Ireland can ride out the slowdown if a cautious approach is taken to expenditure and common sense prevails, writes Paul Tansey

FIRST, THE good news: the Government is facing up at last to the reality of the economic downturn.

For much of the spring and early summer, it appeared that no one was minding the shop and counting the takings. Distracted by the change of taoiseach and the ensuing Cabinet reshuffle, distracted by the referendum on the Lisbon Treaty, the Government did not seem to grasp the speed at which economic conditions were deteriorating.

Now, at least, the Government's collective mind is again concentrated on the economy. The first note of realism was struck last week when the Department of Finance revised downwards its economic forecasts for 2008 and its recast the likely budget outcome for the year.

In the 2008 budget, published last December, the Government predicted that real growth in Gross National Product would reach 2.8 per cent this year. Now, the official growth forecast for 2008 has been cut to a more realistic 0.5 per cent. This is within shouting distance of the Economic and Social Research Institute's (ESRI) recent projection that the economy would contract by 0.4 per cent this year.

Slower growth means lower tax revenue. Already, in the first half of the year, tax receipts have fallen €1.45 billion or 7 per cent below budget targets. As a result, a €3 billion shortfall in tax revenue is now predicted for the full year.

A virtual growth standstill also implies rising unemployment. The projected average numbers signing on the dole this year have now been revised upwards from 170,000 to 210,000.

Unemployment benefits cost the Exchequer some €11,000 per person per year. While public spending was broadly on target for the first half, the addition of 40,000 people to the average numbers on the Live Register this year would add an extra €440 million to the cost of funding unemployment benefits in 2008.

This potential spending overshoot triggered the introduction of the €440 million savings announced by the Government this week. Should the savings package be implemented successfully, it would cancel out the additions to public spending caused by the unanticipated rise in unemployment this year. In these circumstances, public spending would finish the year broadly on target.

The package of savings is a mixed bag of the good, the deferred and the aspirational. The good includes the sensible decision not to accept the pay increases proffered to members of the Government by the Review Body on Higher Remuneration in the Public Sector. While trivial in total spending terms, the Government must be seen to lead from the front if it is seeking sacrifices from others, especially in the sphere of public sector pay. The halting of the deluded decentralisation drive is also to be welcomed.

A large slice of the proposed savings represents the announcement of expenditure deferrals that would have occurred anyway during 2008 due to delays and legislative impediments.

The aspirational includes the requirement for government departments, state agencies and local authorities to reduce their payroll bills by 3 per cent by the end of 2009, except in those areas providing frontline services.

But the whole package is greater than the sum of its parts. It generates strong announcement effects, emphasising that the Government means business on the public spending front. It sets a sombre tone for this year's "estimates campaign" where Government departments compete for more of the people's money. Most importantly of all, it lays the foundations for curtailing public spending growth in the 2009 budget. If successful, the Government estimates that the package would curb public spending growth by €1 billion in 2009.

Now for the bad news. Notwithstanding the savings package, the deterioration in the public finances this year will be severe. At budget time, the Department of Finance was forecasting an overall Government deficit equivalent to 0.9 per cent of Gross Domestic Product (GDP) in 2008. Given the €3 billion tax shortfall, and the absence of the budgetary savings package, the Government would be within touching distance of the 3.0 per cent limit on budget deficits imposed by the EU Stability and Growth Pact.

Moreover, this week's package of savings is but the first step on the road to containing public expenditure growth. Further spending cuts will be required in the 2009 budget if the overall deficit is not to exceed the EU limits by a substantial margin during 2009.

Two factors are conspiring to produce a deficit overshoot in 2009 in the absence of further remedial action. Firstly, a worthwhile growth rebound is highly unlikely next year given evolving trends in the global and domestic economies. Tepid growth in economic activity means continuous weakness in tax receipts. As a result, the Government will not be bailed out of its deficit difficulties next year by any appreciable growth in tax revenues.

Secondly, in its most recent set of forecasts, the ESRI calculated that, allowing for indexation of social welfare payments, public spending would rise by 6.6 per cent in 2009. This ESRI forecast allows for an increase of just 2 per cent in the volume of public consumption next year and would constitute "a significant tightening of fiscal stance". Even then, the projected overall government deficit reaches 3.9 per cent of GDP.

Two rules should govern budgetary policy for 2009 in these circumstances. Firstly, it is often forgotten that the current budget remains in the black and should still generate a surplus of well over €1 billion this year. The 2009 budget should be framed so that current revenues match current spending.

Secondly, capital expenditure next year is planned at €10.2 billion or just over 5 per cent of GDP. Reduce capital spending next year to €6 billion or 3 per cent of GDP and ration resources to those projects yielding the highest rate of return. This approach retards the impact of Government cutbacks on ordinary citizens while keeping Ireland under the EU radar.