ANALYSIS:For the next half decade at least, the rising costs of our debt will soak up projected savings, writes DAN O'BRIEN, Economics Editor
MANAGING THE finances of State is like piloting a supertanker – once momentum gathers, changing course takes time. And the greater the momentum, the more difficult it is to change course, even when evasive action is needed to avoid the most catastrophic of collisions.
As the chart shows, despite the massive cuts that have been introduced and those that are to be implemented in the coming years, public spending will merely stabilise on the basis of the Government’s projections released yesterday in its four-year plan. Total spending will hover around €75 billion annually up to 2014, as measured by the widest-ranging and EU-standardised “General Government” figure.
It is on this measure, not the exchequer measure, that Ireland is obliged to reduce its budget deficit to below 3 per cent of GDP by 2014. This measure is the only one that matters because it is the one that our rescuers and the markets watch.
The effects of allowing spending to run out of control during the boom years, and the costs of preventing the collapse of the banking system, mean that for the next half decade at least, the rising costs of debt servicing will soak up all projected spending savings.
Yesterday’s four-year plan is thus predicated not on total spending falling, but on revenue growth – and lots of it. Again, as the chart shows, the Government hopes that the amount of money it takes in has hit bottom.
By 2014, it expects the EU-standardised measure – General Government revenue – to have grown by more than 25 per cent from its anticipated floor this year.
This is to be achieved by the hikes in many tax rates announced yesterday and by a stronger economy, with the latter being the most important driver.
Underpinning all budgetary projections is the rate of economic growth. Therefore, the starting point for any analysis is to assess the Government’s forecasts for how fast the economy will expand in the years to 2014.
The 2011 budget is predicated on a rate of GDP growth next year of 1.75 per cent. This is lower than the average forecast among other institutions, such as the ESRI and the IMF, and private sector forecasters. In part this is because the Department of Finance’s forecast takes into account the growth-damping effects of next year’s front-loaded €6 billion adjustment. Over the 2012-14 period, the economy will grow at a faster clip, according to the Government’s estimates.
Broadly, given all the uncertainties and risks, the forecast is a plausible basis to proceed even if it tilts towards excessive optimism and the risks to it are heavily on the downside, domestically and, if to a lesser extent, internationally. But to have based the four-year plan on lower growth would have meant even bigger adjustments being implemented in 2011 and beyond. If that becomes necessary, it will happen anyway. Others will see to that.
In the run-up to the plan’s publication, the Government and its officials went to some considerable length to stress their ownership of the four-year plan. They downplayed the input in its drafting of the outsiders who now oversee much of this State’s functioning. From the composition of the four-year plan revealed yesterday, these claims ring true.
While there is no doubt that the measures are huge and very painful, the four-year plan spreads the pain more horizontally than would a typical IMF-style plan, which would tend towards more vertical cutting, such as closing hospitals and involuntary lay-offs in the public sector.
It would seem clear that the rescuers are giving the Government the leeway to proceed as it sees fit, for now at least. It will be highly significant if anything in the terms of the bailout, currently being drawn up in a Memorandum of Understanding (MoU), contradict yesterday’s plan.
On the composition of the plan, the Government stresses the breakdown of its €15 billion adjustment over four years: with €10 billion accounted for by cuts in spending and €5 billion coming from new taxes.
A caveat is needed at this point. Very frustratingly and even bizarrely, the 140-page document published yesterday includes only a handful of figures based on the EU-standardised General Government accounting methodology.
This is significant not only because it is the figure that everyone watches, but also because it is a much more comprehensive measure of all Government income and outlays (there is, for instance, a €13 billion gap in 2010 between the figure for General Government revenues and the smaller exchequer calculation upon which most of the four-year plan’s figures and analysis are based).
Having been bailed out, the Government’s credibility is reduced to near zero. Continuing to present the Victorian-era exchequer numbers when all concerned are interested in the EU-standardised measure does nothing to start the long process of rebuilding it.
Capital spending takes by far the biggest hit in percentage terms when compared to recent years. Total spend in the 2011-14 period is budgeted to be almost half of cumulative figure for the 2007-10 period.
As recently as July of this year, the Government launched, with great fanfare, its 131-page Infrastructure Investment Priorities 2010-16. This was a much downsized National Development Plan, but spinned as a stimulus. Given the circumstances, it was not downsized nearly enough. That changed yesterday, as it had to.
In July the Government planned to reduce annual capital spending from €6.5 billion in 2010 to €5.5 billion by 2014. Now the 2014 figure is €3.5 billion, hence the €3 billion cut flagged by the Government yesterday.
Looked at another way the reduction is bigger still. In July, €22 billion was allocated to capital expenditure in the four years from 2011. The new four year figure is €16.4 billion.
Apart from the department by department capital allocations, there is little detail as to how the cuts will affect the programme by programme allocations. In this sense, the plan is far less comprehensive than the July document.
There is also some sloppiness. An “unallocated adjustment” of €434 million is included the new capital budget. These are make-believe savings which undermine credibility.
Despite the big reductions since July, capital spending in 2011 will amount to 3.7 per cent of GNP. This is still comparatively high. Watch for further big reductions in the MoU or, more likely, in 2011 if the overall budget adjustment veers of target.
The plan is also emphatic in its insistence that the 12.5 per cent corporation tax rate will never be changed. That the European Commission welcomed the document yesterday afternoon (it the closest any of the three institutions involved in this State’s bailout) indicates they will not seek to have it hiked.
On taxation, it is clear from the information disclosed yesterday that income tax rises will be frontloaded (the details will be revealed in the budget on December 7th) and VAT increases backloaded. The Government got this back to front in my view. Bringing more people into the tax net must happen, but increasing taxes on labour when unemployment is so high can only weaken already feeble jobs growth.
Positively, the four-year plan also commits to reviewing obsolete institutions which inhibit job creation and work. But it would have been better if action rather than mere review had been committed to.
Perhaps the most curious aspect of the plan is the intention put billions of borrowed euro into the State’s sovereign wealth fund, aka the National Pension Reserve Fund. That fund was set up when budget surpluses were being run. The excess was squirreled away. It was one of the few forward-thinking big Government ideas of the boom years.
If anyone now believes that those countries who are bailing this State out will allow it retain its sovereign wealth fund while they subsidise it has another think coming. The Government should long ago have amended the legislation governing the NPRF. That will have to happen very soon.
Overall, however, and criticisms notwithstanding, the plan has the European Commission’s stamp of approval.
And although the IMF, as of last evening, had declined to comment either way, Olli Rehn’s fully anticipated acceptance of the plan is what counts for now.
If it doesn’t work, the new government that is all but certain to be in place when that judgement is passed will not have as much of a say in revising it as did the one clinging to power now.