Ireland: Exceptional Recovery

IMF News, July 27, 2016

Source details

Ireland "has made an exceptional recovery" and "output has surpassed its pre-crisis level."
Headline growth figures:
- "7.8 percent in 2015" (already astounding growth rate).
- "26.3 percent"—recently upgraded by the Irish Central Statistics Office; noted that this headline number "is heavily affected by the operations of a number of multinational companies" and has "a limited impact on the true underlying developments of the Irish economy."
Underlying indicators:
- "Private consumption grew strongly (4.5 percent in 2015) on the back of rising employment."
- "Unemployment rate fell to 7.8 percent in June."
- "Inflation has remained very subdued."
- "Public finances have continued to improve, reflecting buoyant tax revenue, and government’s debt-to-GDP ratio has declined rapidly."
IMF assessment: "Ireland’s positive economic performance is expected to continue" though risks remain.

The UK vote to leave the EU is identified as "a major risk to the outlook."
Key transmission channels and uncertainties:
- Severity of impact "is hard to gauge at this stage" and "will depend crucially on the future relationship between the UK and the EU, especially regarding trade, financial flows, and movement of labor."
- Financial-sector linkages: banks and insurers "doing business in the UK" face direct exposure; a UK recession would affect them directly and via Irish exporters to the UK.
- Market reaction: "in the wake of the referendum, market prices of banks and financial institutions of Ireland have taken a tumble."
- Longer-run view: "Brexit would not necessarily affect the Irish financial system a great deal, given that the economy as a whole is now quite diversified."
Policy readiness: "The authorities undertook a very comprehensive contingency planning exercise in advance of the referendum in the UK to identify all the linkages that might be affected and how to mitigate possible adverse effects."

Findings on incomplete recovery:

"Recovery is incomplete" despite the exceptional rebound.
Labor market and social outcomes:
- Job creation "has been uneven across regions."
- "Share of unemployed remains high, particularly among young people."
- "Portion of inactive population" remains high.
- "Private consumption has not reached its pre-crisis levels yet."
Balance-sheet vulnerabilities:
- "Households, corporates and the government still bear large debt burdens."
- Banks "have a large share of distressed loans that need to be resolved before they can better support sustainable growth."

Policy recommendations to complete and share the recovery:

"Policies should focus on cementing macroeconomic stability and supporting durable and inclusive long-term growth and job creation."
Fiscal and tax policy:
- "Further improvement in public finances and reduction of public debt."
- "Fiscal policy could also be more supportive of growth."
- Options include "more efficient public spending to achieve better public services, and by rebalancing the tax mix away from distortionary direct taxes."
Support for firms and innovation:
- "Make wider financing options available for small and medium sized enterprises and support their innovation."
Labor market and inclusion:
- "Better education and training, and the removal of obstacles to women’s labor force participation" to address labor-market weaknesses.
Monitoring and contingency:
- "Monitor closely the economy and stand ready to mitigate any potential spillovers from the UK decision to leave the EU."

Structural changes since the crisis:

Ireland now "operate[s] as part of the European Banking Union."
"Banking supervision is led by the European Central Bank."
Resolution of larger problem banks "is likewise being organized at a European level."
Regulations on "banks, asset managers, and insurance companies have been very substantially augmented."
Supervision "has become much more proactive and investigative."
Irish banking system shift: from "very internationalized, very dependent upon wholesale funding and rather adventurous" to "much more domestically oriented" and "plain vanilla" business for smaller, consolidated banks.

Legacy risks and current vulnerabilities:

Legacy nonperforming loans remain on banks’ books; they "may be performing better now in an environment of strong growth and low interest rates in Ireland" but "if these conditions change, the loans may become problematic."
Bank profitability concerns:
- Large outstanding volume of "tracker loans" originated in the boom years with interest rates tied to market rates such that "banks earn minimal amounts on them."
- "A large chunk of banks’ balance sheet is thus rather unprofitable."
Asset management sector:
- "The Irish asset management sector is immense, with on the order of 3 trillion euros administered out of Ireland."
- Analysis found that "at least the main funds are not highly leveraged" and "have quite substantial liquidity buffers."
- The sector's "connection to the rest of the Irish financial system is weak," so "eventual large losses would not much affect Ireland directly, except perhaps in terms of reputation risk."

Historical context: the 2007 crisis began in a residential real estate price bubble and triggered a sovereign debt crisis.
Authorities’ response:
- Introduction of macroprudential measures affecting residential real estate mortgages, including "a limit on loan-to-value ratios."
- These measures "seem to have had some effect in taking the edge off the residential real estate market" and "price expectations have become more moderate."
Current risks and supply issues:
- "There is probably more sign of heating up in the commercial real estate market."
- Uncertainty over policy response when "most of the financing is not coming from Irish institutions but rather from abroad."
- Construction activity experienced a "prolonged near collapse" after the crisis; "affordable housing seems to be in short supply" and "deserves attention," though "it is beyond the remit of financial sector policies."

IMF News interview: Ireland: Exceptional Recovery (July 27, 2016).