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.