How will the euro fallout affect us here and in the Republic
The eurozone crisis has been raging over the past few months but seems very far removed from our day-to-day businesses. Will it, however, affect us here in Northern Ireland and in the Republic. Two top economists consider the question
Richard Ramsey, Chief economist
An old saying is that when the United States sneezes the world catches a cold. This used to hold true, but the emergence of the new economic superpower that is China has reduced the importance of the US economy as a driver of global economic growth. A key concern will be whether China sneezes and the rest of the world catches cold, or indeed something more serious.
But for now, the spotlight is firmly fixed on the eurozone. The latest consensus forecasts anticipate growth for the eurozone of just 0.4% in 2012 with some of its economies, Greece, Portugal and worryingly Italy, expected to experience outright contraction.
Indeed, some analysts are forecasting the recession in Greece to last until 2015. It began in 2008!
The situation in the eurozone is certainly more serious than a cold, with the sovereign-debt crisis spreading its flu-like symptoms throughout global financial markets.
To date, European policy-makers have struggled to stabilise the patient and the best-case scenario is a long, slow and painful recovery. The key question is will Northern Ireland catch a cold from the eurozone, too?
Northern Ireland is unique in that it is the only part of the UK to share a land-border with the eurozone — the Republic of Ireland (RoI).
Throughout most of the past decade, Northern Ireland enjoyed the positive economic spillovers, or ‘Southern Comfort’ from its proximity to the fastest-growing economy in the eurozone.
Prior to the downturn, exports to the Republic were as large as all other sales to Asia and the rest of the EU combined. As for tourism, the Republic is our second-most important market and visitors from the South contributed to a record year for the industry in 2007.
Since then, however, the trade, tourism and investment linkages have turned into negatives.
Proximity, and the financial and economic inter-linkages with one of the eurozone’s so-called ‘Pigs’ (Portugal, Ireland, Greece and Spain), led to Northern Ireland contracting a ‘swine-flu’.
As a result, Northern Ireland is now experiencing the economic chill from its closest neighbour and a lengthy period of ‘Southern Discomfort’.
It is important to note, however, that the local economy was already shivering as it had already contracted its own property-induced flu.
Since then, the local economy has stabilised, but it has been unable to shake off a heavy economic cold. With the eurozone likely to enter recession and the ongoing sovereign debt woes, these factors will simply delay Northern Ireland’s recovery. The local economy will be pulling a ‘sickie’ for some time yet.
Over the past year, the only part of the Northern Ireland showing any meaningful recovery has been manufacturing. This has been due to the fact that export markets, outside of the Republic, have been relatively buoyant.
However, the rapid economic slowdown is going to partly close, but not shut, that door. This will limit the economic uplift from an export-led recovery.
Meanwhile, the domestic economy within Northern Ireland remains pretty much flat on its back.
Northern Ireland will also not be immune to the rising funding costs within the wholesale money markets. This makes the cost of financing the recovery more costly than it otherwise would have been.
The two most important factors behind a Northern Ireland economic recovery are the strength of the recoveries in the UK and the Republic. In recent weeks, the economic outlook for both these economies has deteriorated markedly with growth forecasts being scaled back.
These two economies are essentially the two tow-trucks for Northern Ireland’s economic recovery. But with economic growth slowing to a pedestrian rate, if not a standstill, these trucks have temporarily run out of fuel, largely due to the economic and financial market deterioration within the eurozone. Therefore, the biggest impact of the eurozone downturn on the local economy stems from the indirect impact on the economic growth and public finances prospects of the UK and RoI tow trucks.
The Chancellor recently provided us with a sobering assessment of the health of the UK economy and its public finances. Put simply, the prognosis is far from good with more tax rises and deeper public expenditure cuts for longer than was previously thought. For a public- expenditure driven economy, such as Northern Ireland, the next two parliaments of fiscal pain will hurt.
Meanwhile, this week our nearest neighbour — the RoI — will receive yet another austerity budget. As we saw recently with the ‘Enda the road for the A5’ the economic and financial impact of this will be felt here too.
While we will not be leaping out of the sick bed anytime soon, it is important to remember that, as with all colds, we will recover from this one. The question is when and with what prescription? Locally, Northern Ireland must take its own medicine, but much will depend on what is administered at a eurozone level. In the meantime, while we are laid up it is perhaps worthwhile bringing forward, rather than pushing back, some of that surgery (public-sector reform) we have talked about.
Conall MacCoille, Economist at Davy
Surveys of economic activity for both the services and manufacturing sectors suggest that the eurozone economy is now contracting.
As the European debt crisis has intensified investors have become increasingly concerned about the solvency of both governments and banks.
Hence, funding costs for both sovereigns and banks have soared.
Collapsing consumer and business confidence has led households and companies to sharply reduce their spending. The euro area economy is now on the brink of a double-dip recession.
How will this affect Ireland’s economy? The main channel will be reduced demand for Irish exports. The euro area economy is a very important export destination for Ireland.
However, it is very difficult to be certain what the impact on the Irish exports will be.
As the Irish economy has become increasingly specialised in internet and communications technology, business and financial services, those sectors’ share of total exports has expanded.
The services sector now accounts for half of Irish exports. So Ireland’s export prospects will depend on how these niche sectors perform.
Similarly, Ireland’s manufacturing exports are highly concentrated in chemicals and pharmaceuticals.
And the food and beverages sector remains an important export sector for Ireland.
To some extent these sectors are characterised by investors as defensive in nature. That is, they are likely to perform relatively well in a recession, compared with more cyclical sectors such as construction or production of capital goods.
It may be that Ireland’s export sector can weather a double-dip recession better than other countries. That said, all in all a double-dip euro area recession is clearly bad news for Ireland’s export sector and most commentators expect Irish export growth to slow next year.
A second channel through which the European debt crisis could affect the economy is through reduced credit availability.
In the UK, funding costs for banks have increased sharply, with premia on credit default swaps for major UK banks surpassing even the levels of late 2008 during the worst of the global financial crisis.
If these funding pressures persist they will become evident in higher borrowing costs for UK households and companies.
Indeed, the Bank of England’s credit conditions survey suggested that UK lenders expected to pass on higher funding costs to households and companies in the fourth quarter.
However, Irish consumer and investment spending have already been squeezed by a much sharper contraction in credit availability than experienced in the UK or euro area.
Irish households and companies have already adjusted their spending plans in response to the tightened credit availability.
And Irish banks remain reliant on the European Central Bank funding support. So the tensions in private funding markets will have a limited impact on Irish banks, which are largely shut out of those markets.
Similarly, the Irish Government’s funding needs will be met by the EU and IMF until 2013 as part of agreed fiscal adjustment program.
So the recent rise in Irish bond yields, back towards 10%, will not have an immediate impact on the Irish Government’s fiscal position. That said, the Government’s stated aim is to return to markets as earliest opportunity ahead of a large bond redemption in early 2014. With investors now busy deserting European bond markets the return of the Irish sovereign to the bond market looks ever more remote.
The third channel is the negative impact of the debt crisis on consumer and business confidence.
Since the recession began Irish households have increased their savings. The savings ratio in Ireland is now above 10% compared to around 5% in the UK.
In part, these high savings reflect uncertainty about economic prospects. And with the European debt crisis intensifying consumers are all the more likely to maintain high levels of precautionary saving.
Similarly, investment is likely to recover only gradually as companies remain nervous about the economic environment.
Of course, many commentators have speculated that extreme events such as the break up of the euro could now be likely.
However, it is almost pointless to analyse how such a scenario might play out. Certainly, the impact on the European economy could be disastrous.
But no one can judge with any confidence what the quantitative impact on economic activity might be. For now, the most likely outcome seems a sustained period of uncertainty with European policymakers taking sufficient steps to avoid catastrophic events. That said, the market’s faith in European policymakers’ resolve has been sorely tested. Indeed, German opposition last week to EU Commission proposals for common debt issuance suggests an agreed solution is some way off. However, with even Germany now struggling to raise finance in bond markets, the end-game for EU policymakers may finally be approaching.