ANALYSIS:The ESRI's assumptions about interest and exchange rates are a bit of a cop-out
LIKE OTHERS, the Economic and Social Research Institute (ESRI) notes that the international context in which its forecasts are prepared is “beginning to look somewhat more optimistic” but quickly follow on with the observation that domestic factors will continue to act as a drag on growth. The net result is little change in its outlook with the Irish economy forecast to contract by about 9 per cent this year and a further 2 per cent or so in 2010.
Like the Central Bank, the ESRI is cautious about the outlook. While each has growth again turning positive in the second half of next year, neither is getting very excited about this prospect. It seems reasonable to assume that the December Budget, when it comes, will adopt a similarly cautious outlook.
This lack of confidence, which incidentally contrasts with the optimistic medium-term outlook produced by the other side of the ESRI house a few months ago, is reflected in its domestic forecasts.
The better international picture has a clear positive impact on exports which are now forecast to contract by much less in 2009 and to turn modestly positive in 2010. Earlier commentaries had envisaged falls in the volume of exports in the range of 4 to 5 per cent this year and 1 to 2 per cent in 2010.
The other piece of good news is on the employment front. The ferocity of the downturn was a surprise – job losses were much greater than expected and, initially, non-residents stayed on the live register. Now they appear to be coming off it in big numbers with many emigrating. Whereas last January the monthly increase in the register was 30,000, now it is almost zero.
This is too good to last and the ESRI forecasts a renewed surge after the Budget, albeit that the unemployment rate now peaks at 15 per cent rather than the 16 to 17 per cent in earlier ESRI forecasts. There is a knock-on impact on consumption as more people at work means greater spending. Consumer spending is still forecast to contract next year but by a lesser amount and this boosts the GDP growth forecast by about half a percentage point.
One might have expected an even greater boost from the improved exports situation but, alas, this does not materialise. While the ESRI has bumped up its exports, it has pared back the fall in imports by more. The result is that net trade, ie the sum of exports and imports, still makes a positive contribution to growth but that contribution is half a percentage less than formerly. The consumer spending and trade effects thus cancel each other out and the overall forecast is little changed.
Like the Central Bank, the ESRI makes technical assumptions about interest and exchange rates. This is a bit of a cop-out given the importance of each to a country like ours. For the record, they have the euro/sterling rate hitting parity later this year before falling back to average 85 cent in 2010. They are rightly fearful that sterling will remain weak given the huge fiscal problems in the UK – that country will have a budget deficit of 13 per cent next year – higher even than the forecast Irish one.
The ESRI has ECB rates rising by a quarter of a per cent in January and a further half a per cent in June – this is well ahead of the market, which does not see rates rising until late 2010 at the earliest – and makes its CPI forecast of no change next year questionable.
It admits that its Budget forecasts are slightly schizophrenic. It sees no alternative to implementing the €4 billion package of cuts which is Government policy. It builds this into its forecasts as outlined last April, ie split between tax increases and spending cuts but argues that, in practice, the focus should be on cuts in pay and other spending but not in social welfare with tax increases limited.
This imparts a negative bias to its forecasts as an attempt to hike taxes by a further €1.75 billion would have a severe adverse impact on the economy. This may partly explain why the better external situation does not have a more positive impact on its overall forecasts. On the other hand, there is little sign that forecasters in general have paid sufficient attention to the negative consequences of a Budget which will take 3 per cent out of the economy next year on top of 5.5 per cent in 2009.
The ESRI say that we need lower wages on competitiveness grounds but is worried that there is little sign of this in the available Central Statistics Office incomes data. Never was there a time when better statistics were needed. The focus on competitiveness is less than it might have been with no attempt to summarise the overall situation or to present the magnitude of the challenge that lies ahead.
Finally, there is a curious section on house prices where it revisits its equation on housing demand. This now tells us that the peak to trough fall in house prices may ultimately reach 50 per cent, a figure that most people would accept as reasonable.
However, a few years ago this same model predicted that house prices were overvalued by only 15 per cent as, indeed, did most other economic models.
Catwalk models are notorious for the trouble they give; it appears that ESRI models are no less difficult.
