The Irish Public Finances:

A Post-Budget 2018 Overview

Simon BarryChief Economist Republic of Ireland

October 2017

Slide 2

Budget 2018 sets out the planned use of Eur1.2bn of fiscal space for next year…

• The July Government Summer Economic Statement (SES) identified net fiscal space of €1.2bn for Budget 2018

• However, after allowing for:• Demographics• Carryovers from Budget 2017• The Action Plan for Housing• Extension of the Lansdowne Road Agreement on public sector pay (€0.18bn)

• Only ca. €0.35bn remained to be allocated for 2018 in today’s budget

• Additional revenue-raising measures announced in the budget have amounted to €0.83bn

• Resulting in additional Budget Day tax and spending easing measures totalling ca. €1.2bn

Slide 3

…incorporating ca. €0.9 bn of extra spending measures and €0.3bn in tax reductions. Extra spending was split roughly in 3:1 in favour of current over capital spending

Budget 2018 Package €mn

Resources available from fiscal space 350Additional revenue measures 830Total package 1180

Used to fund:Tax reductions 335Extra current spending 684Extra capital spending 214

Source: Department of Finance

Slide 4

A range of indicators, notably including employment, point to an economy which continues to perform very well

Economic Activity Metrics, % y/y growthy/y year to date (Q2 unless otherwise stated)

Core Retail Sales 6.6GDP 5.5Modified Final Domestic Demand (MDD) 5.1Tax Receipts (nominal) 5.4Employment 2.9GNP 2.6

1) Variables above in real terms unless otherwise stated2) Core retail sales are year to August3) Modified Final Domestic Demand includes Private and Govt. Consumption, and Investment less aircraft leasing and R&D imports4) Tax receipts are year to Sept

Slide 5

The jobs market in the Midlands has been performing particularly well

Slide 6

Solid improvement in the economy has seen the tax take rise by 5.4% in the year to September (albeit that tax revenue is running slightly below target in 2017, a context not as favourable as in the previous three years)

The forecasts underpinning the Budget look reasonable, and have been endorsed by IFAC (Irish Fiscal Advisory Council). The outlook remains broadly favourable and is looking a bit stronger in the near-term than was projected by last year’s Budget

Slide 7

Budget 2017 SPU 2017* Budget 2018October 2016 April 2017 October 2017

2016 4.2 5.2 5.1

2017 3.5 4.3 4.3

2018 3.4 3.7 3.5

2019 3.2 3.1 3.2

*Stability Programme Update 2017

Real GDP % Growth

Slide 8

The Medium-Term Objective (MTO) is the key anchor for fiscal policy…

• Ireland, like other countries in Europe, is subject to a Medium-Term Objective (MTO)

• Ireland’s MTO is to achieve a small budget deficit of 0.5% in structural terms

• The Structural Budget Balance (SBB) is the balance adjusted for the cyclical position of the economy and the impact of any one-offs; in other words the balance that would prevail if the economy was operating at its full capacity

• In normal economic times, an annual improvement in the SBB of 0.6% of GDP or more must be delivered until the MTO is reached

Slide 9

…and is complimented by the application of the Expenditure Benchmark

• The Expenditure Benchmark (EB) is a complimentary requirement, which sets a limit on allowable expenditure growth after accounting for any discretionary revenue measures:

• If not at the MTO (as is the case currently in Ireland), allowable spending growth is reduced to a level below an estimate of long-run potential GDP growth to ensure progress towards MTO. For 2018, permitted spending growth for Ireland is 2.5% - some way lower than the 4.8% ‘reference rate’ of potential GDP growth in nominal terms.

• Once the MTO is reached his would result in a step up in allowable spending growth relative to recent years when it has been explicitly suppressed to ensure convergence to MTO. But spending growth would still be capped at the trend economic growth rate, as measured by the EB framework.

• NB: Estimating structural balances and trend / potential growth rates (especially for small, open economies like Ireland) can be highly problematic and the EB calculation is complex so implementing this framework is not straightforward. Work is ongoing in an attempt to improve the methodology as it applies in the Irish case.

Slide 10

Budget 2018: rule compliance and balancing the books

• Ireland’s estimated SBB in 2017 is a deficit of 1.2% of GDP and a deficit of 0.5% in 2018, meaning that:

• The planned improvement of 0.7% points would achieve compliance with the required SBB adjustment of 0.6%

• And more importantly, the MTO is expected to be reached in 2018 i.e. the books are set to be balanced next year (in structural terms)

• The relevant spending aggregate is expected to grow by 2.3% - less than the 2.5% allowed meaning that compliance with the EB is also (just about) expected next year

• So the Government may be fully rule-compliant in 2018 for the first time since entering the preventive arm in 2016, though the EB compliance margin (€100m) is very slim

• NB: achieving the MTO in 2018 results in a significant step-up in allowable spending growth from 2019 on under the EB i.e. estimated annual fiscal space increases materially from 2019 on

Slide 11

Returning the budget position to balance (expected by 2020 in headline terms) is a remarkable achievement given the extent of the deficit blow-out in the crisis

After a 65% collapse from peak in government capital spending, the increased allocations to capex spending over the past three years are very welcome…

Slide 12

…as capital spending is now set to pick up meaningfully, albeit from an extremely low base

Slide 13

The planned increases in govt capex would take Ireland’s spend (relative to revenue) back up to relatively elevated levels by international standards

Slide 14

Slide 15

Sizeable MNC-related distortions to GDP reduce the usefulness of the debt-to-GDP ratio; other metrics of Ireland’s debt position, such as the debt-to-GNI*and debt-to-revenue show debt remains uncomfortably high, albeit rapidly declining

Slide 16

…the debt servicing burden also continues to decline, helped by the ongoing improvement in growth and revenue trends…

… with favourable international developments (including the ECB’s QE programme) combining with firm belief in the robustness of Ireland’s creditworthiness keeping Irish sovereign borrowing costs close to all-time record lows; Ireland’s 10-year Government yields are now below France’s, while the spread against Germany is at post-crisis lows

Slide 17

Slide 18

Debt levels look set to continue to decline into the medium-term, but sustainability remains vulnerable to shocks…

220

230

240

250

260

270

280

2016 2017 2018 2019 2020 2021

Baseline (% Revenue)

Scenario (% Revenue)

Debt as % of Gen Govt Revenue: Illustrative Growth Shock Scenario from 2019 Onwards

Source: IFAC Note: The scenario shows the debt ratio path for an illustrative shock equivalent to a typical forecast error on nominal GDP growth (-2pp relative to baseline growth rates) in each of the years 2019, 2020 and 2021

Slide 19Slide 19

…and downside risks; while there are some notable upside risks (e.g. related to construction) the balance of risks over the medium term is skewed to the downside, even aside from Brexit…

• Domestic Risks• Property market developments• Competitiveness / expectations management• High debt • Politics

• International Risks• Brexit• Euro area macro-financial developments and policy settings• Emerging Market slowdown• Global financial (markets) stability• FDI climate / international tax policy changes• Politics / Geopolitics:

• Economic and diplomatic policy choices of new Trump administration in the US• Various upcoming European votes (Germany, Italy…)• North Korea

Slide 20

While the Budget didn’t contain refreshed estimates of future fiscal space, the estimates from the Summer Economic Statement highlight the significant uplift in available resources which is set to take hold from 2019 (i.e. after the MTO is reached)

Indicative Net Fiscal Space, Eur bn

2018 2019 2020 2021

Summer Economic Statement 1.2 3.2 3.4 3.4Source: Department of Finance

Slide 21

But rule compliance may well be insufficient to deliver an appropriate or sufficiently prudent fiscal policy stance for Ireland; the Rainy Day Fund is a potentially useful tool in this regard, though further detail is needed on its operation (a consultation process has now been launched)

Slide 22Slide 22

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