Counting to 3%

One thing about the 2015 budget is for sure: the planned €2bn spending cuts and tax hikes will be watered down for reasons both economic and political.

Ever since the Troika left late last year, the government has been making noises about easing the burden of austerity on Irish families. There is also a sense that now Ireland has ‘regained its sovereignty’, and that the economic emergency can be considered over, people are not willing to wear the hair-shirt any longer. This is precisely the message the governing parties have taken from the drubbing they received in the recent local and European elections.

At most, 2015 will be the last full year before the next general election. The electoral reckoning could well come much sooner than early 2016, meaning October’s budget could be the last before the government faces the voters again.

While there are differing opinions on how and when to get there, there is broad agreement that the budget deficit should be brought below 3% of GDP, in line with Ireland’s legal obligations as a Eurozone member. While the government could ask for an extension, as other countries such as France have done, it is likely that they will not want to squander – as they see it – their hard-won credibility with those who lend us money – the EU, IMF, and particularly the financial markets. It is therefore likely that October’s budget will be carefully calibrated to meet the 3% ‘letter of the law’.

In the first five months of 2014, tax revenues came in €446m ahead of target while spending came in €155m below target, meaning the deficit is about €600m lower than was expected by this time of year. If these trends were to be maintained through the rest of 2014, it is quite possible that the starting point for 2015 – on which October’s budget sums will be calculated – would be more than €1bn better than had been envisaged. Against this, however, must be discounted a number of one-off measures – such as income from the Central Bank and the timing of receipts from the National Lottery – that won’t be in play next year.

As in last year’s budget, there may be some once-off creative accounting to hit the 3% target. This would mean less need for politically toxic spending cuts and tax hikes this side of the general election, but would do little for the long-term sustainability of the public finances.
The ESRI made headlines with its most recent upbeat assessment that, with the return of strong economic growth, no further austerity measures would be needed in 2015 on top of the already enacted water charges. The big ‘known unknown’ here is the growth rate itself. While the ESRI’s analysis is predicated on GDP growth hitting 3.5% in 2015, for instance, the OECD’s Economic Outlook, published last month, forecast a more sedate 2.2% growth rate. In truth, it is impossible to forecast this with any great degree of precision.

So long as there are no wildcard negative surprises – unknown unknowns! – in the second half of the year, it may well be the case that the government will need to announce only minimal new austerity measures in October’s budget. But this is far from guaranteed.

Looking beyond 2015, things get even murkier. The national debt is more than a fifth larger than the entire annual output of the economy, more than double the 60% of GDP level permitted of Eurozone members. New European rules, moreover, mean that this level should fall by a twentieth of the excess every year – so by more than 3% in 2015.

Does this mean more austerity? Again, the growth rate is the critical variable. If the economy gets a tailwind, as investment comes back from unsustainably low levels for instance, the debt-to-GDP ratio could fall rapidly as it did in the 1990s. On the other hand, if growth disappoints, and if interest rates spike higher, then further adjustments would be necessary to ensure the national debt doesn’t spiral out of control, never mind putting it on a sustainable downward path.

While an EU-level deal on Ireland’s legacy debt from the banking crisis could be a game-changer, events have proved this something that can’t be counted on. Even in a best-case scenario, however, there will not – and should not – be any swift return to the giveaway budgets of days passed, no matter what happens in elections.

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