Latest ESRI report paints gloomy picture on the economy:Ireland is now in recession

According to The Economic and Social Research Institute (ESRI) in its latest Quarterly Economic Commentary the economy will experience a recession this year for the first time since 1983, and a return to net emigration in 2009. Ireland of the Celtic Tiger is no more.

It expects that the economy will contract in size by 0.4% this year. The ESRI calculates that the volume of domestic spending this year will fall by 2.6 %. Investment spending is expected to fall by 14.9%. Real consumer spending growth in 2008 is expected to reach just 1%.
The ESRI predicts an economic growth of 1.9% for 2009.
It expects that net emigration will reach 20,000 in 2009.

The unemployment rate is forecast to rise from 4.5% in 2007 to 6% this year and 7.1% in 2009. The Government had a budget surplus of €5.2 billion in 2006. It will have a budget deficit of €7.4 billion in 2009 according to the ESRI. This represents a deterioration of more than €12.5 billion in the space of three years.
The ESRI predicts an inflation rate of 4.5 % for 2008.

Quite frankly many of the problems were foreseeable three years ago. In the run in to the 2007 General Election the FF/PD Government ramped up public expenditure. It rose by 13% alone in 2007. It undoubtedly helped FF win the General Election. However the flood of taxes into the Government coffers-which supported this splurge- stemmed mainly from an unsustainable property boom. Now the bubble has burst with house construction down from 90,000 three years ago to 40,000-45,000 this year.

The economy was growing strongly in 2005, 2006 and 2007. It did not need a huge injection of public expenditure, which just fuelled inflation. Richard Bruton FG spokesman on Finance railed strongly against this approach as did some economists such Dr. Alan Ahearne , David McWilliams and George Lee. Dr Alan Ahearne warned about the dangers of a crash in house prices. More recently Jim Power has been critical.
Unfortunately many economists were swept along on the tide of boom and bloom.
Critics were painted as prophets of doom who were talking down the economy.

A more prudent approach to Government spending from 2005-2007 would have allowed the Government some leeway. Now the cupboard is bare. There are precedents for the inadvisability of the budgetary strategy adopted by FF/PDs in 2006 and 2007.
The boom bust approach was adopted by FF in 1977-81. Its 1977 Manifesto was a winner with the electorate promising no rates and no car tax. FF inherited an economy, which had come out of recession and was growing solidly. The Lynch and Haughey Governments pump primed public expenditure –much of it funded by borrowing. By 1981-82 the economy was in serious trouble. The hardship of the 80s had its genesis in this irresponsible Manifesto.

In the run in to the 2002 General Election the FF/PD Government let public expenditure rip. Once more Charlie McCreevy slammed on the brakes in the wake of the 2002 General Election.
The FF/PD/Green Government is now facing a double whammy. Internally tax revenue is way below expectations, the housing sector is in free fall, inflation is close to 5%, and unemployment has risen by 48,000 in the last twelve months. Externally rising fuel prices and higher interest rates have impinged strongly on the Irish economy.

The ESRI expects the general government balance to show a deficit of 2.8 % of gross domestic product this year after a 0.3 percent surplus in 2007 and worsen to a 3.9 % deficit in 2009.
"On the face of it, a breach of the 3 % ... (EU Stability and Growth Pact) guideline in a single year does not signal the death knell of fiscal prudence and given our very low debt levels could well be afforded," it said in the survey.

This advice from the ESRI should be binned immediately. The country cannot buy its way out of the mess. Unfortunately hard decisions on public expenditure are necessary. The advice from the ESRI would return Ireland to the failed policies of the late 70s and 80s.
It is likely that the real tax burden will rise. This will be supplemented by increases in stealth taxes such as local authority charges, and by large public expenditure cuts. All in all not a pretty picture.

Ireland: House construction nose-dives

In 2006 approx 93,000 new houses were built. In 2007 this dropped to 78,000. The prognosis for 2008 is bleak with forecasts generally in the range of 40,000 to 45,000 house completions. The estimate for 2009 is even bleaker with suggestions that figures could drop to 37,000. In 2007, 20,000 construction workers were laid off
Clearly the bubble has burst.

There are a number of reasons for the slow down:

(1) The 2% rise in EU interest rates is a contributory factor.

(2) Uncertainty on the Stamp Duty issue contributed to the instability.

(3) Excessive house price inflation has priced houses out of the reach of many in the middle class.

(4) The Government tax takes is too high.

(5) The 5% general inflation rate has weakened purchasing power.

(6) Up to 200,000 houses remain unsold.

A major reduction in EU interest rates will not be sufficient to return the house building sector to health. Further reductions in VAT and Stamp Duty are required. The 200,000 overhang in unsold houses must be substantially cleared. A further substantial reduction in house prices is required. General inflation must fall substantially.

The implications for Government finances are quite severe. There was an Exchequer surplus of €2.3 billion in 2006. A deficit of €4.9 billion is projected for this year.
Tax receipts for January and February are 684 million lower than for the corresponding period in 2007 . VAT receipts for January and February are 7.3% lower than anticipated whilst Stamp Duty receipts are down 44% on the first two months of 2007. The unemployment hate has risen to 5.2%. A rocky road lies ahead for the economy.

Ireland-Construction Downturn

There is increasing evidence of a downturn in the building industry. House prices are overvalued by about 20% . Some optimists forecast that the moderate fall in house prices would have run its course by early 2008. It is more likely that the correction underway will continue for some time. The spectre of negative equity looms for some.
There are several reasons for the decline in house building:

• The 2% rise in interest rates has impacted strongly on repayments.
• Many builders were over optimistic in their assumptions in relation to future demand. They are now left with unsold houses.
• There has been an unsustainable rise in house price inflation.
• The Government takes 30%-40% of the cost of a new house in tax.
• The Stamp Duty issue has not been resolved.
• Unemployment has begun to rise.

There is a tendency to scapegoat economists -like David McWilliams- who have forecast choppy waters ahead. Some have gone so far as to blame them for the fall in house prices. This is of course nonsensical.

There are indications that on average builders have up to 10 new houses unsold in some parts of Ireland. In 2008 a more conservative approach will be adopted. Forecasts for 2008 vary widely.It is likely that new house starts will drop from 90,000 to 60,000 in 2008. There is a danger that it could drop to 50,000 as builders must first off load large numbers of unsold houses.

The growth rate for the economy will drop to 3.5%-This is the benign scenario. Government cutbacks rising oil prices and a housing crisis could drag the rate down to 1% or less.