Irish Economy and Public Finances
- Ireland’s economic growth was undeniably strong in 2015/16 despite distortions that exaggerated Ireland GDP data. These distortions resulted in Ireland’s GDP growing by 26.3% (real) and 32.4% (nominal) in 2015.The main reasons for this exaggerated growth was 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. Looking past the headline figures, Ireland grew closer to 5.5% y-o-y in real terms in 2015 and 3.2% in Q3 2016.
- The reclassification of multinational companies’ activity as Ireland expanded the capital stock in 2015 by c. €300bn or c. 40%. In some cases, whole companies redomiciled 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 has occurred in Ireland in the past but did not have a significant net impact on GDP since the company 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. €80bn in 2015) has also not been seen before.
- Better measures of economic activity are necessary. On a constant basis, underlying domestic demand grew by 5.5% in 2015 and is currently growing at around 3.2% (Q3 2016). This measure is domestically focussed and is unaffected by the activities of multinational companies. The measure includes private consumption, government consumption and investment less intangible assets and transport equipment.
- Employment is also a good barometer of the economy’s health. Employment has increased by 10.6% from its low in Q3 2012. In the year to Q3 2016, 12 of 14 sectors saw employment growth. Unemployment was 7.3% of the labour force in November 2016 – a fall of nearly eight percentage points from its peak. Encouragingly, all regions have seen a fall in their unemployment rate in the last year. Despite this strength, unemployment is still above its natural rate. The picture is not uniform across the economy: certain sectors are operating closer to full capacity whereas others are weaker. As a result, wage inflation is back in sectors such as IT, retail, and admin and support services. In contrast, the public sector, construction and tourism lag behind. Employees are also beginning to work longer hours. One slight concern is that labour force participation is not recovering: a similar situation has emerged in the US post-crisis. The need to re-skill and the high costs of childcare are probably among the reasons for this phenomenon in Ireland.
- Recent high frequency indicators remain robust, notwithstanding the impact of Brexit. Ireland’s average composite PMI reading for Jan to Nov 2016 was 57.8, comfortably above the expansionary threshold (50). Moreover, the gap between Ireland’s reading and the euro area’s remains relatively wide. The November PMI reading for services was 56 down from H1 2016 average of 61.9. For manufacturing, readings suffered post-Brexit. The average for Q3 was 50.3 but the indicator recovered in November (54.2 reading). The construction PMI remains well into expansionary territory. November’s reading of 59.8 is just below the 2016 average of 60.6.
- Turning to the outlook for Ireland, the Department of Finance forecasts that real GDP will continue to grow in the coming years. In its Budget 2017 forecasts, the Department of Finance expect real GDP growth of 4.2% for 2016 and 3.5% for 2017. It is likely “Brexit” will act as a headwind to Irish growth prospects in the short term. Department forecasts were previously closer to 5% and 4% respectively. Despite Brexit, consumption growth is expected to continue and fixed investment is forecast to expand at double-digit rates in 2016, 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 car sales in 2016 (18.1 % annual increase in Jan-Nov period). Disposable income has expanded in aggregate, thanks to more people at work. Hours worked and wages are still low (but improving in 2016) while relatively high marginal tax rates curb spending. Positives exist though: 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 11.8% of GDP in Q3 2016. This is a turnaround of near 20 percentage points from a deficit of 6.9% at the nadir in 2008. On this metric, Ireland has adjusted more than the other troubled euro area countries. Much of the dramatic improvement comes from activities of redomiciled companies and imports of intellectual property. Even allowing for such activities, however, the transformation is real.
- The end-2016 general government balance forecast is 0.9% of GDP. Again, given the inflated GDP data, caution is warranted in using the usual deficit metrics. Excluding the distortions, Ireland’s fiscal picture is improving. Ireland is in primary surplus, revenue data for 2016 so far were steady and spending has been restrained in the main. The government forecast is likely to be met. For 2016, Ireland moves into 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 forecasts by the Department of Finance meet this target by 2018.
- 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 78.6% at end-2015. The ratio is likely to fall further by end-2016 (forecasted to be 76%). The inflated GDP denominator means other metrics of debt serviceability are required. Debt-to-GG Revenue (277%, forecast for 2016), interest as a percentage of revenue (8.6%) and the average interest rate on Ireland’s debt (3.1%) are more apt measures for comparison with other sovereigns regarding Ireland’s debt serviceability.
13 December 2016