EN Official Journal of the European Union C 142/7

COUNCIL OPINION

on the updated stability programme of Ireland, 2009-2014

2010/C 142/02

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty on the Functioning of the European Union,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 26 April 2010 the Council examined the updated stability programme of Ireland, which covers the period 2009 to 2014.

(2) After the period of very high growth of the second half of the 1990s, Ireland settled down to a more steady growth phase supported by buoyant domestic demand in 2001-2007. Ireland's competitive position weakened somewhat during this period, due to price and wage inflation together with declining productivity growth. The sharp correction in the housing market from the peak in 2006 led to a severe economic downturn, aggravated by the global financial crisis and the recession in Ireland's main trading partners. Despite five consolidation packages adopted since mid-2008, these developments have also produced a dramatic deterioration in the Irish public finances, with the general government balance moving from a surplus position in 2007 to a double-digit deficit ratio in 2009 and government debt exceeding the 60 % of GDP reference value in 2009. On 27 April 2009, the Council thus decided under Article 104(6) TEC that an excessive deficit exists in Ireland and on 2 December 2009 set a deadline for its correction by 2014. A first key challenge for the years ahead relates to implementing a broad-based and credible fiscal consolidation strategy, building on the significant efforts already made. A second is to return to sustainable growth, which will involve the re- and up-skilling of the newly-unemployed and regaining competitiveness through productivity-enhancing measures and adequate wage policies, and to foster an orderly restructuring process in the financial sector. With a view to improving the long-term sustainability of public finances, reforming the pension system is another important challenge.

(3) Although much of the observed decline in actual GDP in the context of the crisis is cyclical, the level of potential output has also been negatively affected. In addition, the crisis may also affect potential growth in the medium term through lower investment, constraints in credit availability, increasing structural unemployment and the return to net outward migration, if sustained. Moreover, the impact of the economic crisis compounds the negative effects of demographic ageing on potential output and the sustainability of public finances. Against this background it will be essential to accelerate the pace of structural reforms with the aim of supporting potential growth. In particular, for Ireland it is important to undertake reforms in the areas of human capital, competition and R&D.

(4) The macroeconomic scenario underlying the programme envisages that after declines in real GDP by 7,5 % in 2009 and 1,4 % in 2010, the economy will return to positive growth averaging 4 % over 2011-2014. Assessed against currently available information (2), this scenario appears to be based on plausible growth assumptions in 2010 and favourable growth assumptions thereafter, especially in view of the reduction in trend growth to be expected as a consequence of the current crisis in conjunction with the ongoing balance sheet adjustments. The programme's outlook for inflation appears realistic given the projected drawn-out adjustment process in the labour market. The projected return to an external surplus would appear to be contingent on a continued recuperation of competitiveness.

(5) The programme estimates the general government deficit in 2009 at 11,7 % of GDP. The significant deterioration from a deficit of 7,2 % of GDP in 2008 to a large extent reflects the substantial knock-on effect that the broad-based recession has had on the public finances, including a considerable tax shortfall and a surge in unemployment-related expenditure. At the same time, the significant consolidation packages adopted since mid-2008, with a combined deficit-reducing effect estimated by the authorities at 5 % of GDP in 2009, have helped limit the fiscal deterioration. While the overall thrust of the budgetary strategy is deficit-reducing, Ireland also adopted a modest package of stimulus measures to support economic activity of 0,7 % of GDP in line with the European Economic Recovery Programme (EERP). In line with the exit strategy advocated by the Council, and with a view to correcting the excessive deficit by 2014, substantial fiscal tightening is planned to continue over the programme period.

(6) At 11,6 % of GDP, the deficit ratio in 2010 is targeted to stabilise as compared to 2009, based on a significant savings package amounting to 2,5 % of GDP, broadly in line with the Council Recommendation under Article 126(7) of 2 December 2009. Given the steep rise in the interest burden, the primary balance is targeted to improve by 0,75 pp of GDP. Nearly all of the adjustment effort is on the expenditure side, including public sector wage cuts, social welfare savings, other current savings and a reduction in public investment, each contributing in broadly equal measure to the overall package. On the revenue side, the effect of a new carbon tax is broadly offset by a reduction in the standard VAT rate and in excise duties on alcohol. Despite these consolidation measures, the primary expenditure-to-GDP ratio would rise marginally reflecting higher unemployment-related spending. The revenue-to-GDP ratio is expected to increase by 1 pp on the back of rising ratios of social contributions and other revenue to GDP (3), which should more than offset a further drop in the tax-to-GDP ratio. The planned fiscal stance appears to be neutral in 2010, as the structural deficit, i.e. the cyclically adjusted deficit net of one-off and other temporary measures, calculated according to the commonly agreed methodology is estimated to stay broadly unchanged as compared to 2009. However, it is important to note that, without the savings package of 2,5 % of GDP, a significant further worsening of the fiscal position would have taken place in 2010. The ongoing underlying deterioration of the fiscal position on a no-policy change basis explains the discrepancy between a bottom-up (the savings package in the budget for 2010 amounts to 2,5 % of GDP) and a top-down approach (unchanged structural deficit) to estimating the adjustment effort.

(7) The main aim of the programme's medium-term budgetary strategy is to pursue further consolidation efforts so as to reduce the deficit below 3 % of GDP by the end of the programme period (2014). The nominal deficit would improve by 1,75 pps of GDP in 2011, 2,75 pps in 2012, 2,25 pps in 2013 and 2 pps in 2014, when the primary balance should turn into surplus again. This strategy taken at face value is in line with the Council Recommendation under Article 126(7) of 2 December 2009. To reach the targets, the government envisages further, quantified consolidation efforts on the current side of the budget in conjunction with a freeze of the level of capital expenditure (after the reduction in 2011). However, these efforts are not underpinned by broad measures. The technical projections of the programme suggest a mainly expenditure-based consolidation, as the expenditure ratio would be reduced by nearly 7 percentage points of GDP over the period 2010-2014, especially in the areas of government consumption and social payments, whereas the revenue ratio would rise by close to 2 percentage points. The structural balance is projected to improve by 1 pp. of GDP in 2011 and 1,75 pps. annually in the period 2012-2014. As communicated by the authorities, the medium-term objective (MTO) for the budgetary position of Ireland is a structural deficit of 0,5 % of GDP, which the programme does not envisage to achieve within the programme period. Given the most recent projections and debt level, the MTO reflects the objectives of the Pact.

(8) The budgetary outcomes could be worse than targeted in 2010 and considerably worse than targeted thereafter. First, the significant consolidation efforts planned from 2011 onwards are not underpinned by measures so that also the planned contribution of revenue versus expenditure measures to these efforts is not clear. This risk is compounded by the fact that even the targeted size of the consolidation packages for the different years is stated to be subject to review in the context of future budgets, notwithstanding the fact that for 2010 a savings package of the previously announced size was implemented. Second, an important downside risk is related to the economic outlook, which appears to be favourable in the outer years of the programme. Furthermore, also in view of the size of the planned consolidation, there is a risk of expenditure overruns in 2010 and also beyond, to the extent that the still to be spelled out strategy should rely on expenditure restraint. At the same time, it is noted that significant consolidation efforts have already been implemented since mid-2008. Specific additional risks relate to the government's bank guarantees to support the financial sector, which, if called, would lead to increases in deficit and debt. However, some of the cost of government support to the financial sector could also be recouped in the future.

(9) The government gross debt ratio was above the Treaty reference value in 2009 and is projected to be on an increasing trend until 2012. Specifically, according to the programme the debt-to-GDP ratio soared to nearly 66 % of GDP in 2009 from 44 % of GDP in 2008. The primary deficit was the main driver of this increase (+ 10 pps). However, a positive snowball effect (rising interest expenditure and negative nominal GDP growth) and adverse stock-flow adjustment (mainly related to the financing of capital injections into the financial sector) also made sizeable contributions. The programme projects a further steep increase in the debt ratio to a peak of nearly 84 % of GDP in 2012, followed by a gradual decline to below 81 % of GDP by the end of the programme period (2014) on the back of the improving primary balance, the anticipated return to strong nominal GDP growth and the unwinding of the cash balances currently held for precautionary purposes against the uncertainty in financial markets. In view of the likely need for significant further capital injections into banks and of the negative risks to the budgetary targets, the evolution of the debt ratio is likely to be less favourable than projected in the programme.

(10) Medium-term debt projections that assume GDP growth rates to gradually recover to the values projected before the crisis, tax ratios to return to pre-crisis levels and include the projected increase in age-related expenditures show that the budgetary strategy envisaged in the programme, taken at face value and with no further policy change, would stabilise the debt-to-GDP ratio by 2020.

(11) The long-term budgetary impact of ageing is clearly higher than the EU average, mainly as a result of a relatively high projected increase in pension expenditure over the coming decades. The budgetary position in 2009 as estimated in the programme compounds the budgetary impact of population ageing on the sustainability gap. It is noted that assets have been accumulated in the National Pension Reserve Fund in order to pre-fund part of future pension expenditure. Reducing the high primary deficit over the medium term, as already foreseen in the programme, and implementing structural reform measures including to curb the substantial increase in age-related expenditure would contribute to reducing the risks to the sustainability of public finances which were assessed in the Commission 2009 Sustainability Report (4) as high. According to the programme, a reform of the public sector pension system for new entrants to the service is to be introduced in 2010. Pension payments would thereafter be based on career average earnings rather than final salary, while the retirement age would be increased by one year to 66. It will be important to implement more broad-based reforms to address the projected increase in ageing-related expenditure. On 3 March 2010, the authorities published the ‘National Pensions Framework’ setting out their plans for pension reform, including a gradual increase in the age at which people qualify for the State pension, from 65 years currently to 68 in 2028 (5).

(12) Ireland's medium-term budgetary framework has some weaknesses. In particular, budgetary targets for the years beyond that covered by the budget, especially expenditure envelopes, can be changed in subsequent budgets. As experience has shown, this makes it more difficult for policymakers to maintain a prudent fiscal policy course in the presence of (persistent) windfall revenues. The programme acknowledges the importance of a robust budgetary framework and highlights the recent introduction of quantified targets for consolidation packages for years beyond the budget year in the supplementary budget adopted in April 2009. However, as mentioned above, the quantified targets set for the outer years in the stability programme are not underpinned by concrete measures. Without providing further details, the programme indicates that further reforms are under consideration, such as the introduction of binding multi-annual envelopes for current expenditure and a fiscal rule stipulating the use of future windfall profits for deficit reduction purposes. Regarding the more short-term budgetary framework, while the authorities publish monthly statements on central government revenue and expenditure developments, a regular review of budgetary plans at higher than annual frequency so as to limit the risk of deviating from the targets will be important.

(13) The sharp decline in revenue recorded in the context of the housing market correction and the wider recession has revealed some vulnerabilities of the Irish tax system, such as a narrow tax base and a high reliance on taxing transactions in assets. The need to broaden the tax base in the context of a comprehensive medium-term strategy was a key message from the report published in September 2009 by the Commission on Taxation set up by the government. This report, together with the recommendations for the improvement of public expenditure programmes from the report published in July 2009 by the ‘Special Review Group on Public Service Expenditure and Numbers’, will according to the programme inform the government's further budgetary strategy. A limited number of recommendations have already been taken into account in the budget for 2010, including the introduction of a carbon tax. The above mentioned reforms relating to the public sector pension system together with the further pension reforms under consideration according to the programme would further improve the quality of Ireland's public finances.

(14) Overall, in 2010 the budgetary strategy set out in the programme is broadly consistent with the Council recommendation under Article 126(7). However, from 2011 on, taking into account the risks to the deficit targets, the budgetary strategy may not be consistent with the Council recommendation. In particular, the deficit targets for 2011-2014 need to be backed up by concrete measures and the plans for the entire period need to be strengthened to address the risks from less favourable GDP growth and slippages on the expenditure side. The marked cyclical contribution to the consolidation in the outer years foreseen in the programme, consistent with its favourable macroeconomic scenario, implies that the average annual structural effort needed according to the programme to correct the excessive deficit by 2014 falls short of the 2 pps of GDP recommended by the Council. This reinforces the conclusion that the authorities should stand ready to take additional measures beyond the planned consolidation packages in case growth turned out to be lower than projected in the programme. Unless these risks are adequately addressed and the consolidation plans fully implemented, the budgetary strategy may not be sufficient to bring the government debt ratio back on a declining path by the end of the programme period. A rigorous implementation of the programme's consolidation strategy building on the significant efforts already made would also be appropriate given the high risks to the long-term sustainability of the public finances, driven by the expected change in age-related expenditure in the medium term as well as the rapid projected increase in debt, and the likely need for further support to the financial sector.

(15) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme has some gaps in the required and optional data (6). In its recommendations under Article 126(7) of 2 December 2009 with a view to bringing the excessive deficit situation to an end, the Council also invited Ireland to report on progress made in the implementation of the Council’s recommendations in a separate chapter in the updates of the stability programmes. Ireland partly complied with this recommendation. In particular, the consolidation efforts in the outer years are not underpinned by broad measures.

The overall conclusion is that Ireland responded swiftly and with determination to counter the widening of the government deficit. In spite of this, and due to the severe recession, the general government deficit widened further in 2009 but is planned in the programme to stabilise in 2010, at 11,6 % of GDP. From 2011 onwards, the programme envisages a reduction of the deficit to below the 3 % of GDP reference value by 2014, the deadline for the correction of the excessive deficit set by the Council. Debt would peak at around 84 % of GDP in 2012 and then decline mildly. The budgetary outcomes could be worse than targeted throughout the programme period, mainly due to (i) the fact that the consolidation efforts planned after 2010 are not underpinned by broad measures and are stated to be subject to review in the context of future budgets; (ii) the programme's favourable macroeconomic outlook after 2010; and (iii) the risk of expenditure overruns in 2010 and also beyond, to the extent that the still to be spelled out strategy should rely on expenditure restraint. This, together with the likely need for further support measures for the financial sector, implies that also the debt ratio could turn out higher than planned in the programme. While the significant size of the savings package for 2010 is broadly in line with the Council recommendation issued on 2 December 2009, it will be important to address the above mentioned risks, by spelling out the measures underlying the consolidation strategy and adopting additional consolidation measures if growth turns out weaker than projected in the programme or if the risk of expenditure slippages materialises. Building on the significant efforts already made, implementing a credible fiscal consolidation strategy, which should be facilitated by a stronger budgetary framework, should foster a return to sustainable economic growth. To help achieve this, there is also a need to regain competitiveness through measures enhancing productivity growth and adequate wage policies, and to support the re- and up-skilling of the newly unemployed to prevent them from turning into long-term unemployed. With a view to improving the long-term sustainability of public finances, further reforms to the pension system will be important in addition to the fiscal consolidation efforts. These reforms could usefully build on the March 2010 National Pensions Framework.

In view of the above assessment and also in the light of the recommendation under Article 126(7) TFEU of 2 December 2009, the Council welcomes the substantial consolidation measures which have been implemented and invites Ireland to:

(i) rigorously implement the budget for 2010 and back up the envisaged consolidation packages for the following years with concrete measures within a broad-based consolidation strategy in order to achieve the recommended average annual fiscal effort of 2 % of GDP in line with the Article 126(7) Recommendation, while standing ready to adopt further consolidation measures in case risks related to the fact that the macroeconomic scenario of the programme is more favourable than the scenario underpinning the Article 126(7) Recommendation materialise; seize, as prescribed in the EDP recommendation, any opportunities beyond the fiscal efforts, including from better economic conditions, to accelerate the reduction of the gross debt ratio towards the 60 % of GDP reference value;

(ii) in view of the significant projected increase in age-related expenditure, and also of the further increase in debt expected over the programme period, improve the long-term sustainability of public finances by implementing further pension reform measures;

(iii) to limit risks to the adjustment, strengthen the enforceable nature of its medium-term budgetary framework, as well as closely monitor adherence to the budgetary targets throughout the year.

Ireland is also invited to provide more information on the path and the broad measures underpinning the envisaged consolidation in the outer years in the EDP chapters of the forthcoming stability programme updates.

Comparison of key macroeconomic and budgetary projections (7) (8)

2008 2009 2010 2011 2012 2013 2014 Real GDP (% change) SP Dec 2009 n.a. –7,5 –1,3 3,3 4,5 4,3 4,0 COM Nov 2009 –3,0 –7,5 –1,4 2,6 n.a. n.a. n.a. SP Oct 2008 –1,4 –4,0 –0,9 2,3 3,4 3,0 n.a. HICP inflation (%) SP Dec 2009 n.a. –1,7 –1,2 1,0 1,7 1,8 1,8 COM Nov 2009 3,1 –1,5 –0,6 1,0 n.a. n.a. n.a. SP Oct 2008 3,1 0,5 1,5 1,8 1,8 1,8 n.a. Output gap (8) (% of potential GDP) SP Dec 2009 0,0 –7,0 –7,6 –4,6 –2,2 –0,6 0,1 COM Nov 2009 (9) –0,1 –7,2 –7,8 –5,4 n.a. n.a. n.a. SP Oct 2008 0,5 –3,5 –4,1 –3,4 –1,6 –0,5 n.a. Net lending/borrowing vis-à-vis the rest of the world (% of GDP) SP Dec 2009 n.a. –2,0 0,6 1,2 1,6 1,6 1,3 COM Nov 2009 –5,1 –3,1 –1,8 –1,4 n.a. n.a. n.a. SP Oct 2008 –6,3 –4,2 –3,5 –3,4 –3,0 –2,8 n.a. General government revenue (% of GDP) SP Dec 2009 34,8 34,2 35,2 35,5 36,3 36,7 37,1 COM Nov 2009 34,9 34,4 34,4 33,8 n.a. n.a. n.a. SP Oct 2008 33,6 33,7 34,4 34,6 33,9 34,4 n.a. General government expenditure (% of GDP) SP Dec 2009 42,0 45,9 46,8 45,5 43,5 41,5 40,0 COM Nov 2009 42,0 46,9 49,1 48,4 n.a. n.a. n.a. SP Oct 2008 39,9 43,3 43,4 41,0 38,7 37,0 n.a. General government balance (% of GDP) SP Dec 2009 –7,2 –11,7 –11,6 –10,0 –7,2 –4,9 –2,9 COM Nov 2009 –7,2 –12,5 –14,7 –14,7 n.a. n.a. n.a. SP Oct 2008 –6,3 –9,5 –9,0 –6,4 –4,8 –2,6 n.a. Primary balance (% of GDP) SP Dec 2009 –6,1 –9,6 –8,8 –6,6 –3,4 –1 1 COM Nov 2009 –6,1 –10,2 –11,3 –10,6 n.a. n.a. n.a. SP Oct 2008 –5,2 –7,3 –6,4 –3,5 –1,7 0,7 n.a. Cyclically adjusted balance (8) (% of GDP) SP Dec 2009 –7,2 –8,9 –8,6 –8,2 –6,3 –4,7 –2,9 COM Nov 2009 –7,1 –9,6 –11,5 –12,5 n.a. n.a. n.a. SP Oct 2008 –6,5 –8,1 –7,4 –5,0 –4,1 –2,4 n.a. Structural balance (10) (% of GDP) SP Dec 2009 –6,4 –9,3 –9,2 –8,2 –6,3 –4,7 –2,9 COM Nov 2009 –7,1 –10,1 –11,5 –12,5 n.a. n.a. n.a. SP Oct 2008 –6,2 –8,1 –7,4 –5,0 –4,1 –2,4 n.a. Government gross debt (% of GDP) SP Dec 2009 n.a. 64,5 77,9 82,9 83,9 83,3 80,8 COM Nov 2009 44,1 65,8 82,9 96,2 n.a. n.a. n.a. SP Oct 2008 40,6 52,7 62,3 65,7 66,2 64,5 n.a. Stability programme (SP); Commission services’ autumn 2009 forecasts (COM); Commission services’ calculations

(1) OJ L 209, 2.8.1997, p. 1. The documents referred to in this text can be found at the following website: http://ec.europa.eu/economy_finance/sgp/index_en.htm

(2) The assessment notably takes into account the Commission services’ autumn 2009 forecast, but also other information that has become available since then.

(3) The increase in the social contributions reflects a positive carry-over effect of the measures introduced in the April 2009 supplementary budget. The category ‘other revenue’ will increase due to the higher surplus of the Central Bank paid to the government in 2010 as compared to 2009, increased receipts from the bank guarantee schemes, as well as due to a one-off transfer of pension fund assets to the general government of 0,6 % of GDP in 2010 after a similar operation in 2009 yielding 0,4 % of GDP.

(4) In the Council conclusions from 10 November 2009 on sustainability of public finances ‘the Council calls on Member States to focus attention to sustainability-oriented strategies in their upcoming stability and convergence programmes’ and further ‘invites the Commission, together with the Economic Policy Committee and the Economic and Financial Committee, to further develop methodologies for assessing the long-term sustainability of public finances in time for the next Sustainability report’, which is foreseen in 2012.

(5) These reform plans are not included in the estimated impact of ageing on the public finances reported at the beginning of the paragraph.

(6) In particular, the data on nominal effective exchange rate; EU GDP growth, and growth of relevant foreign markets are not provided. More significantly, the revenue and expenditure projections in the programme are of a technical nature rather than being targets.

(7) The Commission services’ autumn 2009 forecast was prepared on a pre-budget basis.

(8) The figures reported as having been taken from the October 2008 stability programme actually refer to its January 2009 addendum.

(9) Output gaps and cyclically adjusted balances from the programmes as recalculated by Commission services on the basis of the information in the programmes.

(10) Based on estimated potential growth of 1,8 %, – 0,5 %, – 0,7 % and 0,0 % respectively in the period 2008-2011.

(11) Cyclically adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 0,4 % of GDP in 2009 and 0,6 % in 2010 (both deficit-reducing) according to the most recent programme and 0,5 % of GDP in 2009 (deficit-reducing) according to the Commission services’ autumn 2009 forecast.

Source:

Stability programme (SP); Commission services’ autumn 2009 forecasts (COM); Commission services’ calculations