New Brexit deadline makes next Irish budget hard to get right

The current account of the balance of payments is a key indicator of the state of the economy, and a deterioration is an important signal of likely trouble ahead.

In the run-up to the economic crisis, the current account deficit rose to 6 per cent of national income in 2006, having been zero in 2004. The economy was booming, but in a distorted way – the construction boom squeezed domestic manufacturing, whose exports stalled, while rising incomes sucked in increased imports.

The building and consumer splurge was only possible because of ever-increasing foreign borrowing through the banking system. When the crisis hit in 2008, the banks could no longer borrow abroad and the rest is history.

The CSO has provided a very useful adjusted current account balance figure for the years up to 2017

A large balance of payments surplus means an economy is lending abroad (or repaying debt). It is possible, as in the case of Germany, to run continuing surpluses over long periods, building up foreign assets. While this may not be the wisest policy for Germany, and it is certainly not the best policy for Europe, there is no simple mechanism within EMU that will halt this pattern of behaviour.

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Running a continuing current account deficit, where an economy continues to borrow abroad, is not always problematic provided this lending is used to fund productive investment that will, in turn, produce foreign sales to help repay the borrowing. That approach can actually enhance growth in the medium term and is potentially sustainable.

However, if the foreign borrowing is not invested to develop the productive sector and grow exports, then as foreign debts build up, things are likely to come to an abrupt stop when foreign lenders lose faith that their money will be repaid.

One of the problems with the investment boom of the last decade was that, while the huge number of houses built made housing much more accessible during the crisis years, the houses did not produce exports for sale abroad. And then it all crashed.

Impenetrable data

Keeping an eye on the current account of the balance of payments is important to spot emerging trouble. However, the large flows associated with our foreign-owned sector and our aircraft-leasing business has rendered the Irish data pretty impenetrable.

The latest CSO figures for 2018 suggest a massive balance of payments surplus of almost 12 per cent of national income. If real, this would reflect huge foreign investment (or repayment of foreign debts). But the data on the current account balance are seriously distorted by the operation of foreign multinationals.

It seems likely that, once again, the UK will delay decisions until the last minute

A major part of this accounting surplus represents the depreciation of the tech industry’s intellectual property and of aircraft owned by foreign firms, and are not funds available for the Irish people.

The CSO has provided a very useful adjusted current account balance figure for the years up to 2017. This measure shows a surplus for that year of 1 per cent of national income. While dramatically lower than the headline figure, the fact that Ireland was still in surplus in 2017 when the economy was booming suggests that our growth was sustainable in the medium term.

Although, because of data limitations, there is no CSO figure available for 2018, the Department of Finance has estimated a 2018 surplus of 2 per cent in their recent Stability Programme Update. This suggests current growth in our economy is sustainable, with scope to continue growing into the next decade.

Risk of shocks

In contrast to that indicator of robust economic health, this week's Department of Finance conference on globalisation and taxation highlighted the risks of adverse shocks to corporation tax revenue in coming years.

The move to electric cars will also affect traditional revenue from excise duties on petrol and diesel. And the looming spectre of Brexit remains an even bigger threat.

The risks to future tax revenue would suggest Minister for Finance Paschal Donohoe plan for a significant budgetary surplus for 2020. However, if the UK drops out of the EU without an agreement, Ireland would face an immediate dramatic economic shock, which might require a neutral or even stimulatory budget to soften the impact.

The timing of the new Halloween Brexit deadline renders it exceptionally difficult to make the right strategic choice in October's budget. Should the Minister prepare the country for a Brexit crash-out or for continued growth?

It seems likely that, once again, the UK will delay decisions until the last minute. In which case, a budget in October, followed by a possible supplementary one in December if there is a hard Brexit, may be the best course of action.