Celtic Tiger’s recovery highlights the benefit of being open

February 2016

From the dark days of being bailed out in late 2010, Ireland’s rapid economic rebound has been in stark contrast to the rest of the euro zone. Despite the potential headwinds of slowing global growth, a general election and the UK vote on leaving the EU, Ireland’s recovery is unlikely to be derailed, says Stewart Robertson, senior economist at Aviva Investors.

Ireland’s recent revival from the economic abyss has been so rapid, broad-based and so out of step with the experience of its euro-zone peers, it would be easy to forget what a precarious position the country was in a little more than five years ago. When Ireland, an early victim of the single-currency bloc’s sovereign debt crisis was forced in November 2010 to accept an €85 billion (£65 billion) programme from the European Union (EU) and International Monetary Fund (IMF), it seemed that the widely-lauded ‘economic miracle’ of the ‘Celtic Tiger’ had abruptly ended.

The bailout did not bring an immediate end to Ireland’s pain. After boasting one of the lowest debt levels of any advanced economy in the pre-crisis years – in 2006, its debt-to-gross domestic product (GDP) ratio was under 25 per cent - by 2013 it had spiralled to 120 per cent1. Unemployment, meanwhile, topped 15 per cent at the start of 2012, while at one point,yields on its 10-year government bonds were approaching 12 per cent.

Turnaround kid

Fast forward to today, and the turnaround is clear. In fact, given how its fellow members of the euro bailout club – Spain, Portugal and Greece – have made only limited economic progress since their own rescues, much worse in Greece’s case, it would not be overstating matters to suggest Ireland’s recovery from crisis rivals the earlier ascent as an economic miracle.

Ireland’s debt-to-GDP ratio was back down to 98.4 per cent in 2015 and is expected to fall further to 91.5 per cent by the end of 2017. Unemployment is on a similar trajectory, back down to 8.6 per cent in January 2016 and forecasted to drop to 7.5 per cent by the end of 2017, while 10-year bond yields are less than one per cent. This is happening without undue inflationary pressure.  While Ireland’s inflation was typically higher than experienced by most other countries in the single-currency bloc in the 2000s, the territory’s inflation rates have matched average euro-zone rates more recently.

Best of all, Ireland’s GDP is expected to have grown by 6.9 per cent1 in 2015, according to the European Commission’s estimates, putting Ireland comfortably at the top of euro-zone economies.

Contrast that to Portugal. From a debt-to-GDP ratio of 83.7 per cent in 2009, the country has seen its debt hover around 130 per cent for the past four years, while growth is expected to show only a modest gain of 1.5 per cent. Spain is set to report more encouraging growth of 3.2 per cent for 2015, but its overall debt burden shows no sign of falling, having risen every year from 40.2 per cent in 2008 to top 100 per cent last year. Greece’s situation, with its debt now close to 180 per cent, is so desperate it is barely worth making the comparison.

There are two immediate questions that Ireland’s resurgence trigger. First, are there any obvious lessons that can be applied elsewhere, particularly in the euro zone? Second, with a few headwinds on the horizon – a general election on 26 February, increasing concerns around a new global crisis and the UK’s vote on whether to stay in the EU, to name a few – will Ireland be able to keep on track?

What goes up

To answer those questions, it is illustrative to look back at the reasons for Ireland’s initial economic surge. While the subsequent collapse highlighted that its economy was not especially well-balanced, it was at least characterised by an [IM1]

openness to trade and investment that has undoubtedly helped propel its recent recovery. Throughout the 1990s and much of the 2000s, Ireland rose the Celtic Tiger wave (see chart one). The country saw its growth rate average 7.5 per cent a year in the nineties. Between 2000 and 2007 GDP growth still averaged six percent annually. Enormous wealth was created: output per head doubled and more than one million net new jobs were generated (the nation’s population is only 4.6 million1) over the period. By 2007, Ireland was one of the ten richest countries in the world.

Ireland’s particular economic model included a rapidly growing and well-educated labour force, a low corporation tax rate, light regulatory touch and an extremely open economy. Large amounts of inward investment were attracted, while low interest rates and a reversal of migration flows (from out to back in) helped fuel a construction and housing boom. This was unusually pronounced, however, due to the unhealthy close relationships between construction companies, politicians and bankers.

When the bust came after 2007, recession hit Ireland especially hard. Output dropped by 13 per cent, the housing market crashed and the banks required unprecedented state support. The country almost followed until the rescue package was agreed in late 2010.

Chart 1: Irish annual GDP bounces strongly (%)


Source: FactSet, January 2016


So how did Ireland became a case study within the euro zone of how to transition from a problem child to a poster boy in dealing with post-crisis austerity?

A template for recovery?

So just how did Ireland become a case study within the euro zone of how to transition from a problem child to a poster boy in dealing with post-crisis austerity? The worst excesses of the bloated construction and banking industries have gone and both sectors are in better shape. With other peripheral euro-zone economies struggling to adjust, Ireland’s successful transition has much to do with its no-nonsense approach, with wages and jobs sharing the burden as employment costs were cut and competitiveness was restored.

It would be an exaggeration to imply the Irish political and business scene has been free of playing the blame game in the post-crisis years. However, any damage arising from such conflict has been more than offset by the broad willingness to find solutions to Ireland’s challenges and get the country back on track. The decision in late 2009 to establish a state-owned bad bank in the form of the National Asset Management Agency (NAMA) was not without controversy, but time has shown it to be a beneficial move. By taking on distressed assets with a nominal value of €74 billion from Ireland’s five biggest banks, NAMA ensured that non-performing loans would not impede those banks’ efforts to recover. Given the agency acquired the loans at a 57 per cent discount, and has subsequently raised €32.7 billion through an orderly process of asset sales, any potential losses to the taxpayer have been minimized.

An open policy to trade and particularly foreign investment relative to its peers was one of the defining reasons for Ireland’s original period of growth. From a modest current-account surplus in 2004, the Emerald Isle swung to a deficit of more than six per cent of GDP in 2008/9 and back to surplus of 6.2 per cent in 2014. The restoration of competitiveness, weaker euro, open economy and successful attempts at attracting inward investment mean that trade flows have contributed significantly to Ireland’s recovery. Exports and imports make up almost all of the country’s output and both have grown considerably quicker than the pace of world trade growth in recent years.

At the time of its rescue, Ireland faced considerable pressure from its euro-zone partners to bring its low rate of corporation tax more in line with their significantly higher levels. Ireland resisted, and its current rate of 12.5 per cent remains an outlier compared to Greece (29 per cent), Spain (28 per cent) and Portugal (21 per cent). It is little wonder that foreign direct investment (FDI) makes up a significant proportion of GDP. Having dipped below 10 per cent in 2011, according to the World Bank, Ireland’s FDI was back up to 34.6 per cent of output in 2014, the most recently available data. FDI in Greece remains less than one per cent of GDP, and while FDI in to Portugal has improved – up from 2.3 per cent in 2009 to 5.4 per cent in 2014 – it falls a long way short of Ireland. In its Global Opportunities Index, the annual measure of a country’s attractiveness to foreign investors by economic think tank the Milken Institute, Ireland ranked ninth in 2015, compared to Portugal (34th), Spain (40th) and Greece (73rd)1.

Positively for Ireland, domestic demand contributed far more to growth in 2014 and 2015 than at any other time since 2007 (see chart two, p3). While growth may slow moderately, the greater contribution of domestic demand should put the economy on a more stable footing in the long-run.

Election looms, but ‘Brexit’ risk bigger

As for those headwinds, the Irish electorate go to the polls on 26 February. The Fine Gael party is set to remain the biggest political force but, as seen in recent euro-zone elections in Spain and Portugal, there is a chance that votes are cast so widely among the others that no clear-cut victor or coalition emerges quickly. This would lead to a protracted period of horse-trading, which should not derail the recovery, but may heighten risks for Irish investment assets in the short term.

The election result, however, is less of a concern when set against the potential repercussions from a UK vote to leave the EU. Ireland is the UK’s fifth biggest export market and tenth biggest source of imports. Indeed, the latter at £12.1 billion equates to around half of Ireland’s exports - the bulk of the remainder being split fairly evenly between the euro zone and the US, with only around five per cent ending up in Brazil, Russia, India or China. Brexit may trigger at least a 20 per cent plunge in bilateral trade flows between both nations according to some commentators5.

Chart 2: Domestic demand helps aid recovery


Source: Oxford Economics, January 2016


There would likely be increased FDI to Ireland as companies locate European bases in the euro zone rather than the UK. Nevertheless, a Brexit may do far more to increase the attractiveness of investing in continental European economies as a base rather than Ireland. Our central view is that the UK will vote to remain in the EU, but the alternative is arguably the biggest risk facing the Irish economy. It would inevitably be a long drawn out process, but could in the short term push the UK into recession.

Ireland has restored its reputation as a competitive industrial base within the euro zone. Despite mounting opposition from other euro-zone nations to Ireland’s tax regime, the country has stubbornly resisted calls for “competitive tax harmonisation”. Tax rates are still low and a large, educated workforce remains. Exports are expected to continue to grow, aided by a weak euro as the European Central Bank continues to keep monetary policy loose, while domestic demand should continue to support output.

On balance, we expect Ireland’s economy to remain among the strongest performers in the single-currency area for some time, creating an encouraging backdrop for domestic financial assets.

Why do negative rates matter to investors?

At a simple level, negative interest rates lower the benchmark against which potential investment returns are judged. In ‘normal’ times, investors will compare a bond yield, an equity earnings (or dividend) yield or a property rental yield against some concept of a ‘risk-free’ rate. This might be a government bond yield, but it is also common for investors to compare returns against what can be earned when cash is held in a bank deposit.

Theoretically, when the risk-free rate falls it should raise the relative attractiveness of competing assets. But the behavioural consequences of a negative return on cash are uncertain – this is new territory. The euro zone has had negative rates since June 2014 and Switzerland since December 2014; yet equity markets in both regions are down between ten and 15 per cent since.

So, does this mean negative rates are not working, not working yet or have resulted in a better situation than would have otherwise been the case? The truth is that no one knows for sure, but it is reasonable to assert that negative interest rates are not instilling confidence in investors, who are interpreting them as a sign that conditions are far from normal.

There is also no guarantee that a persistently low risk-free rate will lead investors towards riskier assets. Japanese interest rates have been closer to zero than one per cent for much of the past twenty years, and yet the country’s key equity index, the Nikkei 225, has not once come close to returning to its peak of 38,900 in December 1989, despite the recent tailwinds provided by ‘Abenomics’. The euro zone is not caught in quite the same grip of fear and paralysis that struck Japan during these ‘lost decades’. Nevertheless, given the uncertain economic backdrop, it is not hard to foresee a scenario where savers and investors continue to seek comfort in risk-free assets for a prolonged period, despite the paltry returns on offer.

1 Source: Trading Economics, February 2016

2 Source: European Commission, February 2016

3 Source: Central Statistical Office, April 2015

4 Source: Global Opportunities Index, Milken Institute, June 2015

5 Source: The Economic and Social Research Institute, data as at 5 November 2015

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In Summary

  • Irish growth is set to continue expanding at a far quicker pace than the rest of the single-currency bloc for many years
  • Buoyant growth creates an encouraging backdrop for the outlook for domestic financial markets
  • Our central view is that the UK public will vote to remain in the EU. However, ‘Brexit’ is arguably the biggest risk facing the Irish economy 
  • Some commentators forecast Brexit may trigger at least a 20 per cent plunge in bilateral trade flows between Ireland and the UK
  • If no clear-cut victor or coalition emerges after this month’s Irish election, this may heighten risks for Irish assets in the short term