My Sunday Times article from 26/02/2012 - unedited version.
So far, the explosive nature of Greece’s crisis has been a boon for Ireland, as international perceptions of our economic and fiscal fortunes have turned more optimistic in some analysts’ and investors’ circles. This shift in the sentiment, however, may be threatening to derail the already fragile momentum for economic reforms here.
Irish budgetary dynamics for 2011 were largely on target, although this achievement conceals significant pressures on the tax receipts side and the lack of real progress in tackling runaway spending in three core current expenditure areas – Social Welfare, Health and Education. In fact, much of the previous deficit adjustments have been based on the Governments picking the low hanging fruit of capital spending cuts, administrative savings, and substantial tax increases, soaking the middle and upper-middle classes. Budget 2012 was pretty much the firs attempt by the Irish Government to rebalance the overall budgetary dynamics that, since 2008, have penalized higher-skilled and entrepreneurs. It is hard to see how this approach of piecemeal changes targeting the path of political least resistance can continue delivering ever-rising levels of fiscal adjustments already pencilled in for 2012-2015, let alone maintain the budgetary discipline thereafter.
Accounting for the delayed December 2011 tax receipts that were incorporated in January 2012 figures, the Exchequer deficit in the first month of 2012 was €160 million ahead of that recorded in January 2011. This gap shows that the pressure on Ireland’s fiscal dynamics has not gone away.
There is a more fundamental problem looming on the horizon – the problem of growth. To deflate the public debt that is now well in excess of 107% of our GDP and climbing, we need some serious economic growth. On average, over the next 10 years, we will need growth of over 3% annually over and above inflation in order to bring our Government debt down to 90% of GDP. To sustain some private sector debts deleveraging will require even higher rate of growth. Compare the current situation with that in the 1980s and the maths required for budgetary and households’ deleveraging become dizzyingly high.
In Q3 2011, Ireland registered the twin contraction in GDP and GNP and majority of the analysts expect the same for Q4 figures. For the year as a whole, we are likely to post approximately 0.9% real GDP expansion. Forecasts revisions for Irish economic growth have been driving us beyond the bounds of the fiscal targets we set out for this year. The Budget 2012 assumed economic growth of 1.3% against the IMF, Central Bank, EU Commission, and ESRI forecasts of 0.9-1.1% growth. More recent February forecasts by the markets analysts and ESRI put the range for 2012 growth at -0.5% to 0.9%. Much the same is true for forecasts out to 2015, with Government growth prognoses coming in at a rather optimistic 2.43% annual average against IMF November 2011 projection of 2.25%. Taking the lower range of most current forecasts, the shortfall on Government current assumptions for growth can be as high at €5 billion – a sizeable chunk of change. Under the adverse shock scenario by the IMF, if average growth were to decline to 1% of GDP – a statistically plausible assumption – the shortfall will be close to €10 billion.
This means that the pressure is still very much on to deliver on 2012-2013 fiscal deficit targets of 8.6% and 7.5% respectively. More importantly, the entire recovery framework for Ireland is clearly misaligned. Instead of focusing on the simple short-term targets for fiscal deficits, Irish Government must focus on long-term growth environment. Putting the patient – the Irish economy – ahead of the disease – the fiscal and household debts overhang – is a must.
This puts into the context the events of the last two weeks. Specifically, it highlights the levels of unease with Irish Government plans being expressed, for now rather quietly, by some markets participants. It also underpins the subtle change in the Government own signals to the Troika. And, it is simultaneously contrasted by the Government public rhetoric that has been stressing the PR spin over sombre determination to act. Virtually all recent actions suggest that the Government is hoping that something will happen between now and 2013 to miraculously restore growth, thus alleviating the need for serious corrective measures on the current expenditure side.
First, take the Memorandum of Understanding (MOU). Last week, the Government review of budgetary adjustments targets stated that 2013 fiscal savings will be “at least €3.5 billion” (page 14 of the MOU). The subtle change of language from the November 2011 version of the MOU which did not include the words ‘at least’ in relation to 2013 target might be a sign that the Government is being forced to accept the reality of its multiannual growth projections being overly optimistic in the current global and domestic growth environments.
Yet, when it comes to outlining reforms agenda, the MOU contains nothing new compared to its previous versions. The already inadequate set of measures on dealing with personal debt announced last night is presented as the end-all reform. Dysfunctional energy and utilities sectors are barely covered with exception for one specific measure – creation of the unified water management bureaucracy. Inefficiencies in the domestic services sectors, poor institutions relating to supporting competitive markets in these sectors and labour markets reforms are treated with generalities in place of tangible proposals. Vague promises of reforms of social welfare system and structural reforms in the state enterprises sector and financial services unveiled and partially actioned in the past are simply repeated once again in the current MOU.
In contrast, the Government has claimed this week that it has rather specific targets for yet another spending project – the ‘jobs creation’ efforts to be financed via privatizations returns. In other words, unlike Charlie McCreevy who spent the money he had, Minister Noonan is eager to spend what he hopes to have. To-date, Minister Noonan has managed to spend quite substantial funds on ‘jobs creation’ with various announcements taking potential total bill for these initiatives to well over €1 billion annually. Outcomes? Well, none, judging by the QNHS and Live Register data. The JobBridge programme is a resounding failure with the vast majority of ‘apprenticeships’ in effect displacing real jobs that would have been created through the normal course of business growth. The ‘Vat stimulus’ to tourism and hospitality sector is another failure. Fas restructuring is shambles.
The privatization plans, supported by the ESB and other state monopolies, are clearly designed to minimize any potential disruptions in the status quo of the semi-states-dominated sectors. Thus, privatization-induced changes in the energy and transport sectors will be purely cosmetic, the structure of the regulated markets will remain as anti-consumer as ever. Vast swathes of the domestic economy will remain protected from private investment and enterprises as ever.
Despite major risks present in the global and domestic economic environments, the Irish Government is slipping into the comfort zone of PR exercises, photo opps, and foreign ‘investment missions’.
By postponing the reforms necessary to boost our economic growth potential, the Government currently is putting an undue amount of risk onto the Irish economy. Its gamble is that sometime over the next 9-12 months Irish economy will be propelled to a miraculously higher growth plane and that this growth will be sustained through 2015 and thereafter. In the mean time, the Government will spend its way into jobs creation, while protecting its vested interests of the shielded sectors and avoiding any real structural reforms.
Sources: IMF WEO database and country updates
Much of the latest attention paid to the external trade data has been devoted this month to the sudden and rapid slowdown in exports over the recent months. And this analysis is very much correct: in H1 2011, Irish goods exports and trade surplus grew by 6% and 2.5% respectively. In H2 2011, the same rates of growth were 1.9% and 1.5%. However, there are some very interesting trends emerging from the trade statistics by geographical distribution. Using eleven months data for 2011, annual rate of growth in Irish trade surplus vis-a-vis the EU is likely to come in at -1.7%, against the overall annual rate of growth of 1.5%. In contrast, Irish trade balance with Russia is likely to rise a massive 92% in 2011 compared to 2010. Our trade deficit with China is likely to decline by 9%. Although our trade deficit with India is expected to widen by almost 11%, our trade surplus with Brazil is on track to increase by almost 32%. Courtesy of Brazil and Russia, Irish trade surplus with BRICs in 2011 is likely to have reached close to €238 million, first year surplus on record.