Ireland is missing the usual signs of recession

Fears of a looming downturn in Europe sent stock markets tumbling this week and the euro to a 20-year low against the dollar. Another hike in gas prices has intensified the economic strain and much of the pass-through to consumers has still to land.

The World Bank is warning that many countries will find it hard to avoid a recession in the coming months as Russia’s invasion of Ukraine, lockdowns in China and ongoing supply-chain issues disrupt activity and trade, and accommodative monetary policy is withdrawn.

Despite these headwinds and the worst cost-of-living squeeze in a decade, the Irish economy is expected to continue to grow, and grow significantly – by over 9 per cent this year, according to the Central Bank’s latest forecast.

Employment is at a historic high, exports are booming and the Government looks set to run a budget surplus this year, way sooner than anybody expected.

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“Some households may feel like we’re in a recession because incomes are being hurt by higher energy prices and inflation,” Davy chief economist Conall Mac Coille says. “But let’s not forget what a recession looks like. It’s big cuts in employment. It’s big falls in house prices. It’s people in negative equity. It’s the Government doing austerity. We’re not seeing any of those things at the moment.

“The crucial point is that we are not seeing cuts to employment,” Mac Coille says. Ireland’s employment performance is perhaps the most remarkable metric. At a record 2.5 million, employment in the Republic is already 8 per cent above pre-pandemic levels. Participation and vacancy rates are also at record levels.

Mac Coille highlights the strong rebound in credit/debit card spending in hard hit sectors, such as hospitality, in recent months as evidence of a strong recovery in the domestic economy.

Output in domestically orientated sectors such as accommodation, restaurants and transport rose by 27 per cent, 15 per cent and 11 per cent respectively in the three months to May, pointing to a strong rebound in spending.

“A sudden deterioration in conditions for the multinational sector, or a sustained spike in natural gas prices due to events in Ukraine would likely be required to push Ireland into recession,” he says.

“Ultimately people have to start losing their jobs to have a real recession,” Mac Coille says. “Why would companies cut back on jobs? Retailers, Irish hotels and restaurateurs would have to see a much sharper pullback in consumer spending and tourism to do so,” he says.

“I don’t believe what we’re seeing at the moment – which is people on low incomes being squeezed by high energy prices – is sufficient to make those companies start cutting back on employment,” he says.

Mac Coille doesn’t dispute there’ll be some slowing in demand on the back of curtailed consumption and that households will feel the pinch from higher energy bills, particularly in the autumn and winter when the heating requirement kicks in, just that this on its own won’t lead to a downturn.

Level of price growth will depress real incomes by about 3.3 per cent this year, representing the biggest drop in living standards since the immediate aftermath of the 2008 financial crash

His analysis roughly ties in with the Central Bank’s latest economic commentary, which points to continued strong growth in terms of GDP (forecast to rise by 9.1 per cent this year) and modified domestic demand, a better indicator of domestic conditions (forecast to rise by 4.3 per cent this year).

“The economy was in a good position at the start of the year, having shown considerable resilience through Covid,” the regulator said.

“However, the demand recovery from the pandemic has been tempered by the effects of the Russian invasion of Ukraine and persistent supply chain challenges. While positive economic growth is still expected in 2022, higher prices and costs are already impacting negatively on households and firms,” it said.

It predicted Ireland’s cost-of-living squeeze was likely to intensify in the short term, with inflation expected to rise above 10 per cent in the third quarter, a level not seen since the early 1980s. This level of price growth will depress real incomes by about 3.3 per cent this year, representing the biggest drop in living standards since the immediate aftermath of the 2008 financial crash.

The headline barometers don’t capture the impact at the household level. Many, particularly poor households, will experience much bigger slides in real earnings than 3 per cent.

With household budgets fraying, the Government is under pressure to act to alleviate the strain while being warned that untargeted measures similar to the €200 energy credit or the cuts in excise duty could merely fan further inflation.

In its Summer Economic Statement, published on Monday, it signalled a €6.7 billion budgetary package – a mixture of temporary and longer term measures – to be revealed on budget day, now pencilled in for September 27th, two weeks ahead of the original date.

It will almost certainly include big hikes in welfare and pension rates.

Ironically, inflation has aided the Government’s budgetary arithmetic. Higher prices and wages mean bigger VAT and income tax receipts. Half-year exchequer returns show the Government has collected just under €37 billion in taxes so far this year, up 25 per cent or €7.4 billion on the same period last year.

Corporation tax generated €8.8 billion for the period, 53 per cent up on last year’s total, signalling another windfall.

In publishing the Summer Economic Statement, the Government said it was likely to run a budget surplus this year of about €2 billion. However, it noted that this was largely driven by excess corporation tax receipts and that, without them, it was likely to record a deficit of about €7 billion.

The admission encapsulates the risk posed by corporation tax. Without them, we’d be facing a very different budgetary dynamic. The Central Bank estimates that as much as €8 billion – more than half – might be “unsustainable” or at risk. Worryingly it has all been funnelled into permanent expenditure.

With 10 firms responsible for the bulk of receipts, the concentration risk around corporation tax is huge. Put another way, 10 firms account for €1 in every €8 collected in tax here.

The Government acknowledges the concentration risk but plans to siphon off the excess into a rainy day keep getting deferred.

The public finances have also been boosted by the ending of pandemic-era supports, most notably the employment wage subsidy scheme (EWSS), which was discontinued in May. Consultancy firm PwC estimates that up to 4,500 businesses would have failed in the absence of State supports during the Covid period.

Whether they’ll be able to survive now is a key question. Many will be returning to a different, more digitised environment. Ken Tyrrell, business recovery partner at PwC Ireland, says we’re likely to see an uptick in insolvencies, albeit from a low base.

“We were at historically low levels of insolvency entering the pandemic and the insolvency rates are even lower now. We are at a very low base,” he says.

Ireland is an extremely expensive place to live and work – the priciest, along with Denmark, in the euro zone. So we’re starting this inflationary spiral from a much higher price point than others

In Ireland, since 2004, the average number of insolvencies a year per 10,000 companies has been 52. It peaked at 109 in 2012. The rate over the past 12 months is 16 business failures per 10,000 companies and it has been in or around that for the past few years.

“It seems inevitable that insolvency rates will increase from this low level as we see the impact of high inflation, increased energy costs and higher interest rates to come. Whether this is a sudden surge or a slow uptick in insolvencies over the coming years is uncertain,” Tyrrell says, noting the UK government’s removal of supports triggered an upsurge in insolvencies.

“The insolvency rate generally lags by at least six to 12 months from when an economy’s growth starts to decline/enter a recession. It will also depend on whether we see a mild recession that tames inflation or a more prolonged recession if high inflation persists,” he says.

Tyrrell notes that Irish businesses are generally carrying lower levels of debt than had been the case before the global financial crisis.

“Many businesses learned the lessons of being overleveraged and have built more resilient balance sheets. The resilience of SME balance sheets and debt levels was severely tested with the onset of the pandemic and the results showed that many were a lot better capitalised than expected and the level of bank defaults were lower than would have been expected,” he says.

“While Irish businesses availed of forbearance measures, such as payment breaks, during the pandemic, approximately nine of every 10 that availed of forbearance returned to full payment when the payment break expired,” he says.

There’s no denying some of the innate strengths of the Irish economy, foreign direct investment and exports being the obvious ones. There’s also no denying that Ireland is an extremely expensive place to live and work – the priciest, along with Denmark, in the euro zone. So we’re starting this inflationary spiral from a much higher price point than others.

The increasing divergence between headline GDP numbers and the real feel on the ground is a perennial theme. The Brexit and pandemic crises haven’t gone away entirely but we’ve motored through them. The experts say we’ll do the same with inflation – even if the pain on households promises to be intense – but every forecast is heavily caveated with downside risk.

“A more intense and protracted Russia-Ukraine war leading to higher energy prices and reduced supply would result in lower growth and higher inflation than outlined in the baseline forecast,” the Central Bank says.