IRELAND'S chances of emerging from the public finance crisis depend critically on economic recovery. If the rate of economic growth, currently zero or thereabouts, picks up soon, government revenues will improve automatically, helping to close the budget gap.
ut if there is no growth, the deficit, even with some extra cuts and tax impositions, will persist, because of the steady rise in debt-service costs.
Government plans have been based on the assumption that economic recovery is just around the corner. Since the crisis struck in 2008, a succession of government forecasts have been released, always showing that things will get better next year.
But next year never comes. Two reports released last week, one from the IMF, the other from Ireland's new Fiscal Advisory Council, should dampen the misplaced optimism about a successful exit from the EU/IMF programme and an easy return to the markets and national solvency.
The most recent forecast from the Department of Finance dates from April last. It envisaged economic expansion at 2.2 per cent next year, followed by a respectable three per cent in the two subsequent years. If this were to happen, there would be some worthwhile buoyancy in tax revenue and perhaps even some modest employment growth. But the economy has been flat for quite some time. The latest figures are for the first quarter of 2012 and show little change over a year earlier.
Economic activity collapsed from 2008 through 2010 by a cumulative 15 per cent, stabilised in 2011 but has shown no signs of any broad-based recovery since then. The European economy is in a double-dip recession, the US is sluggish and recent forecasts for Ireland have been downgraded. A continuation of zero growth over the next few years is a serious possibility and there is little that can be done about it here in Ireland. If the main export markets are flat, the Irish economy will in all likelihood do no better. Economic forecasting is not even an inexact science. Forecasts are regularly wrong and often by wide margins, sometimes too high and sometimes too low. It is essential to consider the worst-case outcome given this uncertainty.
Both the IMF and Fiscal Council reports caution against excessive optimism about prospects over the next few years and it would make good sense to assume that the trends evident in recent quarters continue. That means contemplating seriously the consequences of a zero-growth outlook.
Of course, things could turn out better than this, a nice problem to have. It is fine to hope for the best but prudent to prepare for the worst. On the Government's optimistic forecasts from April, and assuming a big package of spending cuts and tax increases in December's Budget, Ireland's debt ratio will reach a peak at about 120 per cent of output next year. In following years, the debt ratio will decline only slowly, even with more tight budgets. This level of public debt is excessive and unlikely to prove sustainable without substantial relief on the substantial bank-related element, even if economic recovery starts fairly soon.
What if economic growth turns out to be zero over the next few years, and the Government fails to secure meaningful relief on bank-related debt? Stripped of the technical details and the diplomatic language, the two reports are saying the same thing: Ireland is unlikely to get the debt under control. That means a second bailout, or sovereign default or
some other catastrophe lies in store. The Fiscal Council concludes that the substantial fiscal adjustment planned over the next few years is inadequate and should be even more stringent.
The IMF officials seem to believe that some of the bank-related debt was improperly imposed by our European partners and have consistently been supportive of Ireland's case for relief. Thankfully, this is now on the European agenda and Finance Minister Michael Noonan was in Cyprus last week lobbying fellow finance ministers on the issue.
The different strands of the European response to the peripheral sovereign debt crisis have become compartmentalised and the Irish case presents the opportunity for a more joined-up approach. Instead of focusing on legalistic arguments about promissory notes and the mandate of the European Central Bank, or on the prospective growth rate of the Irish economy, it is time to address the following question: what is a sustainable debt target for Ireland given poor growth prospects, and what needs to be done to achieve it? Clearly the Irish authorities need to get the budget deficit down as quickly as possible, and the EU Commission and the ECB appear to acknowledge that some measure of debt relief is in order.
There are distinct risks that the relief on bank-related debt will be too little and that the rate of economic growth could be low or zero. If both these things happen, the Irish adjustment programme will fail, even though it is regarded as the nearest to a success story among the bailed-out countries. It could fail anyway, since there is no margin for error or bad luck. If it fails, Ireland will not be able to re-enter the bond market in a way that matters and there will have to be a further bail-out, or some other undesirable or even catastrophic outcome, for the country lauded as best pupil in the class. There is the basis here for a path-breaking and imaginative deal. The Government has unwisely ruled out three of the most important options available in getting the deficit down. These are increases in the rates of income tax, further reductions in rates of payment under the social welfare system and further reductions in public service pay.
Without escape from this self-imposed straitjacket, it will be difficult to stick with the fiscal programme agreed with the troika. Without meaningful debt relief, it will in addition be difficult for Ireland to exit the programme successfully. But if the straitjacket could be shed, and serious relief offered from debts -- a substantial portion of which were improperly imposed -- Europe could declare that at least one of the bailout programmes had actually worked. A meaningful debt deal is within the control of European partners, while a retreat from unwise pre-election promises is up to the Government. The deal is obvious: the Government could offer to do more than it is committed to,
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abandoning the TUP (the Three Unwise Promises), provided the Europeans offer debt relief in amounts that will ensure a decent chance of success.
The Fiscal Council report shows that, even if the planned budget adjustments are delivered, low growth could easily scupper the Irish programme, unless there is serious relief from bank-related debt.
The council has made a very important contribution to the pre-Budget debate in Ireland, which should also be taken on board by our European partners in their consideration of the debt relief discussions. The IMF has been careful never to declare the prospective Irish debt level unsustainable but they have never pronounced it sustainable either, or not without heavy qualifications. On Friday, both Jean-Claude Juncker of the EU Council and Christine Lagarde of the IMF were fulsome in their praise of the Irish commitment to getting back on track in line with the troika programme. Mario Draghi of the ECB and Olli Rehn of the EU Commission have expressed similar sentiments. It would be a tragic outcome for all four if the sole distressed eurozone member deemed to have made the best adjustment effort should fail regardless.
The credibility of the Irish programme, and by extension of the European response to the greater eurozone crisis, can only be established if the remedy works in Ireland. There remains, after four years of assiduous commitment to the terms of the fiscal consolidation effort in Ireland, substantial doubt that the plan will work, due in part to the improper imposition on the Irish State of debt repayments to careless investors in dodgy Irish banks. The Government has apparently chosen not to challenge the legality of the ECB's behaviour in this matter.
So be it. It is past time to accept that the agony needs to be given an early burial. Portugal and Greece deserve some generous consideration too, and the blame game has gone on far too long. But the case for Irish debt relief now enjoys the imperative that it is beginning to look inevitable.
When precisely does the European leadership propose to declare a clear and unambiguous success? If the answer is vague, there is no European leadership.
