THE IRISH economy will shrink by 9.8 per cent this year, according to one of the most pessimistic forecasts from the Organisation for Economic Co-operation and Development (OECD).

The Paris-based think-tank has said that unemployment will reach 14.8 per cent in 2010, and that the country’s gross domestic product (GDP) will contract by 14 per cent over the three years to 2010.

The Government estimated in April that economic output would shrink by 7.7 per cent this year.

The OECD said substantial spending cuts and tax increases were required in the coming years to correct the budget deficit.

“Considerable further consolidation will be necessary in coming years to close the underlying gap between tax revenues and expenditure,” said the organisation.

Irish GDP will contract by 1.5 per cent next year, which is slightly more optimistic than other predictions.

Economic recovery, which is likely to begin in 2010, will be “sluggish”, the OECD said, as weak labour market conditions, household indebtedness and the increased burden of taxation will “dampen consumption”.

“Reductions in Government expenditure will further depress activity,” said the OECD.

The think-tank said the banking sector “must be resolved at a reasonable cost”, and that competitiveness “must be restored by lower wages and stronger competition”.

“There are risks that the recovery will be weaker than anticipated or begin later as it may be hampered by tighter fiscal policy or falling wages depressing real incomes.”

The OECD estimates that the Government’s borrowing target of 10.75 per cent, set in April, will rise to 11.5 per cent this year and 13.6 per cent next year.

“The fiscal balance has deteriorated very sharply due to the slowdown and drop in property-related revenues.”

The OECD estimates that the Government’s structural deficit will reach 9.2 per cent of GDP.

Economist Dermot O’Leary at Goodbody Stockbrokers said that this could require expenditure cuts and tax increases of €10 billion to return the Government deficit to the EU limit of 3 per cent.

He said this may take longer than the Government’s planned five-year recovery programme.

“I am not totally surprised at the OECD’s numbers – the GDP projections for this year are a little bit more pessimistic than recent estimates,” said Mr O’Leary.

The OECD said that “an adequate flow” of bank finance will be “essential for any recovery”, and Government measures to repair the banking sector “should allow banks to provide new credit”.

It said the slowdown across the 30 developed member countries was close to the bottom – the first time in two years its outlook has improved.

It predicts growth of 0.7 per cent for the countries next year, following a 4.1 per cent decline last year, though it warned that rising unemployment and ballooning budget deficits could knock weak recovery off course.