Syndicated News

Diverting from planned road map to cut deficit has risks

According to opinion polls, there is even a gender distinction of this kind in attitudes to fiscal policy – which, of course, is what we are talking about.

Having once put the car in a ditch while taking the scenic route, perhaps I am biased towards the side of caution in such matters as well.

The one thing we can all agree upon is that, when Michael Noonan finishes his budget speech in October, the planned deficit for 2015 will be just under 3pc of GDP. The argument is mainly over which route to take to achieve that outcome, but it would be wrong to think that is all that is involved.

Some people think it is the wrong destination. Few analysts now argue that a €2bn correction is definitely needed in the Budget to achieve that magic number – but many think it would still be a good idea, in case things take a turn for the worse. Besides, they say, 3pc is no more than a magic number.

Selecting magic numbers is an old pattern in Irish fiscal policy; one which was responsible for much of the destruction of the public finances during the boom. If results were ahead of the target, policy was loosened so as to return to the original figure the following year. The result, after five years of a bubble, was an enormous deficit representing five years of slavishly following pre-determined, wildly inadequate fical balances.

It is possible to make the same 
mistake in the bust. The target has been set and will remain the same whatever the economy does. All that will change is the amount needed to achieve it.

In its analysis last week, the trade union-backed Nevin Economic Research Institute suggested an €800m correction would be enough. Its estimates incorporated significant capital spending financed off balance-sheet, and a boost to domestic demand from the easier budget, in order to generate the growth which would deliver the magic number for the deficit.

The Government seems minded at this stage to go for €1bn, although it will be interesting to see how well its nerve stands up to the practical details 
of achieving even that level of adjustment.

Its argument for not having as tough a budget as is set out in its own programme is curious. Ministers claim to have discovered unexpected growth, which makes the target easier to achieve. In fact, there is no sign of unexpected growth beyond the 3.5pc forecast (in cash terms) set out by the Department of Finance. There may have been something amiss with the plan.

There was always some slack embodied in these deficit forecasts, which is why Ireland consistently met, or beat, targets in the past. Now, political pressures appear to dictate that the minimum necessary to achieve them should be done, and hope that nothing goes wrong.

Any edifice built on the foundation of a very precise deficit, with a margin of error of less than half a percent of GDP, is bound to be shaky. With so much uncertainty, in current circumstances, the crude political approach may be the right one. How much can the public tolerate?

A €2bn correction does look beyond the bounds of possibility. But it can still be argued that the approach should be, not how little can the Government get away with doing, but what is the maximum it can feasibly impose.

There is no room for kindness for its own sake. The Brussels-based Bruegel Institute recently updated its debt analysis for the original little PIG: Portugal, Ireland and Greece. They think things have improved a bit since their last report in February, but it still makes for scary reading.

Not if you take the official assumptions at face valueof course. These require that the economy grows by close to 4pc a year for the next five years.

Much of this growth would then have to be recycled into a surplus of government spending over revenues, which averages around €4bn a year over the period.

If these two far-from-certain developments take place, and there is no unexpected surge in interest rates, Ireland’s public debt will fall below the psychologically important level of 100pc of GDP in 2020.

Psychologically important, but by no means safe, even by then.

The dilemma posed by the Nevin Institute plan is whether the extra growth generated by an easier budget can prevent a reduction in the size of that primary surplus, before interest payments. Make no mistake, such a surplus is necessary if another debt crisis is to be avoided, but it is a very tall political order to achieve it.

On Bruegel’s calculations, a primary surplus one percentage point smaller (i.e. €1 bn less) would postpone the achievement of 100pc debt ratio by two years. It does not sound a lot, but it is two more years for things to go wrong.

On the other hand, they estimate that a €7bn recapitalisation of the banks would postpone things by just one year. It is certainly arguable that the benefits of using that kind of money to make serious progress in writing down company and mortgage debt would be well worth the risk.

As the born-again developers prepare to build more office blocks for the anticipated companies seeking shelter from US taxes, Nevin’s idea of significant investment in public infrastructure is also attractive, although there can hardly be money for both that and more debt relief.

It may be harder than the authors suggest to persuade the EU statisticians to keep such investment off the government books. But the mood has changed since the European elections and some things may be possible which would not have been possible before. If the price is structural reform of the legal profession, who would not pay?

The political pressure though, is not for for a better electricity grid or water system. Quite the reverse, it would seem. More income is what people want, and indeed need, but therein lies the danger.

Should growth and the primary surplus turn out to be one percentage point less than official projections, and interest rates one percentage point higher, Bruegel calculates that Ireland could make no worthwhile progress on its debt burden.

The risks are a bit less than they were, and the policy options a bit wider, but the stakes are just as high.

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