Banks not even half our problem
Ducking tough budget choices will damage our image abroad and won't spare us pain in the long run, warns Colm McCarthy
IT is not possible to deliver finality about the cost of a banking rescue until the damaged assets have finally been sold off. Last Thursday's announcements, however, have brought greater clarity, and focus should now shift to the continuing crisis in public finances.
In round numbers, three-quarters of the debt Ireland will owe when the figures finally come under control will relate to the accumulated budget deficits and just one quarter to the costs of the bank rescue. Getting down the rate of borrowing for day-to-day purposes is the critical component in putting the public finances in order. Of course the costs of the bank rescue are horrendous, and make a difficult task much harder. In addition to a more credible estimate of these horrendous costs, the announcements last Thursday serve to take the banking issue off the radar for the next few months and should refocus policymakers' attention on what needs to be done with the Budget.
Since the Greek crisis, Ireland and Portugal have been in the firing line, and both countries are facing borrowing costs which must be reduced if they are to escape resort to the IMF and the European bailout fund. For countries with large debts and a requirement for further borrowing, there is a limit to the interest rate that can be afforded. That limit was being approached in recent weeks, and the decision to withdraw from selling new Government bonds over the next few months is understandable.
But when Ireland re-enters the bond market, perhaps in January, the Government will need to be able to borrow large amounts on a regular basis for at least three or four more years, and at affordable interest rates. This means that the confidence of the bond markets must be maintained, and many people find this frustrating: why should a sovereign nation find itself beholden to anonymous interna- tional financial markets? The simple answer is that you can safely ignore the bond market only if you don't need to sell more bonds. We need to sell truck-loads to finance the planned deficits over the next few years.
The cold reality is that our austerity programme is a programme of substantial extra borrowing for the next several years, most of which does not arise from the bank rescue. For the last couple of years, Government has been borrowing almost €400m per week for day-to-day purposes. This needs to fall below €100m per week by 2014, and ultimately to zero, if Ireland is to comply with the rules of eurozone membership. Even if there were no such rules, the borrowing must reduce or the funds will simply not be made available. Those who resent the dictates of the bond market should logically be supporters of deficit reduction, the only way to restore policy independence.
The most likely consequence of failure is inability to borrow in the markets, and an externally imposed policy regime, the price of temporary lending from the IMF and the European Financial Stability Facility. This is a new body established in the wake of the Greek crisis, and these two organisations are funding the Greek government for a three-year period. They have assumed powers of fiscal supervision in Greece.
The Government has resolved to avoid this outcome through continuing with the budgetary correction which has been under way since July 2008. Spokespersons for the Opposition parties have also committed to maintaining access to the bond market and seeing through the public finance correction. This is surely the right course: a failure to take tough fiscal measures, resulting in an inability to borrow, will result in externally imposed fiscal actions not very different from the action which has been ducked. What is the point in declining to do what will be demanded anyway? For Ireland to lose its creditworthiness and be forced into IMF and European rescue would do enormous reputational damage and would inhibit long-term recovery, particularly in areas like services exports where reputation matters.
It is sometimes asserted that an externally imposed fiscal correction would be savage and more deflationary than an alternative domestic solution. In reality, the measures we can take voluntarily and those that would be externally imposed may not be all that different, and all that is gained
by failure to face the music is the reputational damage. One way or another, the budgetary correction has to be faced, and doing it ourselves has the lowest costs, aside entirely from the loss to national self-esteem in being forced into an IMF/European bailout.
The Minister for Finance will announce a set of medium-term budgetary measures in four weeks' time, and the Budget for 2011 is due on December 7. The markets will expect a re-commitment to a sharp reduction in borrowing over that timeframe. This can only be achieved through a combination of expenditure cuts and increases in tax revenues. Some increase in rates of tax is beginning to appear inevitable but measures which broaden the base of Government revenue can no longer be avoided. It is ridiculous that Irish households pay regular bills for all the main utilities (electricity, gas, telephone, cable or satellite TV) but water is free, at least for urban households. If water is to be free, who pays the considerable costs in providing the service? It is not beyond human ingenuity to devise a charging system which would ensure that the poorest households received a free allowance. Most rural households already pay for water, many through sinking and maintaining their own wells. Charging would also provide the opportunity for an overdue restructuring of the water industry.
The Commission on Taxation sent politicians scurrying for cover when it recommended a reintroduction of some form of residential property tax. Just about every politician I know concedes privately that the abolition of rates back in 1978 was a mistake, and it is time to restore some real local self-financing to local government. Again, some abatement of liability for the poorest households should be possible, along with some phased remission for those who have paid substantial stamp duties in recent years. These measures would yield little in 2011 but that does not matter: we will borrow large sums in 2011 anyway. What restores credibility is a set of concrete medium-term measures to expand the revenue base.
Even with the recently-announced trimming back of capital spending there are reasons to believe that the public capital programme is still too big. Economic activity in Ireland over the next several years is likely to be about 20 per cent below the levels expected when the National Development Plan was put together back in 2005 on the expectation of continuing rapid growth. Pressure on various national infrastructures has diminished and there is no point adding ghost infrastructure to the ghost estates which litter the countryside. We should build only what we need and cancel or defer nice-to-have projects such as Metro North in Dublin.
Inevitably, worries will remain about bank losses until the ledger can be ruled off, but the Government, Nama and the Central Bank appear to have done as much as is possible for now, and it is time to shift attention back to the maintenance of economic sovereignty through getting the budget back in some kind of balance.
That task has been rendered more difficult by the mismanagement of the Irish banking system and the failure to regulate. The Central Bank Governor has insisted that the public finance adjustment is feasible, even with the appalling extra costs imposed by the banking collapse. There is a venerable football adage to the effect that 'you make your own luck'. With even average luck, which we have not enjoyed in this crisis to date, I agree with his assessment.
Colm McCarthy lectures in Economics at University College Dublin. He has headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, aka An Bord Snip Nua