ECONOMICS: Although an appreciating currency should dampen inflation, demand for our exports may suffer and thereby jeopardise profits and domestic employment.

The proposed new national pay deal has raised concerns in some quarters about Ireland's competitiveness, particularly in the wake of the euro's recent appreciation on the foreign exchange markets.

The single currency rose from 90 cents to 1.05 against the US dollar in 2002 (and from 62 to 65 pence against sterling) and many feel that further gains are on the cards.

An appreciating currency should help to dampen Irish inflation, via lower import prices, but also risks hitting demand for Irish exports, and hence profits and domestic employment.

The economy is particularly exposed to the euro's external value as so much of Ireland's international trade is still with countries outside the single currency.

In the first nine months of 2002, only 21 per cent of Irish imports came from the euro area, with 37 per cent of exports going to markets within the euro zone.

This is well below the norm for other economies in the EMU, making Ireland uniquely vulnerable to the vagaries of the foreign exchange markets, despite having given up the pound.

The extent of this vulnerability can be assessed by looking at the euro's performance against Ireland's main trading partners, although some foreign exchange rates matter more than others - a euro rise against sterling will have a bigger impact on Irish industry than a similar move against the dollar or the yen.

Fortunately, the Central Bank captures such a trade-weighted exchange rate for the post-EMU world, publishing it as the Trade Weighted Competitiveness Indicator (TWCI).

This comprises 10 countries, six of which are in the euro area, accounting for over 40 per cent of the index, and, as such, with fixed exchange rates against Ireland.

So the euro's foreign exchange rate has an impact on only around 60 per cent of the index, with the UK (27.7 per cent) and the US (18.3 per cent) accounting for most of the weights.

Singapore is also included, presumably to capture the influence of a competitor in the technology sector.

According to the Central Bank, Ireland's TWCI rose by 4.5 per cent through 2002, following a smaller 1.4 per cent rise in 2001, but this has not offset earlier falls over the first two years of the single currency - the TWCI fell by some 8 per cent in 1999 and by over 3 per cent in 2000.

In other words, Ireland's effective exchange rate is still over 5 per cent below the level in January 1999, despite last year's euro appreciation.

Yet, Irish inflation has generally been higher than that of its competitors over this period.

Consequently, a better measure of competitiveness would be to adjust for this by capturing a real TWCI, which takes account of relative price movements between Ireland and the 10 countries included in the index.

On that basis, the fall in the euro has not been sufficient to offset higher inflation in Ireland, as the real TWCI has risen by around 2 per cent over the four years of EMU membership, although 2002 saw an estimated 5 per cent rise.

On this measure, Ireland does seem to have lost competitiveness, particularly over the past year.

On other measures of competitiveness in manufacturing, however, the conclusion is precisely the opposite.

One such index, again conveniently compiled and published by the Central Bank, uses the TWCI adjusted by relative unit labour costs, as opposed to prices. This captures the impact of wages and productivity and the growth of the latter has been spectacular in Ireland, offsetting the recent acceleration in wage inflation.

As a result, Irish competitiveness on this measure improved by around 5 per cent in 2002, having already gained consistently over the past decade.

Of course, the productivity performance of many Irish indigenous firms would be well below the level used to derive national unit labour costs, and for them the real TWCI might be a better indicator of their competitiveness position.

A recent technical paper for the Central Bank (by Bredin, Fountas and Murphy) found that Irish exports were indeed sensitive to price, with each 5 per cent rise in the real exchange rate reducing export demand by 4 per cent, albeit over a long time period.

The same study also concluded that income growth in Ireland's foreign markets was a much more important influence on exports (each 1 per cent rise in foreign GDP boosts Irish exports by 3.6 per cent), so the exchange rate is only one factor influencing Irish trade - with the corollary that the impact of a pick-up in global demand would dwarf any negatives stemming from the euro's recent rise.

It may well be that such a recovery would also depress the euro, as there is evidence that the single currency has benefited from a decline in global equity flows, and as such would suffer should these flows increase.

A euro reversal is not guaranteed, however, and is outside Ireland's control anyway. What is determined here is wages.

Perhaps the simple lesson from the above discussion on competitiveness is that a 7 per cent pay rise over 18 months across the private sector is indeed far too high for many Irish firms, and hence would not have been paid, but too low for others.

Dr Dan McLaughlin is chief economist at Bank of Ireland