-rate mortgages and significantly increased household debt levels make housing market vulnerable to sharp increases in interest rates, though market expectations of the monetary policy tightening cycle in the euro area are for moderate and gradual increases.
- Policy recommendations and constraints:
  - Near term: public communication can play an important role in taming expectations and help induce a soft landing; staff strongly supports the Central Bank’s public expressions of concern regarding recent rates of house price increase and credit growth.
  - Medium term: structural aspects must be addressed.
    - Strong case for removing interest-deductibility of mortgage payments on primary dwellings.
    - Strong case for introducing a market-value-based wealth tax on property.
    - Second homes are not subsidized but are not taxed; argument they should be taxed given scarce infrastructure being provided.
  - Authorities noted political, likely insurmountable, difficulties of removing interest-deductibility of mortgages or introducing taxation on property given electorate’s long history of strong attachment to, and preference for owning, property.

*Italic: IMF staff report excerpt (content unit: _cr04348).*

### 22.      High profitability and capitalization levels have bolstered the capacity of the

### _cr04348 - 22.      High profitability and capitalization levels have bolstered the capacity of the

### Banking sector resilience and exposure
- High profitability and capitalization have bolstered the capacity of the domestic banking system to withstand shocks without creating systemic stress.
- Property sector composition of banks’ loan books:
  - residential mortgages 34 percent
  - commercial property 12 percent
  - construction 4 percent
- Stress-test findings and assessments:
  - Strong capitalization levels provide a significant cushion against sharp declines in property prices combined with simultaneous increases in unemployment and interest rates.
  - Rating agencies share the view that capitalization is strong.
- Credit and borrower metrics:
  - Low effective loan-to-value ratios imply prices would have to fall considerably before negative equity is widespread.
  - A strong culture of servicing mortgages is evidenced by low bad/nonperforming mortgage rates of 1 to 20 basis points despite the recent growth slowdown.
- Supervisory and policy emphasis:
  - Strengthened surveillance by the supervisory authority welcomed to ensure prudential concerns are factored into banks’ lending behavior.
  - Staff recommended greater attention to the effects of normalization of interest rates from present cyclical lows and increased borrower awareness of interest-rate prospects and debt-servicing impacts.

### Housing market risks and macroeconomic channels
- Role of housing in household behavior:
  - Mortgage equity withdrawals are not prevalent in Ireland.
  - Aggregate consumption has not shown a strong identifiable relationship with house prices; consumption has tracked disposable income more closely.
- Potential macroeconomic consequences of a sharp housing correction:
  - Correction could harm consumer confidence and, more importantly, affect employment via construction-sector losses.
  - New house building represented some 12 percent of GNP last year, compared with 5 percent in the US and 3 percent in the UK.
  - The scenario of greatest concern: coincident large increases in unemployment and interest rates.
- Labor market absorption:
  - Authorities and observers noted flexibility in the labor market during the recent downturn, suggesting construction job losses could be absorbed elsewhere.
  - Staff were more agnostic, noting the construction boom predated the slowdown and that absorption into the traded sector is uncertain given no reason to expect a coincident upswing and potential skill-matching issues.

### Fiscal policy: recent adjustments and near-term stance
- Recent fiscal outcomes and budgetary adjustments:
  - Nominal expenditure growth: 18 percent in 2001, 12 percent in 2002, lowered to 7 percent in 2003.
  - 2003 outturn: nominal surplus of 0.2 percent of GDP, almost 1 percent of GDP better than budgeted.
  - 2004 Budget (framed before final 2003 outturn): envisaged a small improvement in the cyclically-adjusted balance of about ¼ percent of GDP and a nominal deficit of 1.1 percent of GDP.
  - Staff revised projections to a nominal fiscal deficit of ⅓ percent of GDP this year.
  - Excluding one-off effects, staff projects a structural or underlying deficit this year of about ½ percent of GDP.
- One-off revenue sources cited:
  - Higher-than-expected receipts from changes in the capital-gains tax regime and from stamp duties reflecting property-market buoyancy.
  - Authorities attribute well-above-expected revenue performance also to anti-fraud measures.
- Medium-term fiscal objectives and recommendations:
  - Authorities committed to the SGP and achieving a zero structural balance over the medium term; staff supports this.
  - Given staff’s estimate of this year’s underlying deficit of ½ percent of GDP, a modest adjustment is required over the next few years to reach the medium-term objective.
  - Staff argued for beginning modest longer-run fiscal tightening in the next budget (Budget 2005) due to limited spare capacity and upside risks to inflation and revenues from the property market.
  - Political pressures to reduce taxes or increase spending should be resisted to avoid procyclical policy that would raise inflation, hurt competitiveness, and reduce value for money.
- Fiscal institution and framework recommendations:
  - Staff called for an overall multi-year spending framework and extension of rolling multi-year spending envelopes (already extended to public capital spending) to current spending.
  - The authorities extended rolling multi-year spending envelopes from transportation to all public capital spending in the last budget.

### Public investment, service delivery, and value for money
- Government capital spending:
  - Targeted at 5 percent of GNP, which is well above levels elsewhere.
  - Faster increases risk bottlenecks and inefficiencies; past excesses led to double digit rates of associated price inflation.
- Quality and efficiency of public services:
  - Popular dissatisfaction with quality in health, education and infrastructure despite double-digit spending growth suggests inefficiencies or inadequate output information.
  - Authorities’ initiatives:
    - Monthly reviews of departmental expenditures.
    - New guidelines for management and appraisal of capital projects.
    - Better contractual arrangements for construction projects shifting risk to contractors.
    - Fundamental administrative reform begun in the health sector.
    - Program for modernization of public service delivery.
  - Staff recommendations:
    - Shift focus from inputs to outputs and emphasize quantified performance targets to motivate efficiency gains.
    - Improve monitoring and measurement of public outputs to reduce pressures for additional spending.

### Data, trade, and development commitments
- Statistics improvements:
  - Newly-introduced data on external debt welcomed.
  - Need to improve fiscal reporting at the general government level and to publish a national earnings index and sectoral balance sheets.
  - Authorities extending scope and consistency of earnings data and compiling sectoral balance sheets, expected to be completed by 2005.
- Trade and agriculture:
  - Ireland is a strong supporter of trade liberalization in the EU; on the CAP the authorities noted they had agreed to two reforms in preparation for the WTO and were unlikely to agree to further reforms.
  - Priority: ensure a balanced agreement in agriculture across domestic support, market access and export subsidies; agriculture should not be sacrificed within a new WTO round.
- Official development assistance:
  - Authorities remain committed to reaching UN target of 0.7 percent of GNP for ODA by 2007.
  - ODA budgeted at 0.4 percent of GNP in 2004.

### Staff appraisal: outlook, risks, and policy priorities
- Recent performance and short-term outlook:
  - Ireland’s performance has been enviable despite global shocks; growth resilient; labor market flexibility limited unemployment increases; inflation converged to euro area rates.
  - Near-term prospect: stronger and broader-based growth; inflation to remain moderate.
  - Private consumption likely restrained by increases in debt servicing costs as interest rates normalize; residential investment should slow from unusually high rates.
  - Underlying/core inflation expected to remain in the vicinity of 2 percent.
- Medium-term growth and transition challenges:
  - Medium-term growth forecast: 4½ percent in GNP, markedly lower than second-half 1990s averages.
  - Key challenge: manage transition of expectations to slower growth; ensure adjustments are seen as structural.
- Competitiveness and labor policy:
  - Competitiveness has deteriorated as price levels and wages rose relative to partners.
  - Recent wage increase is in line with prospective core inflation and productivity but does not compensate for past competitiveness erosion or risks from further euro appreciation.
  - Recommendation: extended period of wage restraint and increased wage flexibility; consider shortening national wage agreement duration from three years.
- Housing market policy recommendations:
  - Aim to engineer a soft landing in housing; Central Bank communications to tame expectations are appropriate.
  - Increase borrower and lender awareness of prospects for interest rate increases from current cyclical lows and implications for debt-servicing.
  - Policy proposals:
    - Remove interest-deductibility of mortgage payments on primary dwellings.
    - Introduce a market-value-based wealth tax on property.
    - Tax second homes at higher rates given scarce infrastructure.
- Fiscal timing and prudence:
  - Fiscal policy has adjusted to slower medium-term growth, but cyclical considerations argue for frontloading remaining consolidation starting in Budget 2005.
  - Underlying deficit in 2004 estimated at ½ percent of GDP; start adjustment to attain medium-term balance.
- Public spending efficiency:
  - Improve delivery and value for money rather than raise taxes/expenditures.
  - Extend multi-year spending envelopes to current spending to protect against procyclical pressures and improve planning.
  - Continue health-sector reforms and modernization of public service delivery; shift focus to outputs.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04348.pdf*

### 41.      Scope remains for improving the provision of statistics. Ensuring the timeliness of

### _cr04348 - 41.      Scope remains for improving the provision of statistics. Ensuring the timeliness of

### Policy recommendations and near-term actions
- Scope remains for improving the provision of statistics. Ensuring the timeliness of general government accounts and developing a national earnings index should be priorities.
- The authorities should adopt a more supportive stance within the EU in favor of further CAP reform, particularly in view of the adverse impact of this policy on developing countries and EU consumers. This would complement the welcome commitment towards achieving the UN’s ODA target by 2007.
- It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

### Macroeconomic outlook and projections (selected)
- GDP (annual percent change): 9.9 (2000), 6.0 (2001), 6.1 (2002), 3.7 (2003), 4.7 (2004), 5.0 (2005, Proj.).
- GNP (annual percent change): 10.1 (2000), 3.8 (2001), 1.5 (2002), 2.8 (2003), 4.5 (2004), 5.0 (2005, Proj.).
- Domestic demand (annual percent change): 9.1 (2000), 3.8 (2001), 3.4 (2002), 3.3 (2003), 3.3 (2004), 3.6 (2005, Proj.).
- Net exports (contribution to GDP growth): 2.2 (2000), 2.8 (2001), 3.1 (2002), 1.2 (2003), 2.0 (2004), 1.3 (2005, Proj.).
- Harmonized Index of Consumer Prices (annual average): 5.2 (2000), 4.0 (2001), 4.7 (2002), 4.0 (2003), 2.3 (2004), 2.1 (2005, Proj.).
- Unemployment rate (in percent): 4.3 (2000), 3.9 (2001), 4.4 (2002), 4.7 (2003), 4.4 (2004), 4.1 (2005, Proj.).
- General Government Balance (In percent of GDP): 4.4 (2000), 1.1 (2001), -0.2 (2002), 0.2 (2003), -0.3 (2004), -0.5 (2005, Proj.).
- Primary balance (In percent of GDP): 6.4 (2000), 2.6 (2001), 1.2 (2002), 1.6 (2003), 1.1 (2004), 0.8 (2005, Proj.).
- General government debt (In percent of GDP): 38.3 (2000), 35.9 (2001), 32.7 (2002), 33.2 (2003), 32.5 (2004), 32.0 (2005, Proj.).
- Current account (Percent of GDP): -0.4 (2000), -0.7 (2001), -1.3 (2002), -1.4 (2003), -1.6 (2004), -1.3 (2005, Proj.).

### Balance of payments (selected levels, in millions of euro)
- Current account balance: -379 (2000), -757 (2001), -1,617 (2002), -1,894 (2003), -2,250 (2004), -2,077 (2005, Proj.), -2,026 (2006, Proj.), -2,344 (2007, Proj.).
- Trade balance: 27,266 (2000), 30,493 (2001), 35,443 (2002), 33,421 (2003), 35,996 (2004), 39,272 (2005, Proj.), 42,311 (2006, Proj.), 45,630 (2007, Proj.).
- Exports of goods: 79,971 (2000), 86,690 (2001), 89,495 (2002), 79,186 (2003), 83,671 (2004), 90,330 (2005, Proj.), 96,169 (2006, Proj.), 102,391 (2007, Proj.).

### Public finances and fiscal profile (selected)
- Current balance (percent of GDP): 6.9 (1999), 8.0 (2000), 5.5 (2001), 3.9 (2002), 3.9 (2003), 3.4 (2004, Proj.), 3.4 (2005, Proj.).
- Total revenue (percent of GDP, medium-term projections): 34.1 (2003), 34.0 (2004), 33.0 (2005), 33.0 (2006), 33.0 (2007), 33.0 (2008), 33.0 (2009).
- Total expenditure (percent of GDP, medium-term projections): 33.9 (2003), 34.4 (2004), 33.5 (2005), 33.4 (2006), 33.4 (2007), 33.5 (2008), 33.5 (2009).
- Budget balance (percent of GDP, medium-term projections): 0.2 (2003), -0.3 (2004), -0.5 (2005), -0.5 (2006), -0.5 (2007), -0.5 (2008), -0.5 (2009).
- Structural budget balance (including one-offs, percent of potential GDP): 0.5 (2003), -0.2 (2004), -0.5 (2005), -0.5 (2006), -0.5 (2007), -0.5 (2008), -0.5 (2009).

### Fiscal sustainability assessment (summary of projections and stress tests)
- Baseline: gross general government debt declines gradually from about 34 percent in 2003 to slightly below 31 percent in 2009; the primary balance remains in surplus during the period.
- Public sector debt (gross general government debt) projections, in percent of GDP: 48.7 (1999), 38.3 (2000), 35.9 (2001), 32.7 (2002), 33.2 (2003), 32.5 (2004), 32.0 (2005), 31.6 (2006), 31.3 (2007), 31.1 (2008), 30.8 (2009).
- Identified debt-creating flows (4+7+12) as percent of GDP: -9.6 (1999), -10.8 (2000), -5.2 (2001), -3.3 (2002), -1.9 (2003), -2.0 (2004), -1.8 (2005), -1.7 (2006), -1.6 (2007), -1.6 (2008), -1.5 (2009).
- Residual, including asset changes (2-3) as percent of GDP: 4.5 (1999), 0.5 (2000), 2.8 (2001), 0.1 (2002), 2.3 (2003), 1.3 (2004), 1.3 (2005), 1.3 (2006), 1.3 (2007), 1.3 (2008), 1.3 (2009).
- Stress-test outcomes (selected bound tests, public sector debt in percent of GDP):
  - B1 (Real interest rate at historical average plus two standard deviations in 2005 and 2006): 32.5 (2004 baseline), 33.2 (2005), 34.0 (2006), 33.6 (2007), 33.3 (2008), 33.1 (2009).
  - B2 (Real GDP growth at historical average minus two standard deviations in 2005 and 2006): 32.5 (2004 baseline), 33.3 (2005), 34.6 (2006), 35.3 (2007), 36.2 (2008), 37.0 (2009).
  - B6 (10 percent of GDP increase in other debt-creating flows in 2005): 32.5 (2004 baseline), 42.0 (2005), 41.4 (2006), 40.9 (2007), 40.5 (2008), 40.1 (2009).  
- Worst stress-test outcome described: a rise in the debt ratio from 32½ percent in 2004 to around 40 percent in 2009 under the assumption of a 10 percent of GDP increase in other debt-creating flows in 2005.

### External sustainability and net investment position
- The net external position (excluding direct investment) shows substantial claims on the rest of the world (around 90 percent of GDP), indicating external debt sustainability is not a concern.
- The net investment position, including direct investment, is in a relatively small deficit given strong continued FDI inflows.
- Large gross assets and liabilities in portfolio and other investments reflect activities of the International Financial Service Center; the 2000 FSAP noted these do not appear to pose a systemic risk to the domestic financial system.

### Fund relations, exchange arrangement, and statistics
- Membership: Joined 8/08/57; Article VIII.
- Quota: 838.40 (SDR Million) 100.00 percent.
- SDR Department net cumulative allocation: 87.26 (SDR Million) 100.00 percent; Holdings 55.18 (SDR Million) 63.23 percent.
- Projected Fund charges/interest payments: 0.29 (2004), 0.59 (2005), 0.59 (2006), 0.59 (2007), 0.59 (2008) (SDR Million).
- Exchange arrangement: As of January 1, 1999, the euro became the currency of Ireland and the irrevocably fixed conversion rate between the euro and the Irish pound is 0.787564.
- Article IV Consultations: last discussions were in Dublin during May 6–15, 2003; staff report considered by the Executive Board on July 30, 2003 (EBM/03/75); Article IV consultations with Ireland are currently on the standard 12-month cycle.
- Statistical issues: Ireland is subject to Eurostat and ECB timeliness and reporting standards; data on monetary, international reserves, and selected other financial statistics are considered comprehensive, reliable, timely, and well documented. Ireland has subscribed to the Fund’s Special Data Dissemination Standard (SDDS).

*Source: IMF staff report content as provided in the document.*

### 1. Quarterly national accounts on an ESA 1995 basis have been introduced and are

### _cr04348 - 1. Quarterly national accounts on an ESA 1995 basis have been introduced and are

### Data reporting, timeliness, and gaps
- Quarterly national accounts on an ESA 1995 basis are currently published within 4 months of its reference period.
- Real sector data are sometimes published with a lag of 3–6 months.
- Some non-SDDS series are published with a lag of one and a half years (example given: household disposable income).
- Lags are particularly long (3–7 months) for employment, earnings, unit wage costs, and national income and expenditure data.
- Ireland does not have an overall earnings index or comprehensive sectoral balance sheet data.
- While Exchequer returns are published monthly and quarterly, only annual data on the general government balance are currently available.

### Core statistical indicators (as of August 12, 2004) — selected dates and frequencies
- Date of Latest Observation: 8/12/2004; Exchange Rates: 8/12/2004 (Daily frequency; Daily reporting; Internet publication; Public confidentiality; Frequency of Publication: Daily).
- International Reserves: June 2004 (Monthly frequency; Monthly reporting; Internet publication; Public confidentiality; Frequency of Publication: Monthly).
- Central Bank Balance Sheet: June 2004 (Monthly frequency; Monthly reporting; Internet publication; Public confidentiality; Frequency of Publication: Monthly).
- Reserve/Base Money: June 2004 (Monthly frequency; Monthly reporting; Internet publication; Public confidentiality; Frequency of Publication: Monthly).
- Broad Money: June 2004 (Monthly frequency; Monthly reporting; Internet publication; Public confidentiality; Frequency of Publication: Monthly).
- Interest Rates: 8/12/2004 (Daily frequency; Daily reporting; Internet publication; Public confidentiality; Frequency of Publication: Daily).
- Consumer Price Index: July 2004 (Monthly frequency; Monthly reporting; Internet publication; Public confidentiality; Frequency of Publication: Monthly).
- Exports/Imports: May 2004 (Monthly frequency; Monthly reporting; Internet/publication; Public confidentiality; Frequency of Publication: Monthly).
- Current Account Balance: 1st Quarter 2004 (Quarterly frequency; Quarterly reporting; Internet/publication; Public confidentiality; Frequency of Publication: Quarterly).
- Overall Government Balance: 2003 (Annual frequency; Annual reporting; Internet/publication; Public confidentiality; Frequency of Publication: Biannual).
- External Debt: 1st Quarter 2004 (Quarterly frequency; Quarterly reporting; Internet/publication; Public confidentiality; Frequency of Publication: Quarterly).
- GDP/GNP: 1st Quarter 2004 (Quarterly frequency; Quarterly reporting; Internet/publication; Public confidentiality; Frequency of Publication: Quarterly).

### Macroeconomic performance, outlook, and staff-authority views
- Authorities broadly share the analysis and conclusions of the Staff Report.
- The Irish economy "has proved remarkably resilient to the global downturn, with growth well above the EU average through 2002/03 and strengthening more recently."
- Authorities anticipate full-year GDP growth of the order of 4¾ percent (GNP 4¼ percent).
- A balanced budget is foreseen, rather than the 1.1 percent of GDP fiscal deficit initially forecast, underpinning a further fall in Ireland’s already-low debt ratio.
- Despite strengthening personal consumption and significant imports associated with recovering machinery and equipment investment, the balance on the external current account is expected to show little change, with exports picking up in line with growth in world trade.

### Labor market, inflation, and productivity
- Employment is indicated to expand by about 2 percent through 2004.
- Unemployment is expected to ease only slightly from last year’s level of 4.6 percent, reflecting ongoing net inward migration and further increases in labor force participation.
- EU-HICP-measured inflation is expected to average about 2¼ percent this year.
- Net excise changes in Budget 2004 broadly approximated consumer price inflation.
- Measured labor productivity growth in certain technologically modern sectors reflects both (a) increases in labor efficiency in existing businesses and (b) the “birth” of new, more capital-intensive and higher-labor-productivity, businesses.
- Example productivity context from staff quotation (reported by authorities): labor productivity in Office Machinery and Electronic valves etc. at 40-60 percent above EU averages, but 10-20 percent below US levels, in 2001.
- US Bureau of Economic Analysis report referenced: total assets employed per worker in Irish-based (non-banking) affiliates of US entities in 2002 were 2¾ times the level of assets per person employed in the average EU15-based affiliate.

### Competitiveness, wages, and policy stance
- Authorities agree that safeguarding competitiveness is essential.
- Authorities insist that, at a minimum, wage increases must be limited to those recently negotiated under the social partnership agreement.
- Regaining lost competitiveness is a key priority of economic policy and of Social Partnership going forward.
- Authorities recognize the merits of achieving greater wage flexibility but note significant logistical and practical difficulties associated with more frequent negotiations and the heavy burden on the social partnership process.
- Ongoing efforts aim to enhance competition in product and services markets, with focus on markets for “non-traded” services.
- Authorities view improving the efficiency and effectiveness of public service and infrastructure delivery as preferable to raising tax and expenditure ratios.

### Fiscal policy stance
- Authorities are committed to managing public expenditure within the overall constraint of growth in current resources.
- Authorities welcome staff assessment that fiscal policy has adjusted to slower medium-term growth prospects.
- Staff notes that the size of government in Ireland is not small in comparison with other OECD countries.

### Financial sector resilience and housing market risks
- Ireland’s domestic banking system described as robust, capable, and well-placed to support future economic expansion.
- Staff conclusion cited: even “in the event of an abrupt unwinding of Ireland’s housing market boom, financial stability is likely not a concern”.
- Central Bank and Financial Services Authority view aligns: based on extensive stress-testing, banking system shock-absorption capacity is currently adequate even in the face of a sudden and unanticipated fall in residential property prices accompanied by an increase in default rates.
- Banking sector strengths cited: high profitability and strong capitalization.
- Authorities note mixed signals on whether house prices are overvalued relative to “the fundamentals”.
- Authorities warn: if house prices were to continue to increase at the double-digit pace of recent times, the risk of a sharp correction would become more pronounced.
- Work to strengthen financial sector supervision continues (assisted by recommendations of the 1999/2000 FSAP, to be revisited in the coming year).
- Authorities emphasize the role of public communication in taming expectations to help induce a soft landing in the housing market.
- Authorities are heightening awareness among economic agents of potential implications of rising household indebtedness, especially given the prevailing low interest rate environment.

### Authorities’ medium-term growth assessment
- Authorities agree with staff that medium-term growth potential of the economy — with continuing economy-wide commitment to sound policies — is in the 4-5 percent range.
- In the context of prospective population growth, this suggests annual per capita growth potential in the 3-3 ½ percent range.

*Source: Statement by Charles X. O’Loghlin, Alternate Executive Director for Ireland; Appendix III — Core Statistical Indicators (As of August 12, 2004).*

### 11. Like the staff, my authorities have no illusions that Irish growth over the years ahead

### _cr04348 - 11. Like the staff, my authorities have no illusions that Irish growth over the years ahead

### Growth outlook and constraints
- Medium-term economy-wide growth potential is assessed in the 4-5 percent range.
- Annual per capita growth potential is assessed in the 3-3 ½ percent range.
- The unprecedented expansion of the 1990s (“Celtic Tiger”) cannot be sustainably emulated; several contributing factors were one-off and cannot repeat at the same pace or extent.
- Staff projections (staff projections, except where noted):
  - GNP growth of 4½ percent in 2004.
  - GNP growth of 5 percent in 2005.
  - Over the medium term, real growth expected in the 4 to 5 percent range.
  - Core inflation forecast to stay close to 2 percent.

### Labor market and demographics
- Unemployment is now around 4½ percent.
- No significant contribution to growth can be expected from further reducing unemployment given current low unemployment.
- Spectacular gains in labor force participation of recent years reduce the scope for future gains relative to a decade earlier.
- Prospective reversal of the declining trend in overall dependency will slow per capita economic growth.

### Housing, credit, and financial stability
- Low nominal interest rates and financial liberalization led to a rapid expansion in household credit and a housing boom.
- Real house prices have risen by 187 percent since 1995.
- Directors underscored importance of achieving a soft landing of the housing market; an abrupt unwinding could have significant impacts on employment and private consumption even if financial stability would likely not be a concern.
- Central bank communications to curb expectations in credit and housing markets were welcomed; further efforts encouraged to increase borrower and lender awareness of prospective interest rate increases and implications for debt-servicing costs.
- Many Directors advised against additional incentives in the form of subsidies to home ownership.
- Steps advised for medium-term consideration:
  - Removing the interest-deductibility of mortgage payments on primary dwellings.
  - Introducing a market-value-based wealth tax on property, graduated to tax second homes at higher rates.
- Directors welcomed authorities’ efforts to strengthen financial supervision, including by implementing the FSAP recommendations.

### Fiscal policy, public spending, and public services
- Fiscal position improved markedly in the late 1990s; government debt to GDP fell from over 80 percent in 1995 to less than 40 percent in 2000.
- Fiscal developments:
  - Fiscal surpluses during rapid revenue expansion; fiscal balance slipped into deficit by 2002 as expenditure increases continued.
  - In 2003, expenditure growth was lowered and indirect taxes were increased, producing a surplus of 0.2 percent of GDP.
- Directors called for a modest, front-loaded tightening in the structural fiscal balance in the next budget to avoid procyclical fiscal policy, consistent with authorities’ commitment to achieve a structural balance over the medium term.
- Noted that better-than-expected outturns in 2003 and early 2004 partly reflect one-off receipts from changes in capital-gains tax, anti-fraud successes, and property market buoyancy; resisting political pressures for increased spending was advised.
- Public service and infrastructure concerns should be addressed by improving delivery rather than raising tax and expenditure ratios.
- Multi-year spending envelopes for public capital spending were welcomed; government capital spending is already 5 percent of GNP.
- Most Directors saw merit in extending multi-year spending envelopes to cover current expenditures.
- Support for health sector reforms and modernization of public service delivery; shift focus from inputs to outputs encouraged.
- Directors considered Ireland well-placed to deal with population ageing through sound fiscal position and high degree of pension funding.

### Competitiveness, wages, and structural policies
- Safeguarding competitiveness is a key priority for economic policy and social partnership.
- Although inflation in goods and labor markets has decelerated, the level of competitiveness has deteriorated.
- Outcome of the latest social partnership wage negotiations is in line with prospective core inflation and productivity developments, but agreed increases do not account for past erosions in competitiveness or risks of further euro appreciation.
- To address competitiveness vulnerabilities, Directors called for:
  - An extended period of wage restraint.
  - Increased wage flexibility within the social partnership, e.g., shortening national wage agreements from three years.
- Improving domestic competition, especially in the services sector, would help contain input costs in the export sector.
- Directors encouraged continued support for multilateral trade liberalization and a more supportive stance within the EU for further reform of the Common Agricultural Policy.
- Authorities committed to raising official development assistance to attain the UN target of 0.7 percent of GNP by 2007.

### Risks and recommended policy responses
- Main near-term risks:
  - Potential for further euro appreciation in response to global imbalances.
  - Possibility of an abrupt unwinding of the housing boom.
- Recommended policy responses and measures:
  - Wage restraint and increased wage flexibility (shorten duration of national wage agreements).
  - Strengthen borrower and lender awareness of interest rate risk; central bank communications to curb credit and housing expectations.
  - Avoid procyclical fiscal easing despite improved outturns; pursue modest, front-loaded structural tightening.
  - Use multi-year spending envelopes to safeguard capital spending from procyclical pressures, improve planning and predictability, and encourage efficiency; consider extending envelopes to current expenditures.
  - Improve delivery of public services rather than raising tax and expenditure ratios.
  - Consider mortgage interest-deductibility removal and market-value-based property wealth taxation as medium-term options.

### Key statistics (as reported)
- Growth and labor:
  - Real GDP: 9.9 (2000), 6.0 (2001), 6.1 (2002), 3.7 (2003), 4.7 (2004 1/).
  - Real GNP: 10.1 (2000), 3.8 (2001), 1.5 (2002), 2.8 (2003), 4.5 (2004 1/).
  - Unemployment rate (in percent): 4.3 (2000), 3.9 (2001), 4.4 (2002), 4.7 (2003), 4.4 (2004 1/).
  - HICP: 5.2 (2000), 4.0 (2001), 4.7 (2002), 4.0 (2003), 2.3 (2004 1/).
- Public finances:
  - General government balance (percent of GDP): 4.4 (2000), 1.1 (2001), -0.2 (2002), 0.2 (2003), -0.3 (2004 1/).
  - Structural balance (in percent of potential GDP): 2.2 (2000), -0.7 (2001), -1.9 (2002), 0.5 (2003), -0.2 (2004 1/).
  - General government debt: 38.3 (2000), 35.9 (2001), 32.7 (2002), 33.2 (2003), 32.5 (2004 1/).
- Money, credit, and interest rates:
  - M3 (end-year, percent change): 14.7 (2000), 17.2 (2001), 9.3 (2002), 9.6 (2003), 8.3 (2004 6/).
  - Private sector credit (end-year, percent change, adjusted): 21.3 (2000), 15.1 (2001), 15.0 (2002), 17.9 (2003), 24.8 (2004 6/).
  - Three-month interest rate (year average): 4.8 (2000), 3.3 (2001), 2.9 (2002), 2.1 (2003), 2.1 (2004 7/).
  - 10-year government bond yield (year average): 5.1 (2000), 5.1 (2001), 4.3 (2002), 4.3 (2003), 4.2 (2004 7/).
- External sector:
  - Exports of goods and services (change in percent): 20.4 (2000), 8.4 (2001), 5.7 (2002), -0.8 (2003), 5.0 (2004 1/).
  - Imports of goods and services (change in percent): 21.3 (2000), 6.7 (2001), 3.3 (2002), -2.3 (2003), 3.8 (2004 1/).
  - Trade balance (goods and services, percent of GDP): 13.2 (2000), 15.0 (2001), 16.6 (2002), 15.4 (2003), 15.3 (2004 1/).
  - Current account (percent of GDP): -0.4 (2000), -0.7 (2001), -1.3 (2002), -1.4 (2003), -1.6 (2004 1/).
  - Reserves (end of period, in billions of SDRs): 4.1 (2000), 4.5 (2001), 4.0 (2002), 2.8 (2003), 1.6 (2004 6/).
- Exchange rate:
  - Present rate (August 12, 2004): US$ per euro 1.2256.
  - Nominal effective rate (1995=100): 88.3 (2000), 89.2 (2001), 90.7 (2002), 96.7 (2003), 96.7 (2004 6/).
  - Real effective rate (1996=100, CPI based): 91.0 (2000), 94.4 (2001), 98.9 (2002), 106.8 (2003), 106.5 (2004 6/).

*IMF — Public Information Notice (PIN) No. 04/122, November 4, 2004, IMF Executive Board discussion of the 2004 Article IV consultation with Ireland.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04348.pdf_