Thursday, 22 April 2010

The great fiscal shell game

Michael Taft: The only enjoyable aspect of Eurostat’s decision today to reclassify the Anglo-Irish Bank subsidy as a liability on the General Government Balance/Debt is to watch the Government’s hands move even faster in an increasingly vain attempt to prevent us from seeing under which shell the real deficit is hidden. But they must be getting tired; and eventually we’ll glimpse it

In short, the Government keeps two sets of books: one for the EU which determines our General Government Balance (GGB or annual deficit) and our General Government Debt (GGD or overall debt) for the purposes of the Maastricht guidelines; GGB must be kept below -3 percent and our GGD must be kept below 60 percent of GDP). That’s one set of books – the other is for us. There’s nothing shady about this – there are a number of expenditure items that don’t appear on the EU books (e.g. payments into the Pension Fund), while there is revenue that appears on the EU books but not on our own (e.g. Social Insurance Fund surplus).

As a rule, expenditures in the form of bank recapitalisations don’t count in the EU books as they are considered equity investments. For instance, recapping Bank of Ireland through equity purchases should, in theory, be recouped. The Government had hoped that recapping Anglo-Irish would also be considered as an equity purchase and, therefore, not appear on the books they keep for the EU. Eurostat put paid to that. The money flowing into Anglo-Irish, according to Eurostat, could not realistically be considered an equity investment. Instead, it is now considered a straight-forward capital transfer. This transfer now appears on both sets of books.

Does this make any difference to the bottom-line? In one sense it is merely re-aligning statistical methodology with economic reality. At the end of the day, regardless of whether the capital transfer to Anglo-Irish appears on the EU books or not, it certainly will weigh down the economy’s books. This is money that has to be borrowed on the bond market. These borrowings will have to be serviced. For every €1 billion we borrow, we increase our debt servicing costs by €45 million at current rates. If the Government transfers the maximum amount - €22 billion – this debt servicing cost will rise to nearly €1 billion a year. It doesn’t matter whether the debt appears on this book or that; it will be a very real item on the current budget.

How will Eurostat’s reclassification impact on the Maastricht guidelines and the Government’s target of reducing the annual deficit to below -3 percent by 2014? Be prepared to receive two new words into the popular economic debate: the ‘headline’ deficit and the ‘underlying’ deficit. The Government will make this distinction to downplay the official (for EU purposes) GGB, or annual deficit, level.

For instance, prior to the reclassification, the Government estimated the GGB to be -11.7 percent. After today, it is 14.3 percent. The Government will claim that the former is the true, or ‘underlying’ figure; while the latter, the ‘headline’ figure, is merely the product of a one-off – in this case, the one-off capital transfer to Anglo-Irish.

The problem with this is that there may be considerably more one-offs in regards to Anglo-Irish. Philip Lane points out that such transfers will count on the EU books at the time of the commitment. While the Government may drip-feed the capital transfers into Anglo-Irish over a number of years through promissory notes, it will nonetheless be recorded in the year the decision is made. So if the Government commits €8 billion, it will be recorded immediately.

Still, the Government will hope to have done with these commitments so that by 2014, no such liability for the purpose of determining that year’s GGB, or annual deficit will arise. In that sense, they hope the ‘underlying’ reading will prevail.

But there is no such distinction when it comes to calculating our GGD, or overall debt. This will be a permanent feature. The Government had hoped to keep the GGD below 80 percent of GDP. If they have to hand over the full €22 billion to Anglo-Irish, the GGD will balloon to over 91 percent. Both the optics and the reality of that ballooning debt will not be good.

And here is where the Government is on a slippery slope. This reclassification will invite further scrutiny and this kind of scrutiny rarely has a favourable conclusion. Regardless of Eurostat rules, investors into our debt will start examining NAMA’s impact and may start their own mental reclassifications.

Further scrutiny may be made of the Government’s credibility in regard to their strategy. Already, the EU Commission has recently given a thumbs-down in its update on their excessive deficit procedure against Ireland. They have concluded that (a) the Government’s growth projections are too optimistic (and if this is the case, unemployment, tax revenue and the deficit will all go south); (b) the Government’s future fiscal consolidation plans are too vague; and (c) even if the Government somehow manages to hit their targets, they will still have to make more fiscal adjustments than planned for.

In short, this reclassification by Eurostat could prompt an opening up of Pandora’s deflationary box. Independent forecasters are already predicting lower growth and higher debt than the Government is doing – and that’s without today’s decision.

So the Government has no choice but to keep up this glorified shell game – continually reassuring all of us that nothing has changed. But it has. It is. It will.

And don’t forget – shell games are just a confidence trick. If you buy into it, you will lose.

1 comment:

SlĂ­ Eile said...

@Michael Thanks for this very clear and lucid account. The recen EU Commission assessment of the Stability Programme Update said: 'Council established the deadline of 2 June 2010 for the Irish government to take effective action to specify consolidation measures in the budget for 2010 in line with the package announced in the April 2009 supplementary budget and to outline in some detail the consolidation strategy that will be necessary to progress towards the correction of the excessive deficit.' The question remains - is the strategy credible? I think not.