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The Celtic phoenix

The hype surrounding the debt-fuelled surge of the Irish property market and its subsequent denouement only served to detract attention from the underlying strengths of the economy - we think that UK investors should now take a fresh look across the Irish Sea
October 24, 2014, Jonas Crosland & Mark Robinson

With fears mounting that Europe's recovery has stalled, it mightn't seem an opportune moment to highlight the progress being made by our friends across the Irish Sea. But we think that investors could benefit from taking a fresh perspective on the Irish Republic.

After all, it could be argued that investors have routinely been presented with a hyperbolic view of Ireland's economy since the dot.com boom. Talk of the so-called Celtic Tiger readily gave way to warnings over an existential crisis once the scale of Ireland's banking scandal became apparent. At its peak, Ireland's credit-fuelled real estate boom generated around a quarter of the country's gross domestic product (GDP) and a third of the government's tax revenues. Ireland's runaway growth and the subsequent ravages to its economy were both brought about by virtually non-existent risk controls on the part of the banks – domestic and foreign – but the polarised views on Ireland also obscured many of its underlying strengths.

So now that the dust has settled, is there cause for renewed optimism? Well, as recently as the first quarter of 2013 it might have seemed fanciful to suggest that Ireland's economy - which had contracted by over 3 per cent during the period - would become the stand-out performer in the euro-zone within a year or so. Ireland easily outpaced its European trading rivals during the second quarter of 2014, although any resultant optimism should be tempered by news that even the mighty German economy appears to be faltering. Nevertheless, you can only beat what's put in front to you. And Ireland's recent performance surely provides more evidence that its economic recovery is now firmly entrenched. The country's Central Statistics Office revealed that gross domestic product rose 7.7 per cent from the second quarter of 2013, with both exports and inward investment heading in the right direction.

 

Planning permission in Ireland 2001-13

Source: Office for National Statistics

 

State finances are also on the mend, with Ireland well on the way to reducing its annual deficit below the targeted rate of 3 per cent. That's some achievement when you consider that Ireland was unable to tap international bond markets as recently as 2012. With private and public debt in a parlous state, Ireland had been forced to seek assistance from the European Union (EU) and the International Monetary Fund (IMF). Hardly an ideal scenario, but Ireland's borrowing costs have fallen appreciably in the intervening period. As a result, the Dublin government now plans to retire a significant portion of the loans advanced by the IMF through private bond issues. This will save the Irish state an estimated €375m (£294m) in annual interest fees.

Of course, Ireland's recovery has gained traction partly due to the improved economic performance of the UK economy. Whatever the vagaries of the political relationship down through the years, there is little doubt that the UK and Ireland are joined at the hip from a trade perspective, so the continued rehabilitation of Ireland's battered economy also provides a fillip for its key trading partner across the Irish Sea.

As mentioned, the near-collapse of Ireland's debt-laden property and banking sectors diverted attention from the competitive strengths of the wider economy, ergo: low corporation tax, strong protection of property rights, efficient business regulations, a skilled youthful workforce and high productivity levels. Ireland is ranked ninth in the 2014 Index of Economic Freedom - a quantitative measure of the efficiency of government business regulation compiled by the US conservative think-tank Heritage Foundation. Judging by the latest rankings, it's easier to do business in Ireland than countries such as the US, the Netherlands and Germany – to name but a few. “Despite its recent difficulties,” according to the Heritage Foundation, “Ireland's overall level of economic freedom has been consistently competitive.”

Admittedly, the post-crisis exodus of Irish graduates' remains a cause for concern; a perpetual concern, so it seems. But a study published last year by the National Youth Council of Ireland concludes that the vast majority of young emigrants expressed the intention and desire to return to Ireland as the economy picks up – time will tell. It's also worth remembering that the wage competitiveness of Ireland's economy, like that of the UK, has been bolstered by an influx of immigrants from Poland and elsewhere in eastern Europe.

 

Europe's innovation-driven economies

And despite a fall-away in capital channels in the wake of the banking crisis, Ireland still boasts a high rate of start-up and enterprise businesses. This is best typified by the information and communications services sector, which is growing at an annualised rate of 9.9 per cent based on the three months to the end of July. Bulk chemicals are another area of strength, while food exports – traditionally a key area of the Irish economy - have risen by 42 per cent over the past five years as more primary producers switch to a 'value-added' model – there's no point in selling an apple, when you could turn it into cider and then sell that instead. Annual exports have grown to €10.3bn, well within reach of the 2020 target of €12bn set by Ireland's Department of Agriculture.

The Irish government has a number of initiatives aimed at funding start-ups, including direct investment in commercially-focused venture capital funds. For investors, it's worth noting that even with the contraction of 2008/9 factored-in; the Irish Small Cap Price Index delivered a total return of 29.3 per cent over the past five years – that's 54 per cent in advance of the total return of the FTSE UK Small Cap Index over the same period. In recovery mode the growth characteristics of the Irish market are all the more apparent, with the Irish index up by 68.7 per cent since October 2012. The recent return is even more impressive when you consider that about one-third of the weighted constituents are resource companies, many of which have underperformed the wider market during the period. An average P/E ratio of just 4.9 probably reflects the relative risk profile of the sector constituents, but it seems modest when set against recent returns.