The «Celtic Tiger» rose from the ashes like a phoenix in 2014, becoming the fastest growing economy in Europe. Long gone are the days when the Irish financial sector was into the spotlight, but some hazards still remain. The aim of this article is to analyze the evolution of the macroeconomic imbalances that put the Irish economy against the ropes. This is an outlook on Irish current economic climate.
The outstanding performance of its national output, growing by 7% in 2015, contrasts with the drop by almost 8% registered between 2007 and 2009. Since then, a broad-based battery of structural reforms has been applied, starting in 2010 with the financial support of the European Union and the International Monetary Fund (IMF) to repair the imbalances of the Irish banking sector. But those reforms were deeper than required, ranging from an improvement of competitiveness levels to fiscal sustainability.
The recovery of the pre-crisis levels of output is mostly driven by three factors: the vigor of Irish exports, the strengthening of household consumption and the increase of private investment. This improvement lead to a trade surplus and stronger tax revenues, helping achieve the nominal fiscal targets fixed by the EU-IMF coalition. Furthermore, the extra income fuels the huge deleveraging process that the Irish economy is immersed in. Economic growth also had a positive impact on employment levels, especially for long-term and young unemployed. Thus, the unemployment rate dropped to less than 9% in 2015, and it is expected to further decline in the years to come.
Nevertheless, main legacy issues still need to be straightened, regarding three main front lines: the excessive public and private leverage, the vulnerability of the Irish financial sector and the sustainability of the current levels of growth.
One of the main threats for the future of Irish economy is the limited room for manoeuvre that many private agents have, given the huge levels of leveraging present in both households and non-financial companies. As it was said before, the economic upturn has led to higher corporate profits for the Irish private sector, as well as to an increase in average salaries. The revenues coming from higher growth are used for a more rapid reduction of still high private debt. Although it is true that deleveraging seems an irreversible process for the Irish private sector, debt ratios are decreasing in part due to the boost of nominal GDP.
The aggregate private sector debt –non-financial companies and households– amounts a 263.3% of Irish GDP. According to the targets fixed in the Macroeconomic Imbalances Procedure (MIP), a surveillance mechanism depending on the European Commission, private sector debt should not be more than 133%, far from the actual ratio. Thus, Ireland is largely failing to fulfill the target recommended by the European Commission on private debt, even taking into account the huge effort of deleveraging that Irish households and companies –especially SMEs and national businesses, instead of multinational corporations– are applying to themselves.
In an in-depth analysis of non-financial companies, they have benefited from the momentum their national economy is living, especially those exporting a considerable share of their production. The deleveraging process for firms is active, but is not reflected properly on main figures given the huge influence of multinational corporations. Approximately two thirds of non-financial corporations (NFC) debt are held by those multinational companies; fact that does not reflect the pure evolution of the Irish private sector.
Regarding households, deleveraging has been accelerated on account of a dramatic increase in disposable income, mostly based on employment gains –due to a boost in job creation and an increase in salaries–, income tax cuts and low energy prices. The process is likely to continue improving due to the oversight of the national government in monitoring and encouraging debt restructuring, consisting of the use of personal insolvency and bankruptcy schemes to facilitate debt repayment. Further and stable economic growth would strongly incentivize further deleveraging actions.
These optimistic perspectives explain the fall in the growth rate for households savings, reaching a negative figure of -0.4% of the total household income, dropping from 9.4% in 2009. Thus, households seem to perceive less uncertainty in order to make consumption or investment decisions, and their marginal trend for saving is less conservative. That is one of the main boosts for further increases in consumption, that lies in the origin of the large GDP growth.
In relation to public leverage, the main focus of imbalance was the international financial assistance needed for the banking system, channeled through the Irish government and, thereby, accounted as public debt. Debt-to-GDP ratio fell from 120.2% in 2012 to 98.4% in 2015; showing a good trend in terms of maturity as well: in 2011, the average maturity was around 7 years, whilst in 2015 features an average maturity of 12.4 years, being the national government less tied to its liquidity needs.
The average implicit interest rate of Irish government debt is 3.4%, while the average interest rate among the Member states is 2.8%. In an in-depth analysis on sovereign interest rates, in 2011 Ireland supported a risk premium of 700 basis points relative to the German Bund. In 2015, the risk premium was at 69 basis points, figure that reflects a positive trend in the confidence that financial markets have on the Irish economy.
With regard to the structural budget balance –correcting the general government balance by debt services, cyclic effects and one off events, such as the financial assistance program–, the trend is absolutely positive, dropping from -8.8% in 2010 to -2.6% in 2015. Thus, ceteris paribus, Ireland reached in 2015 a budget deficit of 2.3%, well below the target of 3% fixed in the Macroeconomic Imbalances Procedure (MIP) system, as well as in the Maastricht criteria.
The compliance of the budget balance target is partly owed to the increase in tax revenues. In 2015 revenues were 30.4% of GDP, growing from the figure of 28.2% in 2012. Compared to other Member States, the ratio is far below the top countries in Tax-to-GDP, showing less efficiency in its tax system.
Concerning tax policy, the Irish government is considering implementing expansive policies in 2016, consisting on a fiscal package of €1.5bn in tax cuts, breaking the trend of austerity assumed since 2010. It could be beneficial especially for households, as well as for the private sector in general; but Irish policy-makers should avoid further fiscal stimulus in order to prevent overheating pressures, allocating the excess revenues to debt repayment.
The Irish financial industry is the most burdened sector in terms of legacy issues. The total amount of banking assets felt from the hypertrophic 919% of GDP in 2010 to 531.7% in 2015. Once restructured, the banking sector has now a sustainable size. In terms of bank loans to the private sector, the fall never stopped, proving once again the huge deleveraging process in which the Irish private sector is immersed. Lending interest rates for SMEs remain among the highest in the Euro Area, fact that could be a threat for the momentum Irish non-financial companies are experiencing. Thus, new borrowing is still replaced by debt repayment in the Irish private sector.
Considering Non-Performing Loans (NPLs), levels are now far from the 2013 peak of 25.7% of the total loans issued, although there is still a long path towards a significant improvement. The Irish government has encouraged, as it was mentioned before, personal insolvency and bankruptcy restructuring schemes to help the private sector deal with its large levels of leverage. As a result, the amount of mortgages in arrears for more than three months have decreased consistently since 2013.
With regard to the international competitiveness of the Irish economy, figures show a strong and consistent positive surplus of around 3% on its Current Account Balance, partly due to the large amount of foreign investment carried out by multinational corporations, as well as to the gain in competitiveness and demand shifts. This –together with the international financial assistance program– has affected dramatically the Net International Investment Position (NIIP) of the Irish economy, showing a huge negative deficit of -104.7% of GDP in 2015. According to the MIP targets, the NIIP should be below -35%, far from the actual levels. That reveals Ireland as a strong creditor country in the international scenario.
Concerning the property market, Ireland seems to have returned to the past, when the real estate madness led prices up inconsistently with the real value of the assets. House prices increased by 11.1% in deflated terms during 2015, as a result of supply constraints on new housing, especially in urban areas such as Dublin. Considering the MIP target to avoid further imbalances, a 6% year-on-year growth, housing price levels in urban areas do not look sustainable in the long term, being a serious imbalance that could damage Irish economic growth.
This analysis could be the basis for a further debate about whether if the austerity measures demanded by the IMF and the EU institutions were suitable for the Irish economy or not. It is apparent that the evolution of main macroeconomic figures is purely positive in most cases, and the confidence in the economy is restored.
That is, in my opinion, the essential idea to understand the good performance of austerity policies in this country: boosting confidence in the Irish economy, which is basically designed for attracting foreign investment thanks to low corporate taxes and other advantages. And confidence fuels further investments in the country. Multinational corporations such as Google, Facebook, Apple, Amazon, Dell, Microsoft or Pfizer have their European headquarters in the Celtic island; and all of them canalize their investments in Europe through Ireland. According to the Irish Industrial Development Agency (IDA), a government-sponsored agency with the aim of attracting foreign direct investment (FDI) to the country, the 20% of the new employment created by the Irish private sector came from multinational corporations established in Ireland.
Will Ireland become again a paradigm of economic growth? Will the Irish government compensate the macroeconomic imbalances that a hypertrophic growth could generate? Is Ireland depending excessively on foreign investment? What is the real impact of austerity measures to redress an economic crisis? Which are the alternatives? Those are questions open to further and deeper debate.