Month: October 2010

New European Treaty?

I don’t have time to write about this in detail now but reports that Germany and France are pushing forward with the idea of an amendment to the Lisbon Treaty are an important development (news story here and a nice article by Arthur Beesley here). Apparently they want to use a new Treaty to formalise the sovereign bailout fund that is currently set to expire in 2013 and to formalise sanctions for states that break new EU budget rules.

These announcements appear to hijack what was an ongoing process involving the Commission and a task force chaired by EU President Herman van Rompuy. This process had just arrived at this package of significant reforms, which the accompanying press release had emphasised were “compatible with the existing Treaty of Lisbon”.

I’m pretty unenthusiastic about this. I don’t see why Treaty reform is required to formalise a sovereign bailout fund, when the thing is currently up and running without any Treaty change. The political sanctions element doesn’t strike me as desirable. And the whole idea seems to underestimate the complete lack of appetite of the European public for more Treaties and referenda.

Given that this would require a referendum in Ireland and what would be on offer would be the possibility of political sanctions for Ireland, one might imagine the people who worried about us potentially losing a Commissioner under Lisbon might also get a bit excited.

Budget Calculation Update: Promissory Note Interest Payments

It was always going to be unlikely that the process of briefings for opposition parties would be kept secret. However, with what appears to be authoritative and pretty detailed information all over today’s Irish Independent, it may just be best if the Department of Finance publicly released the briefing information it provided to the opposition politicians yesterday.

One of the more mysterious aspects of the budgetary finances is the magic promissory notes. By my count, we will have issued about €30 billion of these by the end of the year: About €25 billion to Anglo and about €5 billion to INBS.

In this post earlier today, I pointed out that while the principal payments on these notes didn’t count against the general government deficit (because these will all be registered as part of this year’s deficit) they will still be part of our ongoing financing requirement in the coming years.

I didn’t write earlier about interest payments on these notes (the figures I was writing about were just my guess about the annual principal payments). One reason I didn’t discuss interest payments is that I wasn’t sure there were any: They could just be zero coupon bonds. However, it looks as though they are not. On Prime Time this evening, Joan Burton and government junior minister Billy Kelleher agreed that the annual interest cost of the promissory notes was going to be €1.5 billion. With €30 billion or so in notes issued, it now appears that the notes have an interest rate of 5%.

Now, as far as I know (and I’m happy to be corrected) these promissory note interest payments of €1.5 billion a year will count against the general government deficit.

Here I’ve updated the calculations from my Irish Taxation Institute presentation to incorporate the “if the promissory notes pay 5%” scenario. The bottom line?  If one adjusts last year’s budget projections for (a) New projections from the Central Bank for nominal GDP (b) A projected decline in revenue of €1 billion (c) €1.5 billion in promissory note interest payments, then the starting point for this year’s budget prior to any adjustments would be a deficit of €22.5 billion or 13.9% of GDP.

Note that even if one didn’t factor in negative effects of fiscal adjustments on GDP, then with a Central Bank GDP projection of €162 billion, hitting the original deficit target for 2011 of 10% of GDP would require adjustments of €6.3 billion (162*0.039). Factoring in the contractionary impact of budget cuts on GDP, it would likely take €7 billion in adjustments to get to a 10% target.

As I say, these calculations are based on a 5% interest rate on the promissory notes. My interpretation from Minister Kelleher’s apparent confirmation of Burton’s comments is that this is the correct rate. However, I think it’s time for the government to fully clarify the terms of these notes as soon as possible.

No Planned Revision to 2010 GDP

There have been a number of comments over the last few days regarding CSO revisions to nominal GDP.  This has been explained in the Irish Independent today as resulting from a change in the way CSO calculate the size of the economy.   Apparently, there were other comments at Kenmare over the weekend also
suggesting that a downward revision to GDP for 2010 is being contemplated by CSO.

I have been talking to CSO and they inform me that there has been no change in how they estimate GDP.   CSO has already published the first two quarterly estimates for GDP in 2010.  Q3 is scheduled for 16 December.

Talk at Irish Taxation Institute Event

I gave a talk last night at “The Big Tax Debate” organised by the Irish Taxation Institute. Here are the slides.

The opening slides do some calculations of where the government is starting from when preparing the next budget. Taking out the €3 billion in adjustments that had been pencilled in last December, the starting deficit would have been 11.8% of GDP. Adjusting for the lower nominal GDP projected in 2011 by the Central Bank, this rises to 12.4%. Subtracting a billion from tax revenue because nominal GDP growth is projected to be €4 billion less than in the December 2009 budget and the projected deficit becomes 13%.

These figures exclude payments on promissory notes because the full cost of the notes issued so far is getting incorporated into this year’s General Government deficit. However, the payments will be real cash flows and international markets will be aware that they increase our borrowing requirements. So, while one can argue that it may not be appropriate to point to our projected 32% deficit for this year as the correct measure, one can’t also keep excluding the banking-related payments as though we are never paying for the banking crisis. Adding on €2 billion a year for promissory note payments (my guess, based on €30 billion in payments spread over 15 years—no I don’t know what the correct figure is because it hasn’t been released) the underlying deficit rises to 14.2%.

One adjustment I didn’t make was for higher borrowing costs than projected in 2009. In any case, you get the picture. You don’t have to be brought into the Department for secret talks to see that the starting position for the deficit is an extremely serious one and that adjustments of €5 billion are probably the minimum required to establish a credible downward path.

I think this point, that we need to credibly get back to sustainable levels of the deficit in the next year or two, is far more important than the other popular debate about whether we should have a four-year plan or a seven-year plan for getting back to 3%. Colm Keena correctly quotes me in today’s Irish Times as saying that I don’t think anyone believes that we are going to reach a 3% deficit in 2014. That’s been my experience, perhaps others know people who do believe this. Either way, the 3% is an arbitrary figure and when we reach it is not the crucial point.

Of course, if the Commission insists that all our plans end up with 3% in 2014, then that’s the way they will be written. However, what’s far more important is that we can convince people that the deficits for 2011 and 2012 are going to be well below the starting point we’re looking at right now.

Finally, as an aside, Keena also quotes me as saying “On efficiencies in the public service, Prof Whelan said there was no need for any more reports. He believed the Government was not serious about the matter.” I’m pretty sure I didn’t say the latter. In fact, I suspect the government are probably more serious on this matter than those who claim enormous savings can be made from efficiency gains in the public sector. The point I was trying to make was that we should try to get some clarity as to how much, or how little, we can save from public sector efficiency improvements. And then we should implement them.

About The €7.5 Billion Cumulative Adjustment Figure

There has been a lot of reporting about how the cumulative adjustment for the next few years is going to be higher than €7.5 billion and how this was the figure that was announced at the time of the last budget.

I was a bit puzzled by this reporting because I had been under the impression that the figure for cumulative adjustments was €8.5 billion. Here’s why. Here’s the Stability Programme Update released at the time of last year’s budget, which is the document provided to the European Commission to illustrate the details of our multiyear plan.

Click on the document and go to page 19. Table 9 describes €3 billion per year in additional measures to be “delivered” in 2011 and 2012 as being made up of €1 billion per year in capital program adjustments that were “already identified and incorporated into the base” and €2 billion per year of additional adjustments.

For this reason, page 20’s description of the adjustments in future years shows €2 billion in 2011, €2 billion in 2012, €1.5 billion in 2013 and €1 billion in 2014, which adds up to €6.5 billion. However, since Table 9 tells us that an additional €1 billion a year in capital adjustments had been identified and incorporated into the base, I had believed the profile for total adjustments planned was €3 billion in 2011, €3 billion in 2012, €1.5 billion in 2013 and €1 billion in 2014, which adds up to €8.5 billion.

However, it turns out that the baseline for capital spending is a continuation at prevailing levels. Table 10 shows Gross Voted Capital falling from €6.445 billion in 2010 to €5.5 billion in 2011 and staying there afterwards. You can add this €1 billion cut in 2011 to the €6.5 billion identified elsewhere in the table to get to the €7.5 billion.

What about the additional €1 billion of capital spending cuts that Table 9 tells us had been identified and incorporated into the base from 2012 onwards? Apparently, the 2012 element of these “identified cuts” doesn’t exist. (It appears that someone in Finance mixed up their levels and changes.)

So, €7.5 billion is indeed the correct figure. However, those of you who, like me, had thought that the government had been planning €3 billion in adjustments in 2012 haven’t had it right.