Tag: budget

Puzzling Budgetary Reporting

I’m having trouble making sense of most of the reporting of the budgetary discussions.

Two issues are particularly puzzling. The first is the consistent referencing of the idea that the higher requirement for budgetary adjustment is due to a relatively recent worsening in the forecasts for the Irish economy. (Indeed, a number of government politicians have also made reference to the idea that this worsening stems from a recent downgrading of the outlook for the international economy.)

The second is the dismissal of the €7 billion figure for budgetary adjustment mentioned by Michael Noonan and the lack of reference to the 10% deficit target that had been set for 2011.

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Sticking to 2011 Deficit Goal of 10% Requires €7 Billion Adjustment

Despite all the focus in the past few days on 2014 and European Commission, the key issue facing us right now is the how to convince sovereign bond markets that we are back on a stable fiscal path. Without access to the bond markets, you can be sure that the EU will be imposing the 3% target on us whether we like it or not.

Last December, the government told the EU that our general government deficit would be 11.6% in GDP in 2010 and 10.0% in 2011. So the questions we should now be asking are whether we should still aim to achieve the 10% target and, if not, what are the consequences of missing this target.

Michael Noonan appears to have said yesterday that the Department of Finance briefings called for €7 billion in adjustments. The department is now saying that “Given the current working macroeconomic forecast, indicative deficits were set out for consolidation packages of the order of €3bn, €4.5bn and €7bn.”

Fair enough, they could have set out a no-billion in cuts scenario for all it matters. However, as far as I can see, only the €7 billion scenario sees us meeting the 10% target and this likely explains why Noonan emphasised the €7 billion figure.

This isn’t rocket science. There are four elements to this calculation, none of which are complex or require access to secret figures:

1. Lower GDP: Last year, the government projected that €3 billion in adjustments would get the deficit to 10% of GDP. However, they were projecting GDP in 2011 to be €170 billion. Now, both the Central Bank and the ESRI are projecting GDP in 2011 to be closer to €160 billion. So, hitting the 10% target now requires a deficit of €16 billion rather than €17 billion. Hence, an additional €1 billion in adjustment, bringing the total required adjustment to €4 billion.

2. Promissory Note Interest: The 2009 budget figures did not include the interest on the promissory notes, which appears to be 5% on average. This adds €1.5 billion to next year’s deficit, bringing the total required adjustment to €5.5 billion.

3. Lower Tax Revenues: Tax revenues for 2010 are on target. However, last year’s budget projected a €9 billion increase in nominal GDP in 2011. The Central Bank are currently projecting a €5 billion increase in nominal GDP next year while the ESRI are projecting an increase of only €3.6 billion. Undoubtedly, any credible projection for next year will feature lower tax revenues. In my ongoing calculations (updated here to also include the ESRI’s GDP forecast) I’ve subtracted €1 billion from tax revenues next year. This brings the cumulative adjustment required up to €6.5 billion.

4. GDP Effects of Larger Adjustment: Unfortunately, if additional adjustment of this magnitude is required, then the GDP baseline in the ESRI and CB forecasts are probably too high. Hitting the 10% target will probably require about €7 billion in adjustment.

I’m happy to be corrected about any of these above points but, particularly when one factors in Noonan’s comments, I think it’s reasonable to assume that €7 billion is required to meet the original 10% target.

Is meeting the 10% target really necessary? Might an adjustment of €4 billion to €4.5 billion—perhaps getting us to somewhere between 11.5% and 12% of GDP—be ok if it was accompanied by an impressive-looking four year plan?

It might be but then again it might not. I’d be inclined to recommend assuming the latter. The current EU-agreed plan is already our second plan (there was a previous one in which we reached 3% in 2013). Ripping up this one, so we can start again with a third plan where, after years of cutting, we’ve still only got as far as a 12% deficit next year, doesn’t sound to me like the kind of plan that’s going to work.

So, that’s the debate that needs to be had. Wishful thinking involving only €4 billion in adjustments and still hitting the 10% target just isn’t helpful.

A side-issue in all of this is what exactly the government is (and has been) up to in relation to the budget figures. In relation to point one above, as Philip has pointed out, most of this downward revision in GDP stemmed from the CSO’s annual revision released this summer. Indeed, the Central Bank were projecting nominal GDP in 2011 of €163.7 in July, already over €6 billion short of the original budget projection.  So the government has presumably known the 2011 adjustment requirement was drifting outwards due to this factor for a number of months.

On the second point above, since the government started issuing the magic promissory notes early this year, they will have known about the effect of this on the budget figures for some time.

It seems clear, then, that the government were clinging publicly to a figure of €3 billion in adjustments long after they must have known that this figure wasn’t tenable (e.g. as late as the mid-September Fianna Fail think-in the €3 billion figure was being held to).

Equally, it could be argued that yesterday’s dismissal of Noonan’s comments from, among others, the Taoiseach, also served just to obscure the full scale of the fiscal problem that we face.

Update: I’m not sure if this story pre- or post-dates what I wrote above. It says that “Government sources have firmly ruled out a €7 billion adjustment for 2011.” If so, it looks like they have ruled out meeting their previous target for next year of a deficit of 10% of GDP, though it may be some time before they admit this.

Promissory Notes: We Need A Powerpoint Presentation!

Okay, here’s a real treat for all our fans of all things promissory-note related. A classic Burton-Lenihan exchange in the Dail today. My favourite bit:

Deputy Joan Burton: We need a PowerPoint presentation on this.

Deputy Brian Lenihan: We do not.

Deputy Jim O’Keeffe: We need lots of money for this.

Full text below the fold.

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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.

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.