I welcome the opportunity to appear before the committee. I am joined by Rónán Hickey from the Irish economic analysis division of the Central Bank. I will give a brief summary of the outlook for the economy, drawing on the macroeconomic forecasts set out in our latest quarterly bulletin, but I will also take account of the developments and available indicators since then. We will be publishing updated forecasts in our forthcoming quarterly bulletin at the beginning of April.
The Covid-19 pandemic and the measures to contain the spread of the virus, which has caused an unprecedented contraction in the Irish and world economies over the past year, are likely to remain the dominant determinant of the path of the economy this year and in 2022. The near-term prospects have deteriorated following a resurgence in Covid-19 cases early in 2021. However, the prospect of a successful deployment of vaccines from an increasing range of choices does offer the prospect of recovery from the second half of the year, underpinned by continued support from accommodative monetary and fiscal policy.
Preliminary national accounts statistics, which show GDP growth of 3.4% last year, indicate remarkable resilience in headline growth given the exceptional scale of the shock to domestic and world demand. However, the headline GDP figure was boosted by strong export growth that was, in turn, largely accounted for by a surge in pharmaceutical exports and continued strength in the IT sector. This masked a decline in domestic demand which was among the most severe in the EU. Output declined in all other sectors, with the largest declines in sectors with a high dependence on face-to-face contact with customers including the arts, hotels, bars and restaurants and high-street retailers. Private consumption last year was down by 9% compared with the previous year, with modified domestic demand down by 5.4%.
The impact of the pandemic is particularly evident in the labour market. While the headline unemployment rate has not changed significantly, reflecting standard international statistical conventions regarding its measurement, the Covid-adjusted rate, which includes those workers who are availing of the pandemic unemployment payment, PUP, increased rapidly. It currently stands at a rate of 24.8%. When we also include the employment wage subsidy scheme, EWSS, approximately 960,000 people, or 39.3% of the labour force, are currently in receipt of one form or other of income support. The figures also show that younger and lower paid workers have been most affected.
The concentration of the pandemic labour market shock among workers in the bottom half of the income distribution is reflected in a corresponding decline in compensation per worker or earnings. That this has not been reflected in a decline in disposable incomes – disposable incomes actually increased last year by about 4% – is testament to the effectiveness of Government income support measures. Similarly, at firm level, Government support measures have provided significant mitigation to the financial distress to SMEs most affected by pandemic-related business disruption. These supports, while proportionate and appropriate to the size of the shock to households and firms, have been unprecedented in scale, amounting to more than 11% of modified gross national income, GNI*. The general government balance has moved from a small surplus of 0.9% to a deficit of just under 9% of GNI* in 2020 and is likely to remain close to that level again this year. This has resulted also in an increase in public sector debt and the debt-to-national income ratio.
The resurgence in infections since December and the reimposition of strict containment measures weakens the near-term outlook and makes it more uncertain. The containment measures have dampened economic activity significantly in the first quarter of this year and, beyond that, some public health measures are likely to continue to be required, until the successful deployment of effective vaccines reaches a significant proportion of the population. Assuming successful deployment of vaccines by the second half of the year, domestic economic activity should begin to rebound. On this basis, modified domestic demand is forecast to grow by 2.9% in 2021, while GDP is projected to grow by 3.8%, although the recovery in the labour market is likely to lag somewhat until the broader economic recovery becomes more established. The outlook is considerably uncertain, however, and contingent on key assumptions on Covid-19 developments.
Looking ahead, a further pick-up is projected in 2022, with modified domestic demand forecast to grow by 3.6% and GDP projected to grow by 4.6%. While uncertainty and a subdued labour market are likely to keep precautionary savings elevated in 2021, these restraints should ease next year. The unwinding of the large stock of savings accumulated during the pandemic should support a strong recovery in consumption in 2022. Similarly, the reduction in uncertainty should allow investment to begin to recover next year.
The new EU-UK trade and co-operation agreement, TCA, has averted the threat of a no-deal Brexit and means that the significant disruption to economic activity that would have accompanied such an outcome has been avoided. The new agreement allows for the continuation of a basic economic relationship between the EU and UK. Nevertheless, the EU-UK TCA makes trade in both goods and services more cumbersome and costly relative to EU membership. In the short run, this is likely to be associated with continued supply-chain disruption. In the long run, the negative impact of the UK's EU exit on trade flows, migration and productivity will reduce output in the Irish economy.
I will conclude my remarks with some views on the policy response to the pandemic and, in particular, how the available policy instruments can best support a sustainable recovery. The impact of the pandemic has been mitigated by a range of fiscal, monetary, macroprudential and microprudential policy actions to support vulnerable households and businesses. In the near term, policy must remain focused on supporting household incomes and firm liquidity to provide the most solid basis for recovery. However, the size and nature of that support should be ready to adapt to changing circumstances.
Policy support should continue to counter the threat to viable economic activities and employment from the pandemic and, in time, facilitate structural transformations that support economically sustainable activities. This would help to enhance resilience, support the productive capacity of the economy and mitigate scarring effects such as long-term unemployment.
On the fiscal side, the increase in deficit and debt ratios that has occurred has been both warranted and necessary. Policy support will need to be maintained over the short term to stabilise the economy. When health risks diminish, however, any continued support via current expenditure should be targeted and temporary, while any permanent increases in current expenditure will need to be funded in a sustainable manner. Ultimately, more favourable growth dynamics in coming years should support a decline in the public debt ratio. Even if action does not need to be taken now, however, it is important to plan to reduce the level of the debt ratio in time to a more sustainable level to ensure that the economy can face future shocks with sufficient headroom such that all available policy instruments can be deployed.
I look forward to the discussion with members.