Business Irish

Wednesday 7 December 2016

Despite some clouds, the economic outlook is bright

Published 03/01/2016 | 02:30

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'Employment will pass the two million threshold in 2016 and unemployment should fall to around 7pc by year's end'

Predicting the future is an inherently difficult task. In no field is that more the case than in economics, where the past is littered with faulty forecasts. But a thriving market for predictions exists because so much hinges on the future. This demand for forecasts will always ensure there is an abundant supply of them.

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Having once been in the forecasting business, this columnist is the first to stress the inherent unreliability of forecasting economic outcomes.

Nonetheless, a look at the prospects for the year ahead, both at home and abroad, is a useful thought process which can help prepare for future eventualities.

Without doubt, 2015 was the best year since the crash - and such is the momentum in the economy as of now that it would take a major shock to halt growth over the next six months. As such, and considering the strengths and weaknesses of the economy, another good performance can be expected in 2016. This is reflected in the consensus among economists who make forecasts.

As the table shows, all the main domestic and international organisations foresee GDP continuing to grow strongly this year, with a forecast rate of expansion ranging from a low of 3.8pc (the IMF prediction) to 4.7pc (the Irish Central Bank).

It should be added that all forecasters believe that the growth rate will be a little lower than the two previous years, but this is more to do with economists being cautious than any major change in the trajectory of growth.

From a comparative perspective, the outlook appears particularly strong. The European Commission forecasts that Ireland will once again be the fastest-growing economy in the EU.

Ireland is also slated to be the top performer in the OECD, a group of mostly developed countries. But as even the casual observer knows, Ireland's national accounts are inflated by international businesses based here, so these GDP comparisons should not be given too much credence.

Exports are a case in point when it comes to the unreliability of the national accounts data as they have been inflated in recent times. That said, the underlying performance has been good and, with a weaker euro and continued growth in main partners likely in 2016, the traded sector of the economy should continue to contribute to growth.

Turning to the domestic economy, private consumption - the single largest component of GDP - is set to rise again this year. How many people are working and how much they earn in the aggregate are the two most important factors in determining consumption.

With employment on a strong upward trajectory over more than three years, that part of the picture looks positive for the year ahead.

Employment will pass the two million threshold in 2016 and unemployment should fall to around 7pc by year's end. Net migration - a metric we in Ireland focus on more than most - could even turn positive for the first time since 2008.

Also turning positive is wage growth. With unemployment falling, tightness in some parts of the labour market is boosting workers' claims for pay increases.

Add into the mix that the public sector can look forward to the rolling-back of Lansdowne Road Agreement and the national pay bill in 2016 is likely to see its biggest rise since the crash.

Another major component of domestic demand/GDP is investment spending. As with exports, this measure is increasingly inflated by the operations of international companies, as reflected in the Central Bank's forecast of 13.2pc growth in 2016.

That said, the amount businesses invest is likely to grow strongly over the course of the year.

The building and construction segment of investment is worthy of future attention, given the housing shortage. Following on from last year, there may be strong growth, but from a very low base. The 13,100 houses the ESRI predicts will be built in 2016 is still far short of the 25,000 units they have recommended as being required.

Changes in domestic demand will be affected by the availability of credit, which has been as slow to recover as the response to the still huge problem of non-performing loans in the banking system. Indeed, Ireland's strong recovery is all the more impressive, given the fragility in the banking system. The limited amount of new credit and the problem of debt - personal, corporation and state - will all continue to drag on growth in 2016. Further progress can be expected, but the legacy of the boom and bust will linger.

The General Election will dominate the early part of 2016 and very possibly more of the year if the outcome is inconclusive. As the Spanish election just before Christmas showed, when the vote fragments, it becomes much more difficult to form governments (it should not be ruled out that the next Dail fails to produce a government at all, with voters back at polling stations within a few months).

If the year was to be characterised by political instability, the economy would suffer. The only question is how big an effect there would be.

The fate of the rest of the world will, of course, also impact upon Ireland in 2016. As a small and open economy, we are more affected than most by non-national developments. The good news is that the world economy as whole should grow as strongly this year as it did last, if not a little more strongly - the accompanying chart shows the IMF's latest projections.

But it is not all good news. In the last year or so, much attention has been given to the slowdown in emerging markets, which have been the main contributor to global growth in recent years. But some are now facing crises of their own.

Prospects are very mixed for what was known as the BRICs. Brazil faces economic and political turmoil, which may overshadow the Olympic Games in Rio this summer.

Low energy prices and sanctions will hit Russia hard. China is slowing and only India is expected to continue to expand as rapidly as it has done in recent years.

Among the developing countries, most focus in 2016 will probably be on China. A credit-fuelled boom has created the usual sorts of vulnerabilities that come with excessive lending and borrowing. An economic crisis in China could cause widespread contagion and could tip the world into recession. The unusually slow rate of global trade growth over the past year and more compounds such sentiments.

Ireland's exports to China, though growing fast, remain small - less than 2pc of the total - so the damage of a recession in China via the trade channel would be limited. Farmers would be affected more than any other group, given the growing size of exports to the China market and its importance in setting global agricultural prices, especially dairy. But the main impact for Ireland of any big slowdown in China would be through non-trade channels, most notably via the financial system and from second-order effects.

Closer to home, the eurozone is in better shape than in the recent past, although the recovery is likely to be tepid and fragile. Greece, which has dogged the currency area for years, is probably quiet only temporarily. The UK is likely to be the best-performing economy of larger European countries.

The main political issue in the coming year will be the EU referendum.

Another round of talks between British and European governments is due in February, which may determine whether the UK has gained concessions.

If they succeed, David Cameron will be tempted to hold the vote early this summer or autumn. A vote to leave would have many consequences for Ireland, the most immediate of which would be a fall in the value of sterling - very possibly a big fall, given the huge balance of payments deficits Britain is running with the rest of the world.

The US economy performed reasonably well in 2015, prompting the Federal Reserve to raise interest rates in December. Janet Yellen, the Fed's Chair, is expected to continue on a gradual tightening path in 2016. While prospects look positive, rate rises may take some heat out of the US economy.

All told, the outlook for the year ahead looks as good as at any time since the crash. Risks abound, as they always do, but with the domestic economy motoring and prospects looking decent for Ireland's main export markets 2016 should surpass 2015 as the best in a decade.

Sunday Indo Business

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