Figures question stress test credibility

ANALYSIS:LAST WEEK the Central Bank published the two scenarios for the economy that it is using in its stress testing of the banking system. The worst possible outcome for 2010 was a contraction in GDP of 0.2 per cent. Yesterday's official (if provisional) GDP figures showed a decline of 1 per cent.

The difference may seem small, but given that Central Bank economists had three of 2010’s four quarters of data when they did their projections, it can only undermine credibility in a process that – on an Irish and Europe-wide basis – had very little to begin with. Central bankers appear to be avoiding – yet again – a plausible worst-case scenario for their stress tests.

But that was not the only reason that yesterday’s figures on the size of the economy were more than a little worrying.

With no change to the terms of Ireland’s bailout materialising from the EU leaders’ summit and the bank stress tests due for publication next week, the issue of the sustainability of Ireland’s public debt can only rise further up the agenda.

Three factors determine sustainability: the absolute size of the debt; interest payments on it; and the rate at which the economy is growing in nominal terms. Yesterday brought bad news on the last of these three factors.

Nominal GDP fell massively in the final three months of the year. At 6.6 per cent quarter on quarter, it was the biggest such decline of the depression. Combined with some small downward revisions to the previous three quarters, the upshot is that the economy generated nominal wealth of just under €154 billion last year.

The 2010 budget, and the projections of all the political parties at election time, was based on an outcome of €157.3 billion.

As a result, the national debt has suddenly grown when expressed as a ratio of GDP, from 94.2 per cent on Wednesday to 96.3 per cent yesterday. Ireland has inched closer to the great unknown of sovereign default.

Yesterday’s figures also returned Ireland to the very bottom of the EU league table of economic growth. Quarterly GDP contracted by more than any other reporting country, according to data from Eurostat, the bloc’s statistics agency. As chart 1 shows, Greece was the only other euro zone country to experience negative growth in the final three months of the year.

The chart also highlights the ever growing North-South gap opening up in the zone. Portugal has run out of road and is about to be bailed out. Spain and Italy are stagnating. Countries with a Baltic coast are booming. It seems that the further one gets from the Mediterranean, the faster one’s economy grows. Ireland is the exception. Increasingly, the Irish economy looks locked into long term membership of Club-Med.

Economic divergence is causing political divergence which, in turn, is causing further economic divergence. Historically, Europe has not dealt well with such politico-economic vicious circles. More cause for concern.

Chart 2 shows that the Irish economy remained on the floor in the fourth quarter. Most disconcerting is the continued slide of the domestic economy. Domestic demand is back to levels last seen in early 2002, before the real excesses of the building and credit boom began.

Most of the decline in the fourth quarter was accounted for by companies running down inventories, something that reduces overall growth figures.

Not unexpectedly, there was also a further decline in consumer spending on goods and services. That said, at just 0.4 per cent quarter on quarter, it could have been much worse.

Last week’s dismal fourth quarter employment survey by the CSO showed that employment continued to fall. This reduced economy-wide aggregate incomes. The huge uncertainty in the final months of the year could have caused consumers to ramp up precautionary savings. Yesterday’s figures confirmed that they did not do so.

Chart 2 shows that exports declined quarter on quarter for the first time in more than a year.There is reason to believe that this figure could be revised up and there are crumbs of comfort in the fact that services exports continue to surge. Crumbs are all that are on offer these days.