Monday, September 23, 2013

Deficit targets and nominal GDP

The upcoming budget is set to be framed around a general government deficit limit of 5.1% of GDP for 2014.  This was set as part of the EU’s Excessive Deficit Procedure (EDP) in an Council Recommendation to Ireland from December 2010.

There was much comment last week on the performance of real GDP in Ireland (up 0.4% in the quarter apparently) but debt contracts are written in nominal terms.  And last week’s National Accounts release from the CSO was not very positive on that front.

In this year’s budget from December 2012 the following GDP/GNP projections were used.

EFO Budget 2013

The current estimate is that nominal GDP in 2012 was €163.9 (thus exceeding the figure above) but the increases necessary to reach the subsequent levels seem unlikely.

In the Stability Programme Update published in April the projected general government deficit for 2013 was put at €12.575 billion.  If the actual outturn is close to this, nominal GDP will have to be around the €167.7 billion as projected in order for the deficit to satisfy the 7.5% limit set under the EDP.

The two quarters of 2013 data we have give the following estimates of nominal GDP:

  • Q1 2013: €39,106 million
  • Q2 2013: €41,679 million

These sum to give a half-year figure of €80.8 billion.  In 2012 (when nominal GDP was €163.9 billion) the figure for the first half of the year was €82.0 billion.

To meet the 2013 deficit target, nominal GDP needs to be nearly €4 billion higher than last year, but it is already running over €1 billion behind the 2012 level.  With revisions, nominal GDP of €87 billion is required in the latter half of the year for the €167.7 billion level to be reached.  The equivalent figure for H2 2012 was €81.9 billion, so year-on-year growth of just over 6% in H2 is required.

There are some indications that economic activity will pick up in the second half of the year.  Employment seems to be edging higher, retail sales were up in July and the change in car registrations all point to some improvement in Q3 and Q4.  Nominal figures are a combination of real changes and price changes and, on the consumption side at least, inflation is heading ever lower and is approaching zero.

Of course, Irish national accounts data is inherently difficult to predict.  A couple of intra-company changes in the MNC sector can have a huge impact on the figures (MNCs account for 90% of the export figure in the national accounts).  Nominal GDP of €167.7 billion could be reached but if it came up short at, say, €165 billion then a €12.6 billion general government deficit (as projected in the SPU) would give a deficit of 7.6% of GDP – in breach of the EDP limit set for Ireland, albeit by a very small amount (0.1 pp). This overshoot is actually the same as the 2013 deficit-increasing impact of the Promissory Note restructuring which took place in February.

It will be March of next year before a first estimate of the 2013 deficit/GDP ratio is known and no extra fiscal efforts will be introduced if it is felt the EDP limit will be breached this year.  It is also possible that developments since April will result in a smaller deficit than the €12.6 billion projected in April.  Whatever about 2013, it is definitely the case that the nominal GDP figures will have an impact on the fiscal effort required for 2014.

Last year’s budget included a NGDP projection of €174.1 billion for 2014.  The indications from the data released since then are that this projection will need to be revised down.  The 1.5% real GDP growth forecast for 2013 is unlikely to be met and the implicit GDP deflator resulting from the CSO’s chain-linking method may be less than 1.3%.  For 2014, real growth of 2.5% is projected with a GDP deflator of 1.3% again expected.

NGDP for 2013 is likely to be behind the budget projection and the 3.8% nominal growth rate for 2014 may also be underachieved.  A €165 billion outturn for 2013 and a 3% nominal growth rate for 2014 gives a 2014 figure of €170 billion.

If this is the case satisfying the EDP limit of 5.1% of GDP requires a general government deficit of no more than €8.7 billion.

Absent the Promissory Note arrangement, this lower nominal GDP would have meant achieving the 2014 EDP limit with a budgetary adjustment of €3.1 billion would have been difficult.  In last year’s budget projections an underlying deficit (i.e. excluding direct banking measures) of €8.9 billion for 2014 was projected.  This was sufficient to met the EDP limit when NGDP of €174 billion is used but would be in excess of the limit if NGDP was actually around €170 billion.  Using last December’s figures it is possible to see that an adjustment of more than €3.1 billion would be necessary to stay under the EDP limit.

There have been changes since then, of course, most notable the Promissory Note restructuring.  By April, the projection for the 2014 deficit (again with an assumed €3.1 billion adjustment) was down to €7.7 billion.  Even with lower NGDP this will be inside the EDP limit of 5.1% of GDP.  At €170 billion such a deficit in 2014 would be 4.5% of GDP.

It may be the case that next month’s budget will have a smaller package of tax increases and expenditure cuts then envisaged at the time of last year’s budget.  However, this not because of any unexpected improvement in underlying economic conditions.  In fact, the numbers last week suggest that more should be done if the fiscal consolidation plan is to remain “on track” not less.

The reason why less can be done is all down to the Promissory Note restructuring and some comments on these “savings” are presented in the next post.

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