Sunday 22 September 2019

Dan O'Brien: Public debt still remains huge despite much talk of balancing the books

Dan O'Brien

Dan O'Brien

We are out of the woods. Crash and crisis are distant memories. The good times are rolling. It is back to politics as usual. Broadcast journalists have returned to asking politicians why they are not spending more on every problem that arises.

Not so fast. Despite Paschal Donohoe wrongly claiming that he is "balancing the books" (in fact, he plans to run deficits, albeit small ones, until 2020) the public finances are a lot more fragile than the government would have you believe.

There are two reasons things appear to be rosier than they are. The first is the falling level of public debt relative to GDP, the most closely watched metric of fiscal sustainability. The second is the historically low cost of borrowing, another vital element in the debt-sustainability equation. While there is undoubtedly good news on both these aspects of the public finances, a deeper analysis shows things are not so rosy.

Gross government debt as a percentage of GDP is commonly used by economists and financial markets to determine the credit worthiness of a country. For Ireland the ratio is now enshrined in law. Under EU Treaties and the Fiscal Treaty (ratified by the 2012 referendum), the state is obliged to reduce gross debt-to-GDP ratios to under 60pc.

Looking at that metric alone, Ireland's recent performance has been impressive. Gross debt to GDP peaked in 2012, at 120pc, and has since decreased, reaching 73pc in 2016. But these figures flatter to deceive.

In cash terms Ireland's national debt stands at over €200bn - the same as it was five years ago when the State teetered on the brink of national bankruptcy. Because the government plans to run deficits until the end of decade, the stock of debt will actually increase in cash terms over the medium term.

That's the numerator. A much bigger issue comes on the denominator side of the equation.

The main problem is the well-known artificial inflating of GDP figures because of the activities of multinationals. When those activities are stripped out of the figures by statisticians, the measure of economic activity they arrive at - called "Gross National Income*" - is one third lower than GDP.

Ireland's debt looks much less benign when the modified measure is used as the denominator. Gross government debt as a percentage of GNI* was 106pc in 2016. This more accurate measure places Ireland's debt ratio far above the 60pc EU benchmark and the fourth highest in the EU last year when compared to other countries' debt to GDP ratios. Budget forecasts show that it will remain above 90pc in 2021.

A more strictly comparable measure is public debt as a percentage of government revenue. Here, again, the picture is far from good. Gross debt last year was 2.76 times greater than the total revenues raised by all branches of the state. In other words, if every cent in tax, PRSI, business rates, bank levies and other revenues went to paying off the public debt, there would be no spending on anything else for almost three years.

As the chart shows, debt relative to tax and other government revenues is very high by EU standards. Only Greece, Portugal and Italy are ahead of Ireland. It is very far above many other small open economies - the prudent Danes and Swedes could clear their debts in well under a year. Irish social democratic souls, who call constantly for more debt-financed spending, loudly and persistently demand a move to Scandinavian levels of public provision but are curiously silent about emulating Scandinavian fiscal responsibility.

A country's debt ratio is in many ways an indicator of how well it will fare in a downturn or a crisis. However, gross debt only includes one side of a government's balance sheet. The European standard for measuring net government debt takes account of some liquid assets, but excludes most publicly held assets (the Irish state's ownership of a large tranche of the banking system, it is worth mentioning, is excluded from this standardised calculation despite being worth a pretty penny).

As one might expect, net debt is lower than gross debt in all countries. For Ireland in 2016 it was 64pc of GDP, 93pc of GNI*, and 2.4 times government revenue. In theory, net debt is a better measure of a country's debt burden, but in practice it is difficult to choose and place a valuation on assets a government could easily flog in time of need. It is for those reasons that more emphasis is placed on the gross figure.

By most measures Ireland's government remains heavily indebted. In 2016 gross public debt stood at €41,850 per person (or €97,200 per person at work) and net debt amounted to €36,600 per person (€85,100 per worker).

The sustainability of debt also depends on the cost of debt servicing. On this front, there is certainly good news. The effective interest rate on Irish public debt has fallen to 3pc, having been at 5pc at start of financial crisis. This is partly thanks to economic recovery and cheap bail-out loans, but the main reason is historically low international interest rates. Further help has come from the ECB's quantitative easing program, which involves buying government bonds, something that puts downward pressure on yields.

The improvement can be seen in the constant downgrading in the cost of debt interest by the Department of Finance. For instance, in Budget 2014 interest payments were forecast to be €9.2bn in 2016. The bill turned out to be €3bn less.

The large debt burden on the Irish state is apparent in debt interest as a percentage of total government expenditure. Servicing the national debt accounted for one in 12 euro of government spending in 2016, second only to Portugal and well above the EU28 average of 4.6pc.

Over the next three years Ireland has €50bn of maturing debt that will require refinancing. An increase in interest rates globally or for the Irish state more specifically would make the debts falling due costlier to roll over. If that were to happen debt servicing costs would rise.

Unlike in 2008, Ireland no longer has a low public debt or a financial buffer like the National Pension Reserve Fund. The large debt burden makes Ireland particularly vulnerable to an economic shock. We're not out of the debt woods yet.

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