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Irish Economy and Public Finances

Macroeconomic outlook

  • Ireland’s strong economic growth continues even after accounting for distortions to Ireland’s GDP data (see below for discussion on distortions). The CSO have released a metric called GNI* (an augmented Gross National Income) which excludes the impact of multinational companies’ distortions. On a nominal basis, GNI* amounted to €181bn in 2017 compared with €294bn for Gross Domestic Product (GDP). GNI* grew 3% in nominal terms in 2017. No constant price figures for GNI* are provided yet but will be released later in 2018.
  • Until then, modified final domestic demand can give us a more-timely gauge of the real economy in the quarters ahead. Modified domestic demand (excluding inventories) grew in real terms by 5.5% y-o-y in 2016 and 3.2% in 2017.
  • Employment is also a good barometer of the economy’s health. Employment increased by 19.1% from its low in 2012 to stand at 2.2 million people in 2018. In Q1 2018, 11 of 14 sectors saw employment growth. Unemployment was 5.1% of the labour force in July 2018 – a fall of over ten percentage points from its peak. Encouragingly, all regions has seen a fall in its unemployment rate in the last year. All these evidence suggests Ireland is approaching full employment.
  • As a result, wage inflation is back in all sectors however the picture is not uniform across the economy: certain sectors are operating closer to full capacity than others. In IT, financial services and education, wage growth is above 3%. Other sectors like transport are closer to 1% wage growth.
  • Most high frequency indicators point to continued growth for Ireland. Ireland’s composite PMI reading for July 2018 was 56.8, well above the expansionary threshold (50). The reading for services was 57.4. Both manufacturing and construction PMIs remain well into expansionary territory. There is evidence that the PMIs are leading indicators for modified final domestic demand in Ireland. These metrics will be monitored for any slowdown in growth.
  • Turning to the outlook for Ireland, the Department of Finance forecasts that real GDP will continue to grow in the coming years. In its Stability Programme Update 2018 forecasts, the Department of Finance expects real GDP growth of 5.6% for 2018. It is likely Brexit will act as a headwind to Irish growth prospects although if the proposed transition deal is implemented the impact in 2018-2020 would be lessened. In the long term, recent analysis by Copenhagen suggests the impact of Brexit on Ireland could be as large as 7% of GDP (versus a no Brexit scenario) if a “hard” Brexit occurred. This is on the aggressive end of estimates with the Department of Finance estimate an impact closer to 4% of GDP. Despite Brexit, consumption growth is expected to continue and underlying fixed investment is forecast to expand quickly in 2018/19, following years of under-investment to pay for the excesses of the 2002-2007 bubble.
  • Consumer spending is improving as confidence is close to record highs. One example of this is the strong growth in core retail sales (3.3% annual increase in value terms in June 2018). Disposable income has expanded in aggregate, thanks to more people at work. Other positives exist: rising house prices have led to higher net worth, low inflation underpins real income, interest expenditure is nudging down and other non-wage income inducing dividends and rents are rising.

Balance of payments and public finances

  • The current account of the Balance of International Payments recorded a surplus of 13.8% of GDP in 2017. Much of the dramatic improvement comes from activities of redomiciled companies and imports of intellectual property however. A clear understanding of the current account is difficult in the face of these distortions. The CSO has released a modified current account (CA*) measure which aims to be consistent with its GNI* calculation. After further revisions released in July 2018 this CA* metric stood at 1.2% of GNI* for 2017. Current account data in Ireland is to be taken with extreme caution but this CA* metric is a useful estimate.
  • The end-2017 general government balance was -0.4% of GDP (-0.6% of GNI*). Again, given the inflated GDP data, caution is warranted in using the usual deficit metrics.
  • Since 2016, Ireland has been in the preventive arm of the EU’s stability and growth pact. Ireland is now charged with bringing its structural balance (general government balance excluding cyclical factors and one-offs) to below -0.5% of potential output by 2019. The latest estimates suggest Ireland met this target in 2017 but will miss it in 2018. At the heart of whether Ireland meets this target is how one measures potential output. Given the volatility and distortions inherent in Irish national accounts, reliable estimates of potential output are difficult to obtain.
  • Looking through the national accounts distortions and issues with the structural balance, it is clear Ireland’s fiscal picture is improving. Ireland is in primary surplus. Government revenue is going strongly and broadly in line with expectations while government spending is restrained in the main. One area of concern is the reliability of corporate tax receipts. CT receipts are heavily concentrated on several large firms and have grown exceptionally strongly in recent years. Prudence with regards to temporary or unexpected revenue is warranted.
  • Gross Government debt peaked as a percentage of GDP in 2013 at 119.5%.  Following rapid GDP growth and the distortions mentioned above the debt ratio fell to 69% at end-2017. The ratio is set to fall further given favourable debt dynamics.
  • The inflated GDP denominator means other metrics of debt serviceability are required. Debt-to-GG Revenue (263%), interest as a percentage of revenue (7.6%) and the average interest rate on Ireland’s debt (2.9%) are more apt measures for comparison with other sovereigns regarding Ireland’s debt serviceability.
  • Debt-to-GNI* (114% for 2016, c. 111% for 2017) is also a useful metric for evaluating Ireland’s debt sustainability even if it understates the ability of Ireland to repay debt. GNI* excludes certain activities that the Irish State could possibly tax and hence excludes some part of its ability to repay. This means that the Debt-to-GNI* ratio is likely too high. With debt-to-GDP too low, it is fair to say the reality of Ireland’s “proper” debt ratio is somewhere in the middle.

National Account Distortions

  • From 2015 onwards, Ireland’s national accounts are distorted by the reclassification of multinational companies or their assets as being resident in Ireland. Given the presence of such large distortions, GDP and GNP have little information content in regards to Ireland’s economic activity.
  • The reclassification of multinational companies’ activity as Irish expanded the capital stock in 2015 by c. €300bn or c. 40%. In some cases, whole companies re-domiciled in Ireland while in others multinationals moved assets (mostly intangibles) to their Irish-based subsidiary. The goods produced by the additional capital were mainly exported. This resulted in a step change in net exports Q1 2015. Net exports grew by 102.4% in 2015. Complicating matters, the goods were produced through “contract manufacturing”. The result of contract manufacturing is a goods export is recorded in the Irish Balance of Payments even though it was never produced in Ireland. There is little or no employment effect in Ireland from this contract manufacturing.
  • Contract manufacturing (CM) has occurred in Ireland in the past but did not have a significant net impact on GDP since the company engaged in CM would send royalties back to its parent as a royalty import. However now that the parent/intangible asset is here, there is no royalty import and Ireland’s GDP is artificially inflated. This scale of contract manufacturing (c. €70bn) is unprecedented.
  • Further to these distortions, the import of intellectual property by firms in Ireland gives a misleading picture on the drivers within Irish growth. When a firm moves IP into Ireland it is recorded as an import and also as investment. These two net out so overall GDP is not affected however the net exports and investment figures are distorted. Adjusting for this provides a better picture of the drivers of Ireland growth.
  • In response to the distortions, the CSO convened the Economic Statistics Review Group (ESRG) to identify indicators that would provide a better understanding of Ireland’s highly globalised economy. In February 2017, the ESRG released its recommendations. The CSO has agreed to implement these recommendations.
  • Among the main proposals were the publication of two new supplementary indicators, one closely related to Gross National Income (known as GNI*) and another is a modified version of domestic demand.
National Account – Current Prices
(€ Billions, y-o-y growth rates)
2015 2016 2017
Gross Domestic Product (GDP) 262.4bn (34.4%) 273.2bn (4.1%) 294.1bn (7.6%)
minus Net Factor Income from rest of the world
= Gross National Product (GNP) 200.4bn (22.2%) 222.2bn (10.8%) 233.1bn (4.9%)
add EU subsidies minus EU taxes 1.2bn 1.0bn 1.1bn
= Gross National Income (GNI) 201.7bn (22.3%) 223.2bn (10.7%) 234.2bn (5.0%)
minus retained earnings of re-domiciled firms -4.6bn -5.8bn -4.6bn
minus depreciation on foreign owned IP assets -31.0bn -36.7bn -43.1bn
minus depreciation on aircraft leasing -4.6bn -4.9bn -5.1bn
= GNI* 161.4bn (8.6%) 189.2bn (9.0%) 181.2bn (3.0%)

 

  • For GNI*, Gross National Income is stripped of the profits of redomiciled companies, depreciation on R&D/ IP assets and depreciation on aircraft leasing. On a nominal basis, GNI* amounted to €181bn in 2017 compared with €294bn for Gross Domestic Product (GDP). GNI* grew 3% in nominal terms in 2017. No constant price figures for GNI* are provided yet but will be released in time.
  • Until then, modified final domestic demand can give us a more-timely gauge of the economy in the quarters ahead. Modified final domestic demand grew by 5.5% y-o-y in 2016 and 3.2% in 2017 in real terms. This measure is domestically focussed and is constructed to be largely unaffected by the activities of multinational companies. The measure includes private consumption, government consumption and elements of investment.

3 August 2018