Michael Wilson looks at why the Irish economic miracle has fallen apart and whether it can recover at a time of global recession

We haven’t had too many success stories to bring you in the last few Market Insider columns. We talked about Israel, whose stock market lost 45 per cent in the first 11 months of 2008.

We mentioned Spain, which surrendered 40 per cent of its value in just 41 weeks. But pray, a moment’s silence for a stock market which has lost a frightening 75 per cent of its value in less than two years. A market that used to be held up as one of the world’s most go-ahead investing environments. And a place that’s geographically closer to London than either Edinburgh or Glasgow.

Ireland’s rocket-like economic ascendancy over the past ten years has been one of the wonders of the Western world. As long ago as 2005, its per capita income overtook Britain’s to reach US$36,790 (measured in ‘purchasing power parity’ terms that make allowance for price differentials), compared with just US$31,150 for Britain. And in the same year, The Economist’s annual survey declared it to have the world’s best quality
of life, ahead of Switzerland, Norway, Luxembourg and Iceland.

Boom before bust
But then, in those days the Emerald Isle did seem to have everything going for it – world-scale banks and insurance corporations, high-performing technology companies and, of course, a booming consumer economy of its own. American companies were being lured to the country by the fact that Ireland’s currency was the euro but its language was still English, a fact which made it an ideal base for continental European ventures, and an excellent place to hedge against the dollar with euro-denominated ventures of all sorts.

Meanwhile, the Dublin stock exchange was attracting attention from fund managers all over the world, thanks largely to the low rates of corporate taxation that rapidly made the city a magnet for funds looking for a cheap offshore base. You would probably be surprised at how many of the funds your pension invests in are actually domiciled in Dublin, including hedge funds.

Even now, it is a fair guess that two-thirds of the total market value in Dublin comes from managed funds, not from ordinary shares. And, from a low point of 4,000 at the start of 2003, the main stock market index (ISEQ) soared to just under 10,000 in January 2007. How many other Western markets can you name that have ever made 150 per cent in four years?

Sadly, though, the descent into gloom and despair since then has been simply hideous. By the end of 2007, the ISEQ was down 30 per cent to 7,000, which seemed bad enough at the time. But as December 2008 got under way, it was struggling to hold at 2,500. Yes, it had fallen by 75 per cent in two years.

Strategic disadvantages
Why? Well, we could probably start by observing that practically every single one of Ireland’s distinctive industrial advantages has turned into a curse during the past 12 months. Banks, insurance companies and especially hedge funds have been in full retreat as the credit crisis has undermined their asset bases and forced them to retrench.

Technology stocks are facing tough times as risk aversion grows among investors. And even the euro has suffered at the hands of a strengthening dollar: by early December, a euro would fetch just $1.27, compared with $1.46 in January. That, of course, has encouraged American investors to pull their savings back from Irish funds and repatriate them to their home country.

But unfortunately, we can’t just blame everything on the financial markets, because a lot of the problems are 100 per cent home-grown. Let’s remember first that in 2007 the country’s economy grew by nearly six per cent. Then let’s compare that with 2008, when it shrank by 2.5 per cent. At the moment, even the most optimistic scenarios for 2009 point to another two per cent decline.

Deteriorating job markets are coinciding with a drastic fall in house prices, and unemployment is back above six per cent, most importantly because the construction industry that once fuelled Ireland’s growth is now in freefall. If we think we’ve got it bad in Britain, Ireland’s situation is much worse.

Growing deficits
Now, there’s no denying that Ireland’s property boom had become, frankly, rather troublesome. House prices had roughly doubled during the boom years between
2000 and 2006, reaching an average of €311,000 (£206,000) in January 2007, and
in the process they’d created an enormous surge in construction jobs, as well as the aforementioned surge in consumer confidence.

But house prices have fallen back by more than 20 per cent in the past 24 months, which, in turn, has had the effect of slamming the brakes back onto the economy. Retail sales are currently off by six to seven per cent, and even the country’s notoriously high inflation (five to seven per cent) has been moderating a bit under the pressure.

But the government’s scope for action is pretty limited. In theory, Ireland’s government is now under orders from Brussels to devote one per cent of Gross Domestic Product to an economic stimulus package during 2009. But in practice that won’t be easy to achieve, because the economic crash has slashed the central government’s tax revenues. In 2006, the country had a budget surplus worth three per cent of GDP; in 2008 it became a deficit of 6.5 per cent, and in 2009 the shortfall looks likely to grow to 7.5 per cent. Ouch.

In principle, the euro zone rules say that no government is supposed to overshoot its budget by more than three per cent of GDP, so Ireland’s 7.5 per cent would be way off limits. And, although many other member countries are currently cheating on this three per cent requirement, none is in quite such a fix as Ireland.

Euro divisions
Not a very good starting position, I think you’ll agree. But actually the trouble is happening elsewhere. It’s the Lisbon Treaty (the EU’s ‘covert constitution’) that’s taking centre stage in Dublin’s stormy relationship with Brussels. And the public mood is ugly.

Irish consumers are already outraged at the numbers of Poles, Latvians and other East Europeans who are moving into what they perceive as their jobs during these harder times. Consequently, they’re in no mood to approve the Lisbon Treaty, which most people perceive – probably wrongly – as being part of the expansion process that has brought the immigrant problem to their doorsteps. Last June, against government advice, the Irish rejected the treaty in a national referendum that set Brussels firmly back on its heels. They now have until next autumn to approve it at a second attempt, or the treaty will fail.

Finely balanced
This, if course, puts the screws on the European Commission. It knows that, if
the right concessions from Brussels are forthcoming during 2009 – for instance, an agreement to let Ireland retain its tax autonomy and its policies on divisive social issues such as abortion – then the Lisbon Treaty might just get approved, and then there might be more scope for a return of foreign investment to Dublin. But if no concessions appear, it looks like we’re in for more of the same.

For an investor, is it worth taking a gamble on Dublin? Possibly. In early December, Thomson Reuters calculated that a representative sample of Irish listed stocks (representing at least 75% of the market’s total size) would command a very low price-to-earnings ratio (p/e) of just four and would return a mighty dividend yield of seven per cent to investors.

That is substantially cheaper than London, whose p/e at the time was closer to eight. Assuming that you’re happy with the fact that the ISEQ is top-heavy with funds, some of which are bound to report poor results in the next six months, then there might be a case for dipping a speculative toe in the water. But you’re certainly going to need that lucky shamrock.