€10.7bn boost to Irish GDP improves Budget outlook

I recently questioned the timing of calls for a strict €2bn fiscal adjustment in the 2015 Budget (‘Irish Fiscal Adjustment-too soon to know‘, in part based on the simple observation that the first quarter GDP data had yet to be published, with the additional caveat that the CSO figures would incorporate substantial revisions to previous data, reflecting the adoption of a new international standard of accounts. The figures have duly emerged and were a major surprise, both in terms of past revisions and in relation to growth in the first quarter of the year.

The level of Irish GDP  has been revised back to 1995 and is now substantially higher than previously published; the 2013  figure was initially estimated at  €164.1bn but is now put at €174.8bn, in large part due to the inclusion of R&D spending as investment (some illegal activities are also now estimated). The revision might be seen as just a statistical quirk in the arcane world of national accounts but it has an important implication- Ireland’s debt and deficit ratios are now lower than previously thought. The debt ratio in 2013, for example, was over 123% but is now 116.1% thanks to the higher GDP denominator. The annual deficits are also affected but the impact is less dramatic ; the 2013 deficit falls to 6.7% from the initial 7.2%.

The revisions to GDP did not have a huge impact on real growth rates, although last year’s marginal contraction in the economy (0.3%) is now seen as a modest gain of 0.2%. Growth did pick up sharply in the first quarter of 2014, with real GDP expanding by 2.7%, thanks to a strong contribution from net exports and to a substantial rise in inventories. GDP had fallen sharply in the first quarter of 2013 so that also dropped out of the annual comparison, leaving real GDP 4.1% above the level a year earlier. Consequently, the consensus growth figure for 2014 as a whole ( currently around 2%) is likely to be revised up , probably to well over 3%.

In fact the data revisions also incorporated reclassifications to external trade, with the result that exports and imports are  also now higher than previously published. The broader picture of an export-led recovery has not changed as a result however, with domestic demand still contracting over six consecutive years from 2008 to 2013. Indeed, the positive news on first quarter growth must be balanced against another  decline in domestic spending with all three components recording falls. Consumer spending is up marginally on an annual basis, albeit by only 0.2%, and at this juncture the 1.8% rise forecast by the Department of Finance looks unachievable, with deleveraging proving a stubborn offset to the positive impact of employment growth on household incomes.

Export prices are falling, as is the deflator of government spending, so the annual rise in nominal GDP in q1 was not as strong as the volume increase. emerging at 2.8%. Nonetheless it seems reasonable to assume a 3% or so rise in nominal GDP for 2014 as a whole which would yield a figure around €180bn, or a full €12bn higher than recently assumed by the Department of Finance, and result in a deficit ratio of 4.4% instead of the 4.8% currently projected, assuming the actual deficit emerges on target.

For 2015, the Department forecast a 3.6% rise in nominal GDP , to over €174bn, but on the same growth rate the implied level of GDP is  now over €186bn, given the higher starting point..As things stand the 2015 deficit is projected at €5.1bn, predicated on a €2bn adjustment, but that would now deliver a deficit ratio of 2.7% of GDP and as such well inside the 3% limit imposed under the excessive deficit procedure.Of course the deficit may diverge from expectations over the second half of the year and GDP may disappoint (including revisions!) but at this point the news today from the CSO is clearly positive for the economy and the Budget outlook, with the implication that a €2bn adjustment may not be required if a 3% deficit remains the target.

Ireland’s fiscal adjustment-too soon to know

Ireland’s 2015 Budget is four months away but the debate about the scale of fiscal adjustment required has intensified, with contributions from the IMF, the Irish Fiscal Advisory Council, the Minister for Finance and  other assorted politicians. Some argue for the €2bn figure  set out some time ago while others claim that  a lower figure will suffice. In truth it is far too early to be definitive as there is a high degree of uncertainty , both about the fiscal outlook and prospects for the Irish economy, and given this lack of clarity it is puzzling that so many can take a dogmatic position.

Ireland’s total fiscal adjustment since 2008 amounts to some €30bn, and was required to keep the fiscal deficit on a declining path with a target for the latter of under 3% of GDP by the end of 2015. So the adjustment in any given Budget, be it cuts to government spending or measures to raise additional revenue, is a residual with the size determined by the forecast deficit ratio in the absence of any new policy measures. Note that the target is not the actual deficit itself but the deficit relative to GDP, so there are two areas of uncertainty, one relating to the performance of the economy and the other to the evolution of exchequer spending and receipts, although the latter is of course strongly influenced by the pace of economic activity. Inevitably, the actual deficit and the level of GDP will diverge from that forecast, making any projected adjustment less meaningful, particularly into the medium term. Yet in recent years the forecast Irish fiscal adjustment figure has become  a target in itself, rather than the residual. Some claim that sticking to an announced adjustment enhances credibility, which seems to be the IMF view, although it is not clear why a figure projected a few years earlier must be adhered to even if circumstances have changed, and given that such adjustments will dampen economic activity.There is also a temptation for the government to ‘spin’ the Budget presentation in order to be seen to ‘achieve’ the  previously announced adjustment.

Take the 2013 Budget. The  adjustment figure ahead of time was seen as €3.5bn and according to the  pre-Budget Estimates  the 2013 fiscal deficit would be €15bn, or 8.9% of forecast GDP , on unchanged policy.The deficit target was set at 7.5% of GDP, with an actual deficit of  €12.7bn, and the government duly proclaimed an adjustment of €3.5bn, even though the measures announced on Budget day amounted to €2.8bn, with the remainder mainly due to ‘carryover’ effects from previous spending and revenue decisions. In the event the deficit came in almost €1bn below forecast, at €11.8bn, thanks to a significant overestimation of debt interest  and higher non-tax receipts than projected, including profit from the Central Bank. However, real GDP actually contracted in 2013 instead of growing as expected and nominal GDP emerged €3.6bn lower than forecast, so the deficit ratio came in only marginally below target, at 7.2% of GDP, despite the much better than projected outturn in the deficit itself.

The 2014 Budget projected a deficit of €9.8bn in the absence of any adjustments, or 5.8% of forecast GDP. Consequently, policy measures were required to hit the deficit target , announced at 4.8% of GDP, with an adjustment figure of around €3.0bn widely discussed. Indeed, that was the figure announced by the Minister ( actually €3.1bn ) although the measures introduced on the day amounted to just €1.9bn, with the residual due to the familiar ‘carryovers’ and  previously unidentified ‘resources’ on the expenditure side , including ‘savings’ and lower debt interest. So the €3bn ‘adjustment’ was anything but, although the announced measures are forecast to reduce the deficit to €8.2bn, or 4.8% of GDP.

Five months into the year  the authorities are confident that the deficit figure will be achieved and  tax receipts are running 2.9% ahead of profile, which may persuade the Department of Finance to revise up their tax projections for 2015, hence implying a lower deficit figure before any adjustments. It is early days yet, however, as we do not  even know how Ireland’s GDP performed in the first quarter- retail sales have picked up at the headline level but the value of merchandise exports actually fell on an annual basis in q1 thanks to a decline in price, which will dampen nominal GDP. Uncertainty over the latter is also compounded by the change to a new standard for national accounts (ESA 2010) which will count R&D as capital spending for the first time,  and this along with other minor changes may boost the level of Irish GDP  by 2% or more and so impact the deficit ratio, albeit marginally.

So it is by no means clear at this stage what adjustment will be required to meet a 3% deficit target next year, be it  lower or indeed a higher figure. Austerity fatigue has set in across many European countries and the IMF call to maintain a previously forecast adjustment can be seen in that light, but any adjustment involves serious economic and social costs and  is a means to an end rather than an end in itself.

 

 

 

Irish Austerity Budgets: why more may be needed

The 2014 Irish Budget was the eighth in succession since 2008 (there were two  in 2009) which cut government spending or raised taxes with the total fiscal adjustment amounting to €30bn, including around €11bn in tax measures. These austerity Budgets were undertaken in order to reduce Ireland’s fiscal deficit and  therefore  comply with strictures under the EU excessive deficit procedure , with the State required to reduce the deficit to under 3% of GDP by  the end of 2015( last year’ it was 7.2%). The Troika may have gone but that requirement remains and Ireland, like others in the same predicament, has to produce a Stability Programme Update (SPU) each April, which sets out medium term forecasts for the economy, the fiscal outlook and the debt situation.

The latest SPU, just published, revealed that the  Government expects this year’s cash deficit to emerge €0.9bn below that initially forecast but that the General Government deficit ( the preferred EU budget measure) will still be about €8bn or 4.8% of forecast GDP, as per the original projection. Real growth in the economy is expected to be marginally stronger than envisaged last October , at 2.1%, although the Department of Finance is now much more upbeat about domestic spending, including a 2% rise in personal consumption and a 15% surge in investment spending, and now expects the external sector to have a negative impact on GDP, with export growth of only 2% offset by over 3% growth in imports.

The main change to the outlook relates to inflation, however, with price pressures across the economy now projected to be much weaker following the trend in 2013. Consequently nominal GDP  is now forecast follow a lower trajectory  in the medium term than previously thought; the 2014 forecast is for GDP of €168.4bn instead of the original €170.6bn , with similar shortfalls over the following few years That  change affects the debt dynamics and although the burden is still expected to fall from last year’s 123.7% of GDP the decline is now slower; the 2014 debt ratio is now forecast at 121.4% instead of the original 120%.

The growth forecast also envisages the economy gathering momentum into 2015 and beyond (although previous projections were too optimistic in that regard) and further strong gains in employment, a combination that might imply less need for further austerity measures. The Minister for Finance has signaled otherwise and to understand  why that may be  the case it is  necessary to delve a little deeper into the SPU document. The Irish economy, according to the EU, is actually operating very close to capacity and to full employment, a view which would surprise many and one that has met with some opposition, most recently from the ESRI in its latest ‘Quarterly Economic Commentary’. That debate may seem arcane but, unfortunately, it has serious implications for Irish households because on the EU view the Irish deficit is virtually all structural and therefore will not disappear with stronger growth. The actual deficit will shrink but if one adjusts for the economic cycle the structural deficit would still remain, requiring policy measures to reduce government spending and/or increase tax revenue. Moreover, Ireland is charged with reducing the structural deficit to zero  by 2019 from last year’s 6.2% of GDP, which implies the post-2015 fiscal landscape will not be as sunlit as some expect. A given economy’s position in the economic cycle is not observable and estimates are just that,so convincing the EU that far more of the  Irish deficit is cyclical would have a big impact on the perceived scale of  the fiscal adjustment required.