ESRI’s forecast fails to fully reflect economic uncertainty, writes Constantin Gurdgiev
Ever since the official rebirth of the Celtic Tiger in 3Q 2013, Irish economy has been posting growth figures that are increasingly resembling imaginary numbers rather than real increases in the tangible value added.
Over the period of 3Q 2013 through 4Q 2015, average year-on-year growth rates in real GDP have been running at a dizzying 6 per cent, while real GNP growth has been averaging 6.7 per cent per annum. Much of this growth can be explained by two factors: foreign entities activities in Ireland and external support for the Irish economy from the ECB.
In line with this, on an annual basis, personal consumption and current government spending both managed to grow at less than half the rate of growth in GDP, each rising over the aforementioned period by less than 2.2 per cent per annum on average. In contrast, padded by the IFSC, aircraft leasing, MNCs booking superficial R&D investments into Ireland, and vulture funds flipping speculative assets in the property markets, Irish investment was growing on average by 19.6 per cent on a year-on-year basis.
In the context of past growth trends, latest ESRI projections for 2016-2017 growth at 4.8 percent and 4.1 percent, respectively, represent a conservative estimate. This a welcome move, given heavy reliance on future growth for political spending and taxation plans, as well as the risks to growth arising from the unfavourable global environment. And it is a move that sends some somber signals to Irish political establishment, currently facing the prospect of forming a politically fractured and, hence, spending-happy Government post-GE 2016.
On balance, the ESRI forecasts appear to be realistic. GNP growth is projected to reach 4.7 percent and 4.3 percent in 2016 and 2017, respectively, running close to, but still above the estimated long-term potential rates of economic growth. Notably, the ESRI claims that Irish GNP figures are free from the distortions induced by the multinational corporations operations based in Ireland. Put simply, this is not true. ESRI is fully aware that GNP includes investment (or gross fixed capital formation) which, as noted above, is subject to severe impact from the multinational and financial services enterprises. Beyond that, the GNP is also subject to change in multinational corporations decisions on where to book the returns on their intellectual property and how to balance out the need for retaining profits in Ireland as opposed to expatriating them abroad.
As the result, the ESRI forecasts fail to fully reflect the severe uncertainty that surrounds our economy, especially the uncertainty driven by a range of factors, many outside our control.
Firstly, the unbalanced nature of Irish economy implies high exposure to the risks of changes in global corporate investment cycles. For example, over the recent years, growth in earnings retained by multinational corporations in their off-shore subsidiaries has meant that the rates of profits outflows from Ireland have been running at highly elevated rates. In 2015, exports of goods and services net of imports rose by just 0.72 per cent. Over the same period, net factor outflows from Ireland to the rest of the world (capturing multinational companies profits expatriation and cost transfers out of Ireland) rose 20.6 per cent. Any changes in the global interest rates environment, worldwide trade flows patterns, and/or taxation rates and policies, can easily alter the latter figure, thus impacting significantly on our GNP growth rates.
Secondly, changes in the US interest rates, introduced by the Federal Reserve in December, can have a significant impact on both Irish exports and imports, primarily via the multinational corporations channel. Added dimensions of complexity here are the monetary policies pursued by the Bank of England (which is expected to start tightening monetary policy in months ahead) and the ECB (with markets expecting continued and expanding quantitative easing from Frankfurt).
Thirdly, Irish economy is also exposed to risks relating to the corporate capital investment cycle. Until now, global capital expenditure, or capex, by firms (net of shares buy-backs and M&A activities) has been subdued. This environment favoured Ireland by increasing the value of tax breaks accruing to companies operating from here, compared to the rest of the world. However, should the corporate capex cycle turn, Ireland might witness both rising capital outflows and reduced investment by MNCs into Irish-based R&D and innovation activities. This too is likely to act as a headwind to our official growth.
Last, but not least, continued doubts about the global demand growth, driven primarily by weak economic growth in Europe and by outright recessionary dynamics in a number of larger emerging economies, present another set of external risks to the ESRI forecasts.
Still, on the balance, increasingly conservative and more risk-focused ESRI forecasts for 2016-2017 offer a welcome contrast to the political and social partners’ exuberance that was reflected in the general election campaigns across the entire political spectrum.
Constantin Gurdgiev is Professor of Finance with MIIS (Monterey, California) and Adjunct Professor of Finance with Trinity College, Dublin.