Wednesday, December 15, 2010

Ernst and Glum

Ernst and Young today released a winter forecast of the eurozone economies.  Most of the interest has focussed on their pessimistic forecasts for growth in the Irish economy.  The full report can be read here with the sub-section on Ireland available here.  This is key forecast table extracted from page two of the second linked document.  Click to enlarge.

Ernst and Young Forecasts

Although we are not told we must assume that the growth rates given here are real growth rates.  If we compare these estimates to the current Department of Finance Forecasts we see the gap that exists.

Forecast Comparison

Over the period 2011 to 2014 the DoF predict an average annual real GDP growth rate of 2.7% and with a forecast annual inflation rate of 1.3%, the National Recovery Plan is based around a 2014 nominal GDP level of €183.5 billion.

In stark contrast E&Y have an average annual growth rate of only 0.8% over the same period.  With an average expected inflation rate of 0.0% over the period this implies that E&Y’s forecast of nominal GDP in 2014 is €162.2 billion. 

It is worth noting the nominal GDP in 2007 was €189.4 billion in 2007.  And that this time last year the DoF was forecasting that nominal GDP in 2014 would be €204.8 billion!  Here are the three forecasts.

GDP Forecasts

The importance of nominal GDP is that it is used as the denominator in the debt/GDP ratios that are being imposed on us.  To achieve the 3% budget deficit target by 2014 the original DoF’s figures would have allowed a budget deficit of €6.2 billion.  The revised DoF figures would bring this target down to €5.5 billion, with E&Y’s forecasts only allowing a budget deficit of €4.8 billion.

This might not seem like much of a change but based on E&Y’s forecasts this has to be a achieved on significantly less tax revenue (due to less economic activity) and increased social welfare expenditure (due to more unemployment).  In this environment €15 billion of adjustments may seem like a walk in the park. 

Based on E&Y’s projections it is likely we would need budgetary adjustments of about €25 billion.  So we would need three more Budget’s equivalent to last week’s €6 billion adjustment and the low lying fruit on capital expenditure has already been truly harvested.  Some tough decisions would lie ahead.

Of course, it is likely that E&Y’s forecasts will be wrong. All forecasts are wrong as they have as little idea as we do what the Irish economy will look like in four year’s time.  Like the rest of us they are guessing but they sure have changed their tune.

E&Y produce this eurozone forecast every quarter.  Their autumn report was published on the 30 September last (just 11 weeks ago) and can be read here.  Their table of forecasts on the Irish economy is on page 2.

EY Autumn

This was positively bullish compared to what they’re now saying.  Average GDP growth over the four year’s 2011 to 2014 was forecast to be 3.4%.  This is well ahead of the D0F forecasts released a few weeks later and used in the National Recovery Plan which they now describe as “overly optimistic”! 

They had an average inflation rate forecast of 1.9% for the period, again ahead of the DoF forecasts published a few weeks later, and an average unemployment rate of 11.0% which has now jumped to 15.0%.

In September they provided the following relatively positive conclusion:

Despite the difficulties the Irish economy is still facing in 2010, the outlook for a return to relatively strong rates of GDP growth forecast over the medium term, well above the growth expectations for Greece and Portugal, are still maintained. This is premised on Ireland’s core economic and competitiveness fundamentals and the fiscal measures already in place. Although additional new fiscal measures will be required for 2011 in the December budget.

Now the tune is

The main drag on Irish GDP growth in the next two years will come from domestic demand. Beside the direct negative impact of the fiscal measures, growth will be dampened by a range of related factors that include a large out-migration flow of people (and their skills and spending) and a likely rise in retail interest rates that will impact on consumer spending and housing repossessions. Meanwhile, the large excess supply of housing that may take years to clear will be a significant drag on residential investment. Against
this backdrop, the prospects for business investment are also bleak.

As such, we do not expect the domestic economy to recover until a number of years into the fiscal adjustment cycle, and until after the banking system is restored to health and the housing market returns to some degree of normality.

They have downgraded their growth forecasts because of fiscal measures, outward migration, rising retail interest rates, excess supply of housing and problems in restoring the banking system to health.  Did they not know about these when they made their Autumn forecasts back in September?

Although there has been a huge amount of activity on the economic front in the past two months, the real economy has not gotten any worse.  What we have actually seen is a realisation of how grave the problems the Irish economy face actually are.  This realisation is a good thing.  The economy itself has not suddenly deteriorated to the degree suggested by the E&Y forecasts.  It seems they are buying into the mantra “if you are going to forecast, forecast often”.

No comments:

Post a Comment