Structural challenges remain despite recovery
Michael McKernan compares the official and ESRI economic projections and highlights the hidden (and still considerable) problem of sovereign debt.
Since Ireland’s exit from the bail-out in December last year, the economic signs have been looking increasingly favourable. Those who questioned the prudence of the exit, doubting the Government’s ability to meet Ireland’s still substantial deficit financing requirements on the open market, have been proven wrong.
Ireland has been able to borrow on terms significantly more favourable than those that were available within the safety of the bail-out regime and indeed at lower rates than were available pre-collapse when Ireland was in good standing internationally with an AAA credit rating.
Nonetheless, while the cost of funding the deficit has been coming down, the deficit itself, while reducing, remains around €8 billion in the current year. This adds to the country’s already mountainous national debt which has not only been rising in absolute terms but also, until now, as a proportion of GDP. Reducing national debt as a proportion of GDP is a key objective of the coalition government and it is targeted to fall from its 2013 peak of 124 per cent to 107 per cent by 2018.
To achieve the debt-GDP target, the Government needs two things to happen. The first is more fiscal adjustment, better known as continued austerity, to further close the current budget deficit and to reduce the annual borrowing requirement.
The target is the troika figure of reducing the current budget deficit to 3 per cent of GDP. To hit the target, a fiscal adjustment of €2 billion has been set for this year – to be made up with a combination of further expenditure reductions and additional taxation.
The other essential ingredient in reaching the debt-GDP target is economic growth. On the face of it, the news is good on this front too. Most economic commentators are revising their gross domestic product (GDP) and gross national product (GNP) figures upwards although there is some concern around how reliable the official growth figures actually are.
Commentators noted that towards the end of 2013, the sluggish official figures for GDP growth simply did not tally with the increased economic activity clearly under way and evidenced by other key indicators such as rapidly increasing employment. The Economic and Social Research Institute (ESRI) has attributed much of this discrepancy to the accounting practices of Ireland’s large multi-national sector and has suggested that GNP, which nets out such flows, is a more reliable measure of economic growth.
In its recent spring quarterly economic commentary, ESRI has forecast Ireland’s GNP growth of 3.5 per cent in 2014 followed by 3.7 per cent in 2015. The institute also projects 2.7 per cent employment growth in 2014, an impressive 50,000 new jobs on top of the 40,000 jobs created in 2013.
Notwithstanding the ESRI caveats around official data, the spring commentary is generally bullish on the economy. It goes as far as to argue that the growth surge and the continuing fall in unemployment will give the Government some room for manoeuvre on the fiscal side, pointing to an ability to keep the public finances on target with a required fiscal adjustment of as low as €500 million as opposed to the Government’s figure of €2 billion. If this proves to be the case, the Government may have the flexibility for the first time in years to give some relief to middle income tax-payers through a reduction in rates or widening of bands – something Finance Minister Michael Noonan wishes to do.
However, the ESRI’s optimism has been counter-balanced by a more sober commentary emanating from the normally more conservative Department of Finance. The department’s economists, in their most recent Stability Pact Update (SPU), project Ireland’s GNP growth at 2.7 per cent in 2014 and 2.3 per cent in 2015 and predict employment growth of 2.2 per cent in 2014 (42,000 jobs). However, the department does project unemployment to go under 10 per cent in 2016, substantially down from its 2012 high of over 15 per cent.
Although the ESRI’s and the Government’s economic projections are very much in the same direction, the Government’s less optimistic scenario implies that the Finance Minister will have little or no flexibility in his next Budget and that the required fiscal adjustment of €2 billion by 2015 is still broadly correct.
Indeed, unless the Government relaxes its 3 per cent deficit target for next year or its ambition to eliminate the deficit completely by 2018, it will have little scope to ease the income tax burden on middle earners in any of the next three budgets without raising other taxes or cutting expenditure further than already planned.
Despite many encouraging signs in the real economy, it is clear that Ireland is little in something of an economic strait-jacket for at least the next few years. This means that despite exiting the bail-out, the era of austerity is far from over.
It is also the case that the hard won economic stability and the progress on rebalancing the public finances, ground out by the Government over several hard years, is still at risk. This is because of the sheer scale of the public debt even when its expansion has been brought under control. Even as debt finally declines as a percentage of GDP, annual interest payments will be of the order of €9 billion annually, equivalent to around one-third of all receipts from income and wealth taxes.
The SPU document also provides sensitivity analysis around some of the key variables impacting the Irish economy, most notably interest rates. The structural nature of the problem of debt in the Irish economy is highlighted and reinforced by the department’s projection that a 1 per cent increase in interest rates could reduce Ireland’s GDP growth by as much as 1.4 per cent in 2015 and 2.1 per cent in 2016.
So while jobs are being created, investment is rising and houses are selling, it will be quite some time before the Irish economy can throw off the millstone of public and private indebtedness.
