News Analysis

Saturday 23 August 2014

Our prospects for next year? Sadly that all depends on EU

Published 27/12/2012 | 17:00

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IT was, all told, a year of disappointments. Growth fell below expectations, budget targets were missed, the pressures on spending – especially health – increased and there were no real signs that Europe was ready for a deal on bank debt. The resulting political pressures were all too apparent at Budget time.

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Only two areas looked better than might have been expected last January. Bond yields – the rate of interest on Irish government borrowing – fell dramatically. This allowed the Government, through the NTMA (National Treasury Management Agency), to borrow on the market earlier than anticipated.

The two "pillar" banks, AIB and Bank of Ireland, were also able to borrow significant, if not exactly dramatic, sums and without relying on the government guarantee.

With the economy performing well below what was hoped, this improved market sentiment could hardly be ascribed to better growth prospects. The economy bounced around from quarter to quarter, as it usually does, but ended the year on a weaker note than at the beginning. It looks like output fell once again in 2012, and national income shrunk again.

The bond yield falls, which were echoed in Portuguese debt, reflected a growing belief that European leaders will deal with the euro crisis, and will not countenance further defaults on government debt, as happened in Greece. If that turns out to be right, those who bought government bonds at the start of the year will make a killing. Irish pension funds are not among them and seem as reluctant as ever to trust Irish public finances.

Admittedly, progress is hard to discern in the eurozone unless one watches very carefully. The beginning of the year saw more worries about Spain and Italy, especially the state of the Spanish banks.

These worries have not abated and were followed by a protracted stand-off with Greece. Creditor governments demanded another tough austerity package and hung on for signs of political delivery until Greece had just about run out of money.

Nevertheless, the deal when it came was clear evidence that the creditors, led by Germany, are not willing to see Greece leave the eurozone – and may even be looking for ways to give the country more financial assistance.

The pressures on Spain may have convinced eurozone leaders that any 'Grexit' could not be contained. It also may have persuaded the ECB to launch its most dramatic action so far.

This is the promise to purchase government debt at rates that the ECB regards as reasonable, even if market rates are higher. Of course, things have not gone smoothly. To benefit from this system, a country must ask for it to be applied and agree conditions similar to those of a bailout.

The proud Spaniards have so far declined to ask. For the moment, markets seem to be taking the view that all of this signals a determination, led by Germany, to preserve the euro and its current membership.

As 2012 came to an end, there was further evidence both for and against this view, depending on how one reads it. The December summit reached agreement on moving to the creation of a eurozone banking supervisor in 2013. But it backed away from more radical proposals for a banking and economic union. Some feared the ECB would feel governments had not delivered their side of the deal on its radical promise of bank support.

Optimists would also have been cheered by signs of a constructive attitude from the UK at the summit. It remains to be seen whether history will record 2012 as the year when the UK – or perhaps the English part of it – began a departure from the EU.

The situation has certainly changed from the general election, with open discussion of the possibility of leaving the EU, growing public and political support for the idea, and what looks like an inevitable referendum on the question at some point.

Such a poll is a few years away. The result will depend a great deal on how the eurozone finds its way out of the crisis. A return to stability and growth, along with the unavoidable negotiations on the relationship between countries inside and outside a new, more integrated euro area, could allow David Cameron to claim he had a new, satisfactory arrangement and avoid the very risky option of departure.

The Irish will certainly hope so. Other hopes were dashed; especially the hope that the EU summit declaration that Ireland was a special case might lead to some restructuring of debt incurred saving the banking system from collapse.

All eyes are now on the March deadline for the payment of €3bn on promissory notes used to fund Anglo Irish bank. Last year, the Government expressed confidence that the deal would be done but ended up just postponing the payment, which now falls due in 2013.

Communications Minister Pat Rabbitte appeared to up the ante this time, saying the Government would not pay – a phrase later explained, after much recrimination, as meaning it would not have to pay because a deal would be done.

There is as yet little sign that the ECB is ready for such a deal, but the political strains evident after the Budget, and the deal done with the Greeks, increase the pressure to do something for Ireland.

But the real disappointment this year, and a bigger threat to a return to the markets, is not debt, but the performance of the economy.

Evidence that the economy seemed to be weakening as the year approached an end came with the November tax returns, which come mainly from the self-employed and were well off target.

One theory was that income taxes have risen to a level where they are discouraging activity or encouraging evasion. If that is the case, the Budget decision to rely more on tax rises than spending cuts may not work.

Even if it is not the case, the poor economic performance threatens the 2013 targets. Forecasts for growth now range from 0.5pc to 1pc – a long way from the growth of more than 2pc envisaged in the original plan.

Personal consumption is now expected to fall again, for the fifth year in a row. According to the general consensus, it will be 2015 before strong growth is recorded.

There is no doubt the austerity programme is having a baleful effect. ESRI calculations find that the combined impact of the past four Budgets has been to knock five percentage points off economic output. Although the 2010 Budget was even more contractionary than the troublesome plan for 2013, the cuts are much nearer the bone now.

The uncomfortable fact is that without better growth in the EU, Ireland is unlikely to achieve its fiscal targets and return to the markets in 2013. The Budget is full of optimistic assertions and, if the economy does grow by only 0.5pc, the targets will probably be missed.

After the summit, German Chancellor Angela Merkel dampened any remaining Christmas cheer by warning of slow growth and painful corrections for years to come.

She is correct about the outlook for the indebted countries, including Ireland. But if this is not offset by easier monetary policy from the ECB and more deficit spending in countries like Germany, the whole of Europe will face this dismal prospect and the euro's survival will again come into question.

Irish opinion is sharply divided about what should be done. Even theoretical choices are limited. The trade unions in particular, and the smaller opposition groups in general, suggest an investment package funded by the country's remaining cash reserves and some borrowing off-balance sheet.

Even if that were done, it leaves the question as to whether it should be matched by a reduction in the remaining €8bn correction programme, or used to alleviate the consequences of continuing the programme or intensifying it.

Unless things improve abroad, it would seem the earliest prospect of a return to sustained growth is the completion of the programme and the bounce which might come from a resumption of neutral, or even mildly expansionary Budgets from 2015.

In which case, the sooner it is done the better; but as the year ends, it is far from clear that the Government has enough political strength left to carry it through.

Irish Independent

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