Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
A quick glance at any financial publication is enough to highlight that the Eurozone is currently facing a series of arguably unprecedented economic and political challenges. When considering where the troubles lie, at present, Greece and Spain (and perhaps France too) top the list of ‘problem’ countries. However, having undertaken a recent three-day trip to Ireland where I met senior figures from industry, finance, law and academia as well as participating in a number of conversations with local taxi drivers, I came away more convinced about the deep structural problems facing not only Ireland but also much of the rest of the continent. My findings reinforce our conviction at Heptagon of having very limited exposure to Eurozone equities within investors’ portfolios.
Ireland was the first country in Europe to enter recession when the credit crisis struck in 2008 and it was also the first to require a bail-out, from the European Union and IMF in November 2010, six months before Greece. The change in its circumstances from the ‘Celtic Tiger’ economy of the previous decade could hardly be starker. Between 1995 and 2000, average annual GDP growth in Ireland ran at 9.4%, which moderated to a still impressive 5.1% per annum in the following years through until 2008. Furthermore, during the period 1999 to 2007, Ireland enjoyed an unemployment rate of less than 5% and had a consistent government budget surplus, as a percentage of GDP.
By contrast, in 2009 GDP collapsed by 7% and rose by an anaemic 0.7% last year. Despite the nationalisation and recapitalisation of the country’s banks, the receipt of over €80bn in bail-out loans, and a change in government in 2011, there are still huge economic problems in Ireland, evidenced by the current level of unemployment and the size of the budget deficit. Unemployment now stands at 14.3%, down from a November 2010 high of 14.8%, but still at its worst level since 1993 and more than three percentage points above current EU average levels. Almost one in three (30.3%) 17-25 year olds are out of work. Meanwhile, the budget deficit ballooned to 31.2% of GDP in 2010, more than five times the European average. Last year it stood at 11.6%. Economists forecast an 8.3% deficit for 2012, the worst in the Eurozone (Greece is at ‘just’ 7.3% on consensus estimates) and do not see a return to surplus until well beyond 2015.
Against this background, it is hard to see how the economy can return to meaningful growth in the near term. The plans in place to deal with the situation appear highly optimistic: put simply, the numbers don’t add up. Something will still have to give and there will be more pain ahead. In November 2010, the then Irish government published its National Recovery Plan which foresaw the budget deficit limited to 3% of GDP (in line with the now seemingly defunct Maastricht criteria) by 2015, with this target being achieved through a combination of reductions in state spending and revenue-raising measures.
At present, the state’s income-take is below average and its expenditure above average, creating a clear problem and a persistent deficit. Based on OECD data, Irish government expenditure stands at 48% of GDP (against a 46% average) and revenues at 36% of GDP (vs. 41%). Viewed from a different perspective, there is currently a €12bn shortfall in Ireland between state income and expenditure (€35bn vs. €47bn, using 2011 numbers), a figure which the current government estimates will drop to €10bn in 2012 and by more in later years, through a combination of expenditure reductions and a growing base of tax revenues. Furthermore, it is not just these numbers that matter, as the Irish currently also need to find an additional €6bn annually to service the debt interest on loans from the EU and IMF.
However, the Plan’s goals look not only implausible, but also highly unachievable. The targets were predicated on the optimistic assumption of 2.75% annualised GDP growth from 2011-2015. Ireland fell well short of goal last year (with growth of just 0.7%) and the impact of the austerity measures implemented thus far can be seen in a 10.6% decline in investment demand and a 2.7% fall in personal consumption in 2011, according to the government figures. A vicious circle is at work: if growth is slowing, then it will become increasingly hard for the government to raise new tax revenues; and if more austerity means more unemployment, then growth will slow still further.
In April, the Irish Finance Ministry was unsurprisingly forced to revise its 2012 GDP forecast of to 0.7% (from 1.5% previously), implying no growth this year. Neither of Ireland’s major creditors, the EU and the IMF, accepts this forecast for growth, assuming 0.5%; the economic consensus is at just 0.4%. With industrial production and consumer confidence falling in both Ireland and its major (primarily European) export markets, the risk of these assumptions being downgraded further looks high.
Despite lower growth assumptions, the National Plan’s budget-cutting target, to bring the deficit to within 3% of GDP by 2015, remains in place. This implies there is a lot more austerity to come. At present, the government intends to reduce the public sector pay bill (currently 26% of GDP) by €1.2bn between now and 2014 and reduce staff numbers by 25,000, inflating unemployment numbers. To make matters worse, working hours for those staff remaining will likely have to increase (for no extra pay), while the benefits paid to those out of work will probably have to decline. Administrative civil servants and Irish central government staff are required to work 34.75 hours a week and work on average 225 days a year. This is towards the lower end of the range within OECD countries. Unemployment benefit is also currently very generous, the third most munificent in the OECD (after Denmark and Switzerland). An over 25-year-old receives a weekly benefit of €188 in Ireland compared to just £65 (c€80) in the UK.
These are just a few examples of the seismic changes with which the Irish will have to deal. Anecdotally, consumers are ‘treating’ themselves to luxuries such as ice cream less regularly and are even reducing expenditure on staples such as dairy products and bread. Meanwhile traditional ‘leisure’ pursuits such as Guinness consumption and visits to bookmakers are also being curtailed or scaled down. Price deflation in a number of sectors is occurring. How Ireland will achieve 2.2% economic growth in 2013 (the Finance Ministry’s current assumption) does not look at all clear.
In Ireland’s favour, many of its citizens have – at least so far – been quiescent, accepting the clear challenges facing the nation. Some of this may be a legacy of its history, a highly religious nation that has experienced severe challenges before (such as the Great Famine of the 1840s), and dealt with them. Net emigration – one of the previous responses - has been running at more than 34,000 a year for the last two years according to the Central Statistics Office, the highest it has been since 1989. The well-regarded Economic and Social Research Institute forecasts this could rise to at least 50,000 for each of the next two years.
If this is what is currently happening in Ireland more than two years since emerging from its first credit-induced recession and eighteen months after its bail-out and recovery plan, then it has the potential to be much worse elsewhere within the Eurozone, with more of the painful adjustment process still to come. Ireland comprises just 1% of the region’s population and its economy is ranked 57th in the world by size on IMF data. By way of comparison, Italy, for example, is ranked 8th on this measure and Spain 12th. Not only are these countries larger and more globally interconnected, but they also have significantly less compelling demographics and hence medium-term growth prospects. As a result, restructuring may be a lot harder.
In Ireland’s favour (and in contrast to Italy and Spain, Greece and France too), even with current net outward migration trends, the country is still benefiting from strong population growth, of more than 25% over the next 25 years according to the European Union. This is far superior the region’s average of less than 5%. Furthermore, Ireland has a very young and well-educated population. Just 11% of its citizens are aged over 65 (against an EU average of 17%) and more than 85% of current 20-24-year-olds have completed secondary education, the highest level in the EU. High-tech exports account for almost 30% of Ireland’s total, the third best figure in Europe, and well above the region’s 18% average.
If trends in Ireland serve as a proxy or lead indicator for what much of Europe has still to experience, then this reinforces our conviction for preferring to invest in businesses and external managers with limited exposure to the continent. Annualised returns from investing in Ireland (using the ISEQ index as the benchmark) have been -17% over the last five years, more than four times as bad as the European market and almost twice as poor as Spain’s main benchmark. Only the Greek market among those in the Eurozone has delivered a worse return for investors over this period. We do believe there are some structurally attractive investment opportunities within Ireland (such as Paddy Power, 22% returns over this period; and Kerry Group, 11% returns), but these investments tend to be few and far between, as could be said currently for those across much of the rest of the Eurozone.
Alexander Gunz, Fund Manager
Note: unless otherwise stated, all data in this report is courtesy of Bloomberg.
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