Mauled Celtic Tiger is ready to roar again

After the collapse of Lehman Brothers in 2008, few Western nations suffered more than Ireland. Following more than a decade of being lauded as “the Celtic Tiger”, the economy of the Irish Republic contracted by an eye-watering 6.4pc in 2009. It has continued to struggle, registering several years of sluggish or non-existent growth. Ireland pulled out of recession only in the second quarter of 2013 and has since failed to stage a convincing recovery.

Perhaps, that is, until now. The Irish economy surged during the first quarter of this year, according to official figures published on Friday. National income rose 2.7pc during the first three months of 2014, expanding at an annual rate of 5.1pc. Unemployment has subsequently come down, hitting 11.6pc in June. Still well above the UK’s 6.6pc jobless share, it’s Ireland’s lowest unemployment level since April 2009.

Throughout 2013, as the Eurozone began to recover and the US and UK gathered momentum, business and consumer sentiment improved sharply. Ireland then “graduated” from its controversial bail-out, administered by the European Union and the International Monetary Fund, at the end of last year.

Confidence was knocked badly, though, by an unexpected 2.3pc drop in fourth-quarter GDP. Well-informed Irish friends and family were muttering into their pints – “here we go again”. So this latest GDP rebound, driven by a 1.8pc rise in exports over the first quarter and an inventory turnaround, will do much to improve the mood. But while I have a well-known bias – being of Irish origin, and spending a good deal of time in the country – I remain concerned this recovery is extremely fragile.

Ireland has achieved a great deal in recent years. Between 2001 and 2007, GDP grew by an astonishing 5.4pc annually, by far the fastest rate of any Western economy. Germany expanded just 1.2pc a year on average over the same period, while America managed annual growth of 2.4pc and the UK 2.5pc. Much of this Irish boom was built on innovation, hard graft and a business-friendly policy mix.

As a result, The Republic indeed developed an enviable ability to attract foreign direct investment. Even now, per capita inward FDI numbers remain three times higher than those for the UK – despite the UK total itself being well above the EU average. While some countries complain this is due to an unfairly competitive Irish corporation tax regime, it also reflects the country’s well-educated and often tech-savvy workforce.

An underlying truth, though, as some of us warned back in the early 2000s, was that after decades of relative austerity and a rather bleak economic existence by Western standards, far too many Irish people got carried away as they clambered aboard the Celtic Tiger. At the heart of the hubris were the country’s badly-regulated banks, several of which borrowed and lent with abandon, financing an almighty domestic property bubble. The result, as is well-documented, was one of the worst deep-dive crashes of any Western nation in modern economic history.

When the bubble burst, the hole in the banking sector was huge – an estimated €64bn, or €14,200 per person. In response the Irish government notoriously agreed to stand behind the biggest banks’ total liabilities, protecting not only depositors but bond-holders too. That placed a massive burden on Ireland’s public finances, resulting in the 2010 bail-out.

The government took on €60bn-plus of bank liabilities because the EU/IMF forced it to do so. Had the Irish followed their instincts, and restructured domestic banks as originally intended, massive losses would have crystallized at banks elsewhere, not least in France and Germany. So Irish taxpayers shouldered a mighty burden to prevent financial contagion spreading across the Eurozone, “taking one for the team”. The resulting €85bn bail-out, and related debt-service and policy conditions, ultimately causing major resentment.

In Ireland, though, unlike in some other “peripheral” Eurozone countries, the bail-out conditions stuck. The economy endured public spending reductions over four years that were three times greater in proportionate terms than the UK’s so-called “austerity measures” are imposing in eight. This was a very serious economic adjustment, the likes of which Britain hasn’t seen in living peacetime memory. The results, though, are clear. Three years ago, Ireland was unable to raise money on international markets. Since then, Dublin has won enough credibility to issue debt and build a €25bn cash pile, funding itself several years into the future.

That’s why, earlier this summer, Ireland’s long-term borrowing costs fell below those of the UK for the first time since 2007, with the yield on 10-year bonds falling almost to 2.7pc. Just three years ago, the penalty premium on Irish sovereign debt over and above that of the UK was an astonishing 11 percentage points.

Part of the explanation for this turnaround, of course, is the perception that the European Central Bank, if necessary, will launch an emergency asset-buying programme, together with expectations UK rates could soon rise. But Ireland’s borrowing costs have fallen to a much lower level than those of any other previously stricken Eurozone countries, in recognition of the country’s decisive fiscal adjustment.

Having said all that, massive challenges remain. Household debt remains twice as big as annual Irish GDP. Mortgages in 6-month arrears are close to 20pc. House prices have lately picked up, at least in Dublin – but remain 45pc below their 2007 peak. A lot of Irish households are still underwater financially – a big reason why personal consumption remained subdued during the first quarter of this year, falling by 0.1pc compared to the previous three months.

Ireland has just implemented the EU’s updated European System of National and Regional Accounts (ESA) framework on estimating economic activity, which requires various additions to national income numbers, including research and development spending and various illegal activities too. While this change doesn’t affect the growth numbers, as it’s backdated, it does flatter the closely-watched metrics of the deficit and national debt as a percentage of GDP.

As a result of these changes, Ireland is now on course to register a budget shortfall of 4.5pc of GDP this year, down from previous estimates of 4.8pc. The country’s national debt for 2013, meanwhile, falls from 124pc to 116pc of GDP. These numbers looks better, but they’re still far too high to be stable. Ireland has made great strides but isn’t yet out of the fiscal woods.

The reality is that, amidst much international uncertainty, the Republic remains extremely vulnerable to global economic headwinds. “As a very open economy, Ireland is exposed to external shocks,” argues Prof Nick Crafts of the University of Warwick, in a recent paper on the Republic’s economic prospects. “While these were favorable in the Celtic Tiger period, arguably they could be adverse in future – and, in particular, Ireland is exposed to problems in the Eurozone”.

A major danger is that these latest statistical revisions encourage fiscal complacency. Irish ministers are under intense pressure to bring six years of tax rises and spending cuts to an end. While there’s some scope for relief, discipline remains vital. The emphasis must be, as ever, on competitiveness, with the government building on existing efforts to encourage exports, while aggressively promoting the adoption and innovative use of new technologies by Ireland’s generally vibrant small- and medium-sized enterprises.

“It is essential to move away from debt as the main engine of growth,” as the Bank of International Settlements warned last week. “The only source of lasting prosperity is a stronger supply side”. That’s a truth the Western world has lately forgotten – and which Ireland can do much to restore.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: