THE IRISH ECONOMY -- FEW OPTIONS LEFT

C O N F I D E N T I A L SECTION 01 OF 02 DUBLIN 000653 SIPDIS STATE PASS TO TREASURY FOR ATUKORALA E.O. 12958: DECL: 12/02/2018 TAGS: EFIN ECON ETRD PREL EI SUBJECT: THE IRISH ECONOMY -- FEW OPTIONS LEFT REF: A. DUBLIN 573 ¶B. DUBLIN 571 ¶C. DUBLIN 545 ¶D. DUBLIN 508 DUBLIN 00000653 001.2 OF 002 Classified By: Amb. Thomas C. Foley. Reasons 1.4 (b/d). ¶1. (C) Summary: Irish government officials told Emboffs that in the current economic environment it is "almost impossible" to come up with a plan to right the Irish economy. The government will not issue a mini-budget early in 2009 but it looks likely that there will be "adjustments" to the budget as events warrant. Private-sector economists continue to revise down their forecasts, with a fall in economic activity predicted of between 2.5 and five percent in 2009. We are also watching for potential problems with under-funded private pension funds and the possibility that the government and private equity firms may recapitalize Irish banks. In the medium-term, Prime Minister Cowen's focus now is to ensure the economy is on a sound footing in order to take advantage of an eventual upturn in the global economy. In the short-term, however, the Irish government is left with few policy options. What is increasingly clear is that they need to cut public sector spending and be straight with the Irish public about the state of the economy. End Summary. The Government's Finances -------------- ¶2. (C) Emboffs met recently with John Shaw and George Shaw (no relation),economic officials in the Prime Minister's office, and John McCarthy, the chief forecaster in the Department of Finance, to discuss current economic conditions. McCarthy said that forecasting anything in the current uncertain environment is "almost impossible" and that the government can only react given the fast pace of the downturn. He continued that the government's tax take is currently more sensitive to changes in gross domestic product than at any time in recent memory. As a result, he predicts that government revenue from taxes will fall ten percent in ¶2009. In light of this drop in revenue, he agreed that the only viable policy response is for a cut in government expenditure. Otherwise the government will be forced to borrow to finance current spending, which should be the last resort, according to McCarthy. ¶3. (C) Even though the economic situation has deteriorated rapidly since the government announced its 2009 budget (Ref B),John Shaw said that there will not be a mini-budget in spring 2009 as some economists have called for. He did indicate that there will be "periodic adjustments" in the government's fiscal stance as events warrant. He also said that the current wage deal agreed at the social partnership talks (Ref C) will not be abandoned in spite of the changed economic landscape. Shaw said that all agreed that this was the best deal to be had under the circumstances. ¶4. (C) George Shaw reiterated the government line that Prime Minister Brian Cowen and Finance Minister Brian Lenihan are committed to putting in place policies that will enable Ireland to begin growing as soon as global growth picks up. Among these policies, he highlighted the government's plans to foster increased research and development and investing in graduate-level education. Shaw said that these policies fit in with the broader policy of "moving the Irish economy up the value chain." Details of the plan are expected in the next few weeks but Minister Lenihan has already indicated that he will look at the tax treatment of intellectual property in 2009. The Broader Economy -------------- ¶5. (C) At a recent briefing, Jim Power, chief economist at Friends First, painted a very bleak picture of the economy for the next two years. In a trend now common among local economists, Power revised his growth figures downward for next year. He expects a fall in GDP of 2.6 percent in 2008 with the outlook not much brighter in 2009 -- GDP is forecast to decrease by a further 2.5 percent. Like one of the leading local think tanks, the Economic and Social Research Institute (ESRI),Power sees a rapid decline in consumer spending leading to much higher unemployment -- up from 5.9 percent in 2008 to 8.5 percent (or higher) in 2010. ¶6. (C) Power is not alone in his gloomy outlook. Economists at some of the leading banks are equally pessimistic. In fact, Pat McCardle, the Ulster Bank chief economist, described the deterioration in the economy as "shocking" and expects a fall in economic activity of close to five percent DUBLIN 00000653 002.2 OF 002 in 2009. He maintains that the Irish downturn is led by a sharp slowdown in the construction sector and predicts that the number of new homes completed will not bottom out until ¶2010. As a result of the property market collapse, McCardle expects new house prices to fall by 30 percent from its peak. He also predicts that consumer prices will fall in 2009, for the first time since 1946. Issues to Watch -------------- ¶7. (C) We will be monitoring the following issues: -- Potential Pension Fund Shortfalls: A leaked memo from Social and Family Affairs Minister Mary Hanafin to her government colleagues indicated that the deficit on private-sector defined benefit programs is between Euro 20 and 30 billion and that 50 percent of these programs could close in the next year. The leading employers association, Irish Business and Employers Confederation (IBEC),maintains that the shortfall is due to the rule that a company's pension plan must have enough assets to meet all of its current and future benefit responsibilities were the fund to cease operations. Because of dismal returns (over the last ten years funds are up only 1.9 percent),employers' contributions have risen significantly. -- Capitalizing Irish Banks: Responding to persistent calls to inject fresh capital into Ireland's moribund banks, Finance Minister Lenihan said that, while favoring capitalization from private investors, he would examine proposals for government investment on a case-by-case basis. Based on (admittedly) anecdotal evidence, the banks have become either unable or unwilling to extend credit over the past couple of months. The Bank of Ireland held discussions last week with four private equity groups to explore the possibility of selling off a stake in the bank. Comment -------------- ¶8. (C) The talk of economic doom-and-gloom has taken on a life of its own, supplanting the perennially favorite Irish conversation topics -- the weather and politics. While watchful for the occasional hyperbole, there is much that is wrong here. The government has no option at this point other than to cut spending but, of course, that will do nothing to boost the economy. The financial sector cannot be counted on to supply enough credit to get the economic engine going again and the hope that the global economy will rev up soon looks unlikely at best. Right now the government is bouncing from crisis to crisis but at some point it needs to get ahead of the game. Government officials need to better prepare the Irish public for what lies ahead. FOLEY