We are in the biggest downturn in Irish economic history. But the Irish Fiscal Advisory Council (IFAC) in a landmark report this week said we might get back to our pre-crisis economic position in just two to three and a half years. That compared with the 11 years it took to recover from the crash of 2008. So what would it take to get us out of the Covid-19 recession? Policymakers will be walking a tightrope and here are the vital factors.
1. The path of the virus:
This is obvious, of course, but what we have now from the latest IFAC and ESRI reports are a range of possible scenarios, based variously on relatively optimistic and pessimistic expectations.
A quicker than anticipated bounceback is possible, though now seems unlikely. The central scenario of both reports is for a sharp drop in output this year – the ESRI sees a 12 per cent fall in GDP in 2020 and the IFAC goes for 10.5 per cent. Both emphasise the huge downside risks to these forecasts.
If the reopening successfully follows on the Government roadmap – which may even accelerate depending on trends – the economy should start to recover towards the end of the year, recording significant growth in 2021, albeit with the potential for significant ongoing problems in some sectors and much higher unemployment.
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The IFAC says GDP growth could be close to 6 per cent next year. It draws a distinction between 2008 and now. Back then the crisis hit when the economy had lost competitiveness and was in the middle of a property and credit bubble, all of which created huge problems. This time around the economy entered the recession in much better shape, giving hope that, while the shock may be very deep, it could pass much more quickly.
The council – the State’s budgetary watchdog – points out that the path the economy returns to after the initial fall we are now seeing is more important than the precise extent of that fall. The potential costs of the pessimistic scenarios, where the economy can’t get going properly moving into next year, are large.
IFAC’s pessimistic scenario, for example assumes a succession of on-off closures for sectors like construction, hospitality and retail as well a schools. This would mean little growth in the domestic economy next year and employment only inching up slightly after a big 2020 fall.
It would also open up new risks. The government deficit would remain high in the coming years, meaning continued reliance on low interest rates to borrow substantial funds – perhaps €20 billion a year. Rising debts in business and households could create financial instability – the IFAC even pencils in the risk of recapitalisation of the banks if loans went bad, which might cost €25 billion plus. Imagine the fuss that would cause.
Both the IFAC and ESRI believe borrowing should remain high next year to pay for an economic stimulus, before the introduction of measures thereafter to try to get borrowing down. The IFAC report suggests these corrective measures might be delayed until around 2023.
Crucially, growth next year and into 2022 would lead to an automatic fall in the deficit as taxes rise and some pressure comes off spending in areas such as welfare and make this all much easier. We will be walking a tightrope.
2. The ECB to stay actively in the market:
The National Treasury Management Agency looks set to borrow at least €25 billion this year and possibly €30 billion to fund the deficit and pay-off maturing debt. Fortunately it has a lot of cash in hand, as well as €2 billion to come back from Nama and, crucially, no bond maturities – money to be paid back – in 2021.
This week the ECB pointed to big maturities for Italy, Spain and Portugal in 2021 as risks for those countries as they will have to borrow to repay those investors as well as funding huge additional borrowing requirements.
So Ireland will have some leeway in 2021. But with a deficit which could well exceed €20 billion, even on relatively optimistic forecasts, it would be a huge advantage if interest rates were to remain at current rock bottom levels. This cuts annual interest payments to nominal levels, even if the eventual refinancing costs do need to be considered.
Another vital factor is what spending commitments will recur, and need to be funded in future years.
In the ESRI report, the researchers estimate that economic conditions might have already justified a 0.75 of a percentage point rise in the gap between Irish and German bond interest rates. The ECB being in the market has made sure this did not happen. If the ESRI assessment is correct, then ECB action could, very roughly, save Ireland €200 million-plus on annual repayments on what we are borrowing in 2020. And much more importantly, ECB involvement provides insurance against a bigger jump in borrowing rates, if bond investors got jumpy about some EU countries and Ireland got caught up in the fallout.
The IFAC report says there are no signals of this at the moment, but notes that, in the past, we have seen how quickly the mood of the markets can turn. Its more severe scenarios also see a big rise in Ireland’s national debt, which could rise to 140 per cent of GNI* (the measure developed by the CSO to give a realistic measure of the size of the underlying economy) or even 160 per cent if a bank recapitalisation were needed.
The annual deficit could remain stuck at 4 per cent of GDP, meaning large sums would need to be raised from borrowers each year. It might be manageable but it would be difficult, would leave the next government very constrained on policy and would leave Ireland very exposed if growth slowed and/or interest rates rose.
The ECB has promised to “do what it takes” and, if necessary, to continue its bond-buying programme beyond the end of 2020, its initial end date. It will already have to increase the amount it plans to buy to do this. With doubts around the ECB council table about the extent of buying – despite a rock solid economic case for doing so – Ireland will be closely watching the signals from Frankfurt.
3. No nasty international surprises:
The Covid-19 recession has thrown the cards up into the air. Donald Trump is promising to "repatriate" pharma production to the US from Ireland: more widely there is talk of business supply chains being altered and the ongoing tensions between the US and China are another threat. Angela Merkel and Emmanuel Macron have also signalled that corporate tax harmonisation should be back on the EU agenda.
These could all be issues for Ireland. But nothing is an imminent a threat as the risk that the UK could leave the EU trading regime at the end of the year without a deal with the EU, a kind of hard Brexit which would cause problems for trade and notably for the agriculture and food sector, which would face significant trade barriers. This would be the last thing Ireland needs at the end of 2020, when a delicate recovery might be under way – but it is a risk.
And, combined with the pandemic’s impact on tourism, a hit to agriculture would be a further hammer blow to rural Ireland. Both the IFAC and ESRI point out that it is difficult to estimate exactly the additional impact – but we could do without it.
4. Businesses being able to live with Covid-19:
Apart from the risk of further closures due to a return of the virus, some businesses remain particularly under threat. The length of the lockdown – amongst the longest internationally – increases the financial pressures, even if it is not yet clear whether those countries moving more quickly will succeed.
Goodbody economist Dermot O’Leary in a recent report divided employment into green, orange and red sectors. The red sectors were the ones which had the highest percentages on government supports – accommodation and food, construction, retail, health, transport and the arts, which together employ more than 860,000 workers, or more than one in three of the workforce.
Construction is returning to work, but a number of these sectors will remain really challenged due to social distancing concerns and likely changes in the structure of consumer demand – for example will people return to restaurants or favour take-aways; what about bars, and so on.
A report from the Department of Business on economic considerations for reopening economic activity says the price of the long lockdown would be large for businesses. It makes a case for bringing forward reopening in some areas and bringing more clarity in others. Construction is already reopened and the report makes a strong case for manufacturing, where it estimated 15,000 people are affected by closures in a high value-added and regionally dispersed sector.
A couple of sectors remain particularly exposed. Arts and entrainment employs 118,000 and hospitality some 180,000 directly and more via spin-offs. Also at risk are a significant number in retail – which employs 300,000 and where the non-food sector is in real trouble. Add in other smaller sectors and hundreds of thousands of jobs will rely on us finding some way to live and do business with the virus.
One plus is the FDI sector – or perhaps better put as the export sector, which also includes some big Irish firms – that has generally remained operational right through the crisis. An analysis by Davy stockbrokers showed that, in the depths of the last recession, this sector kept growing exports despite falling demand in our markets. Pharma exports in particular have remained strong in recent months and, while Davy expects a fall in export volumes this year, continued employment in this sector and a rebound in 2021, if achievable against what will be a difficult backdrop, would be a boost for Ireland.
