IMF News: How did the Irish economy fare over the last year, and what are the medium-term prospects?
Murgasova: The Irish economy has made an exceptional recovery over the past few years and output has surpassed its pre-crisis level. The already-astounding growth rate of 7.8 percent in 2015 has been recently sharply upgraded by the Irish Central Statistics Office to 26.3 percent. This headline number is heavily affected by the operations of a number of multinational companies which caused an upward level shift in output, but had a limited impact on the true underlying developments of the Irish economy. Yet, there are a number of other indicators that confirm Ireland’s robust rebound. For example, private consumption grew strongly (4.5 percent in 2015) on the back of rising employment. At the same time, the unemployment rate fell to 7.8 percent in June, while inflation has remained very subdued. Public finances have continued to improve, reflecting buoyant tax revenue, and government’s debt-to-GDP ratio has declined rapidly.
IMF News: The UK’s decision to leave the EU is a major risk to the outlook. How can it influence Irish growth?
Murgasova: Ireland’s positive economic performance is expected to continue, despite the fallout from the UK vote to leave the EU. Nevertheless, in light of its tight economic and financial linkages with the UK, Ireland is likely to face some difficulties, the severity of which, however, is hard to gauge at this stage. It will depend crucially on the future relationship between the UK and the EU, especially regarding trade, financial flows, and movement of labor.
Hardy : The authorities undertook a very comprehensive contingency planning exercise in advance of the referendum in the UK to identify all the linkages that might be affected and how to mitigate possible adverse effects.
On the financial sector, one obvious connection is though the banks and insurers doing business in the UK. A recession in the UK affects them directly and through a knock-on effect from Irish exporters to the UK. In the wake of the referendum, market prices of banks and financial institutions of Ireland have taken a tumble. But in the longer run, Brexit would not necessarily affect the Irish financial system a great deal, given that the economy as a whole is now quite diversified.
IMF News: The rebound of the Irish economy has been exceptional, but the recovery is incomplete. Which areas of the economy are lagging behind, and what are the IMF suggestions?
Murgasova: Indeed, the exceptional economic recovery has yet to benefit parts of the population. For example, while jobs have been created at a steady pace, this process has been uneven across regions. Also, the share of unemployed remains high, particularly among young people, and so is the portion of inactive population. In addition, private consumption has not reached its pre-crisis levels yet. Finally, households, corporates and the government still bear large debt burdens, and banks have a large share of distressed loans that need to be resolved before they can better support sustainable growth.
To address these issues, policies should focus on cementing macroeconomic stability and supporting durable and inclusive long-term growth and job creation. This includes further improvement in public finances and reduction of public debt. Fiscal policy could also be more supportive of growth. This could be achieved either by more efficient public spending to achieve better public services, and by rebalancing the tax mix away from distortionary direct taxes. The authorities should make wider financing options available for small and medium sized enterprises and support their innovation. Better education and training, and the removal of obstacles to women’s labor force participation could deal with the weaknesses of the labor market. Finally, it will be important to monitor closely the economy and stand ready to mitigate any potential spillovers from the UK decision to leave the EU.
IMF News : How has the Irish financial sector changed since the crisis, and what are the risks it is facing?
Hardy : The Irish financial system has indeed been quite transformed since and through the crisis. It must now operate as part of the European Banking Union. Banking supervision is led by the European Central Bank. The resolution of larger problem banks is likewise being organized at a European level. Regulations on banks, asset managers, and insurance companies have been very substantially augmented. Supervision has become much more proactive and investigative.
As for the Irish banking system, it went from being very internationalized, very dependent upon wholesale funding and rather adventurous, to being much more domestically oriented. Much of the business of the smaller, more consolidated Irish banks is now, as they say, “plain vanilla.”
Yet there are significant legacy risks because banks still have on their books loans from the past. These may be performing better now in an environment of strong growth and low interest rates in Ireland. But if these conditions change, the loans may become problematic.
Bank profitability too is an issue, in part because of the sizeable outstanding volume of “tracker loans” given out in the boom years with interest rates tied to the market rates in such a way that banks earn minimal amounts on them. A large chunk of banks’ balance sheet is thus rather unprofitable.
The Irish asset management sector is immense, with on the order of 3 trillion euros administered out of Ireland. Just the amounts of money involved mean that even a slight hiccup would be important. But we were relatively comforted by our analysis that at least the main funds are not highly leveraged, that is they do not much rely on borrowing, and they have quite substantial liquidity buffers.
And the fact that the asset managers’ connection to the rest of the Irish financial system is weak means that eventual large losses would not much affect Ireland directly, except perhaps in terms of reputation risk.
IMF News : The 2007 crisis in Ireland started out from a price bubble in the residential real estate market. It triggered a sovereign debt crisis. How does the Irish real estate lending look today?
Hardy: Prompted by the past experience and by the resurgence in prices, the authorities have introduced macroprudential measures affecting residential real estate mortgages, including a limit on loan-to-value ratios. These measures seem to have had some effect in taking the edge off the residential real estate market, while price expectations have become more moderate. There is probably more sign of heating up in the commercial real estate market. But it is not clear what the authorities can and should do about it at this stage when most of the financing is not coming from Irish institutions but rather from abroad.
It must be mentioned that, in commercial real estate and much more so in residential real estate, one consequence of the crisis was a prolonged near collapse in construction activity. Now affordable housing seems to be in short supply. We view this as being something that deserves attention, but it is beyond the remit of financial sector policies.
