A fragile recovery
The Irish economy at year-end finds itself in a healthier state than 12 months ago. After six austerity budgets since mid-2008, which have taken €28.5 billion out of the economy in spending cuts and tax rises, Ireland is more than four-fifths of the way through the bailout programme agreed with international lenders.
However, a recovering economy is still far from fully recovered, and is not yet out of danger. So far the Government has met all the fiscal targets set by the troika made up of the European Union, the European Central Bank and the International Monetary Fund. The Government hopes to leave the programme next year and to resume market financing of its borrowing needs.
In July, the National Treasury Management Agency (NTMA) – which manages Government debt – returned to the sovereign bond market for the first time in almost two years. There, it raised €4.2 billion, mostly from foreign investors. This success indicated growing international confidence in an Irish economic recovery. And that confidence is perhaps best exemplified by the large stake (€8.5 billion – 10 per cent of the Irish bond market) that one US investment firm, Franklin Templeton, has taken in Irish sovereign debt.
An open economy
Ireland – with one of the world’s most open economies – is reliant on growth in international demand to sustain an export-led recovery. The challenge for the Government has been to try to facilitate economic growth while at the same time reducing the budget deficit, stabilising and lowering the debt. In 2012, the rate of economic growth has slowed as the year advanced, and as the external economic environment worsened.
The US and UK markets account for almost half of all Irish exports, but conditions in both economies have deteriorated in recent months. In the US, growth has slowed while the UK and euro zone economies have both slipped back into recession. Growth in the Irish economy, which last year resumed for the first time since 2007, has continued in 2012, but at a slower pace – an estimated 0.9 per cent of gross domestic product.
The world economy in the past year has been marked by sustained uncertainty at two levels, political and financial. In the US, uncertainty about the outcome of the presidential election polarised public opinion and paralysed decision-making by lawmakers for months before the November vote. After the election, the slowness of politicians to agree measures to avert the “fiscal cliff” crisis has further depressed business investment in the US, and weakened consumer confidence.
President Barack Obama has cut short his Christmas break to return to budget talks in Washington but he has until now resisted the big spending cuts Republicans are demanding in return for tax hikes on higher earners. If attempts to avert the fiscal cliff by January 2nd fail, automatic tax hikes and large spending cuts will come into effect and the risk of the US economy entering recession greatly increases.
In Europe by mid-year two turning points of significance, and of particular benefit to Ireland, were reached. In June, euro zone leaders agreed to examine the situation of the Irish financial sector, to help improve the sustainability of its adjustment programme. And they also agreed to break the link between sovereign and bank debt. That held out the prospect that the burden of debt assumed by the Government in rescuing the banks could be reduced when the new permanent bailout fund – the Economic Stability Mechanism (ESM) – is established. A month later Mario Draghi, president of the ECB, committed the bank to do “whatever it takes” to ensure the euro’s survival. His pledge convinced financial markets, which had been pricing in the collapse of the single currency, that speculating on its demise was a likely losing bet. The effect of his statement was to reduce further Ireland’s cost of borrowing, with the benchmark bond yield – over 8 per cent in January – well below 5 per cent by year-end.
The economic outlook remains encouraging, with the unemployment rate showing signs of stabilising below 15 per cent. Ireland’s economic recovery remains fragile and, as the IMF has pointed out, it would be wrong to underestimate the downside risk should projected growth targets for the economy fail to materialise.
That could mean debt – which is expected to peak in 2013 at 121 per cent of GDP – rising faster than the economy is growing. And that would again raise questions about the sustainability of Ireland’s debt.
At the end of 2012, the optimists can see a light at the end of the tunnel, while the sceptics fear there may be another tunnel at the end of the light. Developments next year –most probably outside Ireland – will determine just who is right.