Escape from recession not on the cards in 2013

THE ECONOMY:Modest growth in output and an end to the labour market shake-out is about the best we can hope for

Nobody – at home or abroad – believes that the Irish economy will bound out of recession in 2013. The best forecasters and observers dare to hope for is that output grows modestly and that the shake-out in the labour market comes to an end. However depressing, that’s about the best that can be expected given the multiple headwinds hindering recovery.

If there is very little upside risk to the economic outlook this year, even in the event of the most favourable arrangement being secured on the State’s bank debt (see panel), the downside risks remain big and worrying.

As has been the case for three years, a deterioration of the euro crisis remains the biggest foreseeable risk by some distance. That crisis is very far from being definitively resolved and the very existence of the single currency remains in question.

The crisis will inevitably flare up again over the course of the year, even if the probability of the currency collapsing over the next 12 months is limited thanks to the sovereign backstop arrangements put in place by the European Central Bank late last summer.

Reasons for optimism

Domestically, a good number of indicators are pointing in the right direction as the year begins. Surveys and anecdote point to stronger consumer and business confidence, and last week’s CSO figures on residential property prices (for November) provide further evidence that the stabilisation of that market, in evidence since the first half of last year, is holding.

Externally, the recession-proof nature of much of the exports of Ireland-based companies – such as pharmaceuticals – means the downturn in Europe has had limited impact on export earnings.

Moreover, if the mixed signals from the British economy shift in 2013, with more indicators pointing towards recovery and fewer towards recession, that important market could suck in more Irish exports.

Across the Atlantic, the US had its best year for job creation since the middle of the last decade in 2012 and, for the first time since 2006, the US residential property market perked up.

The massive and sustained fiscal-monetary easing there appears at last to be paying off, and, if recovery is not derailed by politicking in Washington, that economy too promises to import more goods and services from Ireland.

Many weaknesses remain

But for any positives that exist going into the new year, there are more negatives. As has long been the case, the biggest obstacle to recovery will be household and corporate debt. The very slow rebuilding of balance sheets, via the paying down of debt, will grind on in 2013 and well beyond – dampening consumer spending and companies’ ability to invest.

How the public finances evolve over the course of the year will be even more important than usual. They will be central in determining whether the State’s three-year international bailout ends on schedule in December.

On this score there is some cause for concern. Growth in tax revenues began to weaken in the spring of last year. If that trend continues into 2013, and if the sizeable overruns in health spending are not arrested, budget targets will be missed.

Other peripheral economies have not always been obliged to take additional budget measures when fiscal targets are missed owing to weaker economic growth.

On that basis, it seems unlikely that a mini-budget will come onto the agenda over the course of the year. But if targets are missed – for whatever reason – the probability of the Government exiting its EU-IMF bailout on schedule will fall.

Eyes on the bond market

Also vital to exiting the bailout will be private investors’ views on Irish public debt. Bond market indicators will be closely watched this year, as will the efforts of the National Treasury Management Agency (NTMA) in selling Irish debt.

It plans to auction enough bonds over the course of 2013 so that, by year’s end, it is sitting on a plump cash cushion which will be used to fund the State’s spending in 2014.

As the year begins, there is room for guarded optimism that the NTMA can achieve this, given the near-uninterrupted 18-month rally in the bond market.

But a clean break from bailout by December still looks highly uncertain. International investor sentiment is fickle. It is even more fickle when it comes to small, volatile economies of which investors’ understanding is shallow.

In 2008 and 2010, sentiment turned against Ireland quickly and dramatically. It could happen again in 2013. Either way, it should be clear by mid-year, and by September at the latest, whether exiting the bailout is achievable.

Euro crisis flare-ups

The wider euro zone picture will also be important in determining whether the State can fund itself normally beyond the end of the year, and much else besides. On that score, there is much to be concerned about.

As Europe enters the fourth year of its sovereign debt crisis, the fundamentals underpinning the euro appear weaker than ever. Despite the actions of the ECB and the few steps forward taken by political leaders in 2012, the political will to address the crisis meaningfully still does not exist.

This was illustrated, if it even needed illustrating, by the near shambles that was the EU leaders’ summit in Brussels in mid-December, where backsliding yet again characterised discussion and outcomes.

Leaders’ hesitancy and the deep differences between them is only one of many deteriorating fundamentals that augur badly for the single currency’s future.

Another is the severe ongoing recessions in Greece, Cyprus, Italy, Portugal and Spain, with the last four economies (and Ireland) all at risk of following Greece into sovereign default.

It is hard to predict what will trigger the next flare-up in the euro crisis, but the terms of the long-discussed bailout for Cyprus are one potential early flashpoint. The island economy’s banking system is in a state of collapse and its public debt is exploding. After six months of discussions, a bailout is expected to be formally agreed once a new president takes office in February.

For the first time since Lehman Brothers, there is a possibility that the European authorities will allow one or more financial institutions to fail. Setting such a precedent, though correct in principle, could send a shock wave through Europe’s highly fragile financial system and trigger panic.

Elections in Italy in late February are another early and obvious cause for jitters. Although Silvio Berlusconi can never be written off, opinion polls suggest that if he were to run again, Italians would reject him.

But even if the buffoon factor is taken out of Italian politics once and for all, there is little reason to believe that whoever wins the election will be willing and able to cure the chronic malaise that has afflicted the economy since the 1990s.

A combination of economic and political weakness has pushed the Italian state ever closer towards insolvency. After public indebtedness was kept steady up to the end of 2011, it rose sharply in the first half of last year. An increase from 120 to 126 per cent GDP in the six months to the middle of 2012 (the latest figures available) is truly alarming.

More alarming still is that the trend looks set to continue: by almost every measure, from retail sales to industrial production, the economy continued to contract in the second half of 2012.

Spain’s pain

Spain has considerably more headroom than Italy on public debt but if the cash earmarked for recapitalising its banks is slapped on the sovereign balance sheet, that will change.

With property prices still falling fast, Spain faces the sort of ever-growing banking losses that were experienced in Ireland between 2008 and 2010. Moreover, given that the contraction in the Spanish economy during 2012 was even sharper than in Italy by most measures, it appears only a matter of time before the solvency of the state comes back into focus.

Matters in Iberia’s other economy are, if anything, worse. Although not quite suffering a Greek-style collapse, Portuguese output and employment in 2012 contracted at a shocking pace and forward-looking indicators do not point to stabilisation, never mind an immediate return to growth.

Public debt, which is rising fast, hit 117 per cent of GDP by mid-2012. Over the course of this year, it will become clear that exiting its EU-IMF bailout in the first half of 2014 is not realistic. Some hard choices on Portugal appear inevitable this year.

Grexit in 2013?

And then there is Greece. Talk of ejecting that country from the euro reached fever pitch in mid-2012. But northern leaders thought better of it as the indirect costs of doing so became clear – capital flight from Italy and Spain accelerated for fear that they, too, might end up outside the bloc.

By November, a very significant deal on loans given to Greece by other countries was agreed. It will buy more time than previous measures, but problems will re-emerge if new debts are run up more quickly than expected – either because the economy contracts by more than anticipated or because the Athens government does not stick to its tax and spending commitments.

While 2013 may bring a bottoming out of the economy’s decline, there are fewer indicators to suggest that Greece’s political class has fundamentally changed its ways. Don’t be surprised if Grexit returns to the agenda over the course of the year.

If the periphery’s problems are multiple and severe, they are not the continent’s only woes. Europe’s leaders are not leading and the EU’s political legitimacy – limited though it has always been – is crumbling.

While the ECB has the capacity to save the euro in the short term, political decisions of historic proportions will be needed to do that over the medium term. Don’t hold your breath for those decisions to be taken in 2013. The future of the single currency is as uncertain as ever.

Deal or no deal: what difference would a bank debt deal make to Ireland’s economy?

A deal on debt has been so hyped that many people believe it would transform the economy’s prospects. No matter how generous, it won’t do that, even if it would be most welcome.

The positive effects would come from a boost to confidence, some lessening in total debt servicing costs and, most importantly, a reduction in the risk of sovereign default over the medium term.

If any deal involved fully severing the link between the sovereign and future additional bank losses, it would also accelerate the fixing of the financial system, thereby accelerating progress towards a more normal supply of credit to businesses, home-buyers and consumers.

But even in the best case scenario, a deal would not have much immediate effect on economic activity. The paying down of private debt – the biggest drag on the economy – would continue.

In addition, there would be very limited scope to ease the pace of fiscal consolidation, both because Ireland is running the largest primary deficit (excluding debt servicing costs) in the EU and because of the need to halt the rise in the debt to GDP ratio.

A deal on bank debt in 2013 would be cause for celebration, but nobody should believe that it would turn bust to boom.