If there were such a thing as a mini-league of the economies that have undergone Troika reform programmes since the financial crisis, Ireland would win, hands-down. That was the clear message of a report published at the end of May by the Brussels-based think tank, Bruegel, which compared the recent performance of Ireland, Portugal and Greece.
Its conclusion was that while the Troika programme has been a failure in Greece, and only “potentially” successful in Portugal, it has met and in many instances surpassed expectations in Ireland.
Dublin’s recovery programme was not quite given full marks by Bruegel, which describes Ireland’s unemployment rate as disappointing. But as Bruegel and most other analysts acknowledge, the most striking feature of Ireland’s economic performance over the last two years or so has been its delivery on so many of the targets.
“Expectations were very low at the beginning of the Troika programme, so it was easy to surpass them,” says Kevin Daly, European economist and executive director at Goldman Sachs. “But our contention back in 2011 was that the main risks to the Irish economy were external rather than internal. We remain confident that while Ireland would be vulnerable to a renewed eurozone crisis, the likelihood of Ireland defaulting in isolation is remote.”
The restoration of order to Ireland’s public finances support this view. As the Department of Finance reported in its Stability Programme update at the end of April, “on the fiscal front, the Maastricht returns published [in April] highlight the progress we are making in restoring order to the public finances. An underlying deficit of 7.6% of GDP was recorded for 2012, well within the EDP [excessive deficit procedure] target of 9.6%. An underlying deficit of 7.4% is forecast for 2013, inside the EDP target of 7.5%. My department remains confident that the fiscal strategy to reduce the budget deficit to below 3% by 2015 is on target.”
Exports to the rescue
The fiscal recovery has been supported by growth, which at 1.4% in 2011 and 0.9% in 2012 may not have been electrifying, but it is better than most of Ireland’s EU competitors have recorded. “Real GDP growth has been sluggish, but at least Ireland is growing, which is impressive, given the problems in the rest of the euro peripheral countries,” says Daly at Goldman Sachs. “The turnaround in nominal GDP has been quite a bit stronger, which has had an important knock-on effect on the fiscal side, with tax receipts higher than expected in 2012.”
Other analysts agree that Ireland’s performance in relative terms has been noteworthy. As Morgan Stanley commented in an update published in February, “even on our cautious forecasts, Ireland will be the strongest growing country in the euro area this year”.
The chief driver of Irish growth has been exports, which rose by 5.1% in 2011 and 2.9% in 2012, according to data published by the Irish Central Statistics Office (CSO). That represents quite a turnaround, given that between 2004 and 2007, the contribution of net exports to economic growth was small or negative, according to the National Competitiveness Council.
“The contribution made by exports to GDP growth over the last three years has been huge,” says Blerina Uruci, UK and Ireland economist at Barclays in London. “The key to ensuring that Ireland has avoided falling into a very negative spiral has been the increased competitiveness of its exporters, which have been helped by the real devaluation of the exchange rate.”
According to the most recent investor presentation from the National Treasury Management Agency, Ireland’s real effective exchange rate has now returned to its 2002-03 levels, and has fallen by some 17% since its peak. Of the other EU members, only Poland, Latvia and Hungary have seen greater falls, while the declines in other troubled peripheral countries was just under 12% in Spain, 3.5% in Greece and 2.9% in Portugal.
That decline, says Uruci, has been driven mainly by the sharp correction in prices in recent years, and most notably by the progressive decline in Ireland’s unit labour costs. According to data published by the NCC, from a high of 9.1% growth in 2001, Irish labour costs fell by 0.6% in 2010 and 1.7% in 2011. “This represents a gain in cost competitiveness as labour costs continue to rise in the EU and euro area,” notes the NCC.
Ireland’s bright export story may, however, be starting to lose some of its gloss. As Davy noted in an update published in March, “monthly data on Ireland’s export performance have painted a worrying picture”. Specifically, Davy noted that goods export volumes fell by 7.5% in the last quarter of 2012.
“Exports have been a stabilising anchor for Ireland over the course of the crisis, but they are starting to slow and we’re unlikely to see the same strength in exports growth in the coming years that we saw between 2010 and 2012,” says Owen Callan, senior analyst, fixed income strategy at Danske Bank in Dublin. “Against that, however, given that 45% of Ireland’s trade is with the UK and the US, it probably has a unique opportunity to outperform its competitors in the eurozone which are more dependent on intra-EU trade.”
Davy forecasts that for 2013 as a whole, annual Irish exports growth will average 2%, but many economists warn that external risk remains a concern, given how open the Irish economy is compared with other peripheral EU members. According to NTMA’s data, exports and imports account for 106% and 84% respectively of Ireland’s GDP. By contrast, they represent 30% and 31% of Spain’s, 29% and 30% of Italy’s and 35% and 39% of Portugal’s.
Ireland’s Achilles’ heel
The snag with Ireland’s strong export story of recent years is that it has done little to fuel domestic demand, in part because many of the industries in which Irish exporters excel are relatively modest employers. The pharmaceutical sector, for example, employs just 22,000 people, but accounts for a whopping 10% of GDP.
“It may be that on a net basis not too many jobs have been created by the exporters, but we have seen strong job creation in the services sector,” says Callan at Danske. “While we’ve lost some jobs on the manufacturing side at companies like HP and Dell, we have seen Google, eBay and Microsoft adding jobs in the services side of the exporting sector.”
Perhaps. But spare capacity in the manufacturing sector and the failure of industry to create jobs on a meaningful scale is just one of a host of reasons explaining why Ireland’s domestic economy remains weak and, by some measures, seems to be weakening even further. In March, retail sales volumes declined by 2.2%, their fastest annualised fall in nine months. In the first quarter, meanwhile, Tesco saw like-for-like Irish sales slip by 3%, blaming “a significant reduction in consumer sentiment and spending following the announced introduction of a local property tax on residential properties”.
“Domestic demand has been Ireland’s Achilles’ heel,” says Uruci at Barclays. “This isn’t surprising when you consider Ireland’s high level of household debt, the fall in nominal and real incomes we’ve seen over the last five years, high unemployment levels and the bursting of the property bubble. This has all led to an increase in savings and a general deleveraging in the household sector.”
Until recently the net result had been what Uruci describes as a “striking divergence between the contribution to GDP of domestic and external demand”. She adds that this gap has been narrowing as exports have slowed and the first, hesitant signs of a rise in domestic demand start to emerge. “We think domestic demand has bottomed out and may start to make a positive contribution to growth beginning in 2014,” she says.
At Goldman Sachs, Daly agrees. “Slowly but surely, the improvement which has been led by the external side is beginning to feed into the domestic economy,” he says. “Unemployment is still high, but it is already well below its peak of 15%, so it is moving in the right direction.”
Household finances may also be edging in the right direction after a long decline. According to NTMA, household net worth improved in the second half of 2012, for the first time since 2007. The improvement needs to be seen in perspective, because there has still been a grim decline of 36% (or €260bn) since mid-2007, compared with a peak-to-trough fall of 38%.
The principal risk to this fragile recovery in consumer confidence, say bankers, is the precarious state of the housing market. Even though house prices have begun to recover in the Dublin metropolitan area, on a nationwide basis they remain some 50% below their pre-crisis level.
The debt dilemma
Achieving sustainable levels of growth will be critical to Ireland’s longer term recovery prospects, given the magnitude of Ireland’s debt. As the NCC acknowledges in its 2012 Competitiveness Scorecard, “at approximately 400% of GDP, the cumulative debt in the Irish economy, encompassing all of the debts owned by enterprises, households and government to both domestic and international lenders (but excluding the debts associated with financial corporations), represents the single greatest challenge facing Irish policymakers. Excessive levels of debt act as a major constraint on economic growth and negatively impact on all economic sectors.”
While economists recognise the challenge presented by Ireland’s debt mountain, most believe that Ireland’s government debt to GDP ratio, which is expected to peak at just over 120% in 2013 and fall thereafter to about 110% by 2016, is probably sustainable. “The deal Ireland completed on the promissory note in February was a significant help in terms of the debt, but an agreement on legacy debt would be even better because it would bring the debt to GDP ratio down by about 20pp,” says Uruci. “There was some hope last summer that there would be a deal when EU leaders expressed their commitment to break the loop between the banks and sovereign risk, but at this point we think this is unlikely.”
“Nevertheless,” she adds, “given healthy nominal GDP growth of 3%-4% and interest rates of 4%-5%, the debt trajectory looks sustainable.”
Danske’s Callan agrees, although he says that the support of the EU is pivotal. “Debt is clearly a problem,” he says. “Interest payments are about 20% of government revenues and 4.9% of GDP. Bringing this down will obviously be one of the government’s main fiscal challenges. This is why the extension of the EFSM and EFSF loans at low rates and very long maturities has been so important for Ireland. This year alone about 35% of Ireland’s debt has been refinanced into long term debt which is important, because if you can keep the interest burden low enough then the nominal debt itself isn’t necessarily a problem.”
Public support for reform
Critically, say economists, there is still broad recognition at a popular level of the long-term benefits of the harsh economic medicine Ireland is being compelled to swallow. “Clearly, there has been much less unrest in the labour force and among the general public in response to the austerity measures than there has been in some other countries,” says Callan.
There are, however, indications that opposition to reform may be gathering momentum. At Barclays, Uruci points to the recent refusal of the unions to agree to the government’s recent proposals to cut the public sector wage bill by €200m this year, as part of a broader plan to save €1bn in expenditure by 2015. “The government has played this down, saying it has plenty of time to make cost savings between now and 2015, but the failure of the wage agreements suggests that reform fatigue may be creeping in,” she says.
Historically, however, when Irish residents have not liked what they have seen in the domestic economy they have generally preferred to vote with their feet than take to the streets. Last year, according to NTMA’s data, 87,000 people emigrated from Ireland while 53,000 moved the other way, giving a net migration figure of 34,000. As NTMA notes in its most recent investor briefing, this means that migration is still not as serious a problem as it was in the late 1980s. But it is pushing up towards 1989’s numbers, when net migration was 44,000. It will also be a concern to the Irish authorities that the number of emigrants was higher in absolute terms in 2012 than it was in 1989, when 71,000 packed their bags.
At Danske in Dublin, Callan cautions against comparing today’s total figures with those from the late 1980s, for two reasons. The first is that the increase in the population over the last 25 years means that as a percentage the gross number of emigrants is still down on the late 1980s.
The second is that the comparison does not take into account the Ryanair factor, which is allowing people to fly around the globe at a fraction of what it cost to do so in the 1980s. These days, low-cost airlines can speed people back home as quickly as they can fly them away, as Ireland proved at the top of the boom in 2006 and 2007, in each of which more than 100,000 immigrants arrived in the country.
Regaining market access
For the time being, fixed income investors have demonstrated that they are prepared to give the durability of the Irish recovery the benefit of the doubt. That was strikingly apparent from the reception they gave to the sovereign when it capitalised on heightened risk appetite to make a highly successful return to the syndicated bond market on a standalone basis in January.
Ireland’s €2.5bn tap of its October 2017 benchmark, bringing the size of the issue to €6.4bn, was led by Barclays, Danske, Davy, RBS and Société Générale, and generated demand of more than €7.5bn.
NTMA built on the success of January’s benchmark in March, extending its yield curve by printing a new €5bn 10 year issue via Barclays, Danske, Davy, Goldman Sachs, HSBC and Nomura which generated orders of about €13bn.
Both transactions were highly significant landmarks which met the NTMA’s principal objectives of demonstrating not just that Ireland had regained market access, but had done so in different maturities and at a minimal concession to its secondary curve. While the five year trade was priced at 250bp over swaps, which equated to a 5bp concession, the longer 10 year bond was offered at 240bp, which was flat to Ireland’s curve.
Another priority for Ireland in its return to the bond market in 2013 has been to diversify its international investor base and to cultivate a broader and deeper following among real money accounts. It has not done badly on either score, with well over 80% of both benchmarks placed with investors outside Ireland, and 90% of the 10 year bond bought by fund managers, pension funds, insurance companies and banks.
Ireland was under no pressure to raise funding in the first quarter of this year, and has already met its funding needs for this year. Its longer term requirements, meanwhile, have been substantially reduced thanks to the promissory note deal, which cuts €20bn from NTMA’s funding requirement over the next 20 years. It has also been diminished by the EU’s decision, announced in April, to extend the maturity of EFSM and EFSF loans to Ireland (and Portugal) by seven years. As Davy advised before the official announcement, “we expect at least €10.5bn of EU loans due to mature in 2015-2016 will be rescheduled to ease Ireland back into regular market access. This compares with the €40bn Ireland had been expected to have to raise during these years.”
These developments mean that NTMA will be under no pressure to fund over the short term. As Nomura’s head of EMEA syndicate, Nick Dent, says, that is good news given the volatility in markets in recent weeks. “Unless we see exceptional funding conditions towards the end of this year, I wouldn’t expect to see Ireland back in the market with significant volumes until early 2014,” he says.