Arthur Beesley: Narrative of recovery must be tempered with caution

Markets have taken a pounding since the start of the year, incurring huge losses amid mounting anxiety about the slowdown in China and other emerging markets. With the general election only weeks away, the volatile global scene provides an especially telling backdrop.

For all of Ireland’s stellar economic growth in 2015, and the prospect of a further advance this year, the world outside seems to be changing fast.

No one really knows whether the present turmoil will turn out to be a bad dose of January jitters or morphs into something worse. At the heart of it all, however, is a fear that the rout in emerging markets could herald a third phase in the long global crisis. (The 2007-08 banking flameout came first; second came the euro zone debt emergency, which took the single currency close to failure).

It goes without saying that such an event would, sooner or later, hamper the Irish economy. This is doubly important in the context of the election as political and public perception tends to lag whatever goes on in economic real-time.

Right now it looks as if the debate will be dominated by questions around the allocation of the fruits of recovery, vis-à-vis tax cuts or new spending. Still, gathering clouds over the global scene call for a deep sense of caution and proportion from all politicians when it comes to their fiscal and economic plans.

If the narrative of recovery now finds acceptance, external threats appear to be multiplying. While these might not affect Ireland until the second half of the year, it is as well to acknowledge them.

It cannot be a given that the world will simply shake off the present ructions. Such concern lies behind ominous assessments from the likes of Royal Bank of Scotland, which has warned of a high-risk outlook for 2016. “We dust off our old mantra: this is about ‘return of capital’ not ‘return on capital’,” it said. “In a crowded hall, exit doors are small.”

After rapid growth and a big build-up in debt, emerging markets constitute almost 60 per cent of activity in the global economy. Thus disturbance in this milieu reverberates around the interconnected world. Take note too that the woes of China are only part of the story. To one degree or another, acute strain is evident in Brazil, Russia and South Africa.

Market risks

Saying “emerging market risks abound in 2016”, credit rating agency Fitch said in an analysis that serious challenges now exist for sovereigns and private sector borrowers in the corporate and banking worlds.

Pressure points include higher US interest rates and the stronger US dollar, which increase the cost of foreign currency borrowings. Another is sluggish global trade.

Still another is weakness in commodity prices. Oil is in sharp decline: over-supply and weak demand have taken the price to levels not seen for more than a decade.

All of this is rattling western markets. Last week British chancellor George Osborne warned of a “dangerous cocktail” of threats. Such concerns have pushed sterling’s value down against other currencies.

Another concern is the “Brexit” referendum on Britain’s EU membership, which would herald big trouble for Ireland if voters there chose to leave the union. That question is for another day, but it underlines the exposure of the Irish economy to the vicissitudes of the outside world.

Ireland’s growth has been spurred over the past year by the pickup in domestic demand – activity originating within the State as employment and consumer spending increase.

Yet external forces are also at work. Trade with the growing US and British economies is a factor, as are low oil prices, the euro’s weakness amid European Central Bank bond-buying, the associated decline in national borrowing costs and low interest rates generally.

Rocky emerging markets could undermine some of that via trade channels, exchange rates and financial markets.

A pickup in euro zone growth is good for Ireland, but that would reverse if a Chinese slump precipitates lower German exports.

In defiance of ECB interventions, capital outflows from emerging markets into safer euro zone assets could push up the euro’s value. Increased capital outflows could also prompt an increase in the cost of capital via a decompression of risk premia, which have been at historically low levels after huge central bank interventions in markets.

In summary, this is no time for blind faith in Ireland’s recent good fortunes.