Strong Mid-Year Returns Suggest Economy Strengthening And Budget Leeway Increasing


Tax revenues significantly ahead of profile on pick-up in jobs market and spending.

Public Spending under control and further helped by lower borrowing costs.

Strengthening economy implies end –year outturn could be €2-2.5bn better than target.

Several economic arguments support some stimulus in Budget 2016.

Task is to find a balance between broadening recovery and improving public finances further.

Notably better than expected tax and spending data for the first six months of 2015 underline the improvement now emerging in the Irish economy and point towards a significantly better end-year Budget outturn. In turn, this creates significant ‘fiscal space’ to deliver some stimulus in Budget 2016 while delivering a further notable improvement in Ireland’s public finances next year.

The end-June data show tax revenues €805mn ahead of target, departmental spending €304mn below target and debt service costs €246mn below target. This outturn reflects the improving Irish economy which we expect to become even more ‘fiscal friendly’ in the second half of the year.

A range of indicators suggest the upturn in activity and employment in the Irish economy is both strengthening and broadening in the first half of 2015. It is expected to continue and to build further momentum through the balance of 2015 and into 2016. A virtuous circle is becoming established in which robust growth in activity is translating into a marked increase in employment, a recovery in property values and a notably healthier trajectory in the public finances.  As a result, there should be scope for further out-performance of fiscal targets over the balance of the year.

Irish budget aggregates can be extremely volatile but with economic activity expected to remain on a strengthening trajectory, the trend thus far suggests the final year outturn could be €2bn and possibly as much as €2.5bn better than the original budget target. Importantly, there has been a consistent pattern of outperformance of late across most major tax and spending headings. Just as the downturn exposed unexpected Irish fiscal frailties, the major adjustment undertaken in the interim, that entailed marked changes to tax and spending settings, may produce unexpected windfall gains for the Irish exchequer in conditions of strong economic growth.

Ahead of a general election that must be held by April 2016, political pressure to provide a boost to incomes and employment is likely to be substantial. However, with rapid GDP growth expected both this year and next and Irish public debt still elevated, the rationale for expansionary fiscal policy has been widely questioned particularly as pro-cyclical fiscal policy repeatedly had a damaging impact on the Irish economy in the past.

We think a number of economic arguments support some element of stimulus in Budget 2016. First of all, there is little question that the Irish economy has significant spare capacity at present. The current unemployment rate at 9.7% is notably above most estimates of full employment. Our best guess is that full employment is between 6% and 7%. With the public finances moving into a notably healthier area, there is a strong argument for introducing measures that look to bear down on unemployment in the next year or two. Efforts to reduce the unemployment rate and improve infrastructure are likely to have both short term and long term positive effects both on the public finances as well as the broader economy. At the current point in the cycle there’s also every prospect that Budget ‘concessions’ foster stronger domestic economic activity, thereby boosting tax revenues and reducing unemployment transfers.

If fiscal concessions make it more likely that the exceptional social cohesion seen in Ireland through the downturn could be sustained and earnings demands remain moderate, this would also support some ‘giveaways’ in Budget 2016. Finally, the recovery is quite uneven and conditions remain weak in some sectors and regions. So, a case could be made for fiscal measures that spread the improvement in economic conditions somewhat wider.

The key issue is to strike a balance that delivers some reversal of major cuts to living standards experienced through the downturn but does not fuel expectations to the point that policy is set on a strongly pro-cyclical path in coming years or risks becoming unsustainable in the event of a further marked weakening in Irish economic conditions. Our sense is that much of the discussion on this topic only sees potential for mistakes on one side of this balance and, as such, doesn’t’ address the key question of what a ‘safe speed limit’ for the Irish economy might be and what policy settings are most likely to deliver it.

The Irish Government is still operating under the corrective arm of the Stability and Growth Pact (SGP) which requires it to reach a deficit below 3% of GDP in 2015. Current official projections envisage a General Government Deficit of 2.3% of GDP this year but on present trends we think the figure may be 1.7% of GDP or lower.

Once Ireland’s deficit is no longer deemed excessive, the fiscal position will be governed by the preventive arm of the SGP. This will require a reduction in the structural (ie cyclically adjusted) budget deficit of more than 0.5% of GDP each year until Ireland’s medium term objective of a structural budget balance is achieved. Current official projections envisage a reduction of just 0.3% of GDP in 2016. We think faster economic growth and more favourable fiscal dividends from this growth will produce the prospect of a notably stronger Budget outturn next year.

In that event, we think that political realities and some supportive economic considerations are likely to result in tax and spending measures in Budget 2016 that boost Irish economic activity by something in the region of €2 billion or just over 1% of GDP next year.

This non-exhaustive information is based on short-term forecasts for expected developments in the economy and financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalised investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a judgment as of the date of the report and are subject to change without notice.