Ireland - Developments in Individual OECD Countries

OECD Economic Outlook, June, 1993

The Irish economy continued to grow during 1992. Despite the recession in the United Kingdom, exports expanded strongly, while sustained personal income growth provided the basis for higher personal consumption. Growth was interrupted in the final quarter by the ERM currency crisis, but the January devaluation was favourably received by financial markets and should, together with the recovery in the United Kingdom, provide the basis for renewed expansion in 1993-94.

Recent developments. A good export performance was the principal factor allowing GDP to grow at an annual rate of around 2 3/4 per cent in 1992. Ireland appears to have increased its share of international trade and the current-account surplus rose to a record level of 6 per cent of GDP. Investment was weak, because of low profits and high interest rates, but consumption recovered from late 1991, contributing to rising domestic demand. The inflation rate (as measured by the consumption deflator) was stable at around 3 per cent. The most negative feature was a further deterioration in the unemployment situation, partly because of return migration from the United Kingdom.

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Economic conditions deteriorated in the last quarter of 1992, when pressures on the Irish pound necessitated steeply higher money-market interest rates to defend the ERM parity. At the same time, the loss in competitiveness as a result of the depreciation of sterling severely eroded profit margins in those export sectors which relied most heavily on the U.K. market.

Policies and other forces acting. The Irish pound was devalued by 10 per cent within the ERM at the end of January 1993. With the currency at the top of the narrow ERM band following the devaluation, short-term interest rates have fallen below those of Germany. Indeed, with German monetary conditions easing and tensions subsiding within the ERM, both short and long-term interest rates are now significantly below their mid-1992 levels.

Maintaining the credibility of the ERM strategy in the wake of the devaluation has required action to stabilise the fiscal deficit. In the 1993 Budget, the new coalition government aligned its fiscal objectives with the Maastricht criteria, which eventually limit participants in the EMU to a general government deficit of 3 per cent of GDP or just above, while making satisfactory progress towards a government debt/GDP ratio of 60 per cent. Given pressures on public spending, in part arising from the increase in unemployment, and despite an increase in taxation, a 3 1/2 per cent deficit was budgeted for 1993. Moreover, the effect of devaluation in increasing the domestic-currency value of foreign debt means that the government debt/GDP ratio is expected to rise slightly in 1993, for the first time since 1986.

Prospects. With interest payments accounting for 18 per cent of current expenditures, fiscal consolidation depends heavily on the future course of interest rates. Short-term rates are expected to decline to around 5 1/2 per cent in 1994, as German monetary easing continues. Government bond yields should settle in the same range, which would provide valuable support to both economic growth and fiscal adjustment.

With nominal wages still being determined according to a three-year incomes agreement which is due to expire in early 1994, total compensation is set to rise by a relatively rapid 6 per cent in 1993. With an inflation rate of around 3 per cent, real income growth should be of the order of 3 per cent. Although unit labour costs are falling in manufacturing, they are expected to increase for the economy at large, putting pressure on profits. Incentives to invest are thus weak. Capital spending is expected to remain sluggish in 1993, before picking up somewhat in 1994 in response to falling interest rates.

Since the devaluation has effectively compensated for a previous appreciation of the Irish pound, it has sustained, rather than added to, the country's international competitiveness. It does not, therefore, provide a platform for further gains in export market shares. The current-account surplus is, nevertheless, likely to remain at between 5 and 6 per cent of GDP. Overall, GDP growth could continue in the 2 1/2 to 2 3/4 per cent range in 1993, rising to 3 to 3 1/2 per cent in 1994. Since the latter growth rate corresponds roughly to the long-term productivity trend, there is little likelihood of a reduction in the unemployment rate, which could reach 20 per cent, as measured by the labour force survey, in 1994 unless U.K. job prospects improve sufficiently to lead to renewed outward migration.

Given its international indebtedness and export orientation, Ireland is highly exposed to changes in interest-rate and demand conditions abroad. In this context, the possibility that monetary conditions in the United Kingdom and Germany could again begin to diverge significantly, with downward pressure on sterling raising the risk premium on Irish interest rates, has been reduced. However, if any budgetary slippage were to emerge, this could affect foreign investor confidence, with adverse effects on interest rates. From the international trade side, Ireland should benefit from faster U.K. growth, but weaker demand in continental Europe could act as a drag on exports, which could be exacerbated if Irish wage costs do not decelerate.