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New Irish economic growth data are encouraging
• Irish economic growth on stronger trend than previously envisaged.
• We now see GDP growth of 2.5% this year on fairly cautious assumptions.
• Separately, measurement changes have greater than expected impact.
• Smaller budget deficit to GDP ratio means smaller adjustment needed in Budget 2015.
• Adjustment of around €1bn likely to be sufficient to hit 3% deficit-to-GDP target.
New Irish economic growth data are encouraging in a number of respects. First of all, they suggest the Irish economy is now set on a stronger growth trajectory than previous national accounts data had implied. This makes them more consistent with other activity indicators. Second, changes in international standards for measuring economic activity mean the size of the Irish economy is larger than indicated by previous estimates. As a result, the ratios of the Government’s budget deficit to and public debt to GDP are somewhat lower.
Reflecting these influences and positive exchequer data yesterday, we think this year’s Government deficit is likely to be in the region of 4% of GDP compared to the targeted 4.8% figure. In turn, this implies the size of the adjustment needed to hit the 3% deficit target in the 2015 Budget is significantly lower than previously indicated. It is still fairly early in the year to make definitive judgements given considerable volatility in both growth and public finances data but, on current trends, an adjustment of €1bn should be sufficient to hit the target.
Data for the first three months of 2014 show unexpectedly strong quarterly GDP growth of 2.7%. The surprisingly large drop previously reported for the final quarter of 2013 of 2.3% has also been revised from -2.3% to -0.1%. So, the Irish economy seems to have a good deal more positive momentum at present than previously indicated by national accounts numbers.
The level of GDP in Q1 is some 3.6% higher than last year’s average, implying that even a flat trend for the remainder of the year would produce an outturn markedly higher than most forecasters envisaged. Today’s data show strength in the first quarter was concentrated in exports (+1.8%) and stock-building (contributing about 1 percentagepoint to GDP growth). Final domestic demand remained relatively weak with consumer spending falling marginally (-0.1%) and the very volatile investment aggregate dropping sharply (down 8.1% after increases of 5.9% and 8.9% in the two previous quarters.
Up to today, economists had some difficulty reconciling the weakness of previous GDP data for end-2013 with stronger signals on activity conditions coming from a range of other indicators. In contrast, today’s exceptional rise in GDP in early 2014 probably implies a pace of growth that is a good deal stronger than suggested by other data (and as such likely overstates the true rate).
Our inclination is to allow for a somewhat weaker trend in GDP over the remainder of the year than that seen in the first quarter, reflecting a combination of smaller contribution from net exports and a negative contribution from stock-building. As a result, on what we judge to be fairly conservative assumptions, we now think GDP growth will be about 2.5% in 2014.
Today’s national accounts data also contain significant historical revisions stemming from changes in the manner in which economic activity is measured worldwide. The new European System of National and Regional Accounts (ESA2010) replaces the current system (ESA1995) and is intended to capture more accurately the forms activity takes in a modern economy.
The most important of these changes is to the treatment of research and development. Previously this was regarded as an input to production and consequently ‘used up’ in that process. In a modern economy, such spending is regarded as a critical form of investment and as such is now being recognised as an asset and treated in the same way as other fixed assets as a final output. This methodological change serves to boost the measured level of Irish economic activity by some €7bn, or 4.1% in 2013.
In addition, the inclusion of estimates of illegal activity boost reported 2013 GDP by about €1bn (0.72% of GDP). Other smaller methodological changes and the more usual revisions to these data raise the level of GDP in 2013 by a further €2.2bn (1.3%).
While it was generally expected that the new measurement process would boost the level of GDP, most guesstimates envisaged a notably smaller increase of around 2% of GDP rather than the 6.5% adjustment reported today. As such, today’s release has larger than expected implications for the various measures of the health of the public finances that use the level of GDP as a denominator. So, for example, the 2013 deficit is now 6.7% of GDP rather than 7.2% of GDP and the end-2013 debt/GDP ratio now stands at 116.1% rather than the previously estimated 123.7%. While the revisions don’t transform the picture, they represent material (and helpful) differences.
These revisions have been applied to all data back to 1995. By raising the level for each year, in principle, this adjustment should not affect growth rates between years. However, because R&D spending has been less sensitive to the downturn than many other areas of the economy, the new method does have a marginal positive impact on Irish GDP growth rates in recent years. We estimate it boosted reported growth by about 0.1% in 2013.