Let's hope ESRI is right to be optimistic on 2010 GNP

ANALYSIS:The predicted zero decline is based on factors particularly difficult to forecast, writes PAT McARDLE

THE ESRI’S decision to alter the timing of its forecast cycle to bring it into line with the rest of the economics profession is welcome.

It has two implications: one, its forecasts are up to date in the sense that they take into account the most recent data released by the CSO; and two, they can more readily be compared with other forecasters.

The data in the accompanying table shows that there has been remarkably little change in the overall 2010 economic picture in the four months since the budget.

Domestic demand is still set to contract by 3 to 3.5 per cent but the bulk of this will be offset by a positive contribution from net exports. It is the latter area that has experienced the main change. The impact of net exports is now more positive, albeit not dramatically so given the uneven nature of the recovery in our main markets and the competitiveness challenges we still face.

The upshot is that there is now near unanimity that the reduction in activity this year, as measured by GDP, will be of the order of 0.5 per cent.

This view is shared by the Central Bank, which issued its latest forecasts just last week, and also by the March Reuters Consensus forecast (this reports the average of about 10 private-sector forecasters, mainly those working in the financial sector).

The modest 0.5 per cent contraction compares with the 1.3 per cent fall in GDP assumed in the budget. About two-thirds of the change in the outlook since then comes from the external side, with the remaining one-third reflecting domestic developments, principally a somewhat less negative outlook for consumer spending on goods and services.

Obviously, there is still a good deal of uncertainty surrounding these forecasts and the ESRI commentary contains an extensive review of the things that could go wrong both at home and abroad.

However, the real difference between the ESRI and other forecasters shows up in the transition from GDP to GNP.

GNP is usually about 20 per cent lower than GDP because of net factor outflows. These comprise the repatriation of profits earned here by multinationals, inflows of income earned abroad by Irish companies and individuals and, increasingly of late, interest on debt paid to non-residents.

The net effect is to reduce our national income by up to €30 billion a year. Net outflows were particularly strong in 2009 with the result that GNP fell at a much sharper rate than GDP (11.3 per cent versus 7.1 per cent). As can be seen from the table, most forecasters expect a much-reduced, but still negative impact from net factor flows this year. The general view is that they might amount to up to 1 per cent, causing GNP, which is a better measure of national income, to contract by about 1 to 1.5 per cent.

The ESRI goes in the opposite direction, forecasting a positive impact which completely offsets their 0.5 per cent forecast GDP fall.

The problem with this is that such flows are particularly difficult to forecast. The ESRI is effectively betting the house on a view that factor outflows, which were abnormally high last year, will begin to revert towards a more normal level and they are doing so at a time when debt interest outflows are growing. Let’s hope it is right for, so far at least, no one else has been prepared to go that far.

The commentary contains the most balanced view of the bank rescue packages that I have seen. This makes what one would have thought were elementary distinctions between gross and net debt, unlike much comment which tends to assume that the assets being transferred to Nama have no value at all and that there will be no return from the recapitalisation moneys. Thus they typically add up to €80 billion to debt with some even going so far as to say that the national debt has been doubled.

The ESRI concludes that the State may end up “investing” up to €25 billion in Anglo Irish Bank and Irish Nationwide with little prospect of recouping a significant part of it. This is a more realistic measure of the impact on net debt. Moreover, it compares this with the general government deficit on day-to-day spending, which is running at about €19 billion a year (or more than €80 billion over the period 2009-2014). They conclude that, while the exchequer outlays are substantial, they should be affordable.

One curious feature is the assumption that the recapitalisations will be averaged over the 10 years from 2010 when the Minister for Finance explicitly stated that there would be no impact on the 2010 borrowing requirement. This, in turn, is associated with a forecast that the general government deficit will be 12 per cent this year, which is at odds with the tenor of the rest of the report.

Finally, and unusually, there is a section at the end which effectively disowns an earlier ESRI paper by Bergin et al, which foresaw an average rate of growth in GDP in the region of 5 per cent per year between 2011 and 2015. The change is attributed to the outlook for the banking system which the ESRI is not sure “will be in a position to support strong growth through appropriate lending in the near future”.

This sits uneasily with recent developments which are going to leave the main banks better capitalised than might have been expected and therefore better able to lend. However, it is to be welcomed for it is accompanied by a realistic-looking forecast growth rate of 2.5 per cent in GDP in 2011.