Tuesday, November 18, 2014

Is Ireland running a primary surplus?

A bit esoteric but probably not.

The Economic and Fiscal Outlook released with last month’s budget shows that a small primary surplus is expected for 2014.  The primary balance is the balance when interest expenditure is omitted.  This is shown in the following table in item 18.

Primary Balance 2014

The overall deficit is expected to be just below €7 billion and because interest expenditure is almost €7.5 billion, a small primary surplus results.  It is supposed to be a measure of the fiscal position once debt servicing costs are excluded, i.e. is government revenue sufficient to cover all non-debt related expenditure.  The above table suggests this is the case.

However, there has been lots of circularity in the public finances over the past few years with money moving between entities (the Exchequer, the NPRF, Nama, the IBRC and the Central Bank) and hence in and out of the definition of the “general government sector” under Eurostat rules.  The NPRF and the IBRC are within the general government sector while NAMA and the Central Bank are not.

As a result of the Anglo bailout and the Promissory Note bond swap the Central Bank holds around €28 billion of Irish government bonds (it was originally €28.5 billion but €0.5 billion have been sold.)  These bonds will see around €900 million of interest paid to the Central Bank during 2014 with around €750 million coming the Floating Rate Notes and €150 million from the 5.4 per coupon 2025 bond.  A large part of this is repaid back to the Exchequer Account and is counted as Revenue in the above table.

Because of this cross-holding in the broader government sector the primary balance can appear different with no actual change at all.  For example, if the interest on the bonds held by the Central Bank was to increase to €2 billion.  This would increase interest expenditure by €1 billion and also see revenue increase by €1 billion when the Central Bank surplus is paid to the Exchequer.  The overall balance would be unchanged.

However, the primary balance would show a €1 billion improvement as the one €1 billion increase in interest would be excluded when calculating the primary balance but the €1 billion increase in revenue from the Central Bank surplus would be included.  This is not how the primary balance should change as it is supposed to be unaffected by interest changes.

So with a reported primary surplus of €575 million and around €900 million of interest being paid to the Central Bank and flowing back to the Exchequer it can be seen that the primary surplus is somewhat notional.  This would be revealed if the Central Bank was to sell the bonds it holds meaning that the interest payments would not be recycled back to the Exchequer.  Alternatively, the primary surplus would disappear if the interest paid on the bonds held by the Central Bank was nil.

Excluding these circular interest payments between the Exchequer and the Central Bank, government revenue is still not sufficient to cover non-debt related expenditure. It should happen in 2015.

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