Monday, November 8, 2010

Why €6 billion?

How did it transpire that the planned ‘adjustment’ in the upcoming budget jumped from the €3 billion announced last year to the €6 billion announced last week

I think we can attribute the increase to three factors.

  1. Reduction in the level of nominal GDP (partly as a result of the increased fiscal contraction).
  2. Continued deterioration of the public finances.
  3. Reduction of the planned General Government Balance as a percentage of GDP from 10% to 9.3%.

We can look at these in more detail to see the size of these effects.

1. Reduced nominal GDP (€1 billion)

Last December the DoF forecast the nominal GDP in 2011 would be €169.9 billion.  Ten months later this forecast is down to €161.2.  With the original forecast this would have allowed a GGB of €17 billion to meet the then published target of 10%.  Sticking with this target and the revised GDP figures would allow a GGB of €16.1 billion.  This means a reduction in the planned deficit of close to €1 billion.

Some of this reduction is due to revisions of GDP figures by the CSO.   For example when first published the 2009 GDP figures were €163.5 billion.  Following the methodological revision the revised figure for 2009 GDP is €159.6 billion.  (See the 2009 figure given in Table 2 of the National Accounts releases linked above.)  The CSO revisions have increased the adjustment by about €0.4 billion!

The remainder of the €1 billion adjustment here is due to reduced inflation expectations (depressing nominal GDP) and the growth effects of the increased budgetary adjustment.  The greater the adjustment, the greater the drag on GDP, the greater the adjustment must be to meet a stated target.  Quite the vicious circle.

The sum of these effects is an additional €1 billion adjustment to meet the 10% target.

2. Continued deterioration of the public finances (€1 billion)

Back in December with the €3 billion adjustment the DoF forecast a current budget deficit of €13.8 billion for 2011 and a capital budget deficit of €4.2 billion.  The latest forecasts are that the €3 billion adjustment would give rise to an current budget deficit of €14.25 and a capital budget deficit (excluding the interest on the so-called promissory notes) of €4.9 billion.  Combined this give an Exchequer deficit of just over €1 billion more.

The deterioration in the current budget deficit is because of a forecast drop in current revenue (€33.9 billion to €33.5 billion).  In the capital budget there is an increase in non-voted expenditure (€0.8 billion to €1.1 billion) likely due to increased interest payments on our growing national debt.

3. Reduction in planned GGB to 9.3% of GDP (€1 billion)

The “four-year plan” to reach the 3% GGB target by 2014 outlined back in December, stated that the target for 2011 was to get the GGB down to 10% of GDP. 

It we stuck to the 10% target it would allow a GGB of €16.1 billion.  Changing the target to 9.3% means the allowable (in the sense of the target) GGB can be of the order of €15 billion.  Moving the goalposts sees another €1 billion added to the planned adjustment.

So there it is.  Each of these three factors contribute €1 billion to the adjustment.  €1 billion because the nominal GDP forecast has been revised downwards.  €1 billion because the ailing public finances are showing further deterioration. €1 billion because we decided the above wasn’t enough pain, and we want to show the EU/bond markets/IMF/Greeks  how tough we really are by cutting another billion just for the hell of it.

And all this to reduce the GGB from 10% to 9.3%.  Seems like an awful lot of effort just to move a number by 0.7 percentage points.  And of course this is only because we have “delayed” the interest to paid on the promissory notes used as part of the bank bailouts.

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