The council would like to thank the Chair and members of the committee for inviting us today. As you noted, Chairman, I am joined today by my council colleagues, Ms Dawn Holland and Professor Michael McMahon, and we are joined in the Chamber by our chief economist, Dr. Eddie Casey, and also by Mr. Kevin Timoney, an economist on the fiscal council.
Engagement with the Oireachtas is an extremely important part of the council's work, including with the Committee on Budgetary Oversight in the previous Dáil. The council is an independent body established under the Fiscal Responsibility Act 2012. Its mandate is to endorse and assess the Government's macroeconomic forecasts and its budgetary projections, and compliance with the fiscal rules and the fiscal stance. It is important to note that the council's mandate is about the overall budgetary position rather than on individual tax measures or spending items.
The Covid-19 crisis has had a huge impact on Ireland and internationally. Even in the first three months of the year, consumer spending is down by approximately 5%. Underlying domestic demand is expected to contract by between 7% and 17% this year. Approximately 26% of the workforce is currently either unemployed or on pandemic unemployment supports.
The council's fiscal assessment report, published on 27 May, provides an assessment of the fiscal impact of Covid-19. There is exceptionally high uncertainty at the moment about the health outcomes and the economic outcomes. To assess this, in the fiscal assessment report the council has outlined three scenarios to 2025 to help people's thinking about this. In the "mild" scenario, conditions improve rapidly and lasting damage to the economy is limited. The "central" scenario builds on the official forecasts in the stability programme update, SPU, published by the Government in April. It is assumed that confinement measures are eased as planned, but with lasting impacts. In a "severe" scenario, there are repeated lockdowns and wider financial distress. These scenarios do not take into account major risks Ireland faces from Brexit or from corporation tax.
In all scenarios, activity falls sharply and the crisis will have a lasting effect. The scenarios imply it would take two and a half to three years for the economy to return to pre-crisis levels of activity. By contrast, the economy took 11 years to recover after the financial crisis.
In fiscal terms, the budget balance will moves sharply into deficit this year; the SPU projected a deficit of 13% of GNI* this year, reflecting €7 billion of crisis-related spending and a much larger fall in tax revenue. This likely underestimates the impact on spending because it does not include the extension of support measures or any future fiscal stimulus package. While the fiscal balance will improve as the economy recovers, the central scenario implies that the deficit could still be approximately 3% of GNI* in 2025.
The appropriate fiscal stance in response to this will evolve over the coming years in three broad phases. In phase 1, the immediate crisis, the Government should limit the negative impacts on health and on the economy. The council welcomes the measures taken to support the economy. These should continue as long as needed, although they may need to evolve to reflect changing needs.
Phase 2 will be marked by the removal of most of the containment measures and the economy will begin to recover, but investment and consumer spending will remain very weak and unemployment will remain high. The council assesses that a sizeable fiscal stimulus would be warranted during this phase to help support the recovery. Borrowing to support weak demand would be an appropriate countercyclical response to manage the economy. It should be temporary, targeted and conditioned on the likely state of the economy.
Public investment could play an important role. While some reprioritisation may be needed, at least maintaining the current level of spending would help support activity and boost long-term output.
Excess capacity in the construction sector may create opportunities.
In phase 3, the economy will settle into a new steady-state growth path. At this stage, the debt-to-GNI* ratio will be very high. The debt ratio could be in the range of 115% to 145% in 2021, up from just below 100% in 2019.
Given the very high level of debt and lower revenues, fiscal adjustment is likely to be required in phase 3 to put the debt-to-GNI* ratio on a downward path towards safer levels. A key factor is the low level of interest rates. Even with the higher debt level, interest payments could actually fall over the coming years in the central scenario due to lower interest rates and a favourable tailwind as existing debt is rolled over. The long maturity of new issuance provides some protection against a rise in rates over the coming years. However, low interest rates cannot be taken for granted. Actions by the European Central Bank and the stability of the euro area will be key. With a very high debt ratio, Ireland will ultimately be much more vulnerable to future changes in interest rates as large amounts of funding will likely be required for new borrowing in the coming years and to roll over existing debt. This is why it will be very important to use the current positive debt dynamics to bring debt to a safer level.
In terms of future fiscal adjustment, the council's analysis suggests that getting the debt-to-GNI* ratio to fall at a pace of 3% a year by 2025 - similar to previous plans - would require total adjustments ranging from €6 billion to €14 billion over the period from 2023 to 2025. In the central scenario of around €10 billion of adjustment, this could take place over several years and against the background of a growing economy. The adjustment would still be less than a third of what was implemented after the 2008 crisis. This does not mean a return to severe austerity. Fiscal adjustment will be needed but some upward and downward adjustments, either in aggregate terms or on specific items, are a normal part of budgetary management. The adjustment could be achieved to a large degree by growing spending at a slower pace than the economy grows. We do not expect to return to severe austerity in the sense of significant increases in unemployment due to fiscal adjustments taking place in a downturn as Ireland saw after 2008.
Any incoming Government will have to take difficult decisions about competing spending and tax priorities during this third phase against the background of required adjustment. Any new commitments will likely require reductions in other areas of spending or higher taxes. Nonetheless, ambitious policies can still be pursued in areas like health, housing and climate change. Three long-standing issues, however, will need to be addressed. The first is spending pressures associated with an ageing population. The council will publish a long-term stability report in July looking at these issues. Second, additional measures could be needed if Ireland is to meet its climate change commitments. Third, the State has become over-reliant on corporation tax receipts, which accounted for some 18% of annual tax receipts last year.
To conclude, there are huge uncertainties for the economy depending on health outcomes but the broad phases of the crisis and recovery are relatively clear. As the economy exits lockdown, a sizeable fiscal stimulus would help recovery. However, some adjustments are likely to be needed down the line to get the debt ratio on a safe downward path again. To safeguard the funding of public services and supports in future, while addressing future challenges, the incoming Government should set a credible path for prudent fiscal policy and take steps to reinforce the budgetary framework. We look forward to members' questions.