Department of Finance report on economy a cold shower

Coming on the back of last week's upbeat economic assessment by the Economic and Social Research Institute (ESRI), the Stability Pact Update (SPU), circulated yesterday by the Department of Finance, amounts to something of a cold shower.

Firstly, it bursts the growing bubble of belief that austerity is now behind us, restating that the planned €2 billion adjustment remains central to the budgetary arithmetic, and will go ahead even with its positive growth forecasts.

The ESRI had indicated the 3 per cent deficit target for 2015 could be achieved without any further adjustments, other than the introduction of water charges, fuelling expectation of some sort of retrenchment on the planned adjustment.

Though Minister for Finance Michael Noonan held out the prospect of doing "something" for hard-pressed middle-income earners, the scope appears limited unless the Government defies Brussels.

Sober reminder
The department's report is also a sober reminder of just how straitjacketed the Government will be in the coming years.

For the three budgets up to 2018, and until the deficit is reduced to zero, Minister for Finance Michael Noonan will really only be in a position to reduce income tax or widen the bands, as he clearly wants to, by increasing taxes or implementing cuts elsewhere.

Essentially, the budgets will have to be tax-neutral for most of this decade.

With property tax already depressing household income and the upcoming water charges likely to add to the load, it’s a sobering outlook.

Under the new post-financial crash rules, all EU member states must submit budgetary reports to the European Commission by the end of April each year.

Members of the Oireachtas Finance, Public Expenditure and Reform committee received the 48-page draft document just hours before Mr Noonan addressed them about it last night.

The Department of Finance’s modest upgrade of its GDP forecast for this year, from 2 per cent last October to 2.1 per cent now, also illustrates just how cautious the bean counters in the department remain about the future prospects for growth.

Of course, they blame this on sectoral issues, like the expiry of patents in the pharmaceutical sector and changes to turnover in the IT sector related to shifting royalty payments.

Patents issue

In contrast to the ESRI, the department suggests the patent issue will be distorting the country’s GDP number for at least the next two years.

At the back of the report, the Department of Finance published the results of a sensitivity analysis in which it examined the impact of aggregates like world output, savings and interest rates on future GDP growth.

The most startling finding was the impact of a 1 per cent rise in interest rates, which has the potential to cut GDP growth by 1.4 per cent next year and by a whopping 2.1 per cent in 2016.

Although, a rise in interest rates does not seem likely, in the short-term at least, the Irish economy's vulnerability, with its high levels of mortgage debt, to such a scenario is striking.

Unemployment rate
The unemployment rate, now under the euro zone average after falling to 11.8 per cent from a 2012 high of more than 15 per cent, is forecast to drop to 11.5 per cent by the end of this year and 9.7 per cent by the end of 2016.

This was probably the most positive aspect of the report.

Especially when you compare it to a figure of 12.4 per cent forecast for this year just six months ago by the department.

This will certainly aid the Government’s run-in to the 2016 election.