Monday 17 June 2019

Colm McCarthy: Budget overshoot is on cards as is a dreaded second bailout

Deficit target for 2013, and our return to the markets, is based on unrealistic growth and expenditure control

Colm McCarthy

Colm McCarthy

Reactions to budgets, and to other newsworthy developments, need to be placed in the correct medium-term context. The EU/IMF rescue funds being loaned to Ireland run out at the end of 2013, after which point the Government will have to borrow whatever it needs under its own steam on the open market.

It will need to borrow very large amounts. The budget deficits will remain sizeable (almost six per cent of GDP is the planned figure for 2014) and there will be big roll-overs, maturing bonds that have to be re-financed with new issues. Eventually the official lenders will have to be re-paid, again through new issues on the open market.

A large portion of these new borrowings will have to be at long maturities of 10 and 20-year bonds. Governments find it easy to borrow short-term money, say one or three-month treasury bills. But if the entire debt, or a large portion of it, becomes concentrated in short-term debt, there will be a continuing re-financing crisis with a mountain of new borrowing every month. This is not a sustainable course.

So by the end of next year, before any further budgets have come into effect, the State needs to recover the ability to sell very large quantities of longer-term bonds on the open market at low and affordable interest rates.

An economy with low inflation and low or zero growth prospects cannot afford high interest rates. Eurozone countries which hope to achieve successful graduation from rescue programmes will wish to do so through selling, for example, €10bn of 15-year bonds at an interest rate below four per cent. If that cannot be achieved in Ireland's case, there will have to be an extension to the existing rescue programme, or the dreaded 'second bailout'.

Last Wednesday's Budget has attracted criticism for all the expected reasons. Every group which has taken a hit is unhappy. But there is a more fundamental criticism. This Budget could fail to hit the deficit target in 2013, the year when Ireland is meant to exit the EU/IMF rescue programme and regain the ability to finance itself. Revenue could be weaker than predicted, expenditure could over-shoot and the deficit could fail to decline as planned. A meaningful return to the markets will be difficult anyway without some debt relief. If the deficit target is missed it could be impossible.

The last few months have seen evidence of weakness in some headings of Government revenue. Revenue can never be predicted with accuracy – the yield from taxes depends on the fortunes of the overall economy. Revenue forecasts for next year, and for 2014 and 2015, are based on an assumption that economic growth will return.

The Department of Finance have assumed that national output will grow 1.5 per cent next year, 2.5 per cent in 2014 and 2.9 per cent in 2015. If this pattern actually emerges, Ireland will be doing better than other European countries, despite the huge public and private debt overhang, crippled banks, weak competitive position and the deflationary impact of domestic policy. The German Bundesbank expects growth in Germany next year to be just 0.4 per cent. The European Central Bank expects the eurozone as a whole to contract by 0.3 per cent next year. The UK economy has stalled.

The most recent Irish figures available are for the second quarter of 2012. In the three years from Q2 2009 to Q2 2012, the rate of growth in GDP in Ireland was precisely zero. The endless job announcements and speeches about export revival and corners being turned are just cheer-leading and boosterism. The economy is as flat as a pancake. There has been no growth at all since the bottom was reached in 2009.

If the economy does manage to expand at the rates assumed by the Department of Finance in 2013 and the following years, it will quite likely be the fastest-growing economy in Europe.

The 2013 Budget adds up because the revenue figures rely on a return of economic growth but also through the inclusion of aspirational expenditure savings, savings which require policy actions which have not yet been taken or even identified. As a result the record of hitting overall budget targets established in recent years is at risk.

In 2012, the overall target was (more or less) achieved despite a severe over-run in some areas, particularly Health, offset by unexpected savings elsewhere. In 2012 Health saw a serious overshoot and it is still not clear that Health spending can be budgeted with any confidence. For 2013, unspecified savings are assumed in the Health department, the very one where expenditure control appears to be weakest, as well as in other departments.

The expenditure savings include payroll reductions yet to be negotiated. Public Expenditure Minister Brendan Howlin explained on Budget day: "Following my invitation, the Public Services Committee of the ICTU recently agreed to enter into discussions to establish if we can reach agreement on such measures. The aim of these discussions is to achieve additional reductions in the cost of delivery of public services of the order of €1bn from the public service pay and pensions bill over the period 2013 to 2015."

Without casting any doubt on the sincerity of the minister's intentions, these are aspirational savings, not Budget cuts. His colleague Health Minister James Reilly, noting that the overall budget estimate for Health will increase in 2013, in recognition of the over-run in 2012, expanded further: "However, despite the extra funding provided, just over three-quarters of a billion euro in savings will have to be made next year, representing a major challenge for the services. In the region of half a billion euro of those savings will be achievable through cost efficiencies and separately through reorganisation under public service agreement. The clear majority of the savings will therefore have no recourse to front-line activity but the ministers acknowledge that it is a very challenging estimate and required taking a number of tough measures to ensure that the most vulnerable are protected."

A total of €781m in savings is required in Health alone for 2013, according to the minister. He identified the following:

• Reduction in the cost of Primary Care Schemes (€323m).

• Pay related savings (€308m).

• Increased generation of private income in public hospitals (€65m).

• Net savings on department's vote (€60m).

• Savings on procurement (€20m).

• Other savings (€5m).

The first two constitute 81 per cent of the total and appear to be cuts in estimates rather than expenditure. The third is an increase in charges (stealth tax), not an expenditure cut, as is the increased prescription charge. The other items are also just estimated cuts.

Job cuts of 3,500 in Health, publicised yesterday, arise from existing agreements and are not new cuts. Health is not the only department where the estimated expenditure totals require decisions not yet taken but it is the principal concern given the experience in 2012.

In summary, the attainment of the deficit reduction for 2013 requires a rate of economic growth in Ireland one per cent higher than what is expected in Germany and almost two per cent higher than the ECB expects for the eurozone, as well as a degree of expenditure control which was not achieved in the year gone by. These are the ingredients for a Budget over-shoot in 2013, the final exam before graduation back into the markets.

The Budget included some new tax breaks for construction-related spending (aircraft hangars this time), for Research and Development spending and more public-private partnerships, all of which will induce profound feelings of nostalgia in students of Irish budgets. Thanks for the memories.

The Achilles tendon in budgetary strategy remains the TUPs, the three unwise promises made before the election. These were to protect public service pay rates, social welfare payments and to eschew increases in the two rates of income tax. A one per cent increase in the 20 per cent rate and in the 41 per cent rate would deliver almost €700m in a full year, create unbridled outrage for about a week and would have yielded 25 times the cash from the controversial cut in the respite allowance for carers. If you enter the ring with your hands tied behind your back, you can expect to ship a lot of punishment.

Sunday Independent

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