Public Information Notice No. 97/14

Press Information Notice: Press Information Notice: IMF Concludes Article IV Consultation with Ireland

July 25, 1997

The IMF Executive Board on July 2, 1997 concluded the 1997 Article IV consultation¹ with Ireland.

Background

Outward-oriented policies, financial discipline, wage moderation, and significant EU assistance have yielded dramatic progress for the Irish economy over the past decade. Since 1987, growth has averaged almost 5 percent per annum--the fastest rate in the EU--while inflation has been maintained consistently below the EU average.

The cornerstone of Ireland's growth performance has been an economic strategy focused on inward foreign investment in dynamic, export-oriented activities (such as microchips, software development, and pharmaceuticals) that has reaped the benefits of globalization and technological change. Ireland's success in attracting these investments reflects a stable macroeconomic environment, favorable costs, a youthful, fast-growing, and increasingly well-educated labor force, a business-friendly tax regime, and the country's position in the EU. Real GNP rose by almost 7 percent in 1996, led by domestic demand. Personal consumption rose by 6 percent, buoyed by income growth, and investment increased by 15 percent, reflecting strong residential and commercial construction. Although exports of goods and services rose by 10 percent, the current account surplus narrowed to 2 1/4 percent of GNP, reflecting an increase in capital goods imports.

Inflation has declined over the past year to 1.5 percent as of May 1997. This trend reflected exchange rate appreciation during 1996, a benign external price environment, and continued wage moderation. A new three-year centralized wage pact agreed in January 1997 stipulates wage increases averaging 3 percent per annum.

Job creation has been exceptional, with employment rising at an annual rate of 3.9 percent during 1994-96. Rising labor demand (particularly for skilled workers) has induced the return of earlier emigrants--whose qualifications and experience acquired abroad has helped raise further the skill level of the labor force--and encouraged inward migration of non-Irish workers, especially from other EU countries. Increasing female participation has also boosted labor supply growth, which averaged 2 1/4 percent annually during 1994-96. As a result, the decline in unemployment, while significant, has been less than commensurate with job growth. Long-term unemployment, concentrated among two groups with low skills--displaced older workers and early school leavers--remains a serious problem.

Fiscal policy in recent years has been geared to keeping the deficit comfortably within the Maastricht reference value of 3 percent of GDP. The 1996 general government deficit (GGD) was significantly lower than budgeted (0.9 percent of GDP compared with 2.6 percent), owing to a surge in corporate and other tax receipts as output growth exceeded expectations. The budget for 1997 targeted a GGD of 1 1/2 percent of GDP and a further decline in the debt ratio to 69 percent of GDP. Fiscal developments so far in 1997 have been encouraging, with strong growth in revenue suggesting that the GGD will turn out below 1 percent of GDP.

The 1997 budget was the first to be couched in a medium-term fiscal framework, which envisaged that the GGD would remain at about 1 1/2 percent of GDP through 1999. The new Government elected in June 1997 established more ambitious goals, announcing that provided its expectations for economic growth in the coming years (4-5 percent per annum) were fulfilled, the deficit would be eliminated within two-three years.

Irish monetary and exchange rate policy is focused on the objectives of price stability and fulfillment of the conditions for adoption of the Euro. Within the exchange rate mechanism (ERM), the Irish pound has fluctuated substantially from 8 percent below its central rate against the deutsche mark in early 1995 to a peak of 11 percent above in early 1997. These moves were associated with fluctuations in sterling, reflecting the significant, albeit declining, share of Irish trade that is with the United Kingdom. The link with sterling has recently appeared to weaken: the Irish pound weakened sharply in late April, both in the ERM and against sterling, as markets speculated that the Irish pound might be converted into Euros in 1999 at a rate below that implied by its early 1997 levels in the ERM. The currency steadied following an increase in official short-term interest rates (from 6 1/4 percent to 6 3/4 percent) on May 2. At end-June, the Irish pound stood at £stg 0.91 (over 12 percent below its August 1996 peak) and over 9 percent above its central rate against the deutsche mark.

Recent economic indicators point to growth of at least 6 percent in 1997. Trends in labor supply and productivity suggest that a pace of expansion well above the EU average is sustainable over the medium term.

Executive Board Assessment

Executive Directors commended Ireland's impressive economic performance, marked by rapid growth and job creation, declining unemployment, and low inflation. Ireland had made welcome progress in raising living standards and appeared well positioned to be among the first members of the euro area. Directors considered that Ireland's strategy of macroeconomic stability, outward orientation, and social consensus deserved much credit for those achievements. The policy challenge was to sustain those achievements into the medium term.

Directors were of the view that continued growth at the pace of the past few years carried risks of overheating. They encouraged the authorities to be vigilant for signs of emerging strains, with particular attention to the tightening labor and housing markets. They, therefore, welcomed the authorities' readiness to tighten macroeconomic policies as needed.

Directors pointed to the policy challenges that would be associated with Ireland's adoption of the euro. First, the prospective loss of monetary independence would add to the demands on fiscal policy. Second, further progress in structural reforms and strengthening incentives was required to bolster the economy's capacity to handle shocks. Directors noted that the current period of strong economic performance offered an ideal opportunity for actions in that regard.

Monetary policy had delivered impressively low inflation during a sustained period of rapid economic growth. Directors noted that the implementation of monetary policy in recent months had been complicated by the Irish pound's strength in the ERM and by market expectations that Irish interest rates would converge downward by the start of EMU. They agreed that, given the economy's robust growth, the central bank should not seek to hasten that convergence process, and that the recent policy tightening had been appropriate.

Directors commended Ireland's long track record of low fiscal deficits and a sharply declining debt ratio. However, Directors expressed concern about the procyclical stance of fiscal policy in the current year, owing partly to the front-loaded tax cuts in the budget. They thought it would be desirable to tighten fiscal policy, focusing on expenditure restraint particularly restraint on public sector pay. They noted that renewed slippages from announced intentions to limit the growth of current spending would reduce the scope for tax reform and weaken the credibility of fiscal policy.

Directors welcomed the adoption of a medium-term framework with the 1997 budget. However, they considered that more ambitious fiscal objectives were warranted by the cyclical position and the increasing constraints on monetary policy, the provisions of the Stability and Growth Pact, and the prospect of lower EU transfers in the medium term. Directors suggested that it would be desirable to aim, at a minimum, at fiscal balance by 1999 and to orient the 1998 budget accordingly.

Directors welcomed the further progress in narrowing the gap between the standard and 10 percent corporate tax rates, and encouraged the authorities to move to a unified rate.

Directors supported the increased emphasis on an integrated approach to strengthening work incentives in the reform of the labor market. On the tax side, priority should be given to reducing the high marginal tax rates faced by those leaving unemployment for entry level jobs. Benefit policies should ensure that work incentives were improved by raising payments to the unemployed by less than wages, and by steps to diminish the differential between child benefits for the unemployed and those at work. Directors also emphasized the importance of measures designed to prevent young school leavers from sinking into long-term unemployment. Regarding the authorities' intention to introduce a national minimum wage, it was noted that minimum wages should be set consistent with the productivity of lower-skilled labor, so as not to affect adversely the re-entry of the long-term unemployed, or the entry of less-qualified young people, into the labor market.

Directors stressed the importance of continued wage moderation embodied in the terms of the new centralized pay agreement to guard against price pressures and preserve employment prospects. They underscored that, in order to avoid possible loss of future fiscal policy flexibility, the associated tax and spending concessions should be conditional on realization of the growth assumptions underpinning the agreement.

Directors welcomed the strengthening of the Competition Authority and encouraged rigorous scrutiny of restrictive practices. They also encouraged a more active privatization policy.

Directors observed that rapid credit growth, rising asset prices, and competitive pressures in the financial sector posed challenges for supervision of credit institutions. Continued vigilance was warranted to ensure that those institutions remained adequately protected against adverse shocks.

Directors commended the authorities for the increase in official development assistance.