Lesson unlearnt: Budget to address the perceived political requirements
Despite Brexit headwinds and a tougher economic outlook, the Government is borrowing to appease as many factions as possible, writes Colm McCarthy
Published 09/10/2016 | 02:30
The 2017 Budget to be delivered on Tuesday is being fashioned to address perceived political requirements rather than the needs of economic management. Last week's Exchequer returns were spun as a reassuring backdrop to whatever giveaways are to feature, and the background music is unmistakeable: recovery is continuing, tax revenue is doing fine and some spending increases and tax cuts can prudently be afforded.
The evidence does not support this happy conclusion. The tax returns for the third quarter suggest on the contrary that the economy is beginning to slow and recent business surveys point in the same direction. Forecasts of economic activity for 2017 from Irish and international agencies have been revised downwards. Sterling continues to sink, damaging the competitiveness of those trading with Ireland's largest business partner. Brexit has introduced major uncertainties into the economic outlook, and the ECB's low-interest-rate policy, which flatters the Budget accounts, could begin to unravel next year. Given the enormous overhang of public and private debt, every single economic advisory body has urged caution on Tuesday.
Tax revenue has weakened under virtually every heading with the exception of corporation tax. VAT, excise duties and taxes on income softened notably in the third quarter. These taxes are payable with a short lag and so give an almost contemporaneous reflection of economic activity. Corporation tax is more of a lagged indicator, reflecting corporate profits several quarters back. Receipts are also dominated by a small number of multinational companies and have been volatile. The apparent buoyancy of overall tax receipts in the third quarter was due entirely to an increase in this unreliable corporate tax component.
Surveys of sentiment for both manufacturing and services are heading south. The most recent Purchasing Managers' Index for both sectors is suggesting that the final quarter of 2016 in Ireland will be weak. Economic forecasts from the Central Bank and the ESRI have been trimmed, while international bodies like the IMF and the OECD have been making downward revisions.
A year ago the sterling rate against the euro was around 73 or 74. Last Friday the rate closed about 90, corresponding to a revaluation of more than 20pc on year-ago levels. This has destroyed margins for firms exporting to Britain or competing with British producers in home and third-country markets. Indigenous firms exposed to UK trade are already facing lay-offs and a leakage of consumer spending across the Border is on the cards. This continuing sterling weakness is in large part the market's reaction to the news on Brexit: Theresa May's speech to the Conservative party conference, and the belligerent reaction from continental EU leaders, point increasingly to a 'hard' Brexit, likely to be more damaging to Ireland than to others among the 27 remaining EU members. Any notion that either British or EU negotiating positions will be tempered by concerns about the adverse effects of a hard Brexit on Ireland is so much wishful thinking.
The European Central Bank has been purchasing government and corporate bonds to the tune of €80bn per month, an enormous monetary injection which has driven borrowing costs to very low levels. This programme is scheduled to end in March next year, although it may well be extended. But it must end sometime, and when it does, the Irish Government will find it more costly to re-borrow maturing debt, driving up the budget deficit as measured. The fall in Government borrowing costs has been a big factor in the reduction of the deficit these last few years.
The Government, with the approval of just about every single Dail deputy, has been indicating Budget giveaways for several months now. As the economic outlook has weakened since the UK referendum on June 23, the scale of the giveaways has been increasing, with the latest leak putting the total of tax cuts and spending increases at €1.2bn. This ensures that there will be another Budget deficit in 2017, and for the ninth straight year. If the economy manages to extend the recent growth spurt through 2017, fiscal balance (no further net borrowing) could still be achieved the following year, despite the giveaways. But there is a risk that the growth spurt could taper off, and in a year when Government borrowing costs could start to drift upwards again.
Recent reports from both the Fiscal Advisory Council and the Central Bank have drawn attention to the risks attendant on any premature loosening of Budget policy. Ireland's outstanding gross Government debt is in the order of €200bn, six times what it was when the financial crisis struck. This debt level, relative to the taxable capacity of the economy, is one of the highest in the eurozone and will place Ireland firmly in the firing line should the current artificial market in government debt, supported by ECB money-printing, be brought to an end. This must eventually happen, if not next year then at some stage over the next several years. It is in the national interest that, whenever choppy conditions re-emerge in debt markets, Ireland does not start with the handicap of an ongoing borrowing requirement in addition to the burden of refinancing maturing debt.
The pre-Budget leaks concern increases in pensions (never actually cut during the austerity period), some reductions in direct taxes on income, and provisions for public pay and other spending increases. Not one of the specific proposals circulating pre-Budget is likely to make a decisive difference to anyone. Some are capable of doing harm, most obviously the apparent intention to reintroduce a first-time buyers' grant to help fuel excess demand in the housing market. Every independent housing expert has cautioned against this proposal, which runs counter to the Central Bank's efforts to avoid another house-price bubble, especially in the Dublin area.
If there was no Budget at all on Tuesday, the deficit, on the Government's own estimates, would fall close to zero next year, an outcome which will be avoided through borrowing to pay for these measures. The Central Bank's chief economist, Gabriel Fagan, last Friday insisted that no fiscal stimulus to the economy is needed for 2017, echoing the advice of every other expert body which has offered a view on the matter.
The risk the Government has chosen to run is to stimulate the economy in what could prove to be the final year of the current expansion. In consequence, the capacity to repeat the stimulus when it might actually be needed is compromised. If the various headwinds already evident cause the economy to slow, the Government will face into a less benign environment with both heavy debts and an ongoing deficit.
This needless risk is being run to deliver small spending increases and even smaller tax cuts, both of which will be denounced as mean and uncaring by Opposition deputies and lobbyists. Not a single economy measure or serious reform initiative will be announced and Government is being conducted on the basis of borrowing enough to appease as many factions as possible. The political class has reverted to type and the crisis lessons have been unlearnt with remarkable speed.