Let’s start with the bald facts. Ireland is broke.
That’s not new news. John Stepek wrote about the parlous state of the country’s finances exactly a year ago: Ireland’s banking woes could spark another eurozone crisis. But here’s the quick version of how it happened.
Ireland used to enjoy steady economic growth. But things got out of hand. As property prices soared in the early 2000s, Ireland’s banks went bananas. They threw money at developers, who went on a building bonanza. Local lenders weren’t the only culprits – plenty of bankers outside the country joined in too.
Then – as always happens when the supply of credit dries up – the property boom turned to bust. The economy shrank by 10%. Banks had to write off vast sums as many of the loans they’d made went bad. In fact the hits were so big, Irish banks found they hadn’t enough capital to cover them.
So they needed state support to keep going. But the losses proved greater than even the government could cope with. The budget deficit – the excess of spending compared with the tax take – soared, lifting the ratio of national debt (what Ireland owes) to GDP towards 100%.
Meanwhile, lenders worldwide panicked, and dumped Irish sovereign bonds. This lowered prices, which drove up yields on the country’s ten-year debt to almost 10%. As Ireland clearly couldn’t afford to borrow at that rate, last November the whole country ended up needing an $113bn bail-out from the EU and the IMF.
But bail-out cash comes with terms and conditions. In Ireland’s case, this has meant battening the financial hatches right down. If you think the UK austerity programme is tough, you should see how the Irish government is cutting spending and lifting revenues.
Taxes have been jacked up while welfare benefits have been chopped. Government payrolls have been sharply reduced. Public sector workers have seen their pay and pensions slashed. Even the politicians – including the prime minister – have taken a pay cut.
The Irish government wants to cut the budget deficit from around 10% this year to below 3% by 2015. In turn this would hugely slow the rise in the national debt.
Austerity seems to be working for Ireland
So is the Irish austerity package restoring confidence?
Douglas McWilliams, boss of the Centre for Economics and Business Research (CERB), reckons it is, and that George Osborne could learn from Ireland’s aggressive fiscal policy. Sure, it took some months to steady the nerves of bond market investors – Irish bond yields hit 14% in mid-July this year. But they’ve since dropped to 8.6%.
Meanwhile, the sense of recovery seems to have reached other parts of the economy too. Exports equate to around three-quarters of GDP. For the last quarter, this increased by 1.9% compared with the first three months of 2011, as the country’s exporters had a field day.
June’s trade surplus rose to a monthly record of €4.08bn. Food exports were up by 19%, while makers of medical and pharmaceutical kit also saw good growth.
The CEBR now forecasts 2% GDP growth in 2011, followed by a 4% expansion next year. Why? Because labour costs are falling in the private sector too, meaning Irish exporters should have a competitive cost advantage when selling their goods.
Indeed, Ireland will again become “one of Europe’s best performers”, says McWilliams. Billionaire investor Wilbur Ross said last week that the country would “once again become the Celtic Tiger”.
Don’t get too excited – Ireland has a long way to go
Gung-ho stuff. But before we pile into Irish shares in anticipation of a major recovery, let’s take stock. There are several reasons why exports alone can’t turn the economy around.
First, that state debt may be rising less fast, but it’s still climbing. More spending cuts and tax hikes are planned for 2012. But any wobbles in the austerity programme could unsettle investors in Irish debt. Indeed, Capital Economics reckons the country could yet need a second bail-out involving a “restructuring of its debts”. That’s another way of saying that Irish bondholders would be forced to take losses. This would hit confidence hard.
Second, there’s a flipside to the state spending cutbacks and lower pay levels: it means less money in peoples’ pockets. Further, the country’s dole queues are longer than at any time since records began in 1967, and don’t look like shortening. That will curb consumption even more. Consumer spending will fall 2% this year, says the CEBR’s Oliver Hogan, who warns the “party isn’t about to start again” as the country “faces four to five years of only modest growth in living standards”.
Third, house prices are cratering – down over 12% year-on-year. Add that to those falling pay packets, and as the FT points out, “financial distress among homeowners is so acute that more than one in ten mortgages are either in arrears or have been restructured”.
Fourth, Ireland’s banks are still on life support, and depend on “large cash infusions from the European Central Bank” to keep going. In turn, these lenders won’t be able to do much new lending to spark up the economy – even if there were any potential borrowers.
Fifth, if the global economy turns down again as looks likely, Ireland’s exporters will find the going tougher once more.
At least we have the up and coming Rugby World Cup to take our mind of things financial!!!
