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GDP Growth Unexpectedly Slips

GDP growth unexpectedly slips into negative territory in Q4; GDP fell by 0.3% in 2013 as a whole, though GNP – perhaps a better indicator of underlying conditions at present – rose by 3.4%

Today’s fourth quarter GDP figures were softer than expected, with a 2.3% quarterly decline defying expectations for a 0.4% q/q increase per the Reuters poll of analysts.  The Q4 drop resulted in a reversal of prior improvement in the trajectory of the annual growth rate, which slipped from +2.7% in Q3 to -0.7% in Q4.  For 2013 as a whole, real GDP fell slightly (by 0.3%) last year relative to 2012 as the economy’s output contracted for the first time in three years, following growth of 2.2% and 0.2% in 2011 and 2012 respectively.

The Irish national accounts continue to be heavily influenced by shifts in net factor income (NFI) flows from the rest of the world.  This is the difference between investment and labour income earned abroad by Irish companies and workers and similar incomes earned in Ireland by non-residents.  In Ireland these flows are typically substantial and negative on a net basis, partly but importantly reflecting profit outflows linked to the large stock of FDI located here.  One implication is a well-documented sizeable downward levels adjustment as one moves from measures of GDP to GNP, as the latter metric strips out such factor flows (though over time their respective growth rates tend to correspond fairly closely).

In the final quarter of last year, there was a large fall in net factor outflows reflecting a decline in overseas-destined profits.  In turn, this had its origins in weaker profitability in some key FDI sectors including pharma (reflecting the patent cliff) as well as computer services (i.e. software).  This decline in factor outflows served to boost Q4 GNP which rose by 0.2% q/q, though this was also lower than (the +0.7% rise) expected by the consensus.  In fact, weaker profit outflows were a theme through 2013, in the process leaving y/y GNP growth at 4.2% in Q4 and at 3.4% for the year as a whole.

Investment trends are very strong, while exports also picked up in Q4; imports were a large drag, however

Investment trends are very strong, while exports also picked up in Q4; imports were a large drag, however

While the news on the headline aggregates for Q4 was disappointing, the detail of the report does offer some important evidence of underlying improvement in several areas of the economy.

Notably, the final quarter saw a further expansion of investment which rose by 3.1% q/q, building on strong gains in the prior two quarters.  This leaves the annual pace of investment growth running at over 20% at the end of last year – the strongest increase in the capital stock since 2003.  The figures for total investment continue to be weighed down by large declines in aircraft investment (a part of investment which tends to have little impact on the domestic economy as new aircraft deliveries are imported).  Excluding aircraft, growth in investment is closer to 25% – the fastest growth rate on record (data go back to 1998).  Growth in non-aircraft machinery and equipment spending is particularly robust at almost 50% y/y (also a record high), underpinned by strong FDI activity.  Building and construction also continues to expand at a solid, if less spectacular, pace of 11% y/y reflecting a welcome return to growth in residential investment and continued healthy expansion in other building and construction.

Investment and selected components

Investment and selected components

Today’s figures also document improvement in export performance, with a 2.1% quarterly rise (from -0.5% in Q3) taking the annual rate of increase to 2.9% – the fastest since early 2012.  The pick-up was led by the services sector which continues to outperform the goods area (where the pharma sector remains a drag), with the respective annual growth rates at 7.1% and -1.9% respectively.  But despite the pick-up in exports, net trade was a major drag on Q4 growth.  This was because the final quarter saw a surge in imports which were up 6.3% q/q and 5.8% y/y partly reflecting the import content of the strong increase in machinery and equipment spending.  However, the growth in Q4 imports looks somewhat at odds with underlying trends so may be subject to future revision.

Elsewhere, consumer spending ended 2013 on a soft note, with a 0.6% quarterly decline, leaving the annual growth rate in negative territory for the fourth quarter in a row at -1.1%.  Higher car sales provided some uplift to spending on goods which was up 1.3% in Q4, but spending elsewhere was weak and services expenditure (including on transport and communications) recorded a second consecutive y/y contraction of 3.2%.

2013 was notable for the weakness of exports but also for the first rise in investment since 2007; Outlook for 2014 supported by a better international environment and solid momentum in both investment and employment

Standing back from the noise of the quarterly figures, a couple of observations are worth making about the economy’s performance in 2013 as captured by the national accounts release.

While both consumer and government spending remained under pressure, a good deal of encouragement can be taken from the strong turnaround in investment.  Notably, the strength here extends beyond the buoyancy of FDI flows, and now incorporates an increasingly well-established pick-up in construction.  Even the beleaguered residential sector is now experiencing growth, highlighting that one of the economy’s strongest headwinds over the past several years has now become a tailwind.  This is an important indication that the recovery has begun to broaden out beyond the export sector which was the sole driver of the return to positive GDP growth in 2011 and 2012.

Unfortunately while investment showed improvement last year, the export sector faltered as growth here barely remained positive at 0.2%, well down on the modest growth of 1.6% seen in 2012 and easily the weakest year of the four-year recovery of the sector which saw annual expansion of over 5% in each of 2010 and 2011.   Export weakness was due in part to a very poor 2013 for the euro zone economy which contracted by 0.4% last year, and in part to the ongoing adjustment within the pharma sector linked to the patent cliff.

Annual growth in GDP and components

Annual growth in GDP and components

As discussed above, weaker exports and profits from the foreign-owned sector continue to weigh on GDP, but GNP (which strips out profit outflows) is less affected.  GNP hasn’t been without its own drawbacks as an indicator in recent years yet, of the two measures, it may be providing a better steer on the underlying performance of the domestic economy at present.  The annual rise of 3.4% in GNP last year certainly chimes somewhat better with the 2.4% expansion in employment than does the outright decline – modest as it was at -0.3% – in GDP.

Irish GDP, GNP, Employment

Irish GDP, GNP, Employment

In any case, despite the somewhat disappointing end to 2013, we think that the economy’s growth dynamic should strengthen over the course of 2014.  While the patent cliff may remain a drag, overall export sector prospects are underpinned by a less uncertain and more favourable international growth outlook in which activity in Ireland’s main trading partners, including the euro zone, is set to accelerate.  Moreover, early-year indicators including retail sales, consumer confidence and house completions point to an encouraging start to 2014 for several areas of the domestic economy, where prospects for the coming year are buoyed by the solid momentum behind recent trends in both investment and employment.

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