After the release of the first-quarter Exchequer returns, the boom that the Republic's economy has enjoyed for the past five years or so is officially coming to an end. The Central Bank and the Economic and Social Research Institute have revised down their growth forecasts for this year to 7 per cent. Comments from the Minister for Finance have also served to confirm that the authorities believe the rate of economic growth is slowing markedly.
The view from experts seems to be that the economy will achieve a soft landing. Indeed, the slowdown will be welcomed by many sectors of the economy given the extent of the infrastructural bottlenecks being experienced. If the economic growth rate slows down to the long-term potential rate of growth of the economy, then we will have achieved that elusive soft landing.
This potential rate of growth is generally accepted as being a function of the rate of growth in the labour force combined with the rate of productivity growth. In the Republic's context, this rate of potential growth probably lies in the range of 5 to 7 per cent. Therefore, economic growth of approximately 6 per cent would be ideal, but a rate of growth of 3 per cent, for example, would reflect recessionary conditions.
Despite the current benign consensus forecasts, the risks that the economy will experience a period of sub-5 per cent growth seem to be increasing. There is no sign that the slowdown in the US economy has been arrested and there is increasing evidence that the European economy is being affected by the US slowdown. Fortunately, the UK economy seems to be holding up well. Some credit for this must reside with the Bank of England, which has been much quicker to reduce interest rates then the European Central Bank.
For the Republic's equity market, the extent of the slowdown will have a significant impact on the rate of growth in corporate profits. Although several Irish quoted companies, notably Elan, have limited exposure to the State's economy, the majority of quoted companies still generate a substantial portion of their profits from the domestic economy. Bank of Ireland and AIB generate 55 per cent and 43 per cent respectively of their profits in the Republic. Eircom generates 98 per cent of its profits from its Irish operations and CRH relies on the State for 15 per cent of its profits.
The economic slowdown, combined with the effects of the foot-and-mouth crisis, has already led to downward revisions to profit forecasts. So far these downward revisions have been confined largely to the food- and tourism-related sectors of the market. However, if the economy continues to slow, it will only be a matter of time before the profit picture for the market as a whole deteriorates.
For investors, this heightens the case for maintaining a cautious stance towards the market. As the table indicates, forecasts for profits' growth this year and next are still a healthy 12 per cent to 14 per cent. With the price-earnings ratio (PER) at just under 15, the Republic's market is still undervalued relative to overseas markets. Therefore, while profit estimates may well be reduced, the fact that valuations are modest will probably act to limit the potential downside to share prices.
