Business review 2014: Economic progress but at political price

As recovery strengthens after a long period of setback and woe, Ireland’s economy enters 2015 in relatively upbeat mode, with the fastest growth rate in Europe. Yet many vulnerabilities remain, even if data point to a marked improvement in conditions since the State made a smooth return to capital markets one year ago in the wake of the bailout.

For all of the economic progress made in 2014, it was a year of political turmoil for Taoiseach Enda Kenny and his Government. After a string of Garda controversies and mid-term electoral losses, the Irish Water debacle sapped both their composure and their authority. This is the immutable backdrop against which the Coalition will seek to regain the initiative in 2015, the last full year before its mandate expires in the spring of 2016. This greatly increases the stakes, politically and economically, for the grounding sense of certainty over fiscal policy, which has prevailed since Fine Gael and Labour took power in 2011, is dissipating as Independents, Sinn Féin and the hard left advance in the polls.

Whenever the election happens and before it too, there will be no escaping scrutiny of the policies planned by various parties to continue repairing the public finances and pay down the voluminous national debt.

The overwhelming force of the crash was such that virtually the entire political establishment rallied behind a stringent recovery programme which imposed daunting costs on the Irish people. Still, the very scale and duration of that effort has stoked the rise of the anti-establishment faction. Whether its anti-austerity rhetoric – and associated policies – can withstand the refining fire of the election itself remains to be seen. It is already clear, however, that the economy will be the battleground for the campaign to come.

While relative political stability was a feature of the most acute phase of Ireland’s financial emergency, polls suggest it is no longer a given. In summary, no one can really know the composition of the next administration or predict the medium-term course of policy. This will remain the case whether the Coalition runs to the very end of its term or goes early to the country.

Goodwill of bond markets

But this debate is crucial in a State which is heavily reliant on the goodwill of sovereign bond markets and multinational investors. For all that, there is little overt evidence of any disquiet or alarm in those quarters at the evolving political situation. In the year to come, however, economics and politics will be deeply entwined .

The good news is that the economy is forecast to expand at a rate not far off 5 per cent in 2015, unthinkable in the aftermath of the crash, when Ireland was in the maw of profound economic depression. This has opened options, although they are limited and do not lack risk. The acceleration in growth follows the return of investment and domestic demand in 2014, with employment rising and retail sales growing in volume terms.

This marks a broadening of Ireland’s export-led recovery, itself fanned by the onward march of the US and British economies. The weakness of the euro zone remains a concern, however, as do divisions on the governing council of the European Central Bank, where president Mario Draghi is making the case for full-blown quantitative easing to avert the threat of deflation. At another level, ructions in the Russian economy late in 2014 demonstrate that the fragile global economy remains prone to shock.

Ireland’s growth in 2014, which slowed down in summer and early autumn, fuelled buoyancy in tax revenues. These were consistently ahead of target as 2014 progressed and were sufficiently strong for the Government to introduce a modest income-tax cut in the new year. Yet this could not be done without an expansionary budget, prompting inevitable resistance from critics in domestic and international institutions. The most vocal was the Irish Fiscal Advisory Council, which saw an opportunity missed in the budget to move the public finances more decisively into a zone of safety.

For the Government, however, the tax concession was an act of acute political necessity after prolonged and ever-encroaching retrenchment. Thus the €2 billion consolidation foreseen at the outset of budget talks swung first to talk of a “neutral” package and then, finally, to a €1 billion increase in expenditure.

After €29.8 billion in tax increases and spending cutbacks since 2008, this marked something of a turning point. The Fiscal Council argued the deficit would come in a full percentage higher as a result, with the level of the national debt roughly €10 billion higher in 2018.

Major policy U-turn

Bruised by complaints that people were seeing little of the nascent economic turnaround in daily life and under political pressure to redress the slide in its support, the Government saw it differently.

The tax cut was cast as the downpayment on an even larger recovery dividend to come. But there was no political dividend for the Government, which saw the prospect of advantage evaporate before its very eyes as the water protest escalated and it was forced into a major policy U-turn to suspend metered charging.

In Coalition circles, this is quietly acknowledged to be a source of considerable frustration for Minister for Finance Michael Noonan. To critics of his budgetary strategy came the reply that he remains on course to achieve a budget deficit below 3 per cent of economic output in 2015, thereby meeting an important target set at the outset of the bailout in the dark days of 2010.

Even so, the Central Bank has argued that a 3 per cent deficit is “not an end-point” in itself. After all, any deficit increases borrowing. Ireland’s national debt is already at an elevated level after large bank bailouts and the precipitous collapse in tax revenue which came with recession.

Although the State shook off the shackles of the EU/IMF troika at the end of 2013, the Central Bank has made the case that markets would look “more closely” at Ireland in the absence of external oversight. While Ireland’s borrowing costs on private markets remain very low, they will be come under close examination as the election draws closer. The Government is wedded to the 3 per cent target for 2015 and will achieve it readily in the absence of any shock. The question, however, is what lies in store in 2016 and beyond.

Having found a willing market in 2014 for long-term Irish debt, the National Treasury Management Agency is likely in the year to come to make preparations for an €8 billion bond redemption due in spring of 2016. This follows steps in recent months to refinance most of Ireland’s IMF debt with cheaper market-sourced debt, moves which will continue in the opening months of 2015.

For Nama, the State’s “bad bank”, the outgoing year saw it redeeem some €9.1 billion of its outstanding senior debt. This brought total redemptions to €16.6 billion, 55 per cent of the amount issued in the first instance. Up to €5 billion could be redeemed in 2015.

For all of the uncertainty in the political outlook, indicators in the real economy point to steady increase in activity.

Tom Parlon, chief of the Construction Industry Federation, speaks of 10,000 additional jobs in the sector in 2014 and more to come in 2015. “It is patchy, there’s no question about that, but it is picking up and picking up strongly in the Dublin area and in the east of the country,” he said.

Big new projects coming on stream in 2015 include the €300 million Gort-Tuam motorway connection, the €100 million Ringsend incinerator and the new Central Bank headquarters.

Still, Parlon notes the conclusion of a €4 billion Intel investment in Leixlip and Shell’s €5 billion Corrib gas project. “That’s a big lot of activity dropping off. But thankfully there’s a good pipeline of other stuff coming on all the time.”

Return of cranes

Amid talk of the return of cranes to the Dublin skyline and emerging skills shortages, recruiters see a continuation of positive trends next year.

“We see ourselves as a decent weathervane for the economy generally and we’re increasing our headcount by 20 per cent in the first half of next year,” said Richard Eardley, managing director of recruitment agency Hays Ireland.

“So if we need another 20 or 30 additional recruitment consultants, there’s a lot more jobs needing to tbe filled in 2015 than there were in 2014. Yet 2014 itself has been a very good year.”

This, in turn, imposes its own pressures. While the rapid recovery in Dublin house prices is well-documented, there is some anxiety in official circles that competitiveness gains seen since the crash could be squandered. Amid concern to avoid a feedback loop between pay and property prices, pent-up wage demands in both the public and private sectors are likely feature in debate next year.

The Government has already signalled that it will invite public-sector unions to talks in 2015 with a view to an orderly unwinding of emergency laws to cut public pay. Within the private sector, employers argue that more needs to be done to ease the income-tax burden.

To contemplate going down that road at all requires a continuation of steady progress on the fiscal front. As the Government’s mandate nears its end, however, there is always the danger that political leaders overpromise. Standard budgetary principles suggest public authorities should plan for the worst and hope for the best. The temptation to reverse that always rises when an election looms.