Thursday, 12 November 2009

The future just got worse

Michael Taft: The EU Commission has announced that Ireland will get an extension to the target date for return to Maastricht compliance. Instead of 2013, it will be 2014. But don’t think that feet will be taken off the contractionary pedal. The EU Commission has called for even deeper deflationary measures spread out over a longer period than the Government had intended. The future just got bleaker.

In one sense, the extension was inevitable. The Government’s strategy to reach Maastricht compliance by 2013, outlined in the April budget, was growing more untenable by the day. Back in April, they hoped to hold the deficit at 10.7 percent by the end of 2010. Over the next three years they intended to reduce the deficit by 2.5 percent annually. That, according to the plan, would see the budget home at -3 percent by 2013.

Already, though, this math ahs gotten knocked off-course. The ESRI has projected the deficit will fall to 12.8 percent next year. Further, GDP will be below the Government’s projection. On that basis, the 2.5 percent annual reduction wouldn’t make it. Already, Goodbody Stockbrokers, the NIB and Ernst & Young claimed the Government would fail to reach the 2013 target.

Enter the helpful EU Commission. They are now allowing the Government until 2014 to reach Maastricht compliance. EU Commissioner Almunia tried to put a positive gloss on this – claiming that this extra year was given in acknowledgement that the Government is going down the right course. However, it had little to do with good intentions – it was merely an acknowledgement of cold math.

The bottom-line in all this is not that the Government is being given extra breathing space. Rather, it is that the Government will have to continue its deflationary fiscal strategy – the planned average annual 2 percent contraction up to 2013 – for another year. The economy has not been given a respite – its deflationary sentence has just been lengthened.

How will this play out in the medium term? Despite media reports that the Government is more optimistic about the economic numbers this year (this is in line with all other forecasters), the issue is what are the growth numbers going forward? In April, the Government projected a growth rate of over 10 percent between 2010 and 2013. Some forecasters disagree. IBEC is projecting 6 percent while NIB is slightly more optimistic at 8 percent. Only Ernst & Young, so far, believe growth rates to 2013 will be as strong as the Government projections.

However, extending the deflationary period will only dampen economic growth longer. To put it metaphorically (and much of the debate is played out at this level – ‘take the pain upfront’, etc.), the economy is likely to trough sometime next year. When it hits the bottom of the recessionary sea it will try to swim back up to the surface. However, the Government’s deflationary strategy is acting like an anchor tied around to the economy’s foot, making that upward swim harder and slower.

There are bleaker growth projections. At a recent economic forum organised by Dublin City Council:

‘Jonathan Stenning of Cambridge Econometrics was considerably more downbeat about the prospect of recovery, saying he expected the Irish economy would pick up slowly and grow at an average rate of 1 per cent per annum between now and 2013.’

If Mr. Stenning is correct, the economy will struggle further. It will not be able to generate the necessary tax revenue; it will not be able to generate the jobs to meet the needs of new labour market entrants, never mind those already on the dole; consumer spending and investment will remain depressed; the economy will be mired in a period of low-growth, high-debt.

I really hope the Mr. Stenning is wrong. For if he isn’t, the EU Commission will be coming back to the Irish government again, saying what a good job they are doing, and because of the that they will be giving them another target date extension – to 2015.

But what they will really be doing is lengthening our deflationary sentence. Again.

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