Inflation poses biggest threat to recovery

Arthur BeesleyOECD cites spending management, wage growth and inflation

The projection by the Organisation for Economic Co-operation and Development that the economy will expand by 6.5 per cent next year is marginally above the consensus forecast of growth in the 4.5 to 5 per cent band. As such, it points to a speedy turnaround from the slowdown during which unemployment increased last year for the first time since 1996.

"The OECD figure does look a little bit on the optimistic side but it does show that the economy is back to what everybody would assume would be a normal growth rate," said Mr Robert Watt, senior consultant with Indecon. "If these figures are correct, it shows there was a very mild shock and a minor slowdown leading to a rapid recovery."

But positive as all that is, the OECD pointed to underlying difficulties that could yet threaten a recovery on the back of a turnaround in the US economic scene since the terror attacks in September.

Advising the European Central Bank against interest rate increases, the OECD said rapidly rising prices for Irish services would keep the domestic inflation rate well above the euro-zone average.

"Strong growth of household real disposable income, driven by tax cuts, is set to underpin robust consumption in the course of the year." But it added: "For an economy experiencing a temporary downturn, the shift in fiscal stance from sizeable structural surplus to deficit has been inappropriately large and suggests weakness in the budgetary system."

Responding, the Department of Finance noted that a separate analysis this week by the European Commission had concluded that the Republic was in compliance with the close-to-balance requirement of the EU Stability Pact.

The OECD had another complaint. "Current public expenditures need to be better managed to avoid a choice of either allowing further fiscal slippage or cutting infrastructure investment."

Here, a Department of Finance spokesman also pointed to the often-stated belief of the Minister for Finance, Mr McCreevy, who advocates spending State money when the resources are available.

For all that, however, it was the quality of the management of that expenditure that was questioned in yesterday's report.

With the OECD noting the fundamental factors that contributed to the Republic having the strongest euro-zone growth were still in place, the suggestion is that the incoming Government should tread carefully to preserve those conditions.

What is more, political parties of all hues are pledging to increase expenditure in the election manifestos. Yet the chief economist at NCB Stockbrokers, Mr Dermot O'Brien, said finance ministers had mostly failed to restrain such spending.

Failure to control public spending could lead to higher demands from the personal and corporate taxpayers although this would be a very retrograde step, he said.

According to the OECD, poor public spending management could magnify other economic problems such as ever-rising wage rates. Although wage growth is expected to moderate, it said "a key risk" was that pay would not ease sufficiently, dampening the impact of growing investment and export markets.

This is crucial, for the domestic recovery will be built on the back of a turnaround in the US.

The head economist at IIB Bank, Mr Austin Hughes, said: "What you are seeing here is that the OECD in general is forecasting an upturn in the global economy. Because of the type of economy that the OECD perceives Ireland to be, it would be extraordinary if Ireland didn't benefit. It is almost a case of a rising tide lifting all boats."

But economists cautioned that a body such as the OECD did not lightly use expressions such as "inappropriate" and "needs to be better managed" when referring to Government policy and expenditure. Mr Hughes said: "Although a rising tide lifts all boats it points to possible hidden holes in ours and that the threat to competitiveness from wage growth and public spending is real."