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.

Tax Take in December implies weak consumer spending

The  Irish Exchequer returns to end-December showed tax receipts for the full year at €37.8bn which is in line with the revised estimate published by the Department of Finance in mid-October. This represents a 3.2% increase on 2012 although still €150mn adrift of the original Budget projection, which was predicated on stronger economic growth than eventually emerged. The last month of the year often throws up surprises and so the authorities will no doubt be relieved that the (revised) target was met although that satisfaction may also be tinged with some disappointment following a very buoyant tax intake in November, which opened the prospect of a strong end to the year for the Exchequer. In the event December proved a very weak month in terms of receipts, with tax revenue coming in €360mn behind profile, or 12%, with all the main headings  adrift, including a very large shortfall in VAT, which came in at €89mn instead of the projected €211mn. The implication is that Irish consumers did not spend as freely as some expected in December, at least before the post-Christmas sales.

Non-tax current receipts were stronger than expected, however, ending the year at €2.7bn against an original forecast of €2.4bn (thanks in the main to the ELG scheme and increased dividends) so total current receipts ended the year at €40.5bn or €200mn ahead of the Budget projection. Voted spending came in 0.4% below profile for 2013 as a whole although again that masks a very strong spending round in December, particularly on the capital side, as the undershoot was over 2% at the end of November. Total current spending actually rose over the full year, by 1.6%, but this reflects higher debt costs and masks a sharp (4%) fall in day to day expenditure.

The combination of revenue growth and spending restraint has led to a steady fall in Ireland’s fiscal deficit although 2013 still saw a Current Budget shortfall of €10.6bn. The capital Budget was boosted by the State’s decision to sell various financial investments in Bank of Ireland and Irish Life with the result that the Capital deficit was  around €5bn smaller than originally envisaged, at €870mn. The overall Exchequer deficit came in at €11.5bn against an original target of €15.4bn and broadly in line with the revised projection of €11.3bn made a few months ago.

On the funding side the authorities drew down the last of the monies available from the Troika , raised some €2bn from State savings products, and used the proceeds from bond issuance early in 2013 to buy back some of the bonds due for redemption this month. That transaction meant that net funding broadly matched the Exchequer deficit leaving cash balances at the end of 2013 at €23.6bn and as such largely unchanged from the previous year. This cash pile is expensive to hold ( given short term yields are virtually zero) but means that the authorities do not have to fund this year unless they want to, but will have to weigh the costs of increasing those balances against the benefit of  returning to the bond market in the near term.