Ireland's economy will continue to contract this year, falling 0.7 per cent in 2010, but will return to growth in 2011, the Organisation for Economic Co-operation and Development (OECD) said today.
The OECD forecast a 3 per cent expansion next year, and said the economy appeared to be close to a turning point following the severe recession in 2009.
However, the recovery will be mostly externally driven, the report said, warning that consumption and investment would remain restrained for some time.
The Government is attempting to reduce its budget deficit, currently forecast to be 11.7 per cent this year and 10.8 per cent in 2011.
The OECD said the emphasis on reducing spending, rather than increasing taxes is appropriate, but ongoing monitoring and "fiscal discipline" was necessary.
Hitting fiscal targets was vital to the Government maintaining confidence and credibility, the report said, and described the bank bailout as an important step in restoring the financial sector to health and getting credit flowing.
"The government's medium-term fiscal strategy rests on an optimistic macroeconomic scenario after 2010, which, if it does not materialise, could threaten the pace of fiscal adjustment and consequently weigh on market confidence, posing a risk to the outlook," the OECD said.
The report also looked at the euro zone economy, which it said is slowly recovering thanks to fiscal stimulus and better trade, but weak competitiveness and public finances in peripheral economies including Ireland pose a risk.
The euro zone economy was likely to expand 1.2 per cent this year and 1.8 per cent in 2011 - a more optimistic forecast than the European Commission's 0.9 and 1.5 per cent respectively.
"A gradual recovery is underway driven by economic policy stimulus, a rebound in world trade and
improving financial conditions, although there has recently been significant financial market volatility," the report said.
"Difficulties in restoring competitiveness and sound public finances in some peripheral countries may
complicate recovery."
Peripheral countries such as Greece, Ireland, Spain and Portugal, have all introduced austerity measures to convince markets that they would be able to repay their debts.
"Deep and sustained fiscal consolidation, coupled with structural reforms, are key to restoring confidence and growth," the OECD said, referring to Greece.
"Success in reining in public expenditures, with reforms in pensions and improvements in public sector efficiency, are crucial to the success of the programme," it said.
Greece secured a €110 billion emergency loan package from euro zone states and the International Monetary Fund after markets effectively refused to keep lending to Athens.
The OECD said Spain should implement its budget consolidation plans which envisages a reduction of the deficit to 7 per cent of GDP in 2011, and embark on a pension reform to put public finances on a sustainable basis.
Economic growth in Portugal is likely to remain weak at 1 per cent this year and 0.8 per cent in 2011 as fiscal consolidation cuts government spending and high indebtedness and unemployment reduce household demand.
The report said that while growth in the 16 countries using the euro was likely to strengthen in the coming quarters, the pace of fiscal consolidation and its dampening effect on demand was a significant downside risk.
It said long-term budget deficit cutting plans of euro zone countries published in February suggested
discretionary budgetary tightening in the euro area of more than 1 per cent of GDP in 2011 and 2012.
"The fiscal adjustment needs and difficulties in restoring competitiveness in some euro area countries may complicate recovery and monetary policy exit," it said.
Additional reporting: Reuters
