The Boom-Bust Life Cycle of Ireland’s Balance of Payments and Net Foreign Assets

 

 

Ireland’s Current Account and Net Foreign Assets position have proved highly volatile since 1970, the earliest date for which data is available. The country was a net debtor for all of this period, with the exception of 1998 and 1999. Ireland ran current account deficits for all years except for the initial export-led phase of its ‘Celtic Tiger’ boom (1991-1999), briefly in 2003 after a mild recession, and again in 2010 as the country was forced to readjust after its property bubble collapsed.

Evolution of the Current Account

The Current Account deficit averaged -5.2% between 1970 and 1989, reaching as low as          -12.9% in 1981, when the full impact of the 1979 oil crisis (Ireland, being an island, is one of the most oil import dependent nations on Earth) and expansionary fiscal policy after the 1977 general election had filtered through.

From this 1981 nadir, the Current Account deficit narrowed rapidly over the course of the 1980s in the face of a brutal recession, being effectively in balance in 1987 and 1988, when the Irish economy had deteriorated to the point that IMF intervention was rumored to be imminent, but never materialized.

Ireland’s economic fortunes gradually improved after 1987. The combination of fiscal contraction and export-led expansion – driven by an increasingly robust multi-national sector – helped move the Current Account into surplus for the first time in 1991. It would remain in surplus, averaging 1.9% for the remainder of the decade. Having been the ‘sick man of Europe’, the term ‘Celtic Tiger’ was coined in 1994 to describe Ireland’s rapid economic growth during this period.

As consumption and inflation picked up, the Current Account moved back into deficit, never more than -1% until 2004 when the Current Account deficit jumped to -3.5%, rising to a peak of -5.8% in 2004. The export-led ‘Celtic Tiger’ phase of Irish growth can be said to have ended in 2004, giving way to a property, construction & consumption frenzy marked by surging imports, exponential credit growth, rising inflation, falling labor productivity and high but unsustainable economic growth.

House prices peaked in late 2006, falling slowly at first, the decline later picking up pace as the broader economy ran into difficulties in late 2007 and into 2008.

Ireland experienced its second wrenching recession in a generation over the 2008-2010 period. GDP fell by 12.5% in nominal terms (GNP by 17.3%). Prices and wages fell. Unemployment surged from 4.3% to 14.8%. House prices would fall by more than 50% by early 2012, with little prospect of early recovery, or even stabilization.

Faced with a ‘sudden stop’ in capital flows Ireland became unable to service its sovereign debt in late 2010, having to resort to an EU-IMF bailout. As consumption and investment collapsed, and exports held up remarkably well given the global financial crisis, Ireland’s Current Account moved back into surplus in 2010. With exports setting records in 2011, it is likely that the Current Account will move further into surplus as the country continues on a long, painful road to recovery.

Increasingly, Ireland’s capacity to run significant Current Account surpluses is likely to be constrained by higher and higher interest payments to foreign holders of Irish sovereign debt. Not only has the sovereign debt increased greatly in recent year but, consequently, so has the average interest rate paid on this debt.  This will become increasingly salient if and when Ireland ‘graduates’ from the EU-IMF bailout program and begins to re-finance its debt at market rates.

Evolution of Net Foreign Assets

Net Foreign Assets, or Net International Investment Position, is a measure of a country’s external wealth, i.e. the sum of its foreign assets less the sum of domestic assets held by foreigners. Typically, one would expect the NFA to be determined principally by the cumulative total of net annual flows, i.e. the historic accumulation of current account balances. Adjustments are also made, however, for the impact of changes in asset values, exchange rates and other corrections.

A simple glance at the accompanying graph informs us that there is far more in play in Ireland than simply the accumulation of current account balances, NFA proving extraordinarily volatile over the years. For instance, the NFA stood at -5.6% of GDP at end 2006, but had deteriorated to -102.4% by end 2009. Cumulative Current Account deficits amounted to -12.9% over the same period. Similarly, Ireland’s NFA improved from -44.1% at end 1996 to 47.5% at end 1999 when the cumulative Current Account surpluses amounted to 3.8% of GDP.

Ireland was a net debtor for all but two of the years between 1970 and 2010: 1998 and 1999. Although this came after a decade of modest current account surpluses, it is rather the extreme volatility in other factors which combined to make Ireland a short-lived net creditor.

One factor which may serve to explain the volatility in Ireland’s NFA position is the size of its international financial services sector vis-à-vis the size of its economy. Thus, Ireland’s NFA may include the impact of changes in the very large gross investment positions of private sector entities registered in Ireland, which are in fact multi-national banks and investment firms. In effect, this overstates Ireland’s gross assets and liabilities, the NFA thus failing to give a true and fair representation of Ireland’s external wealth or lack thereof.

Further work must be done to disaggregate Ireland’s NFA position so as to be able to present it in the most accurate light possible. This is of concrete relevance, for instance, because the NFA is one of the six criteria being used by the EU for identifying the existence of intra-European macroeconomic imbalances.

Life Cycle

Ireland could be classed as having been an immature debtor from 1970 to 1990, when it had a negative Net Foreign Assets and consistently ran Current Account deficits. Ireland became a mature debtor, running Current Accounts surpluses but retaining negative Net Foreign Assets until 1997. Ireland briefly became an immature creditor in 1998 and 1999 before again becoming an immature debtor (without serving time as a mature creditor) in 2000.

With the exception of a modest Current Account surplus of 0.1% in 2003, Ireland retained immature debtor status until 2009, before again becoming a mature debtor in 2010. With its highly negative Net Foreign Assets position, weak domestic demand on the medium-term horizon, and prospects for economic rejuvenation resting on an export-led recovery, it is likely that the country will remain an immature debtor for some time to come.

*****

This was an assignment for my course in Global Economic Policy with Robert Mundell.

With thanks to Philip Lane for kindly providing his data set – from work with Milesi-Ferretti – going back to 1970. His paper’s treatment  of this issue does more justice to it, of course, than I could ever hope to within the scope of this assignment.

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