ANALYSIS:Latest reports from the IMF and OECD show expectations for the economy have stabilised, writes JIM O'LEARY.
TWO INTERNATIONAL agencies (the IMF and the OECD) yesterday published their up-to-date assessments of the Irish economy. Each produced another set of bleak short-term forecasts, envisaging steep falls in output and a sharp rise in unemployment in 2009 and 2010.
If there is any grain of good news to be harvested from the latest numbers it is that they’re not significantly more dismal than the generality of forecasts published in recent months. Expectations, it seems, have stabilised. We are still in a deep slump but, to transpose the verbal dexterity of a former taoiseach, it is not getting slumper.
The bad news is that the more substantial of yesterday’s two reports – that from the IMF – takes a decidedly more downbeat view of Ireland’s medium-term prospects than has been published by any other agency to date.
What the IMF is projecting is that, following a cumulative 13.5 per cent drop between 2008 and 2010, GDP will expand by a meagre 1 per cent in 2011 and at a tepid 2.5 per cent average rate over the subsequent three years. This contrasts especially starkly with the projections set out in the ESRI’s Recovery Scenarios report published last month in which, depending on global conditions, Irish GDP was seen rebounding strongly to achieve average growth of 4.8-5.6 per cent in the 2010-2015 period.
The IMF scenario implies that output would not re-attain its peak level of 2007 until 2017. One of the reasons for this degree of pessimism is the IMF estimate that output in 2007 was more than 7 per cent above its potential level. A useful way of interpreting this 7 per cent is as a measure of the bubble in economic activity at that time. As such, it is an important element in the IMF’s diagnosis of our current economic and fiscal problems and in its policy prescriptions, particularly in relation to the public finances. Not surprisingly, the IMF is a little reticent about its contemporaneous estimates of the bubble. Its 2007 report on Ireland (published in September) estimated that output was just 0.2 per cent above potential that year, tantamount to saying that there was no bubble at the time.
The IMF’s GDP projections obviously have implications for its projections in relation to the public finances. In particular, the fact that it sees the recession being somewhat deeper and the eventual recovery much shallower than envisaged by the Department of Finance means that it expects a significantly lower trajectory for tax revenues. One consequence of all this is that the IMF expects that the budget deficit this year (11.8 per cent of GDP) and next (12.7 per cent) will be well above the targets set out in the Government’s April budget (10.75 per cent for both years). It is worth noting that the OECD takes a similar view.
Another consequence is that the IMF reckons that the scale of adjustment required to restore fiscal balance within a reasonable time frame is even greater than the already demanding schedule for the 2010-2013 period published by the Government.
Regarding the composition of that adjustment, the IMF follows the conventional wisdom in advocating that in the future the primary focus be on spending cuts rather than tax increases, while endorsing the emphasis to date on revenue-raising measures on the grounds that this was part of a “necessary process of returning tax rates to more normal levels”. On the expenditure front, the IMF expresses a preference for cutting pay and transfers. Again, this is in line with the conventional wisdom regarding successful fiscal consolidations. The closest the IMF comes to a fresh idea in this space (though it’s hardly novel) is its observation that restoring order to the public finances can be helped by the adoption of a fiscal rule and its suggestion that some sort of statutory commitment to medium-term budget balance might be appropriate in this regard. It might have been useful if the report developed the case for such a rule at greater length: as it is, it takes up just one paragraph.
One way or the other, the IMF sees fiscal policy being contractionary in the years ahead. It expresses the fear that monetary policy may also exert a dampening effect on activity, as the price level in Ireland falls faster than elsewhere in the euro zone, implying higher real interest rates than elsewhere – the reverse of what was happening during the boom years. In circumstances where both fiscal and monetary policies are tending towards constriction, it is all the more important that the exposed sectors of the economy stand ready to exploit the international upturn when it comes. This places the spotlight firmly on competitiveness, and the IMF has much to say on that score. One measure of the competitiveness challenge we face is the IMF’s estimate that the real exchange rate is currently 15 per cent above its long-run average. It will take an awful lot of discipline and no little pain to bridge that gap.
