I thank the Chairman and committee members for inviting me to speak to them about the Irish stability programme - April 2013 update. I look forward to a constructive discussion. The stability programme was approved by the Government at today's Cabinet meeting which concluded at approximately 2.30 p.m. The statement on the programme was circulated to the members of the joint committee at approximately 3 p.m. They were the first to receive an update on the programme. I will open by providing the committee with an overview of the process involved in the programme and a synopsis of the outlook for the economy in the short and medium term before moving to a discussion of the public finances and an overview of our obligations under the fiscal compact.
I intend to open by giving an overview of the process involved and a synopsis of the outlook for the economy over the short and medium term before moving on to the public finances and an overview of our obligations under the fiscal compact. I will then respond briefly to the most recent report of the Irish Fiscal Advisory Council, following which I will be happy to take questions and comments from committee members.
A number of important improvements were made recently to the budgetary system both at a national level and, in response to the changing fiscal architecture, at a European level. As part of the new European semester process, each EU member state submits a stability or convergence programme to the European Commission in April of every year. The stability programme sets out the official macroeconomic and fiscal policies for the following years. The policies are subject to peer review and recommendations are made for each member state to ensure that the policies set out have a euro area and EU dimension. The document has been laid before the Houses and I intend to submit it to the European Commission following this discussion. The Stability and Growth Pact requires us to set out our economic and fiscal projections for the current year and the following three years. Therefore, the current stability programme sets out the economic and fiscal position to 2016. At a national level, these forecasts set the scene for discussions that will take place over the summer in advance of budget 2014. The recent agreement on the two-pack of European regulations means the budget will be delivered in mid-October, earlier than in previous years.
I will now focus on the Irish economy and the outlook over the short and medium term. Having returned to growth in 2011, Ireland had a second successive year of growth in 2012. Preliminary figures show that real GDP increased by 0.9% in 2012. As is typical in small open economies such as Ireland's, the traded sector is leading the recovery, with exports growing by approximately 3% in 2012. This owes much to the significant price and cost adjustments that have taken place in recent years. However, within exports we are seeing some divergences. Goods exports are falling for the first time since 2009 in response to the general slowdown in our trading partners and product-specific developments, most notably in the pharma-chem sector - the often-mentioned pharmaceutical "patent cliff". By comparison, services performed strongly in 2012 and saw close to double-digit growth, driven by increased exports of business and IT services. In difficult international circumstances, the performance of the services sector is particularly impressive.
There has been a significant improvement in economy-wide cost competitiveness. The European Commission estimates that Ireland's nominal unit labour costs relative to those in the euro area have improved by 23% over the period 2008-2014. This is a result of the wage restraint shown by the private sector, pay reductions in the private sector and productivity improvements achieved across the economy. High-frequency data on the domestic economy provide a tentatively positive picture, with private consumption and investment increasing in the second half of last year. Disposable household income rose over the course of last year while the household savings rate declined from the second quarter onwards. Despite the recent dip in March, core retail sales were in consistent positive territory in the seven months to February and underpin the stabilisation in domestic demand.
Employment growth resumed in the second half of last year. The unemployment rate is now falling. Although it remained at the still too-high level of 14% in March, it has decreased from a peak of 15% in February 2012. I want to stress that the Government does not see the employment and unemployment forecasts contained within the SPU as targets. They are independent forecasts prepared by Department officials. I expect these forecasts will improve as the job creation measures in the budget, the Action Plan for Jobs and the infrastructure investment plans take hold.
On the economic outlook, my Department has made a modest downward revision to the macroeconomic forecasts for 2013-2015 compared to those which underpinned budget 2013. My Department expects GDP to grow by 1.3% this year, with a return to growth in employment and a fall in unemployment. This revision incorporates compositional changes to growth. Domestic demand has been revised slightly upwards on the back of recent high-frequency data, to which I referred already. This revision to domestic demand has led to a slightly more positive revision to employment growth in 2013. The contribution from exports has been revised downwards as the global economy remains weak and the impact of the patent cliff is weighing on pharma exports. We expect this process of GDP and employment growth to continue in 2014 and beyond, although a key risk to the forecast is, of course, economic developments in trading partners. Inflation is set to remain low, contributing further to the improvement in competitiveness that has been evident in Ireland since 2008.
As is always the case with forecasting, the baseline scenario hinges on a number of crucial assumptions. The stability programme contains a quantitative assessment of the impact on the economy of a number of different scenarios. Risks to the forecasts come from internal and external sources. Externally, a more prolonged downturn in key trading partners as a result of a more protracted period of deleveraging in advanced economies or any reignition of the sovereign debt crisis in the euro area would have a negative impact on these forecasts. Domestically, any unexpected increase in interest rates or acceleration in the pace of debt reduction could have a negative impact on domestic demand. Upside risks may present themselves if there is a stronger than assumed global recovery, while domestically, a return to more normal levels of investment from the current low base could boost growth once business confidence and credit conditions are supportive. Increased certainty regarding future prospects could reduce the level of precautionary savings by households, potentially boosting domestic demand.
On the fiscal front, a deficit of 7.6% has recently been estimated for 2012 by the CSO. This represents a significant improvement on the underlying position in 2011, when a deficit of 9.1% was recorded, and is well within the ceiling of 8.6% set by the ECOFIN Council, which sets out a path to achieving a correction of the excessive deficit by 2015.
Turning to this year, a number of developments since budget time have had an impact on the deficit for this year, but in aggregate terms they broadly off-set each other. These developments include a better than expected fiscal position at the end of 2012, the replacement of the promissory notes with long-term Government bonds, the sales of interest-bearing stakes in the financial sector and, of course, the on-target quarter-one 2013 Exchequer outturn, as well as first quarter economic data. This is the first articulation of fiscal policy in the aftermath of February's promissory note deal. As is standard budgetary procedure, the Government will make decisions in light of these developments and policy priorities at budget time. Therefore, the SPU makes a necessary but purely technical assumption that the proceeds of the promissory note savings are allocated to deficit reduction and that the consolidation amounts I outlined at budget time remain unchanged. The utilisation of these savings will be determined as part of the budgetary process.
Looking at this year, the revised forecast is for the deficit to improve to 7.4%, which is within the 7.5% ceiling set as part of the excessive deficit procedure. Importantly, the primary balance, which excludes interest payments, is set to turn positive in 2014 and move into a significant surplus in later years. In turn, gross debt is set to peak this year at 123% of GDP and return to a downward path afterwards. While this represents a small deterioration relative to budget time, it is important to note that the increase is reflective of the NTMA's successful engagement with the market in the first months of this year. It is not because of any deterioration in the underlying fiscal position. Indeed, the 2013 net debt position has improved marginally from budget time and is estimated at 98% of GDP.
In line with European guidelines, the SPU sets out updates on long-term fiscal sustainability, institutional reform of the public finances and quantitative risk analysis for macroeconomic and public finances.
The European fiscal rule book has changed considerably in recent years with the adoption of the six-pack in 2011, the fiscal compact in 2012 and the recent breakthrough on the two-pack under the Irish Presidency. In a nutshell, member states are required to be at their medium-term budget objective, the so-called MTO, or, if not, they should be on an adjustment path towards it. The MTO is defined as a budgetary position that safeguards against the risk of reaching the 3% of GDP threshold, ensuring the long-term sustainability of public finances.
For Ireland, this is a balanced budget in structural terms. More specifically, this involves a budgetary position where general Government revenues and expenditure are equal in a given year once the correction for the position in the economic cycle has been made. For illustrative purposes, today's stability programme sets out the adjustment path between 2016 and 2019, which takes us towards our MTO. It allows for revenues to grow in line with nominal GDP and for modest increases in expenditure over the period. With revenue growth greater than expenditure growth, the deficit will close sufficiently by 2019.
The path we have outlined is not simply for compliance with the European rule book. As we all know, Ireland's debt burden has increased substantially in recent years. Agreements reached over the past two years on the reduced interest rate on the European loans, the promissory note deal and the extension of maturities go a substantial way towards safeguarding our debt sustainability. However, long-term economic growth and job creation can only occur where the debt burden is set on a downward path so as to reduce the long-term drag on the economy and interest rate payments.
As I committed to before and as the chairman of the Irish Fiscal Advisory Council noted when appearing before this committee last week, the stability programme contains a response to the council's most recent report, published earlier this month. The council is largely supportive of the Government's policy of fiscal adjustment and considers that the deficit targets will be met. In light of the tax performance last year and further developments this year, the council is no longer calling for additional consolidation beyond that already specified. Instead, it endorses the consolidation path that I set out at budget time. It is also worth noting that the council considers the Government's fiscal stance conducive to prudent economic and budgetary management. The Government is committed to continuing on the path to sustainable public finances. The council report noted that, given the deterioration in the external environment since budget day, including weaker than expected activity among some major trading partners, and exchange-rate appreciation, achieving the 1.5% GDP growth forecast for this year will be challenging, although growth is expected to be in positive territory. My Department has reached the same conclusions and the forecast for GDP growth in 2013 has been revised downwards to 1.3% in the stability programme.
In the context of discussions about the Department's forecasting methodology, I note the report assesses the approach to macroeconomic forecasting in the Department and finds it is in line with the approach used by the ESRI and the Central Bank. This provides a level of confidence that the Department's approach is in line with best practice nationally. The Government's primary objective is to put the economy back on a sustainable growth path and return to a sustainable level of job creation.
With regard to the public finances, our primary aim remains the correction of the excessive general Government deficit by 2015. We have met all the interim deficit targets and the Government remains committed to bringing the deficit below 3% of GDP within the stated time horizon. Once this is achieved, we must remember that sustainable public finances are essential for balanced economic growth. Once the excessive deficit is corrected, fiscal policy in Ireland will be framed in line with the requirement to make sufficient progress towards the medium-term budgetary objective and to put public debt on a downward path.
I thank the members for their attention. I will be happy to respond to any questions they raise.
