Wednesday 16 January 2019

Yes, we've recovered but they could blow it again

The economy is in good shape - exactly the right time to fix that roof while the sun is shining, writes Colm McCarthy

Comparing debt to the exaggerated GDP measure makes the debt burden look smaller; and debt interest costs to the Government are rising
Comparing debt to the exaggerated GDP measure makes the debt burden look smaller; and debt interest costs to the Government are rising
Colm McCarthy

Colm McCarthy

Five straight years of economic recovery and the slow restoration of financial stability cannot forestall the inevitable query: "They are not going to blow it again, are they?"

The economic collapse from 2008 onwards is fresh in the memory and the more careful politicians have been suppressing their basic instinct (spending money) in pursuit of credibility with the less forgetful voters. The best time to fix the roof is when the sun shines: notwithstanding the huge debt overhang, the State is still adding to the official debt burden.

Last week Finance Minister Paschal Donohoe noted that "….potential challenges, including Brexit, exist, making it even more important that the Government continues its careful stewardship of the public finances. We will continue to focus on prudent management of the economy and on implementing competitiveness-oriented policies to ensure we remain resilient in the years ahead", he promised.

In Paschal Donohoe's case the sentiment is part of the job description, but there is no apparent appetite amongst his Dail colleagues, in government or opposition, to accept that Ireland has enjoyed a very favourable run and is exposed to threats which could bring that run to an early end.

The opportunity to move the budget back into surplus in benign circumstances has been spurned. The ideal budget for 2017 and 2018 would have been no budget at all, permitting the borrowing gap to close faster. Instead there were expenditure giveaways and tax concessions in an economy that had no need of budgetary stimulus.

The third budget from this Government affords what is presumably the final chance to turn sentiment into practice. The next government is unlikely to thank its predecessor if it inherits an uncompleted budgetary repair job. Twelve months from now the United Kingdom will have left the European Union. Aside from the UK, the country most exposed, even in a well-executed and damage-limiting Brexit, is Ireland. The economy is approaching full employment and labour shortages are beginning to emerge in several sectors. The spare capacity to accommodate expansion can only be used up once and continued economic growth at recent rates would be a challenge without Brexit.

For a heavily indebted Exchequer, the interest rate cycle matters and the favourable downward trend in borrowing costs has been a big bonus. Government spending is easier to control when unemployment is falling but it cannot fall forever. Both of these factors have helped the budget gap to close these past few years and both are running out of steam.

Dole payments and other social transfers are linked to the Live Register, which includes short-time workers. Numbers on the register have almost halved since the worst months of the downturn. The decline may well continue for another few quarters but there is a limit - the economy was at full employment towards the end of the bubble and labour demand could only be met through substantial immigration.

The pool of unemployed or underemployed workers in Ireland has, thankfully, been largely used up.

The budget numbers have also been flattered by lower interest costs on government debt. The National Treasury Management Agency likes to measure State debt relative to the tax revenue of government, rather than to the figures for Gross Domestic Product, which are exaggerated by the activities of multinational companies.

Comparing debt to the exaggerated GDP measure makes the debt burden look smaller than is really the case. Ireland's State debt is one of the highest in Europe relative to the wherewithal to service it, the recurring income of government. But the annual interest cost has been lower than expected in recent years because of the emergency policy measures taken by the European Central Bank. They have been purchasing government bonds in a deliberate attempt to force down interest rates.

The second chart shows that the debt interest cost of Irish government rose fourfold from the end of the bubble period up to 2013. Outstanding debt soared due to heavy fiscal deficits and bank creditor bailouts, exacerbated by high interest rates. Outgoings on interest have fallen by a quarter in the period since, even though the debt has continued to rise, since Exchequer borrowing has yet to be eliminated.

The central banks in Britain and the USA have commenced the inevitable tightening of monetary policy and official interest rates in both countries have already been raised. The European Central Bank was slower to respond in the downturn and is still propping up government bond markets through substantial purchases, which keeps the lid on borrowing costs.

The best guess is that official Eurozone interest rates will begin to rise about a year from now. Since much of the Irish government debt is longer-term and at fixed rates the interest burden will not shoot up suddenly. But the experience of the past few years is probably about as good as it gets.

The next government will thus face a period in which economic growth will likely be slower than in the past few years and without the double comfort blankets: falling social transfers due to the Live Register drop, and the low interest regime in Frankfurt.

Add in the risk of a messy Brexit plus Donald Trump's enthusiasm for a worldwide trade war (Make America Grate on your Nerves Again) and the case for a tight 2019 budget is complete.

Budget preparations have already commenced and the ritual Department of Finance circular on the need for restraint lies waiting on a word processor somewhere in Merrion Street.

Meanwhile the Easter parade of pay demands from teachers' unions has been augmented this year by medical doctors, who appear to hanker after a dual status as private self-employed professionals and pavilion members of the public service.

There has already been a commitment, in the National Development Plan, to an expanded Exchequer capital programme in the years immediately ahead. Add in the inevitable demands under every other heading of current spending and assorted demands for tax 'relief' in an election year and they really could blow it again.

Sunday Independent

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