Long march to debt reduction has only begun

The Fiscal Council can hardly have expected garlands for dishing out smelling salts over the budget – the body was not set up to court popularity. And true, the prospect was never likely that the Coalition would ditch plans for a softer budget on foot of its intervention. But as growth accelerates and the clamour for cuts in income tax intensifies, it is as well to note that abundant vulnerabilities remain.

There was some back-sniping at the council in Government circles, but nothing too heavy. One critic charged that the body had got it wrong before, calling for a €3.1 billion retrenchment this year when the deficit target will be comfortably met with the €2.5 billion budget adjustment last October.

‘Boy cries wolf’

Another said too many “boy cries wolf” warnings from the council would undermine its authority in the event that political leaders really were set to run the economy off the rails.

The key point to note is that the council did not declare an emergency or anything like it. Amid rising pressure to loosen the State's fiscal stance, however, its pre-budget statement reflects concern to ensure political and public debate observes the danger inherent in any return to the bad fiscal habits of the past. With a general election on the horizon, this is no bad thing. The resolve of Minister for Finance Michael Noonan may not be in doubt, but certain others around the Government sense an opportunity to ease off on fiscal rectitude. The point is all the more clear when the national debt is still at stratospheric levels and growth is at a standstill in Germany, France and Italy. This constitutes a serious drag, and the threat of a deflationary spiral is all too real.

One of the lessons of the debt crisis was that the frailty of one tiny country in a currency union transmits frailty to all – and it is equally true of frailty in big countries. Ireland’s gathering recovery is being helped along steadily by the turnaround in the US and Britain, and there would be no cause for cheer without them.

Low national debt at the outset of the crisis left ample headroom for the accumulation of new debts once disaster struck. With debt exceeding 120 per cent of GDP in the aftermath of the crash, similar flexibility to radically increase debt would not be available in any new calamity.

Indeed, the present wave of pressure for a recovery dividend underscores the Fiscal Council’s warning that the fading of crisis memories will make it politically difficult to sustain fiscal discipline to cut the debt.

The Government plans to achieve a gradual decline in debt by running a primary budget surplus averaging more than 3 per cent after 2015. (A primary surplus is a budget surplus excluding debt servicing costs.)

Although the council accepts there are "some examples" of primary surpluses of at least 3 per cent of GDP for five years, it cited academic research which found that instances of larger and longer primary surpluses are historically rare. The research in question was carried out by Barry Eichengreen of the University of California and Ugo Panizza of the Graduate Institute in Lausanne. It was published in July by the Centre for Economic Policy Research in London. They question the plausibility of Ireland and other stricken euro zone countries running a primary budget surplus of sufficient scale to cut the debt to 60 per cent GDP by 2030 within the framework of Europe's Fiscal Treaty.

Running surpluses

They add that examples of countries running surpluses in excess of 5 per cent of GDP for 10 years are exceptional. This feat was achieved only by

Belgium

,

Norway

and

Singapore

at various points in the past 25 years.

However, the research recognises that Ireland managed primary surpluses exceeding 4 per cent in the 1990s, when recovery was under way from recession in the 1980s. Yet Ireland was helped by “special circumstances”, including strong global growth, pressure to meet Maastricht criteria to qualify for euro membership and a currency devaluation.

"Whether other euro zone countries – and, indeed, Ireland itself – will be able to pursue a similar strategy in the future is dubious." Still, no mention was made of scope to reduce debt by selling off the State's interests in AIB and Bank of Ireland or the sale of Central Bank of Ireland holdings of Irish bonds.

This is not an exhaustive list of debt reduction options, but it shows primary budget surpluses are not the only lever. Either way, it’s still a long journey.