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News : Irish Last Updated: Apr 24, 2009 - 5:31:05 PM

Irish Economy: Davy says economy will shrink by 3.5% in 2009 - the biggest plunge since 1950's; National debt to soar
By Finfacts Team
Oct 13, 2008 - 11:29:20 AM

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Source: Davy Research

Irish Economy: Davy Research said today that the economy is set to contract sharply in both the rest of 2008 and 2009. GNP is expected to decline 2% in real terms this year. Next year, the economy may shrink by 3.4% in volume and by 3.5% in nominal terms - the biggest plunge since the 1950's.

Rossa White, Davy economist, said that economic prospects will not be helped by a combination of factors:

  • The decline in construction activity will continue. House completions will slip to 25,000 from 50,000 in 2008. New completions of commercial buildings are also likely to fall. Meanwhile, public capital spending is set to decline 8% year-on-year.

  • The severe credit squeeze will continue as banks struggle with nonperforming loans to the construction sector, hurting business investment and consumer spending. Employment may drop by 4%

  • and the unemployment rate may reach 8.5% by the end of 2009.

  • Inflation will decline to 1% or lower, which will help. But the loss of financial and property wealth over the last year, plus deteriorating labour market prospects, will lead to a further rise in the household savings ratio.

  • Export demand will wane, reflecting lower consumer spending in the UK, US and much of the euro area. Low-tech manufactured goods and food products destined for the UK will suffer. In addition, Davy expects financial and business service exports to take a particular hit as a result of the ongoing fallout from the banking crisis.

  • Looking to 2010, the outlook is clouded. The crucial variable is how the domestic financial system responds over the next 12 months. If bank lending to credit-worthy businesses and households picks up, the recession will not be prolonged indefinitely. But that is far from certain.

  • The worry is that credit contractions tend to be pro-cyclical and lengthy.

Davy Report

Source: Davy Research

Huge increase in private sector debt drove economy from 2002 on, but deleveraging now pernicious

Davy says the biggest challenge facing the Irish economy over the next couple of years is the amount of private sector debt in the system. Much of that debt is backed by property assets that are falling in value. The "financial accelerator" is at work in the Irish economy: "just as a healthy financial system promotes growth, adverse financial conditions may prevent an economy from reaching its potential".

The financial system in developed economies is undergoing a massive deleveraging process following a six-year credit binge. That debt reduction process has property at its centre. Unlike in the early 2000s, it  is not non-financial corporations that are heavily indebted; it is financial institutions and households. Much of the debt is backed with property as collateral.

Davy says some suggest that nominal interest rates are much lower than in the early 1990s, so the problem is manageable. That misses the point: when you are highly indebted, each little change in interest rates or, more importantly, cash flow is amplified.

Ireland was a microcosm of that credit bubble in the western world.

Source: Davy Research

Rossa White says: "Households became tremendously indebted. Household debt to disposable income is now 175%, up from 77% in 2001. As that debt burden rose, so did the servicing cost – particularly as interest rates began to increase again from the end of 2005. For example, mortgage  debt interest service has soared from €3.1bn in 2005 to €8.4bn this year.

Including interest and principal repayments, total household debt service costs (secured and unsecured) will eat up 23% of disposable income this year versus 13% in 200."

Dependence on transitory property tax revenue surge was staggering

Davy says revenue from property jumped from 8% of total tax receipts in 2002 to 18% by 2006. Cue the plunge to 5% in 2009. Wrongly, the Government planned as if the revenue was permanent by hugely increasing the ratio of gross current expenditure to GNP. That ratio has jumped from 27% in 2001 to 34% in 2008, its highest point since 1987.

Source: Davy Research

Debt to GDP ratio to start rising; serious look at public sector employment levels is required to stop the rot

Davy says upshot of rising deficits and the shrinkage of the real economy is that the general government debt to GDP ratio will increase significantly in 2008 and 2009. In 2007, the Irish debt ratio was the second-lowest in the euro area at 24.8%. Based on Davy estimates, the ratio will head towards 40% by end-2009. In total, the combined GGB borrowing requirement may exceed €25bn, and interest payments will continue to nudge up due to increased borrowing costs on top of the higher debt level. Yields on Irish government debt are set to increase, in part due to the contingent liability of the government guarantee of most borrowings of Irish banks.

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