War in Ukraine exacerbates Irish economic problems lurking in the background

The search is already on for a magic answer to protect us from higher energy prices. The Government, after all, is expected to protect everyone from all possible inconvenience.

But it can’t, and it now needs to carefully decide what it can and cannot do against the backdrop of the most extreme uncertainty. With the cost of State borrowing starting to creep up, managing the economy looks set to get tricky and very contentious . Everyone agreed, more or less, with what needed to be done during Covid-19 – but this consensus is already shattered.

We first need to kill off magic solutions. Fingers are being pointed at “profiteering” energy suppliers. The European Union has floated the idea of a special windfall tax on companies making profits from higher energy prices and there is talk of changing the way electricity prices are calculated.

A few things have been missed in the swirl of this debate. The competitive practices of gas, electricity and oil companies here deserve tight scrutiny and there will be cases of poor practice. But the suppliers are all facing a big hike in the cost of buying oil and gas – indeed you would suspect that there is already financial stress in some parts of the industry.

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Prices at the pumps and home energy bills are going up because international oil and gas prices have shot higher. The only companies making big profits are those producing oil and gas – and here our only supplier is the Corrib field, which is running down.

Cashing in

Under pressure to " do something", EU leaders will discuss the latest European Commission plans at a meeting later this month. Commission suggestions of a special tax on energy companies or new ways of calculating electricity prices with less reliance on the gas price would appear to have limited relevance in Ireland.

So it will come down to what it always comes down to in a crisis. How much will governments spend, funded by borrowing and higher taxes, to try to address what is happening? The EU could clear the way for some things, such as flexibility to cut the VAT rate on energy bills and more general leeway in relation to tax on fuels. It is also signalling that governments will be allowed to offer supports to businesses under state aid rules – France announced a big package of supports for its companies on Wednesday.

How will this go for Ireland? A lot depends on the extent of the economic hit. Most forecasters had anticipated that Ireland’s domestic economy would grow by a strong 6 to 7 per cent this year. These forecasts will now be cut.

Energy supplies

All the main economic engines – consumer spending, investment and exports – will be hit. The big tech and pharma manufactures – who played a key role in supporting growth and taxes through Covid-19 – will be exposed to higher energy prices. Food supply and prices are also under threat .

Looking at international economic predictions – some of which seem a bit sanguine – forecasts here might be that the domestic economy could grow by 4 to 5 per cent this year, 1.5 to 2 points lower than earlier predictions. As Taoiseach Micheál Martin said, a recession cannot be ruled out – but it would require things to get even worse. The most obvious trigger would be an interruption to energy supplies. The cost for big industrial players if they had to suspend production would quickly outstrip what the extra energy bills they now face.

The Government will come under pressure to do more to protect households and businesses. It won’t be able to delay action until the budget in October. Measures to help less well-off households have to be top of the list. Business and jobs may have to be protected. The cost of all this could rise quickly. If the latest excise cut on fuel was extended for a year, it would cost about €750 million, for example. Compensating poorer households will be costly. Businesses spend €3 billion a year on gas and electricity, so any measures to ease the blow here will not come cheap. Plans to spend more on renewables will have to be accelerated.

The economy has rebounded remarkably from the Covid-19 lockdowns.Managing the economy was not easy during Covid-19 – huge decisions were taken on vital social and business supports – but it was clear what needed to be done and borrowed money was very cheap.

But now the answers about what should be done are less clear-cut. The war has exacerbated problems and challenges which were already lurking in the background – particularly in relation to energy costs and security and the transition to renewables. It has turned a cost-of-living problem into a potential crisis.

And it underlines questions about the globalised nature of economic production already highlighted by Covid and vital to Ireland’s economic future. It was already clear that global supply chains were going to be reshaped after Covid; now there are new questions about not only the place of Russia but also China in a new world political and economic order.

Borrowing

Room for manoeuvre, meanwhile, is narrowing. The cost of State borrowing is starting to rise. The interest rate on Ireland’s ten year borrowing has risen from 0.1 per cent in December to around 1 per cent now. It is still low, but the sharp rise in inflation has raised new questions about interest rate trends. We enter this crisis with an elevated national debt level due to all the Covid-19 borrowings.

And the big decisions – some put on hold during Covid-19 – such as the State pension retirement age and how to fund the ageing population and the energy transition are lining up. Covid-19 brought big economic problems . But dealing with the unpredictable economic consequences of the war may well be a lot more challenging.