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News : Irish Economy Last Updated: Nov 26, 2010 - 6:56:25 AM

Success of Ireland's National Recovery Plan 2011-2014 depends on accuracy of Government's economic assumptions
By Finfacts Team
Nov 25, 2010 - 5:49:44 AM

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Davy Research said in a report issued early on Thursday that the success of Ireland's officially known National Recovery Plan 2011-2014, crucially depends on the accuracy of the Government's economic assumptions. 

DR staff, Robbie Kelleher, Barry Dixon and Stephen Lyons, said having registered a marginal gain in 2010, real GDP growth is forecast to accelerate to almost 2% next year and exceed 3% in 2012. Positive inflation is also expected to return to the system, so that nominal GDP is growing by 4.5% in 2014. The DR report says that is a key metric in driving the recovery that is forecast for underlying tax revenue.

Over the four-year period, nominal GDP is forecast to grow by over 16%, or almost 4% per annum. As a sensitivity exercise, DR considered what the numbers would look like if the nominal growth rate was 2% rather than 4%. DR stressed that this was purely a sensitivity exercise and should not be seen as a forecast.

The debt/GDP ratio would deteriorate, both because the nominal deficit would be higher as a result of lower tax revenue and the denominator would be lower because GDP is lower.

Under this scenario, the deficit in 2014 would be almost €3bn higher or 4.5% of GDP, than in the base case and the debt/GDP ratio would reach 120% and be rising. Equally, of course, the ratios would be correspondingly better if the nominal growth rate turns out to be higher than the 4% assumed.

Targets confirmed for this year and out to 2014

  • Yesterday's plan confirmed the government's intention to make adjustments of €6bn in next month's Budget and to target a total adjustment of €15bn over four years with the objective of reducing the annual deficit to less than 3% of GDP by 2014.
  • Of the €15bn, some €10bn will come from expenditure cuts and €5bn from tax increases.
  • On the expenditure side, current spending is set to fall by 12% over the period but capital spending is to be reduced by over 40% and by 2014, will not be much more than one-third of peak spending in 2008.
  • The main focus of the tax increases is on income tax. Bands and credits will be reduced by 16.5% and will generate more than a third of the total increase in new tax revenues.
  • If targets are achieved, the debt/GDP ratio will peak at 108% in 2013 before beginning a downward trajectory thereafter.

Success will depend on accuracy of economic assumptions

  • The success of the plan will crucially depend on the accuracy of the government's economic assumptions. GDP growth is expected to reach almost 2% next year and exceed 3% in 2012.
  • The plan does not make any allowance for any further capital injections into the banking system which may be required by an IMF/EU deal. But it is possible than any further requirements could be financed from the National Pension Reserve Fund and/or a run-down in cash balances.

Irish Finance Minister Brian Lenihan told CNBC his is confident the government will have "full political support" in parliament for its budget next week. That will bring Irish borrowing requirements down to "single digit figures," he said:

The report says at an arithmetic level, the narrowing of the gap between spending and revenues comes from both lines. Current spending is expected to fall by 12.4% cumulatively over the period, but the real hatchet blow falls on the capital side. Gross capital spending is forecast to fall by 43% in the four years and that comes after two years of significant cuts. The allocation of €3.5bn for 2014 represents a fall of more than 60% from the €9.0bn outcome for 2008.

In contrast, tax revenues are forecast to increase by more than a third over the four-year period. Some of this reflects the €5bn from specific tax measures that were included in yesterday's document. But it also reflects an assumption that underlying tax revenues will increase by 18% over the period as a result of the expected recovery in the economy. DR says on the face of it, that looks like the assumption in the Government's calculations that may be most at risk.

By the end of this year, overall Irish government debt will have risen to 95% of GDP from 66% of GDP at end of last year. This partly reflects the impact of an underlying government deficit of €18.5bn but it also reflects the impact of more than €30bn of capital injections into the Irish banking system.

Finfacts Budget 2011 Page

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