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News : Irish Economy Last Updated: Dec 9, 2010 - 5:08:02 AM


Irish Economy 2011: Budget deficit of €17.7bn and public debt/GDP ratio at 99% plus economic analyses
By Michael Hennigan, Founder and Editor of Finfacts
Dec 8, 2010 - 5:50:45 AM

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Table 1 from Davy Research's commentary on Budget 2011 summarises the broad developments between 2000 and 2007: Over that seven-year period, public expenditure more than doubled, with similar increases across a broad range of categories, including the pay and pensions bill. That compared with an increase of 30% in consumer prices over that period. Public spending was growing at a rate in excess of 10.5% per annum while prices were increasing at an annual rate of less than 4%.

True revenue did increase rapidly over that period as well as a buoyant economy swelled the coffers of the Exchequer - - but not as rapidly as spending did. So the overall government balance went from being in sizeable surplus (almost 5% of GDP) in 2000 to being just about in balance in 2007. At the height of the boom we were allowing ourselves a very modest cushion indeed.

Davy says what happened in the following two years is in many ways even more remarkable. As we all now know, tax revenues collapsed with the collapse of the building sector and a sharp weakening in the economy as a whole. But expenditure continued to increase, partly as a result of a first injection of €4bn in capital into Anglo Irish Bank. That left the government with an overall deficit of over €23bn, more than 14% of GDP.

Irish Economy 2011: Budget 2011 forecasts a deficit in 2011 of 17.7bn and public debt as a ratio of GDP (gross domestic product) will rise to 99%. This article provides more economic analyses on the outlook for the economy.

Davy Research in its Budget report (pdf) says current spending (excluding interest payments) is set to fall by 12%, although within that the pay bill is set to fall by just 5%. The big axe falls on capital spending, down another 43% over the period, having already fallen by over 30% between 2008 and 2010. By 2014, capital spending will have fallen by 61% from its 2008 peak.

On the tax side, receipts are expected to increase by 35% over the period. About half of this will come from specific tax increases and a similar amount is expected to come from the buoyancy of the economy.

Public sector pay and pension payments amounted to almost €18.8bn in 2010, representing almost 35% of gross current expenditure. This comprises €16bn in public sector pay and €2.8bn in pension payments.

Public sector staff numbers are forecast to decline by just over 3% during 2011 from 309,851 at the end of 2010 to 300,308 by the end of 2011.

On the outlook for the economy, Davy says that after stagnating in GDP terms in 2010, the economy is expected to grow again next year and to be expanding at a 3%+ pace by 2012. That is seen as sufficient to result in employment growth resuming and the unemployment rate falling to less than 10% by 2014.

The commentary says on the face of it, these seem like optimistic projections given the magnitude of the fiscal correction that is underway. But the expectation for 2011 is in line with consensus expectations.

Davy says beyond that, a number of points should be borne in mind:

  • The UK is proposing a similar fiscal consolidation over the next few years and it expects decent economic growth over the period. That expectation is not hugely contested by the international economic consensus.

  • Last year, the budget correction in Ireland amounted to €4bn, yet it appears that the economy managed to stabilise during the year.

  • Back in 1987, public expenditure was reduced by 7% in real terms, yet the economy was growing at a rate of 6% within two years.

  • Finally, the overall debt ratios in Ireland are undoubtedly demanding but they were higher in the 1980s and the economy survived. In the 1980s, the debt/GDP ratio reached almost 120%. This time, it is expected to peak at around 100%.

However, Davy says in the 1980s, private sector debt was about 50% of GDP; now it is close to 200% of GDP. As a result, the overall debt ratio is almost twice what it was in the 1980s.

Hence, the most important influence on whether the current fiscal journey is successful or not will probably be how soon and how well the authorities achieve their aim of downsizing and finally fully recapitalising our banking system. In that respect, the early months of 2011 will tell a lot.

Davy Research Summary:

The arithmetic is clear enough

  • There was little new in yesterday's budget. The recently published National Recovery Plan and the memorandum of understanding agreed with the EU and IMF had already revealed what the government intended to do to restore balance to the public finances.

  • Over the next four years, there will be cumulative 'adjustments' of €15bn in budgetary measures: €10bn in spending cuts and €5bn in tax increases.

  • This amounts to a cumulative reduction of 12% in nominal terms in current spending and a whopping 43% reduction in capital spending. Tax revenues meanwhile are slated to increase by 35%.

But can the economy handle it?

  • Putting the numbers into columns and rows is straightforward enough, but is it reasonable to expect the economy to grow in the face of such fiscal retrenchment?

  • It is certainly possible. The UK is attempting a similar mission and the international forecasting community still expects reasonable growth there over the period. And Ireland itself did it before in the 1980s.

  • The big difference this time around is the mountain of private sector debt and a dysfunctional banking system. Hence, the need to follow these fiscal plans with measures to downsize and re-capitalise the banking system must now take top priority.

Bank of Ireland chief economist, Dan McLaughlin, said with a 17.7bn deficit projected for 2011, it will be €1bn lower in cash terms than this year’s, and somewhat different in composition; the current budget deficit is projected to fall to €11.5bn from €13.1bn, while the capital deficit rises to €6.1bn from €5.6bn, reflecting the impact of additional borrowing to fund the promissory notes issued to the state owned banks. The EBR (Exchequer Borrowing Requirement) total of €17.7bn amounts to a forecast 11% of GDP although the General Government deficit declines to 9.4% of GDP (€15.2bn) from 31.9% in 2010 (€50.1bn), the latter figure including direct government support for the state-owned banks. In the absence of corrective measures the 2011 EBR would have risen to €22.5bn.

McLaughlin says Ireland’s general government debt has risen substantially since 2007, although at 65.5% of GDP in 2009 was still below the euro average (79.1%). The Irish figure is now likely to reach 94% this year (the euro average is forecast at 84.1%) and is projected to rise further in 2011 to 98.6%. Nominal GDP is projected to rise by 2.5% but the average interest rate exceeds this, at 3.5% (defined as interest payments in the current year divided by the previous year’s debt total) implying that Ireland would have to run a primary surplus equivalent to 1% of GDP to prevent the debt ratio rising. In the event a primary deficit of 6.2% of GDP is forecast, thereby pushing the debt ratio up to over 101% but the Government is projecting a figure of 98.6% as it intends to run down cash balances.

…spending accounted for two-thirds of the fiscal adjustment…In the absence of any budgetary changes the EBR would have risen to €22.5bn, and the Government announced a €6bn fiscal package to bring the deficit down to under €18bn. This involved a €1bn tax package, largely centered on income tax, a €300m increase in PRSI and €3.9bn in spending cuts, including €2.1bn in current spending with the balance on the capital side. Some €660m was raised via other measures including asset disposals with the total package dampening growth by over 2% and hence reducing tax receipts by €1.2bn, giving a €4.7bn net impact.

Ulster Bank economists, Simon Barry and Lynsey Clemenger, commented:"From a financial markets perspective, there were a couple of noteworthy elements. First, on the issue of burden-sharing of the costs of bank losses, the Minister reiterated that senior bondholders will not play a role. He made it clear that in his view such a course of action was not an option given the banks’ dependency on international investors. But perhaps more tellingly, he was explicit in stating that 'unilaterally reneging on senior bondholders' as he put it was against the wishes of our European partners and the European institutions, underlining again that this particular issue was non-negotiable from the European point of view as part of the terms of Ireland’s package of assistance. However, he said there would be further burden-sharing by subordinated bondholders (whose total exposure to Irish banks amounts to around €17bn), and that enabling legislation will be submitted to the Dáil next week.

Second, the Minister announced that the Government will be proceeding with a proposal put to it by the Irish Association of Pension Funds and the Society of Actuaries. The idea is that Irish pension funds can invest in longer-term Irish bonds (which offer higher yields than currently available elsewhere), and price their liabilities to pensioners on the basis of those higher yields.

For pension fund managers who may opt for such investments, this would have the effect of reducing the present value of such liabilities, albeit with some degree of additional market risk, while for the Government it offers a potentially helpful source of additional domestic demand for new debt issuance at a time when many foreign investors have turned 'Ireland-shy'."

Ulster Bank Budget Commentary including Table of Main Changes

Finfacts Budget 2011 Page

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