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This article is from our latest edition of MarketWatch.
16th November, 2018
Ireland's economy has come a long way in the past few years. 10 years after the onset of the global financial crisis, it is quite amazing where we are today when one stops to reflect on how far we fell during the depths of the crisis. Add to that accomplishment the new challenges we face in light of the United Kingdom's decision to exit the European Union (EU), and one must appreciate not just the extent of the recovery but the resilience of our ever changing economy. Many of the challenges of Brexit are yet to come as the UK and EU enter what should be the final stages of their divorce talks. The next stage will define our trading arrangements and provide clarity to Irish business in terms of the new costs and bureaucracy that will govern our north-south and east-west commerce.
Ireland’s recent economic performance has not been impacted by the ongoing Brexit negotiations. Gross Domestic Product (GDP) grew by an enormous 9% in the first half of 2018. This is flattered by the usual distortions from the multinational sector. We believe Ireland’s true underlying growth rate is closer to 5-6% driven by buoyant trends in employment, retail sales and tax revenue.
This is a world away from the situation in the United Kingdom (UK). The consensus is that UK GDP will expand by a mere 1.3% in 2018. Brexit uncertainties are clearly denting sentiment and spending. A recent Deloitte survey found that UK chief financial officers (CFOs) are pessimistic on their companies’ prospects, and hence, unlikely to raise their capital expenditure. Meanwhile, consumer confidence has faltered since the 2016 referendum, now at its weakest level in five years.
In Ireland attention is focused on the impact of sterling’s depreciation on exports, in particular, the agri-food sector where margins are often thin and squeezed by the exchange rate. However, UK CPI (Consumer Price Index) inflation has remained close to 3% (2.7% in August) on the back of higher import prices as exporters into the UK are rebuilding their profit margins, by passing on the costs of sterling’s depreciation to British households.
In short, the sterling exchange rate is only ever likely to have a transitory impact on Ireland’s economic performance. It is worth noting the UK now accounts for only 13.4% of goods exports, down from over 60% in the early 1970s.
The far bigger issue is what type of trade relationship the UK and EU will eventually agree. Of late, speculation has mounted that the EU could offer the UK a‘supercharged’ trade deal. However, this is merely part of the theatre assisting Prime Minister Theresa May usher a withdrawal agreement through the UK parliament.
The reality is that future trade relations will not be settled for a number of years. In the meantime it is crucial that the UK secures a transition period, maintaining the status quo of effective single market membership until the end of 2020. As long as the EU and UK can agree the ‘backstop’ solution on Northern Ireland and a withdrawal agreement there should be no impact on Irish/UK trade when Brexit occurs in March next year.
There have been some signs that the standoff in the Brexit negotiations is starting to hurt sentiment in Irish businesses and households. In September, the ESRI (Economic and Social Research Institute)/KBC Bank Ireland measure of Irish consumer confidence fell to its lowest level in over two and a half years. Similarly, the Bank of Ireland Economic Pulse survey suggests business confidence has faltered in recent months.
It is worth remembering Ireland has had a two speed recovery. Foreign direct investment has been exceptionally strong, accompanied by burgeoning activity in the multinational dominated, information technology and pharmaceutical sectors. However, the OECD (Organisation for Economic Co-operation and Development) has recently warned that productivity and investment amongst indigenous Irish small medium enterprises (SMEs) has been stagnant in recent years.
Of course, the Irish SME sector has been through an exceptionally difficult period. Over the past decade Irish SMEs have focused on repairing their finances rather than expanding their activities. Since 2009 bank lending to corporates, excluding property related sectors, has halved from close to €60 billion, to just €28 billion in June 2018.
According to the Central Bank one-in-two SMEs no longer had any debt in 2017, an enormous improvement from only one-in-four in 2013. For medium sized companies with debt, the average debt-to-turnover ratio has fallen from 75% to 28% over the past four years.
This is a stark improvement. However, it has come at a cost. Irish SMEs may have reduced their debts, but they have not invested to take advantage of growth opportunities. There is now a risk that the long-awaited recovery in the SME sector could be delayed. New bank lending to SMEs in the first half of 2018 was disappointing,
A recent survey by Allied Irish Banks found that almost 40% of SMEs had put off or postponed investment and expansion because of Brexit. The impact of this uncertainty could become more pronounced should the negotiations deteriorate. For example, the fledging recovery in homebuilding could be interrupted if companies put off decisions because of fears of a hard Brexit.
Some commentators have suggested Brexit could even be a positive for Ireland, by making Ireland more attractive to foreign direct investment relative to the UK. A number of companies have already relocated some of their business activities from London to Dublin, particularly in the financial sector.
However, these benefits should not be overstated. They will not compensate for the disruptive negative impact on the Irish economy from a hard Brexit. In any case, Ireland is already enjoying buoyant multinational sector activity, contributing to emerging bottlenecks particularly in Dublin, such as the lack of housing availability.
Recent reports have suggested the EU/ UK are close to concluding the backstop solution and withdrawal agreement. Of course, several obstacles remain for Theresa May to push a withdrawal bill though the UK parliament – not least opposition from the Democratic Unionist Party (DUP) or hardline Conservative MPs. However, our view remains that there is no realistic alternative to the UK effectively staying inside the EU single market for some time, maintaining the status-quo, at least in all but name.