Fortune is smiling on the Irish economy

Date: 17/09/1998

Alison Cottrell
IRELAND is special.

It is a member of economic and monetary union, and yet shares a land border and the bulk of its trade with a very large non-EMU participant and a sea border with the rest of the euro-zone.

Its growth prospects for the coming few years put all of its EU and most of its Organisation for Economic Cooperation and Development (OECD) neighbours in the shade. In 2000-03, the OECD sees Ireland's economy growing by 5.5% - a rate on a par with Poland, Mexico and Turkey, and more than double the 2.6% assumed for the Union as a whole.

The Irish government recently revised its growth estimate for 1998 up from 8.0% to 8.7%. This would produce a budget surplus of 1.7% of gross domestic product, (although everyone else puts this closer to 2% with a higher surplus to follow in 1999), and a debt ratio falling to a sub-Maastricht 55.4%.

Little wonder that Irish eyes are smiling, and the gleam is nowhere brighter than on the faces of Dublin property owners.

Fuelled both by an economy which expanded by 41% in the four years to 1997 and, more recently, by the expectation of German-level interest rates, house prices in the capital have been soaring: up by 39% between 1995 and 1997.

Business and consumer confidence has been bolstered by both fiscal and monetary policy. True, Central Bank of Ireland governor Maurice O'Connell continues to drag his interest-rate feet. The repo rate is still at the 6.19% level of its birth in October last year.

Nevertheless, both consumers and O'Connell know precisely in which direction the rate is going, and the former are acting on that knowledge.

Official stubbornness about cutting short-term interest rates has not stood in the way of convergence of long-term rates and these have supported growth, particularly once inflation is taken into account. Nor have Irish businesses had to endure the exchange rate squeeze inflicted on their counterparts across the Irish Sea and, of course, in Northern Ireland.

While imported EMU monetary policy is helping to drive GDP growth, fiscal policy is scarcely a laggard in the motoring stakes.

The Celtic Tiger may have learned to roar on the back of EU cash transfers, which are certainly significant, but national budgets have themselves been fuelling the feel-good factor.

Prime Minister Bertie Ahern has already promised direct tax cuts in 1999, targeted this time at low-income earners, and the trade unions have threatened to break the current three-year national wage pact if the government proves less than generous.

The result of all this is inflation, measured by the consumer price index (CPI), accelerating to 3.2% - the highest in the euro-zone - compared with the 2.0% originally forecast, although it should dip below 3% by the end of the year.

But it would be unfair to see in this acceleration a sign of worse to come. The recent rise has had less to do with wage pressures than with the fall in the punt, not to mention the impact of bad weather on fresh food prices.

In joining EMU, and especially in joining before the UK, the Irish political élite took a gamble.

An inappropriate monetary stance was clearly going to be the price of joining an EMU with which Ireland was not fundamentally convergent, but the perceived longer-term benefits outweighed the economic costs. However, the costs have to be paid.

For the Irish government, this means a choice between a tighter fiscal policy to offset inappropriately low interest rates or the risk of inflation. Ahern has had few qualms about opting for the latter and, the recent CPI not withstanding, the near-term odds remain in the gambler's favour.

This is not to play down the problems in prospect should the present incomes policy break down or fail to be renewed. Nor is it to suggest that Ireland will suffer no loss of competitiveness over the next few years.

It will; not least against a German economy which is also enjoying falling labour costs and which will probably benefit from lower non-wage contributions and taxes in the first year of its next government's life.

Should inflation start to rise on more fundamental grounds, there will be no help from an Irish-friendly monetary policy unless, by sheer coincidence, France and Germany just happen to be in the same boat.

Ireland accounts for just 1% of euro-zone GDP. Not all central bankers are equal. From an EMU-wide perspective, even an overheating and inflating Ireland would be a local problem rather than a general emergency.

Fortunately, and despite those Dublin property prices, the Irish temperature has not yet reached overheating on the economic thermometer and high GDP growth rates should not be allowed to cause unnecessary fears.

Irish inflation is, it is safe to say, going to be at the top end of the EMU CPI range for quite some time.

Yet this does not mean Ahern's bet is lost - and just as well. If his luck takes a turn for the worse, the problem will be all his and not European Central Bank president Wim Duisenberg's.

Alison Cottrell is chief economist at PaineWebber International (UK).