The Irish Exchequer’s Annus Mirabilis

It is not uncommon for the Irish fiscal balance to end the year in a very different position than envisaged at the time of the Budget presentation and 2015 has seen more of the same, albeit with a larger than normal  forecast error. This  time the divergence is on the positive side, with the Exchequer emerging with a  cash deficit of just €62mn instead of having to borrow €6.5bn as originally projected. As a result  the level of debt will be lower than forecast and the debt ratio in 2015 may be below 96%  of GDP from 107.5% in 2014.

A key factor in the much better than expected outcome is a number of unbudgeted capital receipts, amounting to almost €4bn.  Early in the year the National Pension  Reserve Fund transferred €1.6bn from the sale of Bank of Ireland shares to the Exchequer, with the latter then benefitting from the sale of Permanent tsb shares (€0.1bn)  and Capital notes (€0.4bn) . The sale of the State’s holding in  Aer Lingus  netted another €0.3bn and in December the Exchequer received €1.5bn from AIB, with the latter redeeming  part of the Preference shares issued in 2009.

Current receipts were also much stronger than expected in 2015. Non-tax revenue came in at €3.5bn instead of the €3bn projected, largely reflecting higher profits at the Central Bank, and tax revenue was €3.3bn or 7.8%  ahead of the initial Budget forecast. This  was in part due to much stronger than expected economic activity ( real GDP probably grew by at least 7% last year against a 3.9% forecast) which led to overshoots in income tax (€379mn), VAT (€170mn)  and Capital taxes (€254mn). However the main driver was an extraordinary forecast error in terms of Corporation tax, which emerged €2.3bn or 49% above the original projection.

On the spending side, debt interest was €0.7bn below forecast, offset by higher  voted current expenditure, following a decision in October  by the Government  to spend some of the unexpected tax bounty,  Nevertheless, total current spending was only marginally ahead of the original Budget target and 1.3% lower than the 2014 outturn. Overall, the current Budget was in deficit to the tune of just €4mn which alongside a capital deficit of   €58mn produced the €62mn Exchequer shortfall.

The General Government balance , the preferred EU fiscal measure  , excludes transfers across the Government sector and includes additional adjustments which have to be confirmed by Eurostat. It would seem though that the General Government deficit is likely to be around €3.2bn,  which is  €2bn below the original projection  and  equates to 1.5% of GDP , against  the Budget target of 2.7% and the revised 2.1% estimate made a few months ago.

The 2015 fiscal outturn also means that  the 2016 Budget assumptions now look redundant. The latter envisaged a 5.8% increase in tax receipts from an expected base of €44.6bn, giving a 2016 tax figure of €47.2bn. That now only requires a rise of 3.5% to achieve given the €45.6bn figure actually received in 2015.  So if tax receipts do indeed rise by 5.8% this year’s figure will emerge at €48.2bn or €1bn ahead of the target announced in October’s Budget. On that basis the projected deficit of €2.8bn could be €1.6bn, or just 0.7% of GDP instead of the 1.2% currently forecast.

On the face of it then the Irish fiscal situation has been transformed and the outlook is indeed positive although there are two caveats. One relates to the international backdrop, which may be less supportive for the economy in 2016. Another relates specifically to Corporation tax, the source of over two-thirds of the tax overshoot last year. A forecast error of that magnitude clearly raises the risk around any projection  of the corporate tax take in 2016 and hence the overall revenue figure.

€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.