Tough year ahead as demand drops off

THE Department of Finance published its annual Economic Review and Outlook for 2002 last week.

Official growth forecasts for 2002 have been revised down with real GDP now expected to rise by 3.6%, compared with the forecast of 3.9% underpinning the Budget for 2002.

A key element in this downward revision is projected slower growth in real personal spending of 4.3% compared with the original forecast of 5.7%. Even this revised figure lower forecast for personal spending may be too optimistic. Retail sales figures for June, published last Friday, show that sales volume fell by 1.1% in June over May and by 1% in the second quarter over the first quarter. Year on year, the volume of sales fell by 0.2% in the second quarter.

On the other hand, the performance of industrial production and exports may turn out to perform more strongly than currently assumed by the department. Manufacturing production rose 5.4% in the second quarter over the first quarter. In the first six months of 2002, the volume of manufacturing output was 9% higher than in the same period of 2001. However, a sizeable slice proportion of this growth was accounted for by multinationals.

It is possible, therefore, that the average growth in real GDP in 2002 could be close to the original figure of almost 4% that underpinned the revenue forecasts in Budget 2002. However, the spending mix is now now different than assumed at the time of the Budget.

As a result, growth in tax revenues is expected to fall well short of the original target. The department has put a figure of 500 million euro on this shortfall, but it could prove worse.

The deterioration in health of the public finances is one of the risks highlighted in the review. The department favours curtailing growth of public spending to leave room for infrastructural spending without recourse to significantly higher taxes.

A second risk factor highlighted in the review is the failure of wage and cost trends to decelerate in the light of weaker external and domestic demand. The review refers to the continued tightness of the labour market as a contributory factor. The main concern is that a continuation of recent wage and cost behaviour would damage Ireland’s international competitiveness.

Wholesale price data published by the Central Statistics Office (CSO) last week show the urgency of restoring more moderate wage increases in the manufacturing sector. CSO data for July show that factory gate prices decreased by 1.5% over June resulting in a year-on-year fall of 3%.

Factory gate prices for export goods fell by 1.9% between June and July and by 4.9% on an annual basis; prices for home sales decreased by 0.3% in July over June, but were still up 1.8% on an annual basis. The data also show that most of the indigenous manufacturers are experiencing increasing deflationary pressures, at least in terms of selling prices.

On the input side, there is some relief coming from the annual fall in the price of petroleum fuels used by industry but the CSO data show a 13.6% annual rise in electricity costs in July. Overall, therefore, energy costs , including electricity, were up 6.7% in the year to July 2002. Manufacturers may also get some relief in terms of lower import prices. However, the limited data available suggest that this has been small to date.

The combination of weak output prices, faltering demand for indigenous products and large increases in input costs, particularly wages, spells trouble for many companies. There is a real danger that in the context of maintaining some semblance of stability in the public finances in the next budget, the Government will resort to a significant rise in indirect taxes in the next budget in an effort to stabilise public finances. This would impact on the consumer price index; maintaining upward pressure on wages as wage earners seek compensation for the rise in living costs.

We expect the rate of inflation to average 4.6% in 2002 and 4.2% in 2003. But our forecasts for 2003 do not take account of any new indirect tax changes. The indications are , therefore, that in the absence of a significant improvement in Irish and global demand for goods in 2003, Irish companies will face a tough year in terms of improving their bottom line.

One way to improve the situation would be to improve their productivity performance. Some of this could come in the form of labour shedding.

Employment growth next year is likely to be modest as Irish companies come to terms with their cost base in the post Celtic Tiger economy.

John Beggs, chief economist, AIB Group Treasury