On behalf of the Irish Fiscal Advisory Council, IFAC, I thank the committee for allowing us to attend and to discuss our recent fiscal assessment report, which was published a few weeks' ago. Joining me today are fellow council members Mr. Michael Tutty, and Dr. Martina Lawless. Unfortunately Mr. Sebastian Barnes and Dr. Íde Kearney cannot attend. Mr. Eddie Casey who is the IFAC head of the secretariat and chief economist is also present as are Mr. Niall Conroy, Ms Kate Ivory and Mr. Kevin Timoney.
At the outset I acknowledge to the committee the work of the council’s previous chairman, Professor John McHale, whose efforts made a huge contribution to the establishment and development of the council over the last years. It is a tough task, but I hope to maintain the standards set during Professor McHale’s tenure.
The council’s work has been helped by interacting with this committee. Our previous chairman valued these engagements, as do my fellow council members and I. We hope we can continue to interact meaningfully with the committee and I would also like to acknowledge the ongoing interaction between the secretariat and the Oireachtas staff to support these meetings.
The IFAC published its 12th assessment report on 7 June. The report covers all aspects of the council’s mandate, as set out in the Fiscal Responsibility Acts 2012 and 2013. The report assesses the macroeconomic and budgetary forecasts in the Government’s 2017 stability programme update, compliance with Irish and EU fiscal rules and the appropriateness of the broader fiscal stance.
I will now turn to the fiscal position. It is worth noting the significant progress that has been achieved in resolving Ireland’s fiscal crisis. Ireland’s underlying deficit was brought below 3% of GDP in 2015 from a peak of 11.5% of GDP in 2009. This achievement reflected a sustained effort at consolidating the public finances by successive governments. The efforts made since 2008 have helped to finally put debt levels on a declining path. While debt is expected to rise in euro terms over the coming years, it is expected to decline steadily as a percentage of total government revenue. Strong economic growth, record low interest rates, and the move toward a balanced budget help underpin this turnaround. In turn, this has helped to restore the State’s capacity to borrow independently but significant challenges remain both from a macroeconomic and fiscal perspective. On the fiscal side, high debt levels limit our room for manoeuvre. Net debt, which strips out the government’s cash and liquid asset holdings, increased from €26 billion at the end of 2006 to more than €175 billion at the end of 2016 and this continues to rise, albeit much more slowly.
Measuring Ireland’s debt against GDP has become increasingly meaningless, given recent distortions. Current debt levels are equivalent to 2.4 times the total annual revenue of the Government, whereas pre-crisis levels were equivalent to just 0.4 times total revenue and the current EU average is 1.5. Ireland’s net debt-to-revenue ratio remains the fourth highest in Europe, behind Greece, Portugal and Cyprus.
On the macroeconomic front, there are risks in the short-run that the recent cyclical recovery in employment and output could continue more strongly than is envisaged in the latest forecasts. This could even lead to overheating, for example, if the property market were to respond more rapidly to persistent supply shortfalls. The latest Department of Finance macro forecasts imply that the number of new houses completed each year would steadily increase by around 3,000 units until annual completions reach 30,000 in 2021 but it might increase much faster. The IFAC would welcome a recovery in housing supply, but notes that higher than normal levels of new house completions might be required for some time to address a large backlog or pent-up demand. Put simply, if we need 30,000 to 35,000 housing units each year, as the ESRI suggest is consistent with structural demand, then we might need to produce more than this until any backlog is sufficiently dealt with. Producing more housing units would lead to faster growth and faster tax revenues but would not be expected to last forever. Instead, high levels of output might only be expected to last until such time as the backlog is addressed before eventually returning to more normal levels. Previous research by the ESRI suggests that an additional 10,000 new house completions would add one percentage point to GNP growth and this would likely be tax-rich in nature. We need to consider how we would deal with any faster than normal, and likely transient, growth in revenues.
An appropriate way to deal with cyclical risks like those potentially arising from housing would be to allow supply to recover and even exceed normal levels, while recognising that the associated revenues would be transient. Looking through short-run developments and increasing spending in line with the economy’s sustainable growth rate would be a sensible way to manage the economy and public finances. To manage the public finances prudently, we need to think carefully about what growth rates - and by extension, government revenues - might be considered sustainable. Looking further ahead, the IFAC sees risks that trend growth rates for Ireland might be weaker than was previously thought. This could happen if a harder than expected Brexit occurs or if risks related to US economic and tax policy were to materialise. Productivity, which is the key driver of growth in the long run, has important links to trade but Brexit could decrease trade and exporters face significant challenges in diversifying into other markets.
Having achieved a general government deficit of less than 3% of GDP in 2015, Ireland entered the domestic budgetary rule and graduated from the corrective part of the EU’s Stability and Growth Pact to its preventive arm. The rules help prevent governments repeating policy mistakes that contributed to crises in recent decades. The new framework can help us to withstand future shocks and help to prevent overheating. The rules help us to avoid using cyclical or transitory revenues to fund permanent spending increases, while allowing faster spending growth if it is funded by sustainable revenues. So far, Ireland has shown a minimalist approach to compliance with the fiscal rules.
This is the first two years in which the new budgetary framework operates. A breach was observed in 2016 and further breaches are planned for 2017. Such breaches can result in levels of spending that are permanently higher than would have been the case if the rules were complied with. If repeated, we could end up with spending levels that outstrip the pace at which Government revenues can sustainably grow.
Strengthening Ireland's fiscal framework is an important, positive legacy of the economic crisis and one which the Government has committed to respecting. The Oireachtas, the Council and the wider public have roles in monitoring and enforcing the national rules. The framework should help to make future boom-bust cycles less severe, guide Government debt to safer levels and underpin borrowing capacity during a period when high debt levels will leave Ireland vulnerable to shocks.
It is important to remember that constraints imposed by the rules are likely to be less severe than the constraints that can also be imposed by debt markets. As experienced by Ireland in 2010, debt markets can be even more demanding in terms of the fiscal policies viewed as consistent with access to funding to cover deficits and roll-over debts. A credible commitment to a framework that ensures debt sustainability can also allow Ireland to expand rather than narrow the room for fiscal manoeuvre.
Our assessment is that plans should remain consistent with this new framework beyond 2018. At that time, the rules will allow us to expand budgetary policy more in line with the economy's sustainable pace of growth, while steadily reducing debt levels sticking to the spending rule - the expenditure benchmark - after that would be a sensible guide for fiscal policy. While not a formal requirement, this position would go some way towards avoiding a fiscal policy that aggravates the boom-bust cycle.
To conclude, I thank the committee for again providing us with an opportunity to attend today. We look forward to taking questions and hearing the views of members.