Ireland: The Celtic Tiger is back
The Irish economy grew very strongly by 7.8% in 2015, largely on the back of investment. The economy and property prices are doing well, but the overall asset quality of banks remains poor.
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 economic developments and monetary policy in the US, the UK and the EU.
1. Strong macroeconomic performance supports deleveraging
The Irish economy grew very strongly in 2015 by 7.8%, the fastest pace since 2000. This strong growth has convincingly raised output above pre-crisis levels, both in terms of gross domestic product and gross national income. Growth was supported by a strong recovery of fixed investment, which is likely to persist in 2016. Private consumption, which has benefitted from rising incomes and a decline in unemployment also supported growth. That said, the unemployment rate remains relatively high at 8.8% in February 2016, but this should come down to around 8% by the end of this year on the back of a strong growth of around 4.5% y-o-y in 2016. The strong economic performance is also luring some of the young people that had left in the wake of the financial crisis back home. This is pushing up rental prices, in the capital Dublin and other cities. The property market at large is recovering, with prices back at 2005 levels and while an uptick in construction permits is visible, construction remains very limited (figure 3).
Debt has long been Ireland’s Achilles heel but indicators have improved decisively in 2015. On the back of strong growth and prudent fiscal policies - the budget deficit has remained 1.8% of GDP and is forecasted to improve further to 1.5% of GDP - total government debt fell below 100% of GDP. Government debt currently stands at 98.6% of GDP and should drop further to 95% of GDP over the course of 2016. A similar decline can be found in consumer debt, which has declined to 83.8% in 2014, before factoring in 2015’s very strong growth performance. Non-financial corporate debt (NFC) has continued to rise to 174% of GDP in 2014 but GDP growth is likely to have outpaced NFC loan growth in 2015. This rise in debt NFC deb is largely driven by multinationals active in Ireland, which have relied on access to international markets and group funding to finance continued growth in inward direct investment.
2. Banking sector's still has credit boom legacy to deal with
The Irish banking sector is recovering, but major challenges remain. NPLs of the three largest banks still amount to 19% of GDP while over 29% of total assets are currently non-earning. This also leaves the government with significant contingent liabilities of up to 7% of GDP because it would need to compensate depositors under the deposit insurance scheme. However, a bank default does not feature in our base case and we see that banks currently have good access to capital, while the Irish government benefits from an advantageous risk perception by financial markets. With the economy and property prices performing well and unemployment dropping, asset quality of Irish banks should improve in the foreseeable future and risks for both the government and the banking sector will decrease. In the meantime, however, the legacy of the pre-crisis credit boom weighs on profitability of banks and makes the banking sector vulnerable to changes in the external environment and sudden changes of risk perception.
3. Ireland worries over Brexit referendum
The June 23rd Brexit referendum is approaching rapidly. As the UK is Ireland’s main trading partner, accounting for 15% of total exports and 34% of all imports, an eventual Brexit would directly affect the Irish economy. As it stands, we do not expect a British vote in favor of leaving the EU and if this were to happen it will probably take a good two years for the EU and the UK to renegotiate trade treaties. However, that period of uncertainty could negatively affect the UK’s economy, which would hurt Ireland and investor’s risk perception on the country as well. In the medium run, a lack of integration of UK in the single market would reduce bilateral trade flows between Ireland and the UK. Analysis shows that Irish exports to the UK are concentrated in the sectors Food and Beverages (26.4%), Chemicals, Pharmaceuticals and Non-Metallic Minerals (24.8%), Financial Intermediation (11.9%) and Business Services (10.2%). A Brexit could also inhibit Irish residents from working in the UK, something that has proved a source of resilience during the last crisis.
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 high quality institutions that can deal with economic shocks. One of the primary examples hereof is the emigration from Ireland as the financial crisis hit. In no other European country was the population as ready to migrate as Irish inhabitants were. The economic crisis of 2007 hit Ireland very hard, with the economy shrinking by some 8% from 2007-2010. Credit growth, house prices (down almost 50%), construction activity, 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 from the EU and the IMF was required. This EUR 85bn package came with strings attached and resulted in severe austerity measures, which dampened economic growth. As a result of the successful implementation of the measures, Ireland was the first country to exit the bailout program, and re-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.