Central Bank of Ireland : Quarterly Bulletin 1 2013

29 January 2013

The Central Bank of Ireland today published Quarterly Bulletin 1 2013.

Comment

While the economic outlook remains challenging, the forecast is for a continuation of the gradual recovery in the overall level of economic activity, though at a slightly slower pace than previously projected. The second half of 2012 saw a slowdown in economic activity at the broader international level and a downward revision to growth prospects in Ireland's main trading partner countries. Weakening global demand has slowed Irish export growth and, given the on-going reliance on exports to offset domestic economic weakness, GDP growth has eased somewhat compared to 2011. Nonetheless, the outcome for 2012 is likely to be a little higher than projected at the time of the last Bulletin, reflecting both a small rise in GDP in the third quarter and the recent upward revision to growth estimates for the first-half of the year. Looking ahead, with growth in key trading partner countries projected to slow this year, weaker external demand is set to dampen Irish export growth in 2013 as compared to earlier expectations, while domestic demand is forecast to continue along its slow path towards stabilisation.

These developments suggest both a slightly stronger growth outturn last year, but a weaker outlook for this year, than previously forecast. GDP is now projected to have grown by 0.7 per cent in 2012, with GNP forecast to have expanded by 1.5 per cent, boosted by a much lower than expected increase in net factor income outflows. While GDP growth is expected to rise to 1.3 per cent in 2013, this represents a downward revision of 0.4 per cent to the previous forecast, reflecting the less favourable international outlook. Assuming a return to a more typical pattern in net factor income flows, GNP growth is projected to moderate to 0.5 per cent this year. In 2014, on the basis of consensus assumptions from the main international economic institutions projecting a recovery in external demand back to its long run trend and also supported by the projected stabilisation of domestic demand, GDP is forecast to grow by 2.5 per cent, with GNP expected to rise by 1.4 per cent. Uncertainty attaches to these projections, however, and with net exports set to remain the main engine of growth in coming years, the outcome will be particularly sensitive to developments in the external environment. Adherence to EU/IMF Programme targets remains strong and progress on the main policy challenges continues to be made. However, on some issues, more needs to be achieved. In the banking sector, the key issues revolve around the need for greater progress in addressing the problems in relation to asset quality and restoring profitability, both of which are essential if the sector is to be put back on a sustained sound footing and to be in a position to increase its lending capacity to support economic recovery. With regard to asset quality issues, of particular concern is the growing long-term nature of the mortgage arrears problem. While banks have now started to develop and roll-out some long- term mortgage modification and resolution measures, the level of implementation, through either debt restructuring or loan recovery, has been far from adequate so far. While there is a delicate balance to be struck here, it is critical that financial institutions move to deal decisively with the issue of long-term mortgage arrears. Much more needs to be done, and in a timely manner. The Central Bank will continue its intensive step-by-step engagement with the banks on this matter until we are satisfied that they have sufficient policies and procedures in place and are making sufficient quantitative progress in ensuring that the growth in arrears is stemmed and that arrears are recovered or, where necessary, restructured or resolved.

On other banking issues, progress continues to be made. With deposits at domestic banks remaining relatively stable in recent months, deleveraging progressing and banks undertaking some market issuance, the dependence on central bank funding, while still elevated, has declined somewhat. Funding challenges remain, however, and allied to pressures from impaired assets and high funding and operating costs, are continuing to pressure profitability. In response, banks have continued to rationalise and restructure their operations and to make progress in reducing costs.

The latest fiscal data confirm that the public finances continued to improve last year and the General Government Deficit for 2012 now seems set to be below 8 per cent of GDP, lower than the level of 8.2 per cent signalled recently on Budget day and well below the 8.6 per cent target for 2012. While, in principle, this lessens the future burden of fiscal adjustment, it would not be appropriate to use the buffer this provides to ease back on the adjustment effort. It is important to continue to adhere to the planned consolidation effort of €8.6 billion between 2013 and 2015, which was reaffirmed in the Medium Term Fiscal Statement (MTFS). Doing so would imply maintaining the 2012 gain in deficit reduction relative to the target over coming years. This would help to get the deficit down to 3 per cent more quickly and should serve to reduce uncertainty and, through this channel, contribute to a faster domestic recovery. By enhancing Ireland's reputation for credible policymaking, it should also help to reinforce the confidence of official and private international lenders and further improve the access of the Irish Sovereign to market funding.

Exports have been a significant mitigating factor during the downturn and, while domestic demand is projected to gradually stabilise, a strong external performance will remain central to a return to steady growth. Given the prospective weakness of external demand and the uncertainties associated with the international outlook, continuing to improve competitiveness and recover more of the ground lost during the boom will be crucial. As has been pointed out in previous Bulletins, due to structural changes in the economy, the standard international measures of competitiveness and productivity growth overstate the level of improvement which has occurred. Reflecting this, further progress is needed. Reducing the elevated cost base of the economy, both in the public and private sectors, and increasing flexibility and efficiency, particularly in the public sector, would be important ways in which such progress could be achieved. The challenges in these areas need to be met to genuinely strengthen Ireland's competitiveness position and its trading performance. Doing so would greatly enhance the prospects for a sustainable return to steady growth and rising living standards.