Sunday 26 May 2019

Our public debt levels are still growing, even in the midst of these good times


'Thanks to the European Central Bank's money-printing, the cost of borrowing for governments across the eurozone has fallen to historic lows.' (stock picture)
'Thanks to the European Central Bank's money-printing, the cost of borrowing for governments across the eurozone has fallen to historic lows.' (stock picture)
Dan O'Brien

Dan O'Brien

The numbers are in. The 2017 public finances data for all countries in the EU were published last week. Thirteen of 28 members of the bloc were back in the black. As the chart shows, they included the usual fiscally responsible suspects in northern Europe: Denmark, the Netherlands and Sweden.

Alas, Ireland was not in this group of surplus-running countries, despite enjoying a better economic performance than quite a few them.

Last year the Government spent €1,000 million more than it took in, the tenth year of deficit in a row.

In the first major publication of the 2019 budget cycle, published two weeks ago, the Department of Finance not only confirmed that it will continue to run a deficit in 2018, it revised upwards the size of the deficit for this year.

Last October, when Budget 2018 was unveiled, Finance minister Paschal Donohoe expected the widest measure of state spending to exceed revenue by €500m. Now he is pencilling in a deficit of €800m.

As if that was not bad enough, the tide of red ink spills into next year.

Yet another deficit is being budgeted for. An imbalance of €350m is expected. That will be the 12th consecutive year in which the government has failed to balance its books.

These on-going deficits are being run, despite three big developments which should have driven the public finances well into the black at least two years ago.

The first is the unexpected windfall gains from corporation tax, receipts of which are far ahead of official projections of a few years ago.

Last year, companies paid taxes on profits of €8.2bn - an increase of 12pc. That was an all-time record amount, which represented an astonishing near-doubling in just three years.

Nobody expected these receipts to mushroom, least of all the Government and its forecasting officials. There is considerable uncertainty whether this level of inflow will persist. No matter. The cash was spent and committed anyway.

A second windfall came from much lower debt servicing costs. Thanks to the European Central Bank's money-printing, the cost of borrowing for governments across the eurozone has fallen to historic lows. That has saved billions of euro annually in debt-servicing costs. Again, these billions were spent, not used to balance the books.

The Government also remains in the red despite officially having the strongest GDP growth rate in Europe in three of the past four years. Although the GDP figures exaggerate Ireland's recent rates of growth, all comparative indicators show that Ireland is indeed growing well above the average rate across Europe. And it has been doing so for half a decade.

Running deficits in good times leaves very little scope for stimulus in the event of a slowdown. Worse still, it increases the likelihood of tax hikes and spending cuts if that happens, measures which exacerbate any slowdown.

Even in mild downturns, revenues slow sharply or contract. Spending pressures also tend to rise. Recent experience shows this. The crash of 2008 clearly blew a hole in the public finances. But one only has to go back a few years earlier to see what a normal type of slowdown can do the public finances.

In 2000, the economy was booming and tax receipts were pouring in. The then government ran a surplus in that year of 4.5pc of GDP. It then ramped up spending, which coincided with a slowdown in economic growth in Ireland and internationally. By 2002 the public finances were in the red.

A swing in the budget balance of 5.4 percentage points took place in just two years. If that happened now Ireland would be running a deficit of almost 6pc in 2020. Such an imbalance would be twice the size of the deficits permitted under the EU's budgetary rules.

That would provoke Brussels' wrath and necessitate the sort of fiscal tightening which would be exactly what a slowing economy would not need.

But even more seriously it would quickly raise fresh questions about the State's solvency.

The biggest danger of going back into deficit is the impact it would have on the dynamics behind the outstanding stock of accumulated government debt.

A decade of deficits and the cost of the bailing out the banks has led to a massive national debt, which now stands at over €200bn.

That amounted to 68pc of GDP last year. By this measure the debt is now below the average for EU countries. But because GDP is so inflated, it is not a good measure.

The State's statisticians estimate that Irish economic output is about one third lower than the headline rate when adjusted the factors that puff it up. That means the outstanding amount of government debt is roughly equal to all the wealth created in the economy in a single year.

Public debt levels of that magnitude are high by historical standards. They lump Ireland in with the Mediterranean group of countries which top Europe's public indebtedness league.

Ireland, along with these countries, will soon no longer have the benefits of the ECB's bond-buying safety net. The bank is due to halt its purchases of government debt at the end of this year.

"When the tide goes you can see who is swimming naked," said financier Warren Buffet. When civil servants in Frankfurt stop buying bonds and the only purchasers are financiers, it will be much clearer how sustainable public debt levels are - in Ireland and elsewhere.

Sunday Indo Business

Also in Business