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News : Irish Last Updated: Dec 19th, 2007 - 13:17:15


IMF says Irish economic growth has become increasingly unbalanced in recent years with heavy reliance on building investment, sharp increases in house prices, and rapid credit growth
By Finfacts Team
Aug 8, 2006, 07:07

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In a review of the Irish Economy published in Washington D.C. on Monday, the International Monetary Fund (IMF) said that economic growth is strong, unemployment is low and labor participation rising, and government debt has been reduced dramatically over the past two decades. Nevertheless, it observed that growth has become increasingly unbalanced in recent years, with heavy reliance on building investment, sharp increases in house prices, and rapid credit growth, especially to property-related sectors.

Figure 2. Heavy Reliance on Building Investment

Sources: Central Bank of Ireland, Central Statistics Office, European Central Bank, Haver Analytics, and permanent tsb/ESRI

At the same time, competitiveness has eroded, reflecting the combination of faster wage growth in Ireland compared to its trading partners, declining productivity growth, and the appreciation of the euro against the U.S. dollar. Directors observed that Ireland's small, highly open economy is also vulnerable to external shocks.

In its annual review of the economy, the IMF forecasts real gross national product (GNP) growth of 6.2 per cent in 2006, which exceeds the Central Bank's prediction of about 5 per cent growth in GNP this year.

The MF cautions cautions against a giveaway budget in December, advocating that any windfall revenues from better-than-expected Exchequer figures should be saved. It says "modest fiscal tightening" is needed in 2007, as a larger cushion is needed because of the risk of a sharp fall in tax revenue.

IMF report on Irish Economy

IMF Statement

On July 26, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Ireland.1

Background

Ireland's economic performance remains strong. In recent years, real GNP growth was one of the highest among industrial countries; the unemployment rate was among the lowest; and HICP inflation declined to close to the euro area average. Employment growth was rapid, reflecting strong immigration and rising labor force participation. This remarkable performance reflected both good policies and fortunate circumstances. Prudent government spending led to declining government debt; low taxes on labor and business income encouraged labor supply and investment; and flexible labor and product markets helped growth. At the same time, favorable demographics boosted the working-age population, and participation in EMU lowered interest rates.

However, economic activity has become reliant on building investment and competitiveness has eroded. The share of the construction sector in economic activity has increased and is now one of the highest in Europe. Bank credit to property-related sectors has grown rapidly and now accounts for more than half of total bank lending. Household debt as a share of household disposable income rose to about 130 percent in 2005, among the highest in Europe. Reflecting the expansion of the labor-intensive construction and services sectors, labor productivity growth has declined. The combination of the slowdown in productivity growth, faster wage growth in Ireland compared to its trading partners, and the appreciation of the euro, has led to an appreciation of the ULC-based real effective exchange rate. Partly as a result, the contribution of net exports to growth has fallen steadily since 2001. After being in balance for several years, the external current account registered a deficit of about 2½ percent of GDP in 2005.

Executive Board Assessment

The Executive Directors commended Ireland's continued impressive economic performance, which has been supported by sound policies, including prudent fiscal policy, low taxes on labor and business income, and labor market flexibility. Economic growth is strong, unemployment is low and labor participation rising, and government debt has been reduced dramatically over the past two decades. Nevertheless, Directors observed that growth has become increasingly unbalanced in recent years, with heavy reliance on building investment, sharp increases in house prices, and rapid credit growth, especially to property-related sectors. At the same time, competitiveness has eroded, reflecting the combination of faster wage growth in Ireland compared to its trading partners, declining productivity growth, and the appreciation of the euro against the U.S. dollar. Directors observed that Ireland's small, highly open economy is also vulnerable to external shocks.

Directors expected economic growth in 2006-07 to remain strong, driven by domestic demand and accompanied by a widening current account deficit and continued rapid credit growth. While the contraction of the construction sector to a more sustainable size over the medium term is likely to be smooth, Directors noted that an abrupt correction cannot be ruled out.

Directors welcomed the Financial System Stability Assessment Update, which finds that Ireland's financial sector soundness indicators are generally strong and that the major lenders have adequate buffers to cover a range of shocks. The recent increase in the risk-weighting on high loan-to-value residential mortgages is an important signal of the need for banks to differentiate between higher- and lower-risk lending within an asset class. Directors suggested that the Financial Regulator continue to monitor banks' risk management practices, including for commercial property lending. Going forward, they called for continued updating of the stress-testing framework, and further strengthening of the regulatory and supervisory framework, especially for insurance.

While recognizing that Ireland's fiscal position is sound, most Directors considered that a modest fiscal tightening would be desirable in 2007, given the strength of domestic demand, potential risks of a hard landing, and the need to prepare for population aging. Slowing the growth of current spending to slightly below nominal GDP growth would also help prevent inefficiencies that could otherwise emerge given the rapid increases in spending in recent years. A number of Directors, however, saw less merit in fiscal tightening at the current juncture, pointing to the need for further increases in spending to achieve social goals, as well as to the recent tightening of euro area monetary policy. Directors agreed that improvements in public services remain a key priority, and, in this context, encouraged the authorities to focus on value for money, including by monitoring government outputs and extending multi-year envelopes to current spending. They welcomed the authorities' plans to further deepen the public debate on fiscal priorities.

Directors considered that continued wage moderation and labor market flexibility are essential to support competitiveness. The implementation of the new social partnership agreement should continue to allow flexibility in wage increases at the firm level and minimize the increase in the restrictiveness of employment protection legislation. 

Ireland: Selected Economic Indicators

               
  2002 2003 2004 2005 2006 1/

Real Economy (change in percent)          
  Real GDP

Real GNP

Domestic demand

Exports of goods and services

Imports of goods and services

HICP

Unemployment rate (in percent)

6.0
2.8
4.3
4.5
2.4
4.7
4.4
4.3
5.5
4.5
0.5
-1.2
4.0
4.7
4.3
3.9
3.6
7.3
8.6
2.3
4.5
5.5
5.4
8.0
3.9
6.5
2.2
4.3
5.8
6.2
6.7
6.4
7.5
2.8
4.3
 
Public Finances (percent of GDP)          
  General government balance

Structural balance 2/

General government debt

-0.4
-1.3
32.2
0.2
0.4
31.1
1.5
1.9
29.6
1.0
1.0
27.4
0.7
0.5
25.9
 
Money and Credit (end-period, percent change)          
  M3 3/

Private sector credit 4/

9.3
15.0
...
17.9
22.5
26.6
19.8
28.8
20.8
29.8
5/

5/

Interest Rates (end-period)          
  Three-month

10-year government bond yield

2.9
4.3
2.1
4.6
2.2
3.7
2.5
3.3
2.9
4.1
5/

6/

Balance of Payments (percent of GDP)          
  Trade balance (goods and services)

Current account

Reserves (gold valued at SDR 35 per ounce

end of period, in billions of SDRs)

17.1
-1.0
4.0
16.0
0.0
2.8
14.9
-0.6
1.9
12.7
-2.6
0.6
11.5
-3.0
...
 
Exchange Rate          
  Exchange rate regime

Present rate (July 17, 2006)

Member of euro area

US$ per euro 1.2541

  Nominal effective rate (1995=100)

Real effective rate (1995=100, CPI based)

89.7
98.0
97.4
107.9
102.6
113.7
98.3
109.2
99.8
112.0
7/

7/


Sources: Central Statistics Office; Department of Finance, Datastream and IMF International Financial

Statistics.

1/ Staff projections, except where noted.

2/ In percent of potential GDP.

3/ The methodology used to compile M3 has been amended in line with Eurosystem requirements.

Therefore, there is a break in the series.

4/ Adjusted change, which includes the effects of transactions between credit institutions and non-

bank international financial companies and valuation effects arising from exchange rate

movements.

5/ As of May 2006.

6/ As of June 2006.

7/ As of April 2006.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


© Copyright 2007 by Finfacts.com

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