Ireland can cope with borrowing for historic stimulus budget

This week's budget provided a huge "stimulus" to the economy of over €6 billion in additional expenditure, almost 2 per cent of GDP. However, the Department of Finance estimates that this will only raise GDP by 0.3 per cent, whereas normally an injection on this scale would have raised GDP by about 1.3 per cent. This gap reflects the very unusual state of the pandemic economy.

Across the developed world, on average households are consuming less – avoiding discretionary shopping and leisure spending – and so they are saving more. For many households, any increases in income due to the budget are likely to add to savings.

A lot of businesses will use the budget funding to pay their fixed costs while they hibernate. Indeed, one of the objectives is to preserve businesses during a period of hibernation so that when society opens up again, they can resume more or less intact.

As I said last week, extensive household savings, now topped up by Budget 2021, may well produce a delayed action stimulus once a vaccine has been widely deployed. This stimulus could see a very rapid return to normal across the economy, probably in 2022.

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How much can Ireland borrow to get through this Covid-19 emergency?

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Borrowing

The huge borrowing this year and next is sustainable for two reasons.

Because of almost zero interest rates, the borrowing will not add significantly to the debt interest burden over the rest of the decade. Debt interest payments in 2021 will be €0.3 billion less than this year.

Households are saving large sums in bank deposits. The demand for bank loans is down, so the banks deposit their surplus funds with the ECB. The ECB then buys Irish government bonds. Thus, there is no increase in Ireland’s foreign indebtedness as the Irish government borrows, indirectly, from Irish households.

This contrasts with the last crisis, when the borrowing by the government came from abroad.

However, post-pandemic, when Irish people start to spend their savings (rather than lend them indirectly to the Government), this borrowing will have to stop. As economic activity rebounds across Europe, interest rates are also likely to rise, making debt more expensive.

Not only does the budget provide for exceptional Covid-related and Brexit-related expenditure, it also provides for a substantial expansion of the scale of services in health and education. This represents a permanent increase in spending which, in due course, from 2022 or 2023, will have to be funded by increased revenue.

If things go well, government borrowing could be much less than forecast and, if things go badly, any overrun in borrowing will be limited

This longer-term upward shift in expenditure needs to be quantified separately so that the funding requirement, when the economy returns to normal, can be identified and planned for.

A decade ago the Department of Finance learned the lesson that in budget arithmetic it is much better to under-promise and over-deliver. Thus, there is a large provision in the budget – over €5 billion – for contingencies to deal with nasty Covid or Brexit surprises.

This means that, if things go well, government borrowing could be much less than forecast and, if things go badly, any overrun in borrowing will be limited.

Wasteful

The expansion of targeted measures in the budget to support business is to be welcomed. However, there are a number of changes in the budget which represent more of a blunderbuss approach, which will be wasteful or ineffective.

Chief among these is the reduction in the VAT rate for the hospitality sector. This change will cost €340 million and the benefit will go to those who have the highest turnover – and who need help the least. There will be no benefit for businesses that are closed and have no sales.

It would have been much better to have used part of the €340 million to directly support businesses that had suffered severe loss of income through forced closure.

A second ill-targeted measure is giving cash to first-time house buyers. While housing supply is highly constrained, giving buyers money to spend in a seller's market just raises prices.

Budget measures aimed at reducing Irish greenhouse gas emissions are significant and to be welcomed. The proposed changes in taxation of cars and the provisions for ramping up the retrofitting of homes are also important.

The commitment to raising the carbon tax, while using the revenue to insulate those on low incomes, will be an essential driver of change. Its impact this year is blunted by the dramatic fall in underlying oil prices, which means that, despite the tax increase, petrol today is much cheaper than after last year's budget.

Overall, the verdict is that the budget was appropriate and generally well-targeted, and though enormous, the borrowing is, for the moment, sustainable.