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Country report Ireland

Country Report

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Ireland exited the EU/IMF bailout package in December 2013, and has regained financial market access. Nonetheless, the country is still dealing with the effects of the popping of the housing market bubble and high level of private indebtedness.

Strengths (+) and weaknesses (-)

(+) Flexible economy

Ireland has proven to be able to decisively deal with economic crises, on the back of a well-established institutional framework and favourable tax regime stimulating foreign investment.

(+) Labour force is highly competitive

Ireland has a highly educated workforce, that allows the country to be competitive in international high-tech sectors.

(-) Financial sector remains weak

The bailout of the financial sector has not yet resulted in a stable sector, as the fallout from the collapse of the housing market has not fully been absorbed yet.

(-) Vulnerable to external events

Although domestic demand is becoming a force in driving growth again, the small open economy remains dependent on the economic developments and monetary policy in the US, UK and EU.

Key developments

1. Strong macroeconomic performance supports deleveraging

The macro-economic environment has improved markedly during 2014. After two years of low growth, economic growth has picked up: GDP growth is expected to post 4.7 % in 2014 and 2.5% in 2015. For the first time since the crisis this growth was not solely on the back of external demand but also a result of domestic investment growth. Nevertheless, external demand will still be a strong driver of economic growth in the coming years. There is no sign that the competitiveness of the Irish economy is declining as unit labour cost remain low. This supports the current account that is expected to remain in surplus (6.2% of GDP in 2014), further aided by the recent depreciation of the Euro. The net international investment position (NIIP) remains deeply negative however (-102.3% of GDP) and will remain a risk to macroeconomic stability particularly as under 20% of foreign liabilities are FDI. Meanwhile, persistently low wages will continue to weigh down on domestic demand and could slow the recovery of the housing market. External demand has been sufficient to reduce unemployment by almost two percentage-points to 11.3% in 2014.

Figure 1: GDP growth in components
Figure 1: GDP growth in componentsSource: Macrobond
Figure 2: House price change since pre-crisis peak
Figure 2: House price change since pre-crisis peakSource: Macrobond

As property prices declined sharply after the crisis, this allows for strong growth rates now the economy is recovering. In 2014 residential properties posted a price increase of 16.3% but remain 38% below their peak level in 2007. Commercial real estate values increased by 30.7% y-o-y in 2014. Increasing property prices improve household balances but private debt still stands at very high levels and some 14.8% of mortgages remain in arrears. Corporate indebtedness is also high (figure 3). This corporate debt is also the main concern for the banking sector. In the Asset Quality Review (AQR), adjustments in the capital position of banks fell primarily in corporate portfolio’s. Overall the adjustments where modest (0.4% of CET1 max) as Ireland recapitalized its banking sector resolutely after the crisis. Of the five large banks that participated in the AQR only Permanent tsb plc. failed the stress-test and has been required to raise additional capital. The banking sector will become more stable when households and corporate balance sheets are supported by a recovery of asset prices and deleveraging, as a result of strong economic performance.

Figure 3: Private debt to GDP
Figure 3: Private debt to GDPSource: Macrobond
Figure 4: Improvement public finances
Figure 4: Improvement public financesSource: Macrobond

2. Substantial improvement budget deficit, but risk remains

The government deficit has been reduced to 3.7% of GDP in 2014 and is projected to decline further to 2.7% of in 2015 (figure 4). The underlying dynamics show that this improvement is driven by GDP growth in the denominator rather than an adjustment of government finances. This is in line with previous advice given by the IMF which focusses on retuning to macro-economic stability trough growth friendly consolidation. Some structural adjustment will be necessary as the crisis has eroded a significant part of the (property) tax base. For now we see no projected substantial improvement in the structurally adjusted deficit. This leaves public debt at 109% of GDP in 2015 with little projected improvement for 2016. The decisive response to the crisis has inspired confidence among investors and can explain the low spread over German government bonds. The high level of gross debt nevertheless leaves Ireland vulnerable to sudden shifts in risk perception.

3. Political stability endures

Ireland is a happy exception to Europe-wide trends of Euroscepticism, fragmentation of national parliaments and rising populism. Support for the Eurozone project still stands at 72%. Parties currently in government are projected to lose some votes but to the benefit of the rather conventional Fianna Fáil, which together with the coalition parties makes up over 60% of votes in the polls. The ongoing parliamentary investigation into the government intervention in the banking sector, that commenced in July 2014, is unlikely to threaten political stability.

Factsheet of Ireland
Factsheet of IrelandSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Ireland gained independence from the United Kingdom in 1921. The country has worked with the UK to stop the violence in Northern Ireland, and although the issues are far less urgent than decades ago, tensions linger. Ireland is one of the frontrunners within the European Union, having joined the European Community in 1973, and being one of the founding members of the European Economic and Monetary Union.

The Irish economy is outward looking and trade dependent. This is combined with a flexible labour force and institutions to deal with economic shocks. One of the primary examples hereof is the emigration from Ireland as the crisis hit. In no other European country was the population as ready to migrate as Irish inhabitants. On the one hand this could lead to a brain drain in the short run but now the economy is recovering, there are signs expats living abroad are returning to Ireland. ­

The economic crisis of 2007 hit Ireland very hard, with the economy shrinking by some 10% from 2008-2010. Credit, house prices (down almost 50%), construction, and external demand all collapsed. The government went all-out to save the banking sector by recapitalising the sector and guaranteeing all deposits. This led to a record budget deficit of over 30% of GDP in 2010 and an aid package being required by the EU and IMF. This EUR 85bn package came with strings attached and resulted in severe austerity measures, dampening (domestic) economic growth.

As a result of successful austerity measures, Ireland was the first country to exit the bailout program, and enter the international capital markets at decent rates. Furthermore, the current account deficit of the pre-crisis years has turned into a surplus. The health of the financial sector remains a concern, as indebtedness of companies and households remains very high.

Economic indicators of Ireland
Economic indicators of IrelandSource: EIU
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Author(s)
Jurriaan Kalf
RaboResearch Netherlands Rabobank KEO
+31 (0)30 21 62666

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