Criticism of Irish National Accounts overdone.

The recent release of Ireland’s national accounts for 2017, showing a (preliminary) increase in real GDP of 7.8%,  precipitated another round of complaints about the relevance of such data, including  ESRI comments calling for a ‘parallel’ set of accounts to be published, stripping out the impact of   the ‘large transactions of a select number of firms’.

In fact the CSO already publish a number of adjustments, following  the clamour accompanying the release of the 2015 accounts, which were  the first compiled under the new EU standard, ESA 2010,  prompting some to talk of ‘leprechaun economics’.  A modifed capital formation figure is produced in the quarterly accounts which strips out two components- aircraft leasing expendidure is excluded from total spending on machinery and equipment and R&D spending on intellectual property service imports is excluded from total spending on Intangibles. The latter is GDP neutral anyway (investment  boosts GDP but if imported will have an offsetting negative impact)  but Intangibles has contributed to a huge increase in the investment share of GDP, as well as being extraordinarily volatile on a quarterly and indeed annual basis. This adds to the difficulty of forecasting Irish GDP but, nonetheless,  is the internationally accepted norm in that such intellectual property  used to be viewed as a cost of production but is now (rightly ) deemed to be an asset , be it dometically generated or transferred from abroad.

The CSO  has also introduced a  modified Gross National Income (GNI) figure , GNI*, albeit only published with the full annual accounts, and one wonders if this was embraced too readily. This concept is unique to Ireland and  makes a number of adjustments to the  headline GNI figure, largely reflecting the depreciation of intellectual property assets and aircraft  as well as excluding the profits of  firms re-domiciled in Ireland.Yet it is unclear what the final figure is supposed to mean and the adjustments are arbitrary, (why aircraft leasing, for eample, which has a long history in Ireland, and are firms domiciled here or not?) as well as confusing in that the term  ‘gross’ is still used, even though  some depreciation is  excluded.  Indeed, if depreciation is the issue why not simply use Net National Income (NNI), which adjusts for total depreciation across all sectors, and  has always been published on an annual basis. Moreover, the correlation between NNI and GNI* on the  annual data going back to 1995 is extremely high , at 0.99.

GDP is the internationally accepted norm, of course, and closer to home  most people would view the debate as arcane. Other readilly available indicators exist that are of  use in capturing real developments in the economy depending on the question asked. The surge in employment in recent years  and the plunge in unemployment is real enough for many households, as is the increase in household incomes. Similarly we can track consumer spending in the national accounts. Some argue that the GDP figure , when used as a denominator, gives a misleading indicator of Ireland’s debt burden, but again there are other metrics which one can use, including debt to tax revenue. Another perceived problem is in relation to forecasting for the Budget, but that is done on a bottom up basis anyway by the Department of Finance  i.e. income tax receipts reflect employment and pay assumptions and VAT  forecasts depend on consumer spending projections.

The change to a new methodology in collating the national accounts had a huge impact on Ireland’s recorded GDP, but this was a step adjustment and need not lead to  a host of ad-hoc exclusions, while any volatility going forward reflects the scale of multinationals relative to the indigenous economy and hence a fact of modern Irish life. Real growth in the latter part of the 1990’s averaged over 9% per annum, driven by multinationals, so the average over the last two years ( 6.5%) is not that unusual. It is also curious that the the Irish authorities spend an inordinate amount of time defending the multinational presence in Ireland as real,  yet also devote time and effort in producing arbitrarily  adjusted GDP figures to strip out part of that multinational impact.

Is Ireland in recession?

With all the hullabaloo surrounding Ireland’s 2015 national accounts the data for the first quarter of the year received less attention than normal. To recap, Irish GDP fell by 2.1% in q1,with large falls in exports, investment, imports and inventories, offsetting increases in personal consumption and government spending. A recession is generally defined in terms of two successive quarterly contractions in GDP, and the available data raises the possibility that Irish GDP may  indeed have fallen again in q2, although as we know the national accounts can throw up the strangest results  so it is impossible to be definitive.

What is clear is that absent revisions the volume of retail sales fell in the second quarter and by a chunky 2.7%. Core sales rose, by 1%, so the decline was  strongly affected by a fall-off in car sales ahead of the new registrations in July, but  it is the total that impacts overall consumption, which in general has been weaker  than indicated by  the trend in retail sales.

It is also noteworthy that VAT receipts have been weaker than expected in recent months; the latest exchequer figures, to end-July, showed annual growth in VAT at 4.2%, against an end-year target of 7.7%. Relative to profile, VAT receipts are €292mn behind, or 3.5%. Income tax is exactly on target and although total receipts are still ahead of profile, the €650mn excess largely reflects a €483mn overshoot in corporation tax , which is not reflective of anything going on in the Irish economy. If one excludes corporation tax, receipts are €164mn ahead of profile, or 0.7%.

There also appears to be something unusual happening in the labour market. The Irish unemployment rate has been on a steady downward trend for the past four years, declining from over 15% to below 8%, but in the three months to July the rate was unchanged at 7.8%, with July alone seeing the actual numbers unemployed unchanged. Again, data revisions can change that picture and the labour force may be growing more rapidly than thought but on the face of it the steady fall in unemployment has stalled.

The GDP figure in the national accounts is dominated by external trade and we do not know what will emerge when the estimates are released in September. The available merchandise data shows exports weakening, with annual growth turning negative in the three months to May. The decline in imports is even more pronounced, implying that investment spending has also continued to fall. The industrial production figures available to May also point to a fall in output in q2 while the CSO’s index of services output was flat in the second quarter.

The Brexit vote is generally seen to be negative for Ireland in the short term but the above raises the possibility that the economy may have contracted in q2 anyway and is therefore  already in recession.

The Irish Economy has some serious Capacity Issues.

The Irish recession was long and extremely steep but it ended over six years ago and the economy is now growing rapidly; real GDP has risen by 25% from the cycle low and is now over 10% above the previous peak. Indeed, according to the Department of Finance, Ireland is now operating above full capacity. Others, including the ESRI and the Irish Fiscal Advisory Council have queried this but all agree that the degree of spare capacity in the aggregate has  diminished. It is also true that one does not have to look hard to observe capacity issues in specific sectors of the economy, particularly in and around the capital.

Take tourism, which is booming; last year the number of visitors to Ireland exceeded 8.6mn, having grown by 13.7%, and on the evidence of the first quarter the figure for 2016 will exceed 9.5mn. That has put pressure on accommodation, and the price of a hotel room rose by over 5% in May alone and is 9% up on the previous year. One could not give a hotel away not so long ago but now rooms are scarce and are 22% more expensive than in 2012. Housing in general is also scarce , of course, particularly in Dublin. Rents, nationally, are at record highs and on the CSO data there is no evidence of any significant change in trend, with the latest figure for May showing a 9.7% annual rise.

Irish residents are taking more foreign trips too ( up an annual 13% in the first quarter of 2016) and it is not surprising that Dublin Airport is now seeing record passenger numbers, with 2.5mn in  May alone , an 11% rise on the previous year, implying the 2016 figure will be well in excess of last year’s 25 million. The Airport is building a new runway to help cater for the increased demand, and it is instructive that the planning permission was initially granted in 2007 and then put on hold.

Car ownership is also growing strongly again, with sales up 31% last year following a 29% increase in 2014. The latest data for this year points to a 25% rise which would take the annual figure to over 150k for the first time since 2007. Hardly surprising then that record numbers are using the M50, with gridlock at peak times not uncommon.

The growth in the population as a whole is also putting pressure on schools and hospitals, although one could be forgiven for thinking the population is falling given some media coverage of emigration. The reality is that the population surged by over half a million in the six years to 2009, reaching 4.53mn, and by 2015 had risen to 4.64mn, as net migration has slowed to virtually zero and is anyway offset by the natural increase.

The conclusion has to be that Ireland needs to embark on a huge programme of capital investment in order to tackle capacity issues, particularly in and around Dublin. Borrowing costs for both corporates and Governments are at historically low levels and there has been some increase in building, both residential and commercial, although the former is still well below the annual demand, so exacerbating  the existing supply/demand imbalance. Unfortunately it is  a mark of the absurdity of the current fiscal rules imposed on euro members that capital spending  by the State  is not excluded from the expenditure constraint (  only some incremental spending is allowed) and so any amelioration in these capacity issues is unlikely to occur any time soon.

Record rise in Irish Household real incomes in 2015

In the absence of some wild data revisions it would seem that the Irish economy grew by at least 7% in 2015, and a few weeks ago it emerged that tax receipts rose by 10.5%, providing further evidence that last year was indeed extraordinary in economic terms. The CSO  recently published figures on sectoral income and savings, taking in the third quarter of 2015, and they show that households also saw a spectacular growth in disposable income- indeed, in terms of spending power, the rise outstripped anything seen in the Celtic Tiger era, albeit coming after a longer series of declines.

Irish Household disposable income peaked in 2008 at over €100bn and then fell for five consecutive years, to under €86bn, a decline of some 15%, reflecting a plunge in employment, falling wages and a rise in average tax rates. Consumer prices were broadly flat over that period so the decline in real income was also around 15%.

The recovery in 2014 was modest, with nominal income rising by 2.7%, but last year saw a sharp acceleration; the annual pace of growth rose from 5% in the first quarter to over 8% in q3. Consequently, absent revisions ( which can be large) household disposable income probably grew by around 7.5% last year, fuelled by strong employment growth and an acceleration in average earnings. This would leave the nominal increase below that recorded in 2003 (7.9%) , 2005 (9.8%) and  2007 (8.6%), when employment growth and wage increases were stronger, but consumer price inflation was also higher over those years, so eroding some of the gains in real terms. CPI inflation in 2007 was 4.9% for example, and  2.5% in 2005. In contrast, the CPI index actually fell in 2015, by 0.3% , so in real terms the rise in disposable income last year is far stronger than recorded in the boom years.

The recession prompted households to boost precautionary savings and repay debt  with the  result  that the gross savings ratio (the proportion of disposable income not spent) rose from 5.8% in 2007 to a peak of 14.1% in 2009. Since then it has declined steadily, falling to 5% in 2014, although the strength of income growth last year seems have caused a significant rebuilding of savings, with the seasonally adjusted ratio rising to 10.3% in the third quarter and implying an annual figure of perhaps 8%.

The income and savings data confirm that households are in better financial shape than they have been for a long time and in that context it is perhaps less surprising to see consumer confidence at a 10-year high.

Irish Growth now likely to be at least 7% this year

The consensus growth forecast for the Irish economy in 2015 has moved up over the course of the year and currently stands around 6.4%. This now appears too low following the release of the third quarter national accounts and is likely to be revised up to 7% or so. The 2016 consensus will no doubt move higher, to above 5%. Nominal GDP  in 2015  may also emerge above the figure assumed by  Government, at €212bn instead of €210bn, so shaving another percentage point off the debt ratio, reducing it to 96%.

There was little in the way of revisions to previous releases (which is not always the case), so Irish GDP  is still seen as  having grown very strongly in the first half of the year, by 2,2% in the first quarter and 1.9% in q2. Growth slowed a little in q3, to 1.4%, but that still left the annual change at 7%  which is also the average over the first three quarters of the year. The q3 increase was  also the tenth consecutive quarter of growth and real GDP is now 7.2% above the previous peak having risen by some 21% from the cycle low .

The recovery was initially driven by exports but that has changed, as evidenced in the third quarter data. Domestic demand rose by an annual   10.2%, driven by a 35.8% increase in capital formation, which followed a similar rise in q2. Construction spending is increasing at a modest pace and spending on machinery and equipment actually fell (it is often affected by volatile aircraft orders) so the surge reflected intangibles, the national accounts name for items such as patents, trademarks and R&D.  Government spending fell but domestic demand was also supported by a 3.6% annual rise in consumer spending. Wages are finally starting to rise, employment is growing strongly and  price inflation is around zero so households are  seeing good growth in real incomes, which is supportive of spending, although the overall figure is lagging retail sales due to falling expenditure on services.

Exports are still performing strongly , rising by an annual 12.4% in q3, but that was dwarfed by an 18.9% rise in imports, with the result that net trade made a strong negative contribution to GDP, which is   fairly unusual in the  Irish national accounts. Multinationals in Ireland often price exports in US dollars and so the latter’s appreciation results in a recorded  price rise in euro terms, which no doubt explains why export prices are increasing at an annual rate of  7%  , which is also the main reason why nominal GDP is growing at a double digit pace against a real rise of 7%.

Multinational profits have also picked up strongly this year and the resultant outflows mean that GNP , the income of Irish residents, is lagging the growth in GDP, rising  by an annual 3.2% in the third quarter. We expect a 5% rise in GNP over 2015 as a whole but profit flows are volatile  and a weaker GNP figure is certainly possible,

All of the available evidence, from the labour market, retail sales, tax receipts and the monthly PMI’s , points  to strong Irish growth and the GDP figures now confirm that to be the case. An expectation that this trend will continue into 2016 is a reasonable presumption at his stage although it is hard if not impossible to get a handle on likely developments in spending on intangibles or indeed  on  external trade flows  as they now  dwarf the merchandise export and import  figures published on a monthly basis. That raises the risk of an unexpected quarterly slowdown or even fall in these variables but for the moment  the headline figures show that the economy is growing at 7% per annum, the strongest since the millennium.

Irish growth surge begs questions about upcoming Budget

The Irish economy is now growing at a very rapid pace, both in real and nominal terms, and much faster than envisaged by consensus forecasts or by the Irish Government when framing the 2015  or indeed  the 2016 Budget.  Real GDP grew by 1.9% in the second quarter,  leaving the annual increase at 6.7%, while  first quarter growth was revised up to 2.1% and the annual change to 7.2%. That means that  growth averaged 7.0% over the first half of 2015  so forecasts for the year as a whole are likely to move up to at least  6% or higher. Moreover, nominal GDP is soaring, rising by an average  12.5% in the first half of the year, and GDP for 2015 may exceed €210bn,  implying a General Government debt ratio below 100%, from 107.6% last year.

The initial recovery in the Irish economy was driven by exports but of late domestic demand, which is more labour intensive, has moved to the fore. The external trade data  is still extremely strong,  albeit affected by recent Balance of Payments  (BoP) changes, and while exports  still greatly exceed imports in absolute terms,  import growth is now outpacing, so reducing or even eliminating the positive  contribution of trade to GDP. In q2 imports rose by 6.3%  so  exactly offsetting the impact of  a  5.4% increase in exports. Looking at the annual change in q2, export growth of 13.6% was dwarfed by a 16.9% rise in imports, resulting in a  negative (-0.4%) contribution to GDP.

Domestic demand was generally expected to pick up in 2015 but  the data has also  surprised, with the second quarter seeing a 4.8% rise, leaving the annual increase at an extraordinary 10.1%. Investment spending was the main driver, rising by over 19% in the quarter and by 34% over the year. Construction output is growing but the main factor was a surge in spending on machinery and equipment, although this is very volatile, particularly given the influence of aircraft orders. One puzzling feature in terms of the other components of demand is the performance of consumer spending, which has also picked up but at a slower pace than indicated by retail sales; consumption rose by just 0.4% in q2  and the annual increase slowed to 2.8% from 3.7% in q1.

Commentary on the national accounts often includes caveats about the GDP numbers, with some preferring GNP , the income of Irish residents, as a better measure. Yet growth is also extremely strong using that metric, averaging 6.7% over the first half of the year, although multinational profit outflows did pick up in q2 and the differential between the two measures may widen over the rest of the year.

Irish GDP is now  5.7 % above the previous peak but the unexpected strength of activity in 2015 raises a number of policy issues. On the face of it the economy is growing at a rapid clip and  employment is rising strongly , which would not signal the need for a further boost  to demand from fiscal policy in 2016, particularly as monetary policy is extraordinarily easy and the exchange rate has depreciated. The Government has already received advice from a variety of quarters urging little or no stimulus and the GDP  figures might serve to reinforce such views. Against that, CPI inflation is around zero, wages are only beginning to rise, credit is still contracting and Ireland ran a BoP surplus of  €4.3bn over the first half of the year, a picture hardly consistent with an overheating economy.

There is also an election due within six months, of course, but times have changed in that the Government is now constrained by EU fiscal rules, including one which limits the growth in real exchequer spending to the growth in potential GDP. The latter figure  is determined by the European Commission (EC), using a 10-year average ( including estimates of the current year and forecasts four year ahead) and as it currently stands it means virtually  zero growth in real spending in the 2016 Budget. This  real limit is translated into a cash figure by using the EC’s forecast for price rises across the economy ( the GDP deflator) which is currently  1.6%,  giving a permitted  expenditure figure of €1.3bn to allocate between spending increases and tax cuts.

Yet the GDP deflator is currently rising at an annual 5.2%, so the 1.6%  forecast for 2016 looks too low. Moreover, the potential growth rate  forecast also looks less credible, given the 2015 data. For example, Ireland’s potential growth rate for the year  was put at 2.8% , which implies that the economy may currently be operating 3-4% above capacity, given that the EC assumed  the economy was around full employment in 2014, which  is not consistent with the  observed wage and price behaviour.

There is now little more than a month to the 2016 Budget, so interesting times ahead, although whatever transpires, a buoyant economy can no longer translate into the tax and spending package we might have seen in the past.

 

 

Irish GDP surges, impressing the Government but not consumers

Ireland’s quarterly GDP figures are volatile and often surprise, with the latest no exception; the economy grew by a seasonally adjusted 1.5% in q2, following a 2.8% expansion in the first quarter, the latter revised up marginally from the initial release. That surge in Irish output left the annual growth in real GDP in q2 at an extraordinary 7.7% and means that in the absence of revisions the average growth rate for 2014 as a whole would average 5% even if GDP was to remain flat in the second half of the year. The consensus growth forecast has moved steadily higher as the year  has unfolded , from an initial 2% to around 3%, but this latest data will no doubt prompt a further substantial upgrade- the Finance Minister has already mentioned 4.5% and that requires a fall over the second half of the year. Some commentators prefer GNP as a better measure of economic activity in Ireland (it adjusts for net  external flows of profits, interest and dividends) but that tells a similar story-indeed, the annual GNP  growth rate in q2 was 9%, although base effects in the second half may mean that the annual  GNP growth rate in 2014 will also be around 5%.

The monthly external trade data had implied a strong  merchandise export performance in q2 (the Patent Cliff impact on chemicals appears to be over, at least for now) but the national accounts included  even stronger figures,  which alongside a better performance from service exports resulted in a 13% annual increase in export volume. Import growth was also very strong, at 11.8%, but such is the dominance of exports (now 117% of GDP)  that annual GDP growth would have been 4% even if the other components made no contribution.

In the event they all contributed. Investment rose by 18.5% on the year, adding 2.5 percentage points to GDP growth, following strong gains in construction output and spending on machinery and equipment. Government spending  also rose , and by a puzzling 7.9% in volume terms, which sits uneasily with the idea of spending cuts and fiscal austerity and may reflect problems with the price deflator. The third component of domestic  demand, personal consumption, also rose, but by a modest 1.8%, and even that was flattered by base effects from last year as the quarterly increase in q2  this year was just 0.3% following a meagre 0.2% rise in q1. It is clear from other data sources that Irish households are still  paying down debt at a steady clip and it is impossible to say when this deleveraging will end. Employment growth has also slowed sharply in 2014 and in the absence of a marked change in household  behaviour personal consumption growth in 2014 is likely to be nearer to 1% than the 2% many expected.

Such is the volatility  and unpredictability of exports and investment that real GDP  growth in 2014  could be over 6% or nearer 4%, but we currently expect  5%.Export prices are falling, as is the deflator of government spending, and for that reason the rise in nominal GDP this year may be less than that recorded for real GDP – we expect 4%.That would give a nominal GDP figure  in 2014 of €182bn but still substantially above the €171bn forecast in the 2014 Budget. Tax receipts are also  running well ahead of target and so we now expect the General Government deficit for the year to emerge at 3.4% of GDP compared with the 4.9% originally forecast by the Government. The implication is that a fiscal adjustment of the order of €2bn in 2015, as originally envisaged and still advocated by the Fiscal Advisory Council (although the Council’s latest paper did  not take account of the q2 GDP figures), would probably push the deficit well below 2% of GDP and therefore comfortably under  the 3% target set by the Excessive Deficit procedure. The  strength of tax receipts had moved the Government towards a much smaller adjustment in any case  but the latest GDP figures appear to have convinced them to abandon austerity and at worse go for a neutral budget, with tax cuts funded by higher taxes elsewhere, mainly the Water Charge.

Ireland now has jobless growth instead of growth-less jobs

The relationship between Ireland’s reported GDP and employment has been a puzzle of late. Output in the economy barely grew last year yet employment soared and this year has seen GDP growth pick up but employment effectively stagnate; growth-less jobs has given way to jobless growth. The unemployment rate is still falling, it has to be said, but the explanation for that is more to do with a decline in the labour force rather than any strength in labour demand. Average pay is also declining and so the picture painted by the recent labour market data is certainly at odds with the recovery narrative currently holding sway.

The main source of information on Irish employment is the Quarterly National Household Survey (QNHS), which means that sampling errors are always present. That aside, the data shows that employment bottomed in the third quarter of 2012, having fallen by a seasonally adjusted 327k (or 15%) and  then rose sharply in 2013, with the annual increase in the final quarter at 61k or over 3%. Not all industries participated and agriculture saw by far the biggest increase in employment, but on the face of it the pace of job creation was extraordinary, and one usually associated with a booming economy. Yet the recorded GDP data, which measures the output of the economy, initially showed a fall in 2013, and although subsequent revisions have been positive, the latest vintage still has real GDP growth last year of only 0.2%.Nonethelss the strength of job creation precipitated a substantial fall in the unemployment rate, to 12.2% at end 2013 from 14.2% a year earlier, despite a rise in the participation rate. The implied tightening of the labour market was not evident in terms of pay, however, as average weekly earnings fell by 0.7% last year.

The data revisions to the national accounts had left exports stronger than previously thought and a positive contribution from external trade was the main driver of the 2.7% rise in Irish GDP reported for the first quarter this year, offsetting another fall in domestic demand. The data left the annual growth rate in q1 at 4.1% and, as we expected, has prompted a substantial upward revision to the consensus growth projection for 2014 as a whole, with many private sector forecasts now  well over 3%. Many analysts are also anticipating a pick up in personal consumption, in part predicated on a strong employment figure, but the latest QNHS data, for q2, is very disappointing in terms of job creation; employment rose by 4.3k on a seasonally adjusted basis in the quarter bringing the increase in employment in the first half of the year to just 5.5k. Coverage of the figures tended to emphasise  the annual increase in employment of 37k but  the quarterly flow implies that  the annual rise will slow sharply by the end of the year .

The unemployment rate fell further in the quarter, to an average 11.5%, despite the weak employment figures, reflecting a fall in the labour force and a decline in the participation rate. The decline in the latter was particularly acute for those  over 16 and under 24, with more staying on at school or entering third-level. Emigration is a factor too, although the net figure fell  to 21k in  the year to April 2014, with an increased inflow of  61k partially offsetting a reduced outflow of 82k.

The surprisingly weak employment figures should also be set against the data on average earnings, showing an annual fall of 1.1% in the second quarter, which again would not indicate a tightening labour market overall, although some industries did see strong annual pay growth including construction (6%), the hospitality sector (5.3%) and manufacturing (4.2%). Some have pointed to the strength of income tax receipts as being inconsistent with the pay and jobs data, which is worth noting, although it should be remembered that the 2014 Budget did include measures to boost income tax by over €200mn as well as strong carryover effects from 2013.

As is often the case with Irish data we are left with a confusing picture- is the economy growing very strongly, as indicated by the GDP figures, or is it much weaker  as implied by the employment figures?. The latter does seem to suggest that domestic demand, and particularly the domestic service economy, where most jobs are located, remains in the doldrums. This does not preclude 3.5% GDP growth but it does mean that growth will again be driven by the multinantional export sector, which is not labour intensive.

 

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.

Irish Consumer Spending continues to Disappoint

According to the CSO’s first estimate, the Irish economy, as measured by real GDP, contracted by 0.3% in 2013. This was well below the consensus , which envisaged modest growth, largely reflecting an unexpected plunge in activity in the final quarter, which left real GDP in q4 0.7% below the figure a year earlier. This in turn now makes it less likely that average growth in 2014 will be above 2% as the current consensus expects.

Much has been made of the impact from the Patent Cliff on Irish merchandise exports and hence GDP ( the corollary, a fall in multinational profits, helped to boost GNP, the income of Irish residents, by 3.4%) but a key concern for the Government must be the continued weakness of consumer spending. Personal consumption in volume terms fell by 1.1% last year against a Department of Finance expectation of -0.2%. Moreover, consumption fell in the final quarter and the annual change in q4 was also -1.1% which makes the Department’s forecast of 1.8% average growth in consumption this year look a little optimistic.

A number of indicators would point to stronger consumption than has emerged. Consumer confidence, for example, has risen sharply and is currently back at levels last seen in early 2007. Employment is also rising strongly, by  2.4% on average last year, which offset a 0.7% decline in average wage earnings implying a net increase in total wage income. The retail sales data has also been positive, with a volume  rise of 0.7% in 2013 or 0.8% if one excludes cars.

The value of retail sales fell last year, however, implying that retailers have to cut prices to boost sales, and spending by tourists is excluded from the personal consumption figure as it is meant to capture expenditure by Irish residents. In addition spending on services accounts for over half of personal consumption and that remains weak. One factor may relate to the nature of the employment gains, with some half due to a growth in self employment, and there is no guarantee that the self employed will make money. Indeed, income tax receipts are flat on the year, and weak self employed earnings may be responsible, at least in part. The CSO also believes that the disposable income of Irish households fell over the first nine months of last year (that measure includes transfers and other sources of income alongside wages and adjusts for taxes on income). Households are also continuing with the deleveraging trend evident since 2008, with the repayment of another €5bn  of  debt in the first three quarters of 2013 bringing the total over the five years to €35bn. We do not have figures for recent months but net lending by banks and outstanding credit card debt is still falling, with  a decline of €416bn in net mortgage lending in January the highest monthly fall on record.

The trend in employment. if maintained, does provide the main argument supporting the expected pick up in consumer spending and buoyant car sales have given retail sales a strong start to the year but the trend in wages and deleveraging may also continue as drags on spending and hence GDP, with household’s attitude to debt a particular area of uncertainty.