Sunday 15 September 2019

Government borrows can of petrol to throw on an economy on fire

With the recovery going nicely, this Budget was a missed opportunity to pay down Ireland's debt, writes Colm McCarthy

‘Reliance on the tender mercies of the ECB should have taught us that when small member countries get into trouble, they can expect no favours'
‘Reliance on the tender mercies of the ECB should have taught us that when small member countries get into trouble, they can expect no favours'
Colm McCarthy

Colm McCarthy

'When you come to a fork in the road, take it' was the advice of the New York Yankees baseball legend Yogi Berra, who passed away three weeks ago. The Taoiseach used the 'fork in the road' metaphor to characterise the Government's Budget strategy in his Dail address on Wednesday, shortly after Fiscal Council chairman Prof John McHale had made it plain that the fork chosen was the wrong one. The Budget was needlessly expansionary for the second year in a row and the Government is trying to spend its way out of a boom.

Prof McHale, whose job it is to consider the prudence or otherwise of budget policy, expressed concern on RTE radio on Wednesday morning not so much about the announcements in the Budget itself, which had been well flagged, but about the figures for 2015 released yesterday week.

The Government provided (borrowed) extra funds for over-shoots on spending targets in the current year and the over-shoots were surprisingly large. The culprits included the usual prime suspect, the Department of Health, but there were expenditures well above budget in several other departments too.

The announced budget allocations for 2016 look more modest against this inflated base level, inflated through borrowing to accommodate poor expenditure control in the current year. Total spending of general government in 2015, current plus capital but excluding debt interest, rose 3.5pc in a year of zero inflation, not exactly an austerity performance.

Moreover, the economy is going through a very brisk recovery, mainly due to favourable external factors which could prove to be one-offs. These include the sinking euro exchange rate, the halving of oil prices and low government borrowing costs. The average growth rate over the three years 2014 to 2016 looks likely to be about 5pc.

Against this background, it is hardly surprising that so many commentators have questioned the timing of the fiscal expansion. With things going so well, a neutral budget would have seen the deficit fall rapidly and possibly to zero as early as next year.

The Government has instead chosen to borrow more money to fuel an economy that is already doing surprisingly well.

There was perhaps an excuse for the softer budget last year, since the strength of the recovery was not entirely visible. That excuse is no longer available.

It is a mistake to blame EU fiscal rules for imposing constraints on budgetary policy unless those constraints preclude policies which are appealing. It is plain silly to complain about a rule which requires you to behave in your own clear interests. Any heavily indebted state in Ireland's fortunate position, growing at 5pc, the highest by far in the eurozone, would be aiming for an early end to borrowing. At current debt levels, Ireland has little room for manoeuvre should the economy falter again.

Whether the Budget complies with the rules will be clarified in Brussels in the next month or so and the Fiscal Council will also have its say. Even if it passes muster, the Government cannot insist, as ministers have been doing all week, that the course they have chosen is needed in order to "sustain recovery". The recovery is doing just fine.

On Tuesday evening, Brian Dobson queried the Finance Minister on this very point. Why borrow more with the economy expanding and the debt level still so high? Michael Noonan cited the declining ratio of gross debt to national output, the EU's preferred measure, and went on to note that there are State financial assets which should really be netted off this gross figure. He is correct on both points.

However, he neglected to draw Dobson's, and the viewers', attention to two contrary points, both weaknesses of the gross-debt-to-GDP number beloved of the European Commission. Just as there are some state assets which it ignores, there are liabilities which are left off the books. Unfunded pension schemes in the public sector have deficits which more than offset the uncounted assets to which the minister drew attention.

Just as important, the GDP number measures the output of the economy, but national income, the base for taxation and debt service, is substantially lower. The main source of the gap is the outflows through multinationals.

The minister is doubtless well aware of both points and that the Irish State's solvency is flattered by using the EU metric. Should there be another crisis and a bond market crash, Ireland's debt could quickly prove less sustainable than it appears to be in today's benign conditions.

In this connection, membership of the eurozone can be seen as more of a trap door than a safety net. Ireland does not have a currency: it was abolished in 1999. There is thus no domestic capability to create liquidity in a crisis for either the State or the banking system.

Reliance on the tender mercies of the European Central Bank for liquidity provision through the recent crisis should have taught a simple lesson: when small member countries get into trouble, whether or not it is their own fault, they can expect no favours.

In our case, it was largely our own fault but the actions of European 'partners' were less than helpful. No proper banking union has been established in the eurozone and the fragilities exposed after 2008 have been papered over, rather than decisively addressed.

Another leg of the international financial crisis is always possible.

The current phase of near-zero official interest rates in all major developed economies is a unique event in economic history, in the sense that nothing like it has happened in four or five centuries of capitalism.

The few economists who claim to know that the crisis has definitively passed are bluffing. In Ireland, even if the threat of a renewed international crisis could be discounted, the economy has enjoyed a couple of years of very good luck.

The favourable movements in oil, the euro exchange rate and in government borrowing costs could all reverse. They certainly will not be repeated and they have been responsible for a fair slice of the 5pc growth rates we have been experiencing.

There is a combination of vulnerabilities here. The economy is small and volatile, exposed to external shocks and domestic policy mistakes. Lacking an independent currency, the country is deprived of economic policy instruments to handle another crisis, and is loaded with debt, all in a foreign currency, in both the state and private sectors. There is no painless route out of the eurozone as Greece has discovered, so the State is stuck, at least for now, with using a foreign currency.

The only unconditional source of liquidity in an emergency is then the State's capacity to borrow, which is unproven at these debt levels in a normal market.

Unless there is complete certainty that no renewed crisis is possible, it makes sense to use the buoyant years to stop the borrowing and rebuild the solvency of the State. Sovereignty, when you do not have a currency, means getting the external debt down, keeping the banks solvent and the cultivation of a long memory. The alternative is reliance on the kindness and understanding of the ECB.

Sunday Independent

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