Sunday 24 September 2017

Brendan Keenan: Optimistic numbers at risk if conditions take turn for worse

In 2017, the Exchequer will still have to borrow €2bn
In 2017, the Exchequer will still have to borrow €2bn
Brendan Keenan

Brendan Keenan

No political risk. Back in the days of the two-and-a-half-party system, that was a big selling point for the Treasury Management Agency when flogging government bonds. No matter how our elections went, there was nothing for our creditors to worry about.

It could be a difficult sell at times, especially for new lenders. There was always high-flown rhetoric about grand new policies from the opposition benches, and at least one newcomer, whose knowledge was based just on the Irish media, concluded that the country was on the verge of revolution.

But Ideology and sweeping promises disappeared once seated on the government benches. It turned out, of course, that there was more than one kind of political risk than dramatic shifts in policy, and the country did come close enough to revolution.

Bank bondholders famously were rescued but the owners of government bonds were all but wiped on paper at the depths of the crisis. They had to be very brave, or very passive, to hang on for the recovery and the vultures grew fat on the losses of those who were not.

The losers must have felt foolish since, after the events of 1982 a collapse of the public finances clearly was the main Irish political risk but they were not complete fools.

The strange truth is that the political risk manifested in the 1970s really had gone.

There is no appetite among the Irish electorate for loose public finances, which is why almost no one, even in this fractured Dáil, openly challenges the government's budgetary fundamentals.

The fundamentals were on display again last week with the 'Stability Update' from the Department of Finance.

This is all part of the eurozone regime for the public finances, designed to remove the political risk of irresponsible government policies in euro member states. Whether it can or not, it is certainly an improvement in terms of information

A bigger update will come in the summer with final pre-budget forecasts and the customary brouhaha about how much there will be to give away come October. Already we are being told that higher than expected growth will increase that magical figure.

That in itself shows that this kind of political risk can never be entirely absent. Everlasting tax cuts are the stuff of modern budgetary debate.

They have all but swamped government spending as a key political issue - certainly where capital spending is concerned, but even to a large degree on current spending as well.

That is politics; reality is different. Since the Troika left, government strategy has been to meet the EU targets, but not to better them, and play politics as best they can with the rest.

It is probably a fair assumption that, where Fianna Fáil at least is concerned, a lender with a knowledge of Irish fiscal history would be justified in thinking that they have no intention of changing that stance, while being wary of their tendency to get blown off course.

The party's mistake in the early 2000s was sticking too closely to the targets, irrespective of conditions. It turned out to be a mistake of gargantuan proportions, even if understandable to some extent.

The same question arises now - admittedly on a much smaller scale. Mr Noonan's indications that better growth means an easier budget, rather than tighter targets, shows that this central strategy is still in place.

The annual improvement in the government finances in the update, as compared with last October's budget, is one hundredth of a per cent of GDP.

The question is whether it is a sufficiently risk-free strategy in present circumstances. There are two sets of circumstances pulling in opposite directions; the exceptionally strong growth of the economy, and the exceptionally large external dangers. Growth has exceeded all expectations. The forecast for this year has been increased from 3.5pc last October to 4.3pc in the update - remember, under the tyranny of small numbers that this is a 23pc increase.

The estimate for next year is up to 3.7pc. In fairness, the Department calculates that faster growth now will mean a slower pace in later years, slipping to below 3pc per annum from 2019.

But then, if there had been no slowdown in the forecasts, the targets would have looked pretty undemanding. The test would come if, for some reason, the economy continued to grow at rates above its assumed long-term potential of 3pc.

That is when a policy of spending the gains of exceptional growth, rather than saving them, becomes dangerous, as in the first decade of the century.

Despite all the talk of a new bubble, such a danger seems remote now. It is also the case, whatever about targets, the overall public finances are tight to a degree not seen before in modern times.

This is easily forgotten, and would probably not have happened without the external demands of, first the Troika, then the commission. In that sense, the blather about tax cuts and giveaways is a useful smokescreen over what has happened.

What has happened is that, this year, the government will collect some €6bn more in taxes than it spends on running the country in order to pay interest on its massive debt - while giving a quite different impression of what it is doing.

There was no choice if Ireland was not to default on its debts. That idea, once popular, has gone off the political agenda, simply because the hard choice seems to be working, but the show is not over yet.

In 2017, the Exchequer will still have to borrow €2bn. In kinder times of old, it would have been allowed classify this as part of the €4.5bn capital programme and everyone would have said that was fine. Now, it is seen as borrowing to pay interest, which is not at all fine. Borrowing is due to be eliminated by 2019, meaning all current and capital spending, along with all the interest on the national debt, will come from the €58bn in tax and non-tax revenue to be collected that year. One has to go back to even older times, to the 1960s and beyond, to find that kind of regime.

There may have been no choice if there was to be no default, but probably it could not have been achieved had conditions not been so favourable, with rapid growth and the interest rate on the existing debt falling to 3pc.

The update assumes, as any official forecast must, that favourable conditions will continue.

At present creditors are very happy, willing to lend to the government for 10 years at 1pc. Citizens are clearly a bit less happy than that but the assumption is that they can be enticed with trinkets at election time while the serious money remains untouched.

The political risk for these numbers, which anticipate debt actually being repaid to the tune of €3bn by 2021 is that conditions take a turn for the worse. This time, there could be no great surprise, as in 2007, because the dangers are headline news all the time.

They were set out comprehensively by Mr Noonan, who went so far as to tell the joint conference of the Central Bank and European Investment Bank last week that the risks were on the downside. We know the list: supply pressures at home, Brexit and US tax and trade policy abroad. (Nuclear war is a black swan event and not included).

Jokes aside, the recognisable swan is the size of Ireland's debt. It still swallows 6pc of tax revenues, which is half as much again as the EU average.

The target is to get it down to 45pc of official GDP - about 60pc taxable GDP, but with the caveat, "if economic conditions allow". That disclaimer is something to put in any sensible risk assessment.

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