ANALYSIS:Even excluding the risks of a euro break-up, there are still more weaknesses than strengths in the Irish economy
GOVERNMENT MINISTERS have been talking up the economy of late. They have reason to feel a little bullish, not least owing to much-improved international perceptions of how things are evolving here. But they are at risk of coming to believe their own propaganda. Even excluding the risks of a euro break-up, there are still more weaknesses than strengths in the Irish economy when everything is considered.
Let’s start with the positives.
Perhaps the most remarkable of these is the State’s re-entry to the bond market, all the more remarkable given that even more euro zone countries are being locked out of it.
Each of the three efforts to borrow money from private sources undertaken by the National Treasury Management Agency this year have proved more successful than could have been hoped.
What a difference six months makes. Early this year many, including some serious people, were urging the Government to seek a second bailout without delay. There was zero chance, they stated with great certainty, that the State could regain market access in the foreseeable future. They may well be proved right ultimately, but with so much uncertainty it is still possible that the bailout programme can be concluded on schedule at the end of next year.
Much will depend on how the international investor community views the economy’s performance and prospects. That amorphous grouping’s changed sentiment towards Ireland is best illustrated by developments in the bond market, as seen in chart 1.
Last summer, Irish bond yields were heading towards the stratosphere in near-lockstep with Portugal. They have since fallen sharply. In recent weeks, they have even at times dipped below those of Spain and Italy.
Deposit trends in the Irish banking system also show how foreigners are less frightened about putting their money into Ireland, and leaving it here. The amount of cash deposited in the Irish banking system has remained broadly stable over the past year, in contrast to 2010 and early 2011 when the system haemorrhaged more than one-third of its entire deposit base.
This stability also suggests some decoupling from the Mediterranean periphery. The most recent bout of euro-area panic saw big deposit outflows from Greek and Spanish banks.
Reinforcing the improved sentiment towards Ireland was the outcome of the June 29th euro zone summit. It was not only potentially the most significant advance towards a real solution to the crisis to date but also included an explicit commitment on Ireland’s bank debt – a major diplomatic achievement for which Enda Kenny and Co may not have been afforded all due credit.
But while these developments are all positive, they do not amount to a corner turned. That remains some distance away and might be preceded by a renewed downturn.
Currently, economic activity is stagnating and may well be contracting as factors at home and abroad weigh against recovery.
In the first three months of the year, the domestic economy grew for the first time in two years. That happened despite consumer spending being clobbered by the two percentage point VAT hike that came into effect at the beginning of the year. Exports continued to grow too, despite the downturn internationally in the first quarter.
But more timely indicators suggest that the economy has since weakened. Manufacturing output and goods exports (see chart 2) have taken a dive in recent months. This is hardly surprising given recessionary conditions across the continent – including in Britain, Ireland’s most important trading partner.
How does this tally with an upbeat survey of purchasing managers in the manufacturing sector published this week? Such surveys are carried out in many large and/or developed economies. Mostly they prove very accurate. In Ireland, however, purchasing manager surveys have tended not to be well correlated with the hard data. They should therefore be treated with caution.
If the outlook for manufactured goods exports is not rosy, prospects for foreign sales of services are better.
Since first-quarter figures were published last month, no more timely numbers have become available. But, as services export growth has tended to be considerably stronger than that of goods exports over the past decade, there is reason to think that there is enough momentum to prevent growth turning to contraction. Moreover, as services exports have in the past been less affected by international downturns, there is further reason to believe that they will keep growing.
But growth cannot be expected in every category of services exports.
Second-quarter numbers are available for foreign visitors (their spending in the economy is considered a services export by statisticians). Tourism numbers in the first half of the year were almost identical to the same period in 2011, at just below three million.
While that may be an achievement given weakness in European and North American markets, the numbers are still well below pre-recession times – in 2006, arrivals in the first six months of the year topped 3.6 million.
Stagnating visitor numbers are one reason for the continued fall in retail spending, illustrated in chart 2. Others include the aforementioned VAT increase, a weak labour market and households choosing to save a higher proportion of their incomes.
Higher savings are normal in economies where property prices have crashed. As the value of their properties fall, households tend to accelerate their debt repayments in an effort to maintain their net worth (assets less liabilities).
As chart 3 shows, Irish households’ collective wealth continued to shrink in the final quarter of last year. Net worth, as represented by the blue line in the chart, contracted by 3.4 per cent in just three months. That brought the cumulative fall to a massive 37 per cent since the peak in 2007.
The decline in net worth happened despite positive trends in two of the three components of household wealth.
First, the value of financial assets, such as pensions, has remained stable despite financial turmoil – Irish households collectively owned €300 billion worth of such assets at the end of last year.
Second, liabilities were reduced as debt was paid down – it has fallen by one-eighth since its peak and stood at €185 billion at the end of last year.
The third component of household balance sheets – property – accounted for all of the overall contraction in household net worth since the crash. But developments in property prices over the first half of 2012 give reason to believe that household balance sheets are beginning to stabilise.
While residential property prices in June nationally were 6 per cent lower than December, there has been a clear easing of the downward trend in 2012, as chart 4 shows. In Dublin, in particular, the evidence suggests that property prices may have hit the bottom following six months of broad stability (though a surge on to the market of repossessed buy-to-let properties could push prices down further).
The stabilisation in prices is all the more surprising given very low levels of mortgage issuance, as banks continue to shrink their bloated balance sheets. But if lending for mortgages and consumer purchases is still falling, firms are doing no better in getting credit from financiers, according to figures for June published by the Central Bank this week.
Businesses cannot expect to get a break from the banks any time soon. With very high levels of non-performing loans of all kinds, a huge loss-making tracker loan portfolio and €1 billion a year in fees to the Government for its guarantee, it will be a long time before the banks return to health and are capable of servicing the economy normally.
Simultaneous deleveraging by banks, households and the Government at a time when Europe is in recession is a recipe for pain.
Despite the positive achievements of recent months, the economy is struggling against ferocious headwinds. If the economy continues to bump along the bottom for the rest of the year, as it has done over the past two years, it will be something of an achievement.
