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News : Irish Last Updated: Dec 11, 2009 - 6:46:36 AM

Irish Budget 2010: Money value of activity in Irish economy to be massive 32% lower in 2010 than was expected in December 2007
By Michael Hennigan, Founder and Editor of Finfacts
Dec 10, 2009 - 6:25:50 AM

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Irish Budget 2010: The money value of activity across the Irish economy is set to be a massive 32% lower in 2010 than was expected in December 2007 - - just two years ago - - according to KBC Ireland economist Austin Hughes. Meanwhile, Ulster Bank economists say that the Minister for Finance certainly faced an unenviable task. The idea of trying to take some €4bn, equivalent to 2.5% of GDP, out of an economy contracting at a record pace with the unemployment rate at a near 15-year high must be every politician’s nightmare. But in fairness to the Minister, he did deliver on the required adjustment.

Peter McLoone, leader of the State’s biggest public sector union Impact warned 350,000 workers would now prepare for industrial action. In a statement, he said:“All existing and former public servants must now mobilise to protect their incomes.”

There was little hope in the Budget for the unemployed but while McLoone had nothing to say about the unemployed, he didn't have to worry about the many well-off public service pensioners, who receive all the pay increases of current workers, including benchmarking. The Budget temporarily delinked their pensions from the cuts in public pay.

So former taoisigh, the Chief Justice  - - who is both protected from a pay cut because of an interpretation of the Constitution and is in receipt of a pension as a former attorney General - - central bankers and many others who are among the well-off in society, have Peter McLoone as their protector.

Finfacts Budget 2010 Page

On Wednesday, it was the head of America's greatest company, General Electric, who was left to speak for the forgotten.  

"I was recently at an event with some unemployed steel workers. Their stories are truly sad. They just want to work. They want to be led. What is my responsibility? What will your responsibility be someday? Technically, nothing. Financially, nothing. We do not have to care. But we should," Jeffrey Immelt said.

He added:"It begins by people telling the truth. We do have to compete to be great; we must improve training and education; we cannot protect everyone in a global economy. In my career, I have had to deliver difficult news that I believed was in the  best interest of the enterprise. At the same time, ethically, leaders do share a common responsibility to narrow the gap between the weak and the strong. I have taken on the challenge to increase manufacturing jobs in the United States. These are the jobs that have created the midwestern middle class for generations. Manufacturing jobs paid for college educations, including mine. They have been cut in half over the past two decades."

SEE: Finfacts article; GE chief attacks "meanness and greed'; Richest made most mistakes with least accountability; Bottom 25% of Americans poorer than 25 years ago

In  a commentary on the Budget, KBC Ireland's Austin Hughes said that the deterioration in the Irish economy since 2007, has meant that tax revenues are 44% lower than predicted in spite of increases implemented in October ‘08 and again in April ‘09.  However, the nature of the problem facing Minister for Ffinance, Brian Lenihan is seen in the fact that even after today’s major spending cutbacks current government spending is just 5% lower than envisaged in December 2007, by then Minister for Finance, Brain Cowen, in a very different world.  Only to a limited extent does the comparatively small change in spending relative to 2007 reflect an extra €2bn in debt service costs but this consideration doesn’t change the stark reality that there is a yawning gap between the Government’s income and outgoings. 

In monetary terms, he says the chart above shows, the shortfall in tax revenues compared to late 2007 expectations is more than ten times the drop in Public Spending.  This ratio gives some indication of the nature and extent of the pressure on Ireland’s public finances.  It also underlines why it was necessary to take the approach adopted in the Budget.  The reality is the existing level of public services wasn’t sustainable.

Hughes concludes: "If the general sense of an economic apocalypse has faded, there is little prospect of a marked improvement in 2010.  Instead, a more gradual easing of strains on companies and consumers, probably interrupted by occasional ‘aftershocks’ of the recent crisis, seems more likely.  Such an outturn would not seem entirely inconsistent with the Department of Finance’s economic forecasts that envisage a very modest decline in activity in 2010 relative to what happened in 2009.  A somewhat clearer recovery should take hold as next year progresses but will only become evident in annual average data in 2011."

Ulster Bank Budget 2010 Analysis:

Simon Barry, chief economist Republic of Ireland, Ulster Bank;  Lynsey Clemenger, economist, Ulster Bank

The Minister for Finance certainly faced an unenviable task. The idea of trying to take some €4bn, equivalent to 2.5% of GDP, out of an economy contracting at a record pace with the unemployment rate at a near 15-year high must be every politician’s nightmare.

But in fairness to the Minister, he did deliver on the required adjustment. Well, very nearly. To be precise about it, Wednesday’s Budgetary package actually fell a touch shy of the planned, and much rumoured, €4bn, with the Minister arriving at a headline figure of €4bn by combining pre-Budget savings on Live Register costs (specified in last weekend’s White Paper) of over €200 million with a combination of measures in the Budget itself of about €3.8bn.

But this is a relatively minor point in the big scheme of things. Indeed, it is worth taking stock of the enormous effort which has already gone into addressing the imbalances in the public finances. In all, Wednesday’s Budget represents the fifth initiative, a process which began in the summer of 2008 with some spending pull-backs at that stage followed by the October Budget in that year. Then in January of this year the Department of Finance unveiled a further update on the fiscal strategy, in turn followed by the public sector pension levy a month later and the Emergency or Supplementary Budget in April.

In total, this series of measures summed to a whopping €8bn in terms of the impact on the 2009 fiscal position. In other words, had the Minister not taken the steps above, the 2009 deficit would have been of the order of 17% rather than the 11.7% which now looks likely, bad and all as that is. While one can argue and debate about the piecemeal and at times seemingly ad-hoc nature of the approach at times, the scale of the response is very much deserving of recognition and credit.

Viewed from a macroeconomic perspective, we also regard Wednesday’s installment as broadly a development to be welcomed. In particular, it is very welcome indeed that the overwhelming focus of the €3.8bn savings was on the spending side. The €1bn cut in the capital spend had been well-leaked. While such spending can and does provide valuable stimulus to a seriously under-heating economy, the significant decline in the capital requirements of an economy operating so far below trend, combined with large-scale declines in tender prices in the construction sector, makes this decision a reasonable one in the circumstances.

In a relative sense, turning the taps off on capital spending is a straightforward task as it is notoriously difficult to achieve large savings in the typically much more sensitive arena of day-to-day expenditure. But the Minister grasped this nettle Wednesday. The €1bn reduction in the public sector pay bill was in fact a bit lower than the €1.3bn which had been flagged but has nonetheless generated much anger in union circles. However, prevailing pay differentials between public and private sectors and the severe adjustment being borne by exposed sectors of the economy (total employment across the economy is down over 8% over the past year, while it is actually up some 3% in government-linked sectors) provide ample justification for Wednesday’s move in our view, as undesirable as it is to have to introduce such measures.

Like the capital programme, the cutbacks (of €760 million) in social welfare had been well-signalled. Cutting unemployment benefits and child benefit is never going to be popular to put it mildly, even if the changes in the former will at the margin help improve incentives to work. The Minister’s intention had been to improve the fairness of the child benefit system by either making it taxable or means-testing it. However, that proved impractical so, for now at least, he has had to resort to the blunt approach of reducing the rates. While it won’t provide much comfort to those affected, the fact that there has been a 6.7% fall in the Consumer Price Index over the past year or so (and a 3.4 fall in the HICP – European Harmonised - measure of prices, which excludes mortgage interest costs) does help to cushion the blow of such initiatives, as the impact in real-terms is correspondingly mitigated.

The Minister also managed to achieve total savings of around €1bn in general day-to-day spending, about 40% of which comes from Health. The focus here is on efficiencies rather than cutbacks in service levels, with the McCarthy Group recommendations proving helpful guidance no doubt. The introduction of a prescription charge of 50 cent per item under the medical card scheme is a visible, if contentious, move in this regard.

On the tax side, it was very welcome indeed that the Minister stuck to his guidance and refrained from adding further to the income tax burden having targeted this area aggressively in previous Budgets, especially in April. The fear of a removal of the PRSI ceiling thus proved misplaced as it turns out, though there was a further restriction of reliefs for very high income earners.

The inevitable carbon tax materialised. Headlines here included an extra 4.2 and 4.9cents on the price of a litre of petrol and diesel respectively, with the total yield from this area at €250million for next year. This gave the Minister scope for reductions in other areas, notably a surprise, and welcome, reversal of the previous 0.5% hike in the VAT rate which goes back down to 21% with effect from January. Excise duties on alcohol were also lowered and should help stem the tide of cash crossing the border, albeit that the exchange rate, clearly beyond the influence of budget policy, will remain a major influence on patterns here. The car lobby will be pleased with a car scrappage scheme even if economists tend to be sceptical about the lasting benefits of such schemes.

There was no provision for additional recapitalisation of the banking system, presumably at least partly reflecting some hope that private resources can be brought into the equation. But the minister did establish a credit review system to include lending guidelines to banks and an appeals procedure for cases where businesses have an application for credit refused.

The overall thrust of the budget is welcome. It represents another very important contribution to the absolutely necessary process of stabilising the public finances. In particular, the overall emphasis on reducing spending rather than adding further to the burden of income taxation is very much the appropriate one.

It is certainly the case that Budget 2010 distributes an awful lot of pain but the reality is that the scale of the problem is still huge. For example, the Department of Finance estimates that about three-quarters of the near 12% of GDP deficit for this year and next is ‘structural’ in nature. In other words, the vast majority of the deficit won’t simply go away even if the economy begins to grow at normal rates again.

This carries the uncomfortable implication that, as painful as everything that has happened to date on fiscal policy has been - including in this latest Budget - there is more to come unfortunately. In particular, the outline of the plan for the coming years involves a further €3 billion of cuts in next year’s budget, with a further €5bn or so in the subsequent three years. While this definitely won’t sound like great news, it does actually represent a considerable improvement – of around 3 billion euros on a cumulative basis - compared to what the April Budget had envisaged.

Compared to that version of the plan, it seems that the Department has been able to find material savings in areas including capital spending (helped by lower tender prices), the Live Register and debt servicing costs and higher non-tax revenue including from the charges to the Banks under the Guarantee scheme. The fact that the planned correction is now to take place out to 2014 rather than 2013 also helps in the lowering of the required annual adjustments.

So all going to plan the deficit will be down to the much more manageable level of 2.9% in 2014, bringing us back to within the limits set by the Stability and Growth Pact. Of course, how the economy evolves will have a major bearing on the trajectory of our deficit and debt profile in the years ahead. The Minister envisages a contraction in GDP on average next year of 1.25% (roughly in line with the prevailing consensus) but has a punchy enough set of growth forecasts thereafter, with an average rate of GDP growth in the 2011-2014 period of over 4%. That kind of scenario is certainly not implausible considering the scope for a rebound from the lowly levels of activity at present. But it might have been more prudent for him to plan on the basis of something a bit more conservative (our own working assumption is for growth around 3.5% in those years).

In any case, even if the Minister’s scenario comes to pass, there will still be a need for further consolidation in the years ahead. We note that the actual announcement of the much flagged cut in the public sector pay bill has intensified strains between the public sector unions and the government. The intention to reform pension arrangements in the public sector also announced Wednesday, along with the need for further savings in day to day spending will likely see tension levels between the government and the social partners remain high over the coming year. The months ahead are likely to provide the sternest test yet of the Social Partnership approach to policy formulation in Ireland.

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