Wednesday 21 August 2019

Brendan Keenan: 'Debt burden a danger if Brexit losses hit Exchequer hard'

Finance Minister Paschal Donohoe after the launch of the summer statement. Photo: Collins
Finance Minister Paschal Donohoe after the launch of the summer statement. Photo: Collins
Brendan Keenan

Brendan Keenan

The puzzle of the Government's apparent intractability on the Brexit question deepened, if anything, with the publication last week of the Summer Economic Statement - where the differences between an orderly and disorderly UK departure were laid starkly bare.

It is an acute dilemma for an election-driven Taoiseach. On the figures, an agreed withdrawal with a one-year transition would barely dent the budgetary position, allowing even the few square metres of fiscal space left over after recent splurges to be put to use.

A disorderly exit, on the other hand, would knock a large hole in all those plans. The Irish Government may be the only body left which can prevent such an outcome. But from its point of view, the political crisis that would follow any weakening of the backstop arrangements might well outweigh the billions which would be saved.

At its extreme, according to the summer statement, the difference would be around €4bn in 2021 alone. That translates to a deficit of almost 1pc of national income, excluding the operation of multinational companies (GNI).

We are told there will be a draft budget for each of these scenarios come October, but that is not quite what we see in the statement. There is one budget, worth €3bn (although much of that is already in train), leading to a surplus of around 0.5pc of GNI if there is an orderly Brexit.

If a disorderly one is expected, it will be the same budget, not a different one. It will simply include added borrowing of up to €3bn to cover the loss of revenue and increased spending as the Brexit crisis erupts.

The politics of introducing such a whopper of a budget while nothing bad has actually happened must be very tempting. And if the Halloween horrors are not unleashed, who is to say when and how it might all be reversed?

On the figures, Remain would not be much different from the consequences of an orderly withdrawal.

In either case, the Government will be left with the more difficult political task of slowing the economy down. As was the case in 2006, anecdotal evidence suggests it is overheating more than the statistics indicate. Back then, the anecdotal evidence turned out to be correct.

The recent past might also make us wonder if that disorderly scenario may not in fact be optimistic. The Irish public finances consistently prove more elastic than expected. Work is still going on in the Department of Finance to determine just how volatile are general tax revenues when conditions change - and now we have the uncertainty over corporation tax revenues as well.

The department had a plausible argument in 2006 that the Exchequer could handle the emergence of a deficit of 8pc of GDP, which seemed as much as anyone could reasonably expect. It turned out to be twice that. Nothing on that scale is anticipated now, but this is not to say that deficits could be bigger than the range forecast in the summer statement.

The year 2019 is very different from 2009, mostly for the better but much worse in one particular area: debt. Ireland was just about the least indebted state in Europe 10 years ago; now it is one of the most. We will not need as much fiscal room as we did after the crash, but we don't have much to begin with, because of the size of the national debt.

On the postitive, the weighted average maturity of Ireland's long-term marketable and official debt was estimated at 10.5 years at end-2018, one of the longest maturities in Europe.

The Finance Minister was at his most gnomic in his closing address to the National Economic Dialogue last week. He pointed out that day-to-day current spending is just 6.5pc higher than the peak of 2009, which we may take as a defence for why it has risen at that rate annually for the past couple of years.

More intriguing, if more obscure, were Paschal Donohoe's comments on capital spending, which is also rising rapidly. He noted that in most departments, capital spending is significantly above levels which many had said were unaffordable when the plans were first announced.

That might be a criticism of pessimistic commentators and advisers, but it might also be a warning that future capital spending demands will get a cool reception if things turn down, given his other assertion to the assembled social partners that the budgetary parameters forecast for a hard Brexit will have to be kept.

That will be difficult enough, even if things are no worse than the official forecasts. In particular, the consequences for a debt burden as large as Ireland's look alarming. In its less-than-complimentary advice to the Government this month, the Irish Fiscal Advisory Council (IFAC)endorsed the forecasts, but also analysed the risks in Irish public debt.

This normally routine exercise has become more pertinent as Brexit dangers increase. The key scenario in the IFAC calculations is a "growth shock" - defined as a recession of around 4pc over two years - which would be a 10-point fall from the growth that would otherwise be expected.

Such a shock sees the debt level rise by almost a third, to 130pc of national income, by 2023. As always, the speed with which things can change in the economy is hard to credit.

So too is the difference in the amounts which would have to be borrowed by the National Treasury Management Agency, both to cover the deficits and replace debt due for repayment. This would explode from €34bn to €112bn over the next four years. The opportunity for debt management provided by 2021, when less than €5bn is currently due to be needed, disappears, and €20bn is required instead.

We may be allowed to assume that such a growth shock will not occur in 2019 but it makes no difference to the knife edge on which Irish debt sustainability is balanced. One glaring extra risk now is that global debt sustainability appears to be on a knife edge too.

In other times, markets would accept Ireland carrying a debt equivalent to a year of national income, when combined with a passable surplus before interest payments. Belgium and Italy maintained such a position for decades.

Italy still does, helped by the fact that tax-averse citizens do most of the lending to their state - and could end up getting repaid in lira. But the strains are showing. One big reason is that Ireland and Italy once were exceptions but now occupy the upper end of a very crowded field.

Even our end of the field is well occupied. According to the IMF, Ireland's debt as a 100pc proportion of its economy now ranks with that of Donald Trump's US, but Greece (182pc), Italy (132pc) and Portugal (126pc) are all higher among richer countries.

Proportions are not everything and it is hard not to be alarmed that the relatively small US federal government owes more than a year's worth of the output of the enormously large American economy.

Things are set to get worse, with Trump's huge tax cuts due to cost up to $2trn (€1.77trn) in government revenue over the next decade - almost 10pc of last year's GDP.

Japan is in a league of its own, with government debt of 240pc of GDP, but it always was a special case and nobody is quite sure if it is a potential problem.

China too is a special case, but everyone agrees it is very much a potential problem.

This is the background to any discussions of the risk from Irish levels of debt. The issue of rising debt may have been around since 2008 but to this must be added the failure of the global system established in the 1980s which might have tackled the issue - a failure on ghoulish display at last week's G20 summit.

Excessive private debt worldwide, not government borrowing, was the cause of the great recession. Much of that has been taken over by governments. Now, public and private debt are at historic highs.

The point is often made that ultra-low interest rates mean another €80bn of Irish public debt is not as terrifying as it used to be, but it is still €300m a year in interest for five years.

Here we see the makings of a debt crisis. It will not start in Ireland - but in some other country where borrowers, probably corporate, find they no longer can service their existing debt.

A lot of people will be found swimming naked if that tide goes out. We are gonna need a bigger towel.

Indo Business

Also in Business