Tuesday 17 October 2017

While more ECB cuts fail to spark a revival, Ireland remains vulnerable

March is not necessarily the time for taking of stock and a look forward, but there is certainly enough going on to make one pause for thought, writes Mark Kennedy

One thing that has arguably kept the economy on the rails so far is Mario Draghi‘s ECB policies
One thing that has arguably kept the economy on the rails so far is Mario Draghi‘s ECB policies

Mark Kennedy

We have, in Europe, far too many in Adam Smith's condition of poverty and misery - and on Greek shores the numbers are growing exponentially while our EU system of governance shows shrinking capacity to cope adequately.

Europe has many problems. But there is a big one: prices are not going up - at all or not at all enough. That is draining life from Europe's economy, destroying lives and failing its citizens.

One thing that has arguably kept economy and society on the rails so far is Mario Draghi's policy for the euro: against political opposition, printing money to keep economy, currency and society alive.

To date, it has succeeded. But the most that Mr Draghi can, or does, claim for his monetary relaxations to date is that it has stopped things being much worse - such as Europe falling into a 1930s slump or depression with the ensuing political mayhem. That in itself is a success of sorts, but it falls far short of a positive situation.

Turning to the rest of the world: since the global financial crisis, the experience in the West, broadly speaking, is one of weak and hesitant growth with no sign at all of serious recovery - and this looks like persisting for years to come.

For quite some time, the American economist Larry Summers has been arguing that the mature industrial economies are experiencing secular stagnation. He describes the West's present predicament as follows: "Real interest rates are very low, demand has been sluggish, and inflation is low...

"Absent many good new investment opportunities, savings have tended to flow into existing assets, causing asset-price inflation".

On the face of it, Ireland appears apart from this 'new normal', if such it is. But then the economy in Ireland is quite a peculiar creature compared to most other countries. It is, in absolute terms, small, but it has become a location for very significant scale global-financial operations by a handful of key global economy undertakings.

These companies in even their Irish book-keeping overshadow the domestic economy. Their activity levels are a function of global demand and also exchange-rate and taxation regimes and board and management decisions in these international businesses.

Their activities also significantly underpin aspects of the domestic economy and the Exchequer. It is a good-news formula but vulnerable to the rest of the world. The truth is that Ireland is through this conduit particularly connected to the global economy.

Unless there is a change in global conditions, and if one accepts the Brussels assessment in the so-called European semester of the country's internal situation, Ireland is not well-placed to withstand a seriously big chill.

Their assessment is that the high headline real GDP growth figures of the past two years "probably overestimate… the recovery" and that the "very large share of multinational companies in value-addition, employment and exports exposes the Irish economy to significant cyclical swings and to various types of external shocks".

It also states that while Ireland experienced three years of reform under the EU-IMF programme and two years of very high real GDP growth, "this has not been sufficient to address all the legacy issues from the crisis, including in particular private and public debt, and financial sector repair.

"These... represent vulnerabilities and imbalances that affect the economy, hinder... investment potential and pose challenges to macroeconomic policy making."

So what do global prospects look like at this point? In short, not good. At the time of writing, we have just had news of a 3.8pc decline in Brazilian GDP, which ground to stall speed in 2014.

It is, of course, of no direct relevance to Ireland - but it is part of a bigger picture with some very disturbing features, in particular the profit crunch which seems now to have taken grip in the US corporate sector especially. This is not just about oil companies or only about America. For example:

• Earnings Per Share of S&P 500 companies have fallen year-on-year for three consecutive quarters;

• The Q4 decline annualised was 3.3pc and the decline was sectorally widespread;

• Across the board a large number of companies have issued profit warnings for the first quarter of the year. This is not an American phenomenon alone, global indices are also falling;

• In Europe, non-financial companies are looking at earnings falling by 1.2pc;

• Revenues are also now forecast to fall;

• There is evidence that companies are massaging their financials while share buy-backs are further putting a shine on performance;

In this context, share prices look expensive. The context also includes fresh downgrades of global economic forecasts; a very weak and lacklustre world trade performance - evident in the collapse of shipping's Baltic Dry Index for example; and a still-weak global banking system, seen by some as probably too weak to withstand a new systemic shock.

Faced with the above, we need to ensure that the 'irrational exuberance' evident in the dying years of the Celtic Tiger does not take hold again. In our economy and in our businesses, we need to be prudent to ensure we are resilient in the face of likely turbulence ahead. The last two years have laid some necessary foundations for a recovery in both economy and society. The job now is to build carefully and wisely on that start.

Mark Kennedy is a managing partner at Mazars

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