Irish consumers' increasing reliance on foreign credit could be a sign that the economy is growing too fast with demand outpacing supply in a manner that is not sustainable, according to a worst-case scenario outlined by the Economic and Social Research Institute (ESRI) yesterday.
"Under this view, the economy is on an unsustainable path and is borrowing from abroad," said the ESRI's Dr Alan Barrett.
Presenting the ESRI's quarterly economic commentary for winter 2006, Dr Barrett said the current account deficit - which reflects foreign borrowing - is predicted to reach 5.6 per cent of gross national product (GNP) next year, up from 0.7 per cent in 2004. GNP is the value of the goods and services produced by the economy.
Despite the expectation that the State's strong economic performance would continue next year, with real GNP growth expected to be 5.3 per cent, Dr Barrett said the deficit presented some concerns.
"The headline figures are very good but it's not that cheery when you look behind the numbers," he said.
Under the worst-case scenario, borrowing from abroad is accumulating, leaving the economy vulnerable to being squeezed by the foreign lenders who are supplying Irish banks with credit, he said.
Underlying the current account deficit is the build-up of debt on international markets on the part of Irish people, via their banks, said Dr Barrett. The worst-case scenario would involve a hike in the interest rates charged by the international banks that Irish banks would have to pay to international lenders.
The ESRI expects there will be one more European Central Bank interest rate hike of a quarter of a percentage point.
A more benign view of the rise in foreign borrowing is that it reflects a high level of investment in the economy relative to savings, said Dr Barrett. Under this view, the balance will be restored when investment needs are met.
Dr Barrett said the recent Budget was overly expansive and would fuel demand when the economy was growing above potential.
Imports are likely to grow by 7.4 per cent this year - higher than the export growth rate of 6 per cent. Export growth is stronger than last year but with world trade growing by 8.9 per cent, Ireland is still losing market share, according to the ESRI. Imports are expected to grow by 6.9 per cent next year, while exports are expected to grow by 5.1 per cent.
High inflation, high wage growth and the strength of the euro are exacerbating the situation. Inflation is expected to peak at 6.1 per cent in January 2007, driven largely by mortgage interest rate rises. Domestic price pressures, such as utility costs and the rise in the price in cigarettes in the Budget, are also adding an upward stimulus, the ESRI said.
With current spending growing by 11.5 per cent and capital spending by 13 per cent, the need for careful appraisal of spending becomes more important, particularly in the context of the second round of public sector benchmarking next year, it said.