Saturday 22 July 2017

Budget pushes us off down the road to nowhere

THE response of ratings agency Fitch told us all we needed to know about last week's Budget.

By downgrading Ireland's credit rating to just three notches above "junk" (due to its concerns about the escalating cost of the bank bailout), Fitch merely confirmed market sentiment that an Irish sovereign debt default is now a matter of when rather than if.

Listening to Brian Lenihan's Budget speech last Tuesday, I was reminded of American band Talking Heads' 1985 hit Road to Nowhere. While a careful softening-up campaign of advance leaks had ensured that it contained no politically dangerous surprises, this Budget is going to hurt like mad once the impact of the income tax increases and the innocuously named new universal social charge begins to kick in next month.

And for what purpose? If, as the Government promised in its four-year economic plan, our fiscal self-flagellation restored the Irish economy to health and the Irish State to solvency then it might be just about bearable. But of course it will achieve neither of these two results. Instead it will merely prolong the deflationary depression which has gripped the Irish economy since mid-2008.

In the four-year plan the Government forecast that, despite taking a further €15bn out of the economy over the next four years, we would somehow still manage average annual real economic growth of 2.75 per cent to the end of 2014. This fantasy bubble was quickly pricked by the EU Commission when it forecast that Irish economic growth would be just 0.9 per cent next year and 1.9 per cent in 2012. If the EU's economic forecasts prove to be accurate, then they make a nonsense of the forecasts upon which the four-year plan is based.

In the four-year plan the Government forecast that tax revenues would rise from €31.5bn this year to €42.5bn in 2014, an increase of €11bn. However, the €15bn of fiscal adjustments that the Government proposes to implement over that period provides for only €5bn of annual tax increases. In other words, the Government is relying on economic growth to deliver the other €6bn of increased revenues.

But what if, as now seems likely, economic growth falls well short of the Government's forecasts? That's when things start to get interesting, very interesting indeed.

On the basis of the EU's forecasts, the Irish economy will grow at only a little over half the pace being predicted by the Irish Government over the next four years. If this does turn out to be the case, then the Government will be at least €3bn shy of its projected tax revenues by 2014. With tax revenues in the intervening three years also likely come up short, that translates into a cumulative shortfall of at least €6bn.

The Government will also feel the impact of lower economic growth on the expenditure side as unemployment, which the Government forecast will fall to under 10 per cent to 2014, remains high. This will of course push up social welfare spending.

But will the Irish economy manage any growth at all over the next four years? The three deflationary budgets from October 2008 to December 2011, which between them took almost €15bn out of the economy, were followed by a one-sixth shrinkage of the real economy. What are the chances of last week's Budget, and the three almost equally tough budgets which are to follow, achieving a totally different outcome? Possible perhaps, but hardly probable.

Zero economic growth between now and 2014 would leave the Government looking at a revenue shortfall of €6bn by 2014 and a cumulative shortfall of over €10bn. No economic growth would also make a nonsense of the forecast €3bn reduction in social welfare spending over the next four years, leaving the Government facing a €9bn budget gap in 2014 and a cumulative budget gap of somewhere in the region of €15bn.

And that's not counting in any more unpleasant surprises from the banks.

Fitch didn't wait long to deliver its brutal verdict. Last Thursday it announced it was cutting Ireland's credit rating by three notches to 'BBB+'. This means Ireland is now considered a similar credit risk to Libya, and our bonds are rated just three notches above junk.

Last Friday Fitch went one step further when it lowered its ratings on AIB and BoI to 'BBB' -- just two notches above junk.

The two developments were inextricably linked, with Fitch commenting that: "The pace of the deterioration of the public finances and continuing fiscal and macro-financial risks emanating from the banking sector mean that Ireland's sovereign credit profile is no longer consistent with a high investment-grade rating."

With the EU/IMF bailout having forced the Irish taxpayer to shoulder the full burden of bank loan losses, Ireland is now trapped. Our current fiscal and monetary policies are totally unsustainable. Something has got to give.

Until it does we are truly, as Talking Heads sung all those years ago, "on the road to nowhere".

Sunday Independent

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