The massive €18bn budget gamble – can it work?

This week’s budget saw plans for an unprecedented hike in Government spending. The total package was close to €18 billion, including the roll-forward of much of the massive Covid-19 rescue programme. Looked at another way, the budget package itself added €6.5 billion to the amount the Government plans to borrow next year. Against a background of unprecedented uncertainty – and no little risk if the pandemic drags on – the Government decided to go further in terms of spending and borrowing than expected.

This came from a realisation, which has become clearer as the year went on, that we have the resources to do this, according to Fergal O’Brien, chief economist at Ibec.

He said the sectors which have kept operating have generated more tax resources than expected, both via corporation tax and income tax from their employees. “It will be the first time in decades that we haven’t seen a brake put on State capital spending when we have had a crisis.”

Meanwhile, the amounts of cash being put into businesses forced to close or severely restrict activities is unprecedented. And it will be needed. The day after the budget presentation the political discussion moved back to the issue of restrictions. The imposition of Level 4 in three Border counties and the threat that it could spread nationwide risks stalling the economy again.

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How much can Ireland borrow to get through this Covid-19 emergency?

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So will it work? Can the €18 billion boost save the economy and chart a way to the future? Here are the key points:

1. The virus and the restrictions

The path of the virus is, of course, the great uncertainty. The budget figures are calculated on the basis of Ireland "co-existing" with the virus next year, with peaks and troughs triggering phased restrictions but no full lockdown.

And there is no doubt that even restrictions at Level 3 have an impact, closing – or largely closing – much of the hospitality sector, for example. Level 4 involves more of the economy closing, though unlike in the original shutdown construction is now judged as essential and can continue.

The latest high frequency indicators published by the Department of Finance the day after the budget suggest that the tightened restrictions in recent weeks are slowing activity. Consumer spending using cards fell back a bit in September, as did traffic volumes, while hiring rates and retail activity is stalling.

The risk now is that if the entire country has to go to Level 4, further damage will be done. And confidence is hit by fears of whether we are facing rolling restrictions at this level for the months ahead.

The budget documents showed that if a prolonged full lockdown was needed the risk is of knocking the economic recovery momentum almost completely next year, and spending, borrowing and unemployment spiralling higher.

We must also note, of course, that the appearance of a widely-available vaccine would, of course, be transformative and lead to a big bounce back.

2. Brexit

Deal or no deal: The budget calculations are done on the basis of no trade deal between the UK and EU. This means that the UK would leave the EU regime and trade would operate under a World Trade Organisation framework. The budget forecasts make clear that the main immediate danger is via the impact on exports to the UK, particularly those exposed to damaging tariffs, notably those in the food sector. It estimates that this could knock as much as three percentage points off GDP growth next year, which is now estimated at a modest 1.75 per cent. With the EU and UK sides still talking and some kind of deal quite possible, this could be the factor that gives the budget numbers more leeway moving into 2021.

It would be most unwise to bank on Ireland being able to raise long-term funding at negative interest rates in the years ahead

An unspecified part of the €3.4 billion largely unallocated recovery fund could be used to soften the Brexit blow, particularly supporting beef exporters. If this is not needed the money could be spent elsewhere, or not spent at all.

3. The ECB

The central factor in allowing Ireland – and other countries – to borrow so much to fight the pandemic is rock bottom interest rates. An era of low growth internationally since the last crisis has meant global interest rates have stayed stuck at low levels, particularly in Europe. The ECB has promised to continue its emergency support for the markets until next June at least, and has other policy weapons at its disposal.

If the virus is then on the wane and growth is reviving, the more hawkish wing will push for special supports to be wound down. But with economies still suffering and inflation likely to stay on the floor, it is hard to see any significant interest rate rise in 2021. Beyond that, markets are currently pricing in the continuation of super-low rates.

It would be most unwise to bank on Ireland being able to raise long-term funding at negative interest rates, as happened last week, in the years ahead. But there is no reason to expect general borrowing costs to rise by any really significant amount in the next year or two.

So the challenge for the Government is to maintain the confidence of lenders to ensure we still have access to the cheapest possible funding as ECB supports wind down perhaps later next year or into 2022.

By the end of next year our national debt could be €240 billion, but the cost of servicing it keeps edging down due to low interest rates. So far so good, but we won’t be able to borrow €20 billion every year, and will have to work out a way to pay for the various commitments in the programme for government and the enduring costs of the pandemic.

4. The Covid-19 rescue programme

The scale of resources now being deployed to help businesses and their employees hit by the crisis is now very significant. Notwithstanding this, the day after the budget saw a range of sectors and interest groups saying “not enough” or asking what would happen for them.

Ibec’s budget analysis sees the packages as an exercise in “cross-sectoral solidarity”, with resources generated by the sectors that have kept going being used to support those hit.

It says it will help many companies in the “experience economy” to stay afloat, noting the new scheme to give cash to companies forced to close due to restrictions, the hospitality VAT cut and the extension of other tax deferral and rates schemes and employment subsidies.

The amounts of cash involved are now really significant. Illustrative calculations show that, for example, a restaurant with turnover of around €32,000 a week and about 20 employees could expect to get €3,200 a week during periods of closure from the new fund set up to apply when restrictions are in place and around €4,250 in wage subsidies.

A small hotel/guesthouse with weekly turnover of €18,500 and 10 employees could get €1,900 a week when closed and €2,000 in wage subsidies.

For bigger businesses, the wage subsidy scheme remains the main benefit. It will be extended until the end of 2021, though the rules may change.

However, such is the impact of the pandemic that this is an exercise in damage limitation – the official forecasts are for a 320,000 drop in the number of people at work this year.

5. The spending boost

While much of the focus is, understandably, on emergency Covid-19 funding, Minister for Public Expenditure and Reform Michael McGrath also announced a boost of nearly €5.5 billion in what he defined as “core” expenditure – which can be expected to continue after the pandemic. The vital issue will be getting value for this extra cash. As McGrath himself put it “now, more than ever, taxpayers’ money needs to be focused on outcomes”.

The previous government was bedevilled by lack of progress – on problems such as reforming the health services and in investment projects like social housing or the national children’s hospital. Now, with massive sums being put into health and State investment spending at a record €10 billion, getting a bang for the extra bucks is economically – and politically – vital.

In particular, plans to boost the output of social housing and come up with a strategy for the provision of affordable housing present a huge challenge. And moving the health service beyond the pandemic response will also be difficult.

Here, as in other areas, the inevitable direction seems to be towards greater State involvement. This raises two longer-term questions.

Getting better outcomes for spending is challenging in Ireland because it is a high-cost country

The first is ongoing spending commitments will have to be paid for and the current base of tax revenue looks unlikely to be enough. It is hard to map the shake-out of the public finances after the pandemic – impossible in fact. But a lot of new commitments were made in the programme for government, and the pandemic has surely pushed politics towards greater social spending in areas like sick pay and and income supports. A new commission on tax and welfare is to try to work out how to set this balance.

The second issue is that getting better outcomes for spending is challenging in Ireland because it is a high-cost country. A recent ESRI paper by Dr Maev-Ann Wren and Aoife FitzPatrick said that while health spending here looks high by some international comparative measures, the high cost of providing services here means the actual volume of what is delivered gives us a much more modest international ranking. The same will apply in other areas.

6. The sectors which have just kept going

One thing that all forecasters underestimated was the impact of the parts of the economy that kept going right through – added to by sectors like construction and non-food retail which reopened after the initial lockdown. The key overperformers have been sectors like pharma and biomedical devices, where major investments have continued to add capacity and jobs – knocking on to tax revenues.

A change to the intellectual property (IP) regime in the budget took the foreign direct investment sector by surprise. But as it only applies to new IP arriving here it will not affect most of the main players, who have already moved IP in recent years in response to changing OECD rules, with much of it finding a home in Ireland. In turn the additional activity created seems to have been a key factor in boosting corporation tax.

With OECD negotiations on a new corporate tax regime coming to a head – and Irish tax revenues likely to face pressure whether there is or is not a deal, possibly from 2022 onwards – this is another complication in the longer-term mix. Corporate tax revenues of €12.75 billion are now expected for this year, with receipts doubling over the past five years and now accounting for more than one in every five euro of tax collected. Ireland is vulnerable here, but so far trends have defied similar warnings made in the past. And for 2021 corporate tax revenues should remain strong.