Thursday 21 November 2019

All is fine. No need for a giveaway Budget...

The proposed path of the Government's budget policy either makes sense or it doesn't

Promises: Taoiseach Enda Kenny and Finance Minister Michael Noonan, along with Tainaiste Joan Burton, have all been hinting at budget giveaways. Photo: Damien Eagers
Promises: Taoiseach Enda Kenny and Finance Minister Michael Noonan, along with Tainaiste Joan Burton, have all been hinting at budget giveaways. Photo: Damien Eagers
Colm McCarthy

Colm McCarthy

Imagine you are the finance minister of a heavily indebted country emerging from a deep recession, during which the state lost the ability to borrow and had to rely on official lenders, including the IMF. You have a legacy of high debt and high unemployment, and the budget is still in deficit. But things are looking up. The economy is expanding again and is predicted to grow in future years. Unemployment is falling. Inflation is roughly zero. What would be the most prudent budgetary strategy to adopt?

If economic growth could eliminate the deficit without further action and the expansion seems to be continuing, the textbook advice would be to do nothing - leave expenditure and tax rates at current levels and take no chances. The budget speech would be short: 'We are pleased with how things are going and have no proposals'.

The Irish Government was presented last week, on the publication of the ESRI's latest economic commentary, with a wonderful opportunity to announce that it proposes to do nothing at all for a while. Instead the plan is to have an April 'statement' on macroeconomic policy followed, it appears, by an expansionary budget in October. Thus the time-honoured Irish tradition of pro-cyclical budgets, as in 'If I have it I spend it', is to be continued for another cycle.

The sharp improvement in economic performance and prospects is due to a range of factors, mostly pieces of sheer good luck. The main ones are:

Recovery in the UK and the US: Ireland does much of its external trade with the UK and the US and benefits more than continental Eurozone countries from the faster rate of recovery in these two trading partners.

Weaker Euro Exchange Rate: The Euro exchange rate is down roughly 25pc against the dollar over the last year, and roughly 15pc against sterling. This gives a double-bonus to any Eurozone country which has extensive trade with these recovering economies.

Weak Oil Prices: Even in depreciating Euros, oil (and gas) prices are well down from their peak levels. Ireland is a big importer of both and a big beneficiary when these import costs decline.

Low Government Borrowing Costs: All Eurozone countries, with the solitary exception of Greece, are enjoying record low-interest costs on new government debt. This has reduced sharply the burden of servicing the €200 billion-plus of national debt. Ireland has also benefitted from interest rate reductions and term extensions on official borrowings.

The recovery also owes something to domestic efforts to improve competitiveness and to keep budget consolidation on track. But it would be naive to discount the element of good luck, or to pretend that the favourable external inflences are likely to persist. The UK and US recoveries are not guaranteed to continue into the medium term - particularly in the US, the period of loose monetary policy and near-zero interest rates could come to an end later this year.

Rising US interest rates could signal the limits to euro weakness, as could an early abandonment of quantitative easing (QE) in Europe. This is the programme of bond-buying under way at the ECB, delayed so long that the eurozone economy seems to have bottomed out just as it was commenced. Any early evidence of a faster European recovery could see the euro exchange rate stabilise and even regain recent losses.

The same pattern of events would likely see European interest rates creep back up, thus raising government borrowing costs again. Finally, oil prices cannot sink forever and fossil fuels are exhaustible after all.

However long these favourable external factors persist, there is no denying that, for now, things are looking good. The ESRI report notes that GDP growth was 4.8pc last year and predicts 4.4pc for 2015 followed by 3.7pc for 2016. Unemployment will drop to 8.4pc in 2016 they reckon, a three-point improvement in just two years. Investment will see double-digit growth and there will be a large balance of payments surplus in both 2015 and 2016. Inflation will be close to zero.

Crucially, and with no policy changes, the budget deficit will fall from 3.7pc last year almost to zero in 2016. Happy days!

With inflation close to zero there is no need to adjust rates of payment in the pension and welfare systems to maintain their real value. Nor is there any imperative about indexing tax bands and credits or rates of excise duty. These items index themselves automatically at zero inflation. The other motive for a pro-active budgetary stance would be a sluggish economy. With the capacity to borrow restored, and borrowing costs cheap, a case could be made for a counter-cyclical stimulus if it was needed. But with the economy expanding at a fair clip and employment rising, it is not needed at all. The economy probably still has spare productive capacity but growth at recent rates will use it up fairly quickly.

The ESRI has advised against any pro-cyclical relaxation of budgetary policy, not surprisingly given its optimism about the immediate economic prospects. In this it echoes the stance of the government's Fiscal Advisory Council. This independent body, established to provide a professional and non-political input, was critical of last October's budget on the grounds that recovery has commenced, fiscal balance is now within reach and a neutral budget for 2015 would have done fine.

The Taoiseach, Tanaiste and Minister for Finance have all been hinting at budget give-aways over the last few months, even to the point of seeking a relaxation of EU budgetary rules. Having respected the rules when it was hard, the desire now is to duck them when it is easy to comply.

If the ESRI's forecasts are anywhere near the actual outcome, Ireland's budget deficit could be zero within a couple of years without any more cuts or tax increases. The economy has no need of a fiscal stimulus either, with employment rising strongly and competitiveness apparently restored. A few years hence, who knows what the economic environment will look like? External demand could have weakened, the euro exchange rate could have strengthened again, government borrowing costs could have risen.

It would be nice if, in 2018 or 2019, a future finance minister could contemplate some fiscal stimulus in a downturn on the grounds that the budget was in surplus and the national debt finally falling. The real cost of a pro-cyclical budget boost next October is that it may not be an option next time it is actually needed.

The government has enjoyed an easy ride from the media on its declared intention to return to the budgetary bad habits of its predecessors. There is, after all, an election to be won and boys will be boys!

If there are siren voices on the opposition benches offering the sun, moon and stars, washed down with copious servings of snake oil, who can blame ministers for competing?

The proposed path of the Government's budget policy either makes sense or it does not. The irresponsibility of opposition promises is a constant and would indicate pro-cyclical budgets in any and all circumstances. There comes a point where this knowing media indulgence veers over into institutionalised cynicism.

Sunday Independent

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