Commission decision raises eyebrows

The news that the European Commission is to ask the member-states of the European Union to censure the Republic on its budgetary policy is difficult to fathom. Firstly, the level of the State's prices is not affected to any degree by changes in fiscal policy. All research published on the determinants of the Republic's inflation - from the Central Bank, the Economic and Social Research Institute or the private sector - has concluded that the external value of the currency is the key factor and not conditions in the domestic economy.

Imports account for more than half of the Republic's GDP and 80 per cent of imports are sourced from outside the euro area. So, despite membership of the single currency, most of the State's imports are priced in dollars or sterling, and a fall in the euro will push inflation higher, regardless of whether the economy is growing at 5 per cent or 10 per cent.

Secondly, the Commission's own forecast envisages a decline in the State's inflation this year. In December, it published updated forecasts for the euro zone, including detailed projections for each member-state. Growth in the euro zone was projected at 3 per cent in 2001, with average inflation of 2 per cent. For the Republic, the Commission envisaged GDP growth of 8.2 per cent and inflation of 3.6 per cent, a decline from the 5.2 per cent recorded in 2000 (on the EU harmonised measure). Clearly, the powers that be in Brussels expect the Republic's inflation to decelerate, bringing it closer to the EU average, and growth to continue at a pace three times the European norm.

On debt, the Commission expects Government debt in the euro zone as a whole to average 61 per cent of GDP in 2001, almost double that of the Republic's 33 per cent, the lowest in Europe outside Luxembourg. Is fiscal policy too loose, as is claimed? Again, this is hard to accept despite the tax cuts announced in the Minister for Finance, Mr McCreevy's Budget last month.

Current spending by the Exchequer in 2001 is expected to exceed total revenue by £6 billion (€7.6 billion), equivalent to 6.6 per cent of forecast GDP. Of course, there is a large capital deficit of £3.5 billion to be taken into account, but this will be spent on much-needed infrastructure and will boost the Republic's growth potential. Even taking this into account, the overall Budget surplus on the EU's definition will reach 4.3 per cent of GDP, a figure never before achieved by any European state in the post-war world.

For some commentators, the rebuke from Brussels is seen as a coded warning to other larger member-states. Yet if this is the case, why not voice this directly to the states concerned? Why pick on the Republic, which is running a huge Budget surplus and which accounts for only 1 per cent of the euro zone's GDP?

Does anyone really think that the US authorities would worry about inflation in Rhode Island, the smallest state in the Union and hence an appropriate analogy to that of the Republic's position in European Monetary Union?

The Commission is merely acting to help the euro, others claim. This again bears little scrutiny. It is true the euro is weak because of inappropriate policies, but not those of the Republic. Investors have deserted the single currency because they see limited scope for returns in an over-regulated, over-taxed European mainland. The paradox is that, had more European economies performed as well as the Republic, the euro would have risen sharply, not fallen.

The last word is probably best left to the market, that herd of hard-nosed investors who are paid to cut through the verbiage and get to the heart of the matter. In the past week, the Republic's equity market has risen by some 5 per cent and the euro has fallen by more than 2 per cent, indicating the Commission's extraordinary verdict on the Republic's economy has not found many adherents outside Brussels.