Financial watchdog says ‘adverse shock’ to economy inevitable

An “adverse shock” to the Irish economy from Brexit, Donald Trump’s protectionist trade policies or changes to the international tax environment is now inevitable, the Government’s financial watchdog has warned.

In a pre-budget statement the Irish Fiscal Advisory Council (Ifac) also cautioned that while efforts to stabilise the public finances since the financial crisis have been successful, improvements in the Government's underlying budgetary position have stalled since 2015. This is despite a strong recovery in the economic cycle.

As a result, it suggested an “earlier-than-planned move” to running a small budgetary surplus may be warranted, particularly if growth and tax exceed expectations this year.

The council's warning echoes comments this week by Central Bank governor Philip Lane, who called for more financial resources to be set aside as a buffer against future economic shocks.

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Having originally targeted a budget surplus in 2018, the Government is still running budget deficits (spending more than it raises in revenues) despite having one of the highest debt burdens in the OECD. It is now not expected to achieve a surplus until 2020.

Ifac chairman Seamus Coffey told The Irish Times that almost all small open economies in Europe, with the exception of the Republic, were currently running budget surpluses, and "those countries don't have the strength of growth that we have or the surge in corporation tax".

Potential clouds

“If they’re managing budgetary surpluses it’s something we should be able to achieve too, particularly given the potential clouds on the horizon,” Mr Coffey said, while noting that running a budget surplus would not preclude the Government from increasing spending on health or housing provided it raised revenue elsewhere.

On Brexit, the council said the “size and nature of potential impacts” from various scenarios were highly uncertain, and may not fully capture the extent of the Republic’s and the UK’s closely integrated supply chains.

Mr Coffey said the impact of Brexit on the State had been modelled by the Department of Finance and others on the basis that it was a “normal shock” with a standard trading partner, but the UK was not a standard trading partner.

He also pointed out that the Irish economic sectors most likely to be affected were the largest employers.

The council also warned that the highly concentrated nature of Irish corporation tax receipts means that substantial reductions in Government revenue could arise if even one large firm were to relocate its operations as a result of changes internationally, such as President Trump’s policy reforms in the US.

About 40 per cent of receipts from the business tax, which generated a record €8.2 billion last year, come from just 10 firms, leaving the State uniquely exposed to changes in the international tax environment.

Tax revenues

Ifac said that any unexpected increases in tax revenues or lower interest costs that arise this year or in 2019 should not be used to fund budgetary measures beyond those currently planned, and should be used to build financial “buffers” to cushion the economy against future downturns.

It urged the Government to stick to its plan for a budget-day package for new measures of around €800 million, which, it said, was in line with the sustainable long-term growth rate of the economy. “There is no case for additional stimulus in 2019 beyond this.”

It said if the Government wanted to introduce additional spending measures “these should be funded by additional tax increases or through reallocations of existing spending”.

The council said the Irish economy looked set to continue to grow at a rapid pace.