Ireland on Brink of Recession ?

Irish GDP contracted sharply in Q3 posting a quarterly decrease of 1.9%, which could push Ireland back into recession if GDP declines again in Q4.

Ireland’s large export sector continues to be the good news story, though the effect of the continued austerity measures is weighing heavily on domestic demand.

We now believe that the Irish economy will grow 0.8% in 2011, with modest growth of 1% in 2012 being led by the export sector.

Irish Q3 GDP very weak

Irish GDP contracted sharply in Q3 posting a quarterly decrease of 1.9%, following a very strong performance in the first half of the year. This could push Ireland back into recession if GDP declines again in Q4. Domestic demand in Ireland remains very weak, with consumer spending down 1.3% on the quarter. However, as we said when the very strong Q2 GDP figures were released, caution should be used in interpreting Irish statistics. With such an open economy dominated by very large export and import flows, quarterly GDP figures tend to be volatile and subject to large revisions.

In reality, the Irish economy is bobbling along the bottom. The real economy is flat but stable, with continued falls in house prices and very high unemployment counteracting the continued positive export performance. This is evidenced in business and consumer sentiment surveys, with Irish PMIs pointing to modest positive growth and consumer confidence improving from very low levels.

We now believe that the Irish economy will grow 0.8% in 2011, down from our previous estimate of 1.6%. We expect 2012 to bring further modest growth of 1.0%, led by continued export growth. While we do not forecast that final domestic demand will see appreciable growth, it will at least stabilise as the effect of continued austerity is offset by a decline in Ireland’s household savings rate, which is the highest in the Euro area.

Export growth to be hit as main markets slump

The slowdown in the European economy will hit Irish foreign trade in 2012, with EU countries accounting for 60% of exports. Ireland is an unusually open economy, with exports accounting for 103% of GDP. Its largest single trading partner (UK) is expected to expand by only 0.6% in 2012, while the Euro area is expected to expand by 0.3%.

However, the relatively recession-proof composition of Irish exports is likely to help support a moderate level of export growth of 4.5% in 2012, with Ireland’s large pharmaceutical and services sectors driving continued growth. Irish exports fared relatively well in 2009 falling only 4%, compared to the 13% in the Euro area, and the latest export figures suggest this might be happening again. While new export orders in the euro area in November pointed to a significant contraction, in Ireland they suggest continued expansion of services exports (52.2) and stable goods exports (49.9).

Domestic demand
Domestic demand was very weak in Q3, driven by the continued fall in consumer spending which is now 13% lower than its peak. The OECD estimate that Irish household savings as a percentage of household income is 16%, around double the EU average.

Households are focussed on deleveraging, with total outstanding loans to households falling by EUR21bn to EUR164bn in three years. Continued deleveraging and austerity will prevent any recovery in consumer demand next year, though we do not expect any large falls either.

Unemployment in Ireland is currently stagnating at a high level, while employment continues to contract. In November the unemployment rate stood at 14.5%, slightly lower than the 14.8% a year previously. Employment continues to fall, though the average quarterly fall in 11,000 persons in 2011 was somewhat less than the 16,000 persons in 2010. Employment falls in public services dominated industries like education and health are starting to quicken as the moratorium on recruitment takes effect. The rise in unemployment has been stemmed by outward migration of foreign nationals, though the number of Irish nationals continues to grow because of Ireland’s demographic profile.

Budgetary Austerity Continues

Ireland entered its fourth year of austerity with the announcement of Budget 2012, the first of the new administration that won the February election. The budget shows a determination to meet the EU/IMF targets with an additional EUR3.8bn in cuts (2.4% of GDP), though this represents a smaller fiscal impact than the three previous years which each saw approximately EUR6bn of spending cuts and tax rises. The Government deficit for 2011 is expected to be 10.1% of GDP, well within the 10.6% target set in Ireland’s bailout terms.
However, the deficit remains at exceptionally high levels, necessitating a
number of years of additional austerity. The government is targeting a budget deficit of 8.6% of GDP in 2012.

The main savings came from a continued fall in the number of public servants, an increase in VAT of 2% and a sharp reduction in the capital spending programme. The main surprise was some measures to revive the commercial property market, though the market still has large challenges to overcome. Corporation tax is expected to remain at 12.5%, and the Irish Government’s determination to maintaining this might cause another battle at European level in the coming months.

Construction sector continues its freefall

Measures to support the property market were announced in the budget, with the continued slide in the construction clearly worrying the Government. Activity in this sector in Q3 was running at one fifth of peak 2006 levels. Further, the Government has a very large property portfolio now as owner of the ‘bad bank’ NAMA, and as such has a vested interest in seeing a stabilisation and ultimate improvement in property prices.

The measures included a reduction in Ireland’s tax on transactions from 6% to 2%, new tax incentives for property investors who hold property for at least seven years and a scrapping of proposed retailer-friendly reforms which had threatened rent levels for investors. While these reforms will help the property market, it still has large challenges to overcome, notably the lack of credit, the oversupply of some types of property and the continued weakness of domestic demand.