Irish economy to contract by 12%, ESRI forecasts

Think tank warns against ‘tapering’ Covid-19 payment as businesses gradually restart

The Republic’s economy is on track to shrink by 12.4 per cent this year, marking the largest annual slump in its history, as the Covid-19 pandemic wreaks havoc on households, firms and government finances, according to the Economic and Social Research Institute (ESRI).

The forecast, contained in ESRI’s summer economic commentary, is more pessimistic than the Government’s projection that gross domestic product (GDP) will fall 10.5 per cent this year.

It is also starker than the 7.5-8 per cent contraction factored in by the country's two main banks, Bank of Ireland and AIB, as they revealed earlier this month that they had started to set aside money to cover an expected fresh spike in bad loans.

The ESRI’s baseline scenario, which sees a gradual easing of lockdown restrictions and Covid-19 unemployment and wage subsidy supports expiring as planned in June, also envisages the Government posting a budget deficit of €27 billion or 9 per cent of GDP this year.

A so-called severe scenario, involving a second wave of infections and another lockdown in the final months of the year, would see the economy contracting by 17 per cent, with a benign case of the economy returning to normal in the fourth quarter resulting in the downturn coming to 8.6 per cent, it said.

Speaking to reporters, ESRI research professor Kieran McQuinn warned against the “tapering” of the special weekly €350 Covid-19 pandemic unemployment payment in the coming months, particularly as the economy is only gradually being opened up.

“The full nature of those payments are very important,” Prof McQuinn said. “They’re helping to mitigate the impact [of declining] household disposable income and that, in turn, is supporting economic activity.”

House prices

Moving too early to reduce this benefit could hit house prices and increase the risk of mortgage arrears, he said. “Whilst not in the short term, ultimately that can lead to financial stability concerns if you have a very sustained and significant increase in mortgage arrears,” he said.

The ESRI research professor also cautioned against the Government moving too quickly to try and rein in the budget deficit in the coming years, while arguing in favour of a stimulus package in the near term to fuel a recovery. He highlighted social and affordable housing as well as projects that advance the green agenda as obvious areas for investment.

“We have to focus on stabilising the economy, managing income supports and reigniting economic activity in the short-to-medium term,” said Prof McQuinn. “Certainly, the incoming government needs to be aware that at some stage there will need to be some sort of fiscal adjustment down the road. But the key point is that if we manage the stabilisation phase well over the short-to-medium term, that will ultimately minimise the scale of adjustment that’s needed over the longer term.”

Stimulus package

The ESRI did not speculate on the potential size of a stimulus package that would be in addition to €14 billion of health spending, unemployment and income benefits and business supports already announced by the Government in the past three months.

Prof McQuinn said the ultimate scale of a plan would depend on EU initiatives and leeway on how much governments can borrow. The European Commission laid out plans on Wednesday for a €750 billion coronavirus recovery fund that would involve loans and grants for EU countries, subject to approval from member states.

The Irish Fiscal Advisory Council said in a report published on Wednesday that the incoming government faces having to push through almost €11 billion of spending cuts and tax increases in the coming years to rein in a yawning budget deficit resulting from the Covid-19 crisis.

It also said a credible stimulus package to rebuild the economy – possibly of the order of €10 billion – would also be needed.

Also on Wednesday, Sean O’Driscoll was appointed as chair of the ESRI in succession to Padraig McManus. Mr O’Driscoll is a former chairman and chief executive of the Glen Dimplex Group and a former partner in KPMG.

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Joe Brennan

Joe Brennan

Joe Brennan is Markets Correspondent of The Irish Times