Irish GDP data shock, highlighting virtual economy.

Anyone familiar with the Irish economy will be aware that the multinational sector has a huge impact on the export and investment data, contributing to the volatility of recorded GDP. Surprises in the latter are therefore not uncommon, but the latest example is without doubt the most jaw-dropping to date. The CSO had estimated that Irish real GDP rose by 7.8% in 2015, an unexpected figure in itself, but have now revised that growth rate to an astonishing 26.3%. Yes, 26.3%. Moreover, nominal GDP in 2015, which was put at around €215bn, is now over €41bn higher at €255.8bn, having risen by over 32% from the previous year on the new data. For those who prefer GNP as a more appropriate measure for Ireland ( it adjusts for multinational profit and other income flows ) real growth in 2015 was still stratospheric, at 18.7%, with the nominal increase at 24%.

What’s going on?. There were a number of factors at work, relating to changes made to the GDP methodology. The first is that business spending on R&D and patents is now captured as investment and classified as intangibles. The latter  rose by over €11bn in 2015, a 100% rise and contributing most of the overall 32.7% increase in capital formation; building and construction rose by over 13% but spending on machinery and equipment expanded by only 3%.

The external sector saw massive value and volume changes, reflecting the inclusion of offshore manufacturing activities and the fact that aircraft for leasing  are now counted  as exports and imports  as opposed to the  previous net impact . Exports  are now deemed to have risen by just shy of €100bn in 2015, and by over 34% in volume terms, with the volume rise in imports put at 22%, with the result that the external sector contributed 18 percentage points to overall GDP growth. That export surge also resulted in a huge balance of payments surplus for Ireland, amounting to over €26bn or 10.2% of GDP.

Extraordinary figures. Spending by the government and households paint a  more realistic picture of economic life on the ground in Ireland last year. Personal consumption did pick up, reflecting rising employment and strong growth in real incomes, expanding by 4.5% in real terms, the best performance since 2007. Government spending on goods and services also rose , albeit by a modest 1.2%.

For many, these GDP figures are not ‘real’ but they are used as the denominator in calculating Ireland’s fiscal and debt ratios. Consequently, the latter  now ended 2015  at 78.7%, well below the euro average, instead of the previously published 93.8%.

If that step jump in GDP last year was indeed a one-off data-related adjustment the risk now is that 2016 will see a dramatic ‘slowdown’ or even contraction. Indeed, real GDP actually did contract in the first quarter, by a seasonally adjusted 2.1%. Consumer spending continued to show good momentum, up over 2% in the quarter, but investment fell sharply , reflecting double digit percentage falls in machinery and equipment and intangibles, while exports  fell by 5% and imports by 10%. On an annual basis GDP is still growing, by 2.3%. and all forecasters, the government included, will now have to make a stab at what all this means for recorded growth in 2016 and beyond. The range of estimates is likely to be wide and handsome.

Irish Austerity Budgets: why more may be needed

The 2014 Irish Budget was the eighth in succession since 2008 (there were two  in 2009) which cut government spending or raised taxes with the total fiscal adjustment amounting to €30bn, including around €11bn in tax measures. These austerity Budgets were undertaken in order to reduce Ireland’s fiscal deficit and  therefore  comply with strictures under the EU excessive deficit procedure , with the State required to reduce the deficit to under 3% of GDP by  the end of 2015( last year’ it was 7.2%). The Troika may have gone but that requirement remains and Ireland, like others in the same predicament, has to produce a Stability Programme Update (SPU) each April, which sets out medium term forecasts for the economy, the fiscal outlook and the debt situation.

The latest SPU, just published, revealed that the  Government expects this year’s cash deficit to emerge €0.9bn below that initially forecast but that the General Government deficit ( the preferred EU budget measure) will still be about €8bn or 4.8% of forecast GDP, as per the original projection. Real growth in the economy is expected to be marginally stronger than envisaged last October , at 2.1%, although the Department of Finance is now much more upbeat about domestic spending, including a 2% rise in personal consumption and a 15% surge in investment spending, and now expects the external sector to have a negative impact on GDP, with export growth of only 2% offset by over 3% growth in imports.

The main change to the outlook relates to inflation, however, with price pressures across the economy now projected to be much weaker following the trend in 2013. Consequently nominal GDP  is now forecast follow a lower trajectory  in the medium term than previously thought; the 2014 forecast is for GDP of €168.4bn instead of the original €170.6bn , with similar shortfalls over the following few years That  change affects the debt dynamics and although the burden is still expected to fall from last year’s 123.7% of GDP the decline is now slower; the 2014 debt ratio is now forecast at 121.4% instead of the original 120%.

The growth forecast also envisages the economy gathering momentum into 2015 and beyond (although previous projections were too optimistic in that regard) and further strong gains in employment, a combination that might imply less need for further austerity measures. The Minister for Finance has signaled otherwise and to understand  why that may be  the case it is  necessary to delve a little deeper into the SPU document. The Irish economy, according to the EU, is actually operating very close to capacity and to full employment, a view which would surprise many and one that has met with some opposition, most recently from the ESRI in its latest ‘Quarterly Economic Commentary’. That debate may seem arcane but, unfortunately, it has serious implications for Irish households because on the EU view the Irish deficit is virtually all structural and therefore will not disappear with stronger growth. The actual deficit will shrink but if one adjusts for the economic cycle the structural deficit would still remain, requiring policy measures to reduce government spending and/or increase tax revenue. Moreover, Ireland is charged with reducing the structural deficit to zero  by 2019 from last year’s 6.2% of GDP, which implies the post-2015 fiscal landscape will not be as sunlit as some expect. A given economy’s position in the economic cycle is not observable and estimates are just that,so convincing the EU that far more of the  Irish deficit is cyclical would have a big impact on the perceived scale of  the fiscal adjustment required.