Much of this morning’s media coverage of the latest ESRI Quarterly Economic Commentary (summary here) has focused on the ESRI’s projection that the 2010 general government balance will be a deficit of 19.75 percent of GDP, which is the sum of the ‘underlying’ deficit of 11.5 percent of GDP and the capital transfer into Anglo/INBS of 8.25 percent of GDP. (Based on the reasonable assumption that Eurostat will adjudicate that the infusions into these banks indeed are capital transfers rather than financial investments.)
This is not really a surprise – the scale of the bank bailout was announced back in April and the accounting issues were dealt with on this site at that time (see here and here). In terms of investor sentiment, the bad news should have been incorporated at that time. Sophisticated investors will understand the distinction between non-recurrent capital transfers and the underlying deficit and also the distinction between accrued liabilities and this year’s funding needs (the use of promissory notes limits the extra funds required this year).
However, beyond the accounting issues, the increase in the government’s liabilities remains a substantial economic and financial cost. In terms of the trajectory for the public finances, debt sustainability requires that an increase in liabilities is met over time with a higher primary surplus – the government will need to raise more taxes and/or cut spending to service the extra liabilities (unless serendipity means that the extra liabilities coincide with a matching upward revision in the forecast for GDP growth).
The next version of the government’s multi-year fiscal framework will need to specify how the opposing forces of the improvement in GDP forecasts and the increase in debt liabilities feed into plans for taxes and spending.