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Silken Change from One PIIG
11/04/2011 8:30 am EST
With all the doom and gloom surrounding Europe’s periphery, you’ll be surprised to hear that Ireland, one of the original PIIGS, is now the second-fastest-growing economy in the European Union, observes Nicholas Vardy of The Global Guru.
Which country is the fastest growing member of the EU? Believe it or not, it is tiny Estonia.
Both Ireland and Estonia offer real-world case studies on the results of pursuing the path of austerity derided by the likes of The New York Times columnist and Nobel Prize-winning economist Paul Krugman. But Ireland’s emerging economic turnaround confounds Krugman’s ridicule.
It turns out that if you’re a small country on the verge of bankruptcy, taking the bitter medicine upfront just may be worth it in the long run. And betting on Ireland as Europe’s top turnaround play just might make you a pretty penny over the next 18 months.
Ireland’s economy has been dire. House prices have fallen 43% from their 2007 peak, making Ireland the equivalent of the worst housing market in the United States. Unemployment stands at over 14%. A year ago, the government was forced to go hat in hand to the EU and the International Monetary Fund (IMF) for a bailout worth €85 billion.
The medicine administered to the patient has been bitter. A combination of tax increases and spending cuts worth €30 billion ($41 billion)—or 20% of a single year’s GDP—imposed between now and 2014 have weighed heavily on the economy. That’s the equivalent of about $3 trillion of cuts in the US economy over the next three years.
But the Irish patient has now been taken off life support. Even as the United Kingdom and others struggle with the prospects of a double-dip recession, the Irish economy has now grown for two consecutive quarters, making it the second-fastest-growing economy in the European Union (EU).
The central bank has recently upped its growth forecasts. Labor costs have plummeted, and Ireland’s current account has swung back into surplus.
Yes, the government’s budget deficit will hit 10% this year. But that’s a big drop from last year’s 32%. And the current government intends to cut the deficit to 3% by the end of 2013. Having cajoled creditors into accepting a 300-basis-point haircut on the interest rate that they charged to provide last July’s bailout financing helped in this aim.
What’s more, Ireland’s central bank, the Organisation for Economic Co-operation and Development (OECD), and a new Irish fiscal council are united in their goal to cut the deficit faster than the EU/IMF program requires. That’s all so that Ireland can return to the sovereign debt market to raise funds, which would signal a completion of Ireland’s turnaround.
NEXT: Europe’s No. 1 Turnaround Play|pagebreak|
Europe’s No. 1 Turnaround Play
Savvy investors have taken note. Yields on Irish debt have fallen from over 14% in mid-summer to just 7.5% by the beginning of October. That’s unleashed a rare bull market in financial assets that has made Irish debt one of the top-performing asset classes during the recent market swoon.
With the Irish stubbornly sticking to their 12.5% corporate tax rates, the key to Ireland’s rebound has been the return of foreign investment. Back in the glory days, the "Celtic Tiger" attracted massive amounts of foreign investment, as it was the beachhead to the EU for high-tech companies ranging from Apple to Dell. Dell moved onto Poland, but Twitter has come to replace it.
The politically incorrect elephant in the room is culture. Ireland is an Anglo-Saxon country where people work hard and innovate. Unlike in Greece, you don’t see police battling rioters in the streets in Dublin. And just like no one in Florida is yet building rafts to escape to Cuba, few foreign investors are beating down Greece’s doors to buy its assets, even at fire-sale prices.
The Irish understand that a big chunk of their boom was a mirage. And a country with Ireland’s history is better able to take the bitter pill of austerity than its Club Med rivals.
What’s less known is that Ireland is following in the footsteps of the even tinier Baltic states—Estonia, Latvia and Lithuania. By linking their currencies to the euro (Estonia joined the euro just this past year), the Baltics were in the same boat as the PIIGS are in now.
Enduring the bust after a post-boom economy, the Baltic countries had to reduce wages and prices to regain their competitiveness. And this wasn’t for the faint-hearted. Governments cut public-sector wages by an average of 28%. Estonia’s economy contracted by 13.9% and Latvia’s by an even more painful 17.9% in 2009.
Today, the Baltic region is booming again. Estonia just recorded a second-quarter GDP growth of 8%. Most of the growth is coming from robust growth in exports to booming, nearby markets such as the Nordic countries, Germany, Russia, and Poland.
But domestic growth is also showing the first signs of recovery. As Estonia’s Toomas Ilves put it: "After [Stalin’s] mass deportations, [austerity] didn’t seem that bad. I guess it’s harder if you’ve been living the good life of [Italian Prime Minister Berlesconi’s] bunga bunga parties."
The Other "Ireland"
Three years ago, the joke was that the only difference between Ireland and Iceland is the "r."
Much like Ireland, Icelandic banks had amassed massive assets that were once worth around ten times the country’s GDP. Their default in 2008 essentially bankrupted the country.
Unlike Ireland, though, Iceland had the flexibility to both devalue its currency and let its banks go bust. After GDP fell by almost 7% in 2009, Iceland’s GDP grew by 2% quarter-on-quarter in the three months ended April 2011. Real wages have grown for five straight months.
Perhaps most impressively, Iceland has been able to return to global capital markets in this past year—raising over $1 billion in July.
The bottom line? A disciplined regimen of austerity—at least for countries with open economies that can count on exports to turn their economies around—works.
I’m betting that Ireland will be the first among the PIIGS out of the sty. Contrarian investor Wilbur Ross, Canada’s Fairfax Financial Holdings and Fidelity Investments all invested in the Bank of Ireland (IRE), and I have done so as well.
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