On behalf of the council, I thank the committee for the invitation to appear before it today. The council views the enhanced role for the Oireachtas in providing greater scrutiny of the budgetary process as a positive step and we wish the committee well in its work. With me this afternoon are council members, Mr. Seamus Coffey and Mr. Michael Tutty, and the council secretariat is also present.
In my opening remarks, I will focus mainly on the key messages from the council's pre-budget statement, published on Thursday last. While we are limited in what we can say as a council by our well-defined statutory mandate, we will, as always, endeavour to be as forthcoming to the committee as possible, making clear in responses to questions where we are giving personal rather than council opinions.
Three developments have created a challenging backdrop to the assessment of the appropriate fiscal stance for budget 2017: the CSO's revised national accounts data showing 26% growth in 2015; uncertainty over the impact of Brexit; and questions over the sustainability of corporation tax receipts. The revised CSO data mean that measures of growth based on headline aggregates, such as GDP and GNP, are detached from underlying developments in the Irish economy that determine the employment and incomes of Irish residents. Moreover, fiscal ratios based on these measures are not reliable indicators of the health of the public finances. This creates challenges for the council in respect of all elements of its mandate. These challenges will be addressed in detail in the council's November report by which time some additional data may be available from the CSO. In advance of budget 2017, an immediate issue is the assessment of the macroeconomic-fiscal position and the appropriate fiscal stance for 2017. In the current circumstances, it is necessary to look beyond the standard national accounts aggregates and to use alternative indicators when assessing the pace of growth of the economy. Based on an estimate of growth in domestic demand, real growth in 2015 measured approximately 5% and this pick-up is also reflected in other aggregates, such as employment and consumption.
The fast pace of recent growth has implications for the cyclical position of the economy. The output gap measures the difference between the actual level of output in the economy and what it could sustainably produce if all resources – human and capital – were being fully utilised. A range of formal estimates of the output gap reported in the council's June 2016 Fiscal Assessment Report suggested that the economy is operating close to potential in 2016. Recent strong growth in domestic demand and employment along with the return to net inward migration in the year to April 2016 are all consistent with the demand shortfall in the economy being reduced rapidly. While there are no major signs of overheating in the economy at present, it is important to note that there is significant uncertainty around this assessment and the position could change over the next number of years. Understanding the cyclical position of the economy and avoiding potential overheating will be important considerations in framing fiscal policy post-budget 2017.
Turning to an assessment of the fiscal position, the problems with the official estimates of GDP and GNP mean that the headline debt-to-GDP ratio underestimates the size of the debt burden and overstates its rate of improvement last year. As a result, alternative fiscal ratios must be used. In this report the council has found it more useful to focus directly on fiscal ratios expressed as a percentage of actual general Government revenue.
The council's adjusted debt ratio improves from 105% in 2014 to 97% in 2015, a fall of eight percentage points compared to the 27 percentage point fall in the unadjusted debt to GDP ratio. Thus the adjusted data point to a continuing gradual reduction in the State's debt burden, although the overall level of debt remains high by historic and international standards.
Turning to the council's assessment of the fiscal stance, the Government's planned stance for budget 2017 is more expansionary than implied by the intended use of the €1 billion of fiscal space for 2017 outlined in the summer economic statement. Previously announced new spending commitments for 2016 and 2017 of €0.5 billion and €0.9 billion, respectively, give a combined package of measures of €2.4 billion.
As the demand shortfall in the economy is likely to be small and is disappearing quickly, the economic case for a more expansionary stance than already planned by the Government through the €2.4 billion package is weak. Regarding debt sustainability considerations, the Government debt level when measured relative to Government revenue remains high. Although the current interest rate environment is favourable, the experience of recent years has demonstrated how quickly market sentiment can change. The State's high debt level means the overall fiscal position is still fragile and an adverse shock could cause the debt ratio and deficit to start rising again.
Moreover, in the wake of Brexit the risks facing the Irish economy have heightened since the publication of the council's last assessment in June. While it is possible that the eventual impact of Brexit on the Irish economy and public finances will be modest, there is much uncertainty and a more severe outcome is also possible.
There is also particular uncertainty related to the sustainability of the recent surges in corporation tax. Although the latest national accounts data give some insight into the reasons for the out-performance, its relationship to the asset and tax management decisions of a small number of multinational corporations gives reason to be cautious about its sustainability. Moreover, when underlying revenues are volatile, prudent budgetary management suggests that buffers should be built up to protect against potential reversals, especially where it is costly to reverse expenditure increases and tax cuts.
Weighing up these considerations, the council assesses that the Government's current plans for a €1 billion package in budget 2017, on top of the pre-committed expenditure increases for 2016 and 2017, is at the limit of the range of prudent policies. Any further relaxation of the fiscal stance in 2016 or 2017 beyond the current plans would not be appropriate given the strong pace of underlying economic activity, falling unemployment and the need to bolster the resilience of the public finances to adverse shocks. While an anomaly in the fiscal rules related to the AIB preference share transaction in 2015 could allow additional expansion in 2016, a further relaxation of the stance, as occurred in last year's budget through late supplementary expenditure estimates, would not be appropriate. The Government should take advantage of the current relatively strong growth in revenue to eliminate the remaining budget deficit and accelerate the reduction in the debt ratio.
The pre-budget statement also analysed the possible implications of Brexit for the Irish economy. Given the uncertainty around the eventual impact of Brexit on the UK economy and on Ireland, the council examined two possible scenarios. In a relatively benign baseline scenario using the most recent post-Brexit forecasts for the UK economy from the National Institute for Economic and Social Research, NIESR, in the UK, estimates suggest that Irish growth could be lowered by approximately three quarters of a percentage point in 2017 with more limited effects thereafter. In this case, the estimated fiscal space out to 2021 would not be significantly reduced compared to the summer economic statement.
A more severe outcome than these relatively benign short-run effects is also possible. Such a scenario could transpire if the UK's potential output growth is reduced by Brexit with knock-on consequences for the Irish economy. The exercise is not intended as a forecast of the possible impact of Brexit but rather is designed to illustrate how fiscal space could dissipate if the economy performs significantly worse than currently forecast in the years ahead.
For illustrative purposes, assuming a reduction in Ireland's potential growth rate of half a percentage point per annum, fiscal space could be reduced by approximately a quarter to €8.5 billion if attainment of Ireland's medium-term objective was also delayed by a year. Drawing on the council's stand-still expenditure estimate, allowing for increases in expenditure in line with projected inflation and demographic pressures would absorb over half of the reduced fiscal space in the illustrative adverse scenario.
Finally, while much of the current focus for the upcoming budget is on short-term considerations related to 2017, as in previous reports, the council would like to highlight the importance of ensuring that annual budgetary decisions are anchored to realistic medium-term forecasts for the public finances. Without a realistic medium-term anchor, there is a risk of a return to the type of ad hoc year-to-year budgeting that served Ireland poorly in the past.
To sum up, amid the unusual uncertainty that prevails in advance of budget 2017, a few fundamental facts about the economy and public finances should not be lost. The economy has made an impressive recovery from the economic and financial crisis and good progress has been achieved in repairing the public finances. However, government debt remains high leaving the public finances exposed in the face of numerous risks and potential negative shocks. The Government should take advantage of the current strong growth in the economy to reduce the debt to safer levels. This would leave policy makers with more scope to offset the effect of future negative growth shocks and to protect the employment and living standards of Irish residents.
I thank the committee again for the invitation to appear today and we look forward to your questions.