OpinionNov 7 2013

When Irish eyes are smiling

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Between 2000 and 2008 the Irish economy grew at a very respectable 6 per cent a year, but the financial crisis and the collapse of the housing market hit the country hard, forcing it into a steep recession. When the yield on its government debt started to rise, Ireland was effectively shut out of the bond market and the government forced to accept an €85bn (£72bn) bailout from international lenders, the ‘Troika’ – the European Commission, International Monetary Fund and European Central Bank. The penance for accepting this aid was a strict plan of budget cuts and tax rises to reduce the fiscal deficit. According to the recent budget release, the total austerity absorbed since the bailout has been a hefty €31bn (£26bn).

Ireland’s 2014 budget, released in October, was its seventh hard-line budget in six years and continues with the austerity programme, although at a slower pace. The government aims to implement another €2.5bn (£2.1bn) in spending cuts and tax increases in the coming fiscal year – less than the €3.1bn (£2.6bn) that the Troika was looking for. However, even at this reduced level of consolidation, forecasts show that the budget deficit is expected to fall to 4.8 per cent in 2014, well below the Troika target of 5.1 per cent. The 2015 estimate of 3 per cent, if achieved, would mean Ireland would actually meet one of the key metrics stipulated under the Maastricht Treaty for entry into the single currency bloc (the other being a debt-to-gross domestic product ratio of no more than 60 per cent). This improving fiscal position means that Ireland is likely to exit from the bailout programme in December this year.

Meanwhile the Irish economy expanded by 0.4 per cent quarter-on-quarter in the three months to June and the outlook for growth is improving. Unemployment has fallen steadily since peaking in 2012, and was 13.3 per cent in September. Exports have increased as global economic momentum builds and there have been tentative signs of life in the housing market, although so far this is isolated in the main centres. All this adds up to the Irish government estimating that the pace of growth will rise to 2 per cent in 2014.

Ireland has been paraded as an example of how fiscal consolidation can be successfully implemented. However austerity alone will not result in a return to competitiveness for many of the peripheral European economies, especially given the crippling effect that budget cuts have had on the economic growth of those countries that have been forced to implement them. In Ireland’s case, it may have been more than just austerity that has helped the economy. Compared with its peripheral cousins, more of Ireland’s exports are destined for countries outside the eurozone, and for many years a weaker euro has supported overseas demand for the country’s goods and services. The very low relative corporate tax rate also made Ireland an attractive site for the headquarters of many multinationals. These factors may have also helped the economy at a time when the government was cutting spending.

Earlier this year Standard & Poor’s upgraded Ireland’s credit outlook to positive, citing the falling debt burden, and its debt is currently rated at BBB+, two notches above ‘junk’ status. However the current debt-to-GDP ratio of more than 120 per cent still leaves the country vulnerable to external shocks and, as an export-orientated economy, it is heavily reliant on the health of its trading partners. The recent strengthening in the value of the euro has the potential to dent the attractiveness of its exports and perhaps the export-led recovery that Irish politicians are hoping for. Ireland will need to maintain a steadily improving pace of growth if it is to address what is still rather a large debt problem.

Ireland’s progress will be monitored not only by politicians in Brussels but also by those other European countries that received funding from the Troika. With the yield on Irish government bonds now below pre-crisis levels, if Ireland can once again tap debt markets it will represent yet another sign of stability and improvement for the eurozone. However if Ireland is unsuccessful it will not bode well for other bailout recipients who will be eager to escape the watchful eye of the Troika.

Kerry Craig is global market strategist of JP Morgan Asset Management

Key points

The Irish is economy is growing, unemployment is falling and the country is expected to be the first to exit its bailout programme.

Ireland’s 2014 budget, released in October, was its seventh hard-line budget in six years and continues with the austerity programme, although at a slower place.

Earlier this year Standard & Poor’s upgraded Ireland’s credit outlook to positive, citing the falling debt burden, and its debt is currently rated at BBB+.