The business and finance year

 

THERE ARE grounds for optimism about the economy and the business climate as one of the most testing of years draws to a close. It is heavily qualified optimism, however. The challenge that faces the economy remains formidable, but has grown no larger nor become more difficult. What is also positive is that the Government has made significant progress towards its primary objective – stabilisation of the national finances. Optimism now rests on whether it is reasonable to believe the remainder of the plan to restore the national finances and resuscitate the economy will be implemented.

The single biggest step in that stabilisation process was the introduction three weeks ago of an extremely difficult Budget, the third in 18 months. The stand-out measure in it was the decision to cut public sector pay despite trenchant opposition from public sector unions and a number of softer alternatives on offer. The cuts were painful but necessary and hopefully reflect an acceptance by the Government that tough and unpopular measures are unavoidable. The only issue for the foreseeable future is how to spread the financial burden involved as fairly and equitablyas possible.

The dramatic loss of confidence of international bond markets in the Greek administration which coincided with the Irish Budget only served to underline this point. The extent to which we are masters of our own destiny is extremely circumscribed. Any hesitation or doubt about the Government’s willingness or ability to implement its plan to cut the deficit in the exchequer finances will be exposed and punished in a similar fashion. Our ability to borrow in international debt markets and the cost of that borrowing are what will ultimately determine whether Ireland can weather the current storm. The resolve that emerged on Budget day must be a harbinger of things to come rather than a once-off.

Minister for Finance Brian Lenihan takes the credit for much of this resolve, although attention has switched in recent days to the state of his health after the public disclosure that he has been diagnosed with cancer. Mr Lenihan is expected to make a statement in the New Year.

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BY THE Government’s own reckoning, there are at least another two tough budgets ahead if the public finances are to be returned to health, as measured by the European deficit target of 3 per cent. Savings of a similar magnitude to those contained in the recent Budget will have to be made.

The Government held out the prospect on Budget day that these may be achieved without further increases in the tax burden though that, necessarily, may not be the correct approach.

A similar resolve is required to successfully execute the second leg of the Government’s plan for economic recovery – cleaning up the banking system.

The National Asset Management Agency is now up and running and the five Irish-owned banks are due to have sold their impaired land and development loans to the agency by the middle of 2010. The price that Nama will pay and the related issue of the extent of the Government’s holding in the main banks should be resolved over a similar timeframe. The question of whether Nama has paid too much or too little will not be known for a good while longer.

Of more immediate relevance is whether the Nama process will get the banks lending normally. The Government must ensure that the funds received from Nama are not used merely to bolster the banks’ balance sheets and protect what little value remains for shareholders. The €50-€60 billion that will flow into the banks must result in an increased availability of credit within the economy and business in particular.

If the experience of the last 18 months has revealed anything, it is that the banks cannot be relied on to do this unless it is in their own direct interest. The dissembling over the true extent of credit being extended to business would indicate that a stick rather than a carrot will be more effective as a stimulus for lending in 2010.

However, the banking system is far from out of the woods. Further reform is needed and the interest rate increases expected towards the end of 2010 will expose further weakness in areas such as negative equity and buy-to-let mortgages which will have to be dealt with.

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FOLLOWING THROUGH on Budget 2010 and making Nama work are two clear priorities for the coming year. The third is the restoration of Ireland’s competitiveness as an exporting economy. It is also the area in which the Government has made the least progress during the last 12 months. Its inactivity in this regard has been offset by favourable trends in both inflation and wages which have improved competitiveness.

But these downward trends would have to continue for several years to restore the State to the position that facilitated the original export-led boom. This seems unlikely, given interest rate expectations and signs that the pace of deflation is slowing.

The issues around competitiveness are as challenging and as vital as those involved in sorting out the national finances and the banking system. They need to be addressed with similar determination. Our ability to ride the coat tails of the international recovery is directly related to Irish firms being able to compete with their counterparts abroad.

Unless all the challenges in this arena are met, the efforts of the last 12 months will be in vain.

2010 will be another tough year but there are reasons to be hopeful.