Thursday, January 9, 2014

The slow improvement in the Public Finances

The successful issue by the NTMA of another 10-year bond is a further small step to normality for our public finances.  They are a long way from being under control but the ability to raise €3.75 billion over 10 years at 3.5 percent indicated that decision makers in government bond markets think they are under control (or at least that they will be).

Getting a handle on Ireland’s public finances is not easy.  There are a plethora of sources and a variety of measures.  There are cash-based and accruals-based accounts.  There is the cross-over and subsidisation of central and local government.  There is the difference between voted and non-voted expenditure.  There is the difference between net and gross expenditure.  There are sinking fund contributions and appropriations in aid.  With all those in mind the following table may be comprehensible!  Click to enlarge.

The Public Finances

A fuller spreadsheet with some constituent components of the revenue and expenditure items is available here.  Note though that composition changes have affected some of the items.  For example, on the revenue side, the Health Levy, a departmental receipt for Health, was replaced by the Universal Social Charge and now appears under Income Tax.  On the expenditure side, FÁS, or equivalent, was transferred from Enterprise to Education.  These changes don’t affect the overall totals shown above.

Some comments on the above table are provided above the fold but offers little that we do not already know.  It is little more than a thought-straightening exercise. 

What do we see?  From 2001 to 2007 both current revenue and current expenditure increased significantly.  In 2007 the headline figures were ‘grand’.  Central government current revenues were close to €60 billion which, after primary expenditure of €53 billion, left a €7 billion current account surplus. This was almost enough to cover the entire voted capital expenditure.  Local authorities were running a small current deficit but it was relatively insignificant.  The snapshot was of overall balance in the public finances.

By 2009 all was utterly changed.  Central government revenues nosedived to €49 billion and the continued increase in current expenditure saw the current account move from a surplus of €7 billion to a current budget deficit of €11 billion; an €18 billion deterioration in just two years.  With capital expenditure still at €7 billion the overall deficit was also around €18 billion (excluding banking-related payments).  The public finances were broken.

In 2009, the difference between current revenue and gross voted current expenditure hit a trough at minus €6.4 billion and slow, but steady, improvement has occurred since then.  In fact in 2013 there was a small surplus on this measure – the tax and other revenues collected were enough to cover the current or day-to-day expenses of the provision of government services (voted current expenditure). 

Local authorities are now also showing a current balance.  Local government current receipts have been relatively stable at just over €4 billion for each of the past five years.  These come mainly from from commercial rates (€1.5bn), motor tax (€1.0bn), water charges (€0.4bn) and housing rents (€0.7bn). Since 2007, Local Authority current expenditure (excluding social welfare, health and education) has come down from €4.6 billion to €4.1 billion mainly because of a reduction in expenditure on Wages, Salaries and Pensions (total €3.2 billion in 2007 to €2.7 billion in 2013).

Since the gap between current revenue and voted current expenditure  emerged in 2009 the cumulative difference between them has been €18 billion.

Of course, the government has to fund more than just voted current expenditure.  There is also non-voted primary expenditure.  Ireland’s contribution to the EU budget usually makes up the bulk of this (it was €1.7 billion in 2013) but in 2013 non-voted primary expenditure  increased to €3 billion.  This was caused by the “once-off” payment under the Eligible Liabilities Guarantee triggered by the liquidation of the IBRC last February. [Such banking-related payments have been “once-off” since around the middle of 2009.]  The ELG payment was somewhat unique in that it appeared in the current budget.  Up to that banking payments from the Exchequer had been non-voted capital expenditure which, as noted, is excluded from the above table.

The item excluded to get the primary balance is interest expenditure on the national debt, which here is combined with the sinking fund contribution (a payment to the Exchequer capital account) and other debt management expenses to give the Servicing National Debt item.  This has increased from €2 billion in 2008 to €8 billion in 2013.  Some of the increase is a result of the money poured into the banks but the majority of the increase is the result of running annual deficits of up to €20 billion to pay for the goods, services, transfers and investment provided by the government.  The increase in debt servicing costs has offset improvements made elsewhere in the current budget.

Combined non-voted current expenditure and debt servicing costs make up expenditure for Central Fund Services.  Over the same time that voted primary expenditure has exceeded current revenue by €18 billion, expenditure on Central Fund Services has totalled €38 billion.  Whatever way it is made up that is €56 billion of current budget deficits in just five years.

From 2010 to 2013, current revenue increased from €48 billion to €52 billion while gross voted current expenditure has been reduced from €54 billion to €51 billion (so last year voted current expenditure was covered by current revenue – for both central and local government).  This €7 billion improvement has been offset by a €4 billion increase in debt management expenses (and the “once-off” ELG payment in 2013) so the overall improvement in the current budget deficit since 2010 is just over €2 billion.

There has been an even greater improvement in the public finances (we have after all being meeting our EDP deficit targets) but that has been achieved by slashing voted capital expenditure.  This peaked at €8.5 billion in 2008 and was down to €3.0 billion in 2013.  A lot of this capital expenditure happens via the local authorities and the decline in gross fixed capital formation (GFCF) by local authorities (roads, houses, water, other amenities) can be seen above.

Local authority capital expenditure on housing has fallen from €2.1 billion in 2007 to €0.4 billion last year, on transport it has fallen from €2.0 billion to €0.8 billion, and on other services and amenities it has fallen from €2.1 billion to €0.7 billion.  While the current budget is slowly moving in the right direction it is the capital budget has provided most of the improvement in the public finances. 

From here on if there is to be continued improvement it will have to come from (accelerated) improvement in the current budget.  In the last three years the current budget deficit has reduced by €2.3 billion.  Over the next three years an improvement of a multiple of that will be required.

Will this improvement happen?  Maybe.  In the Economic and Fiscal Outlook released with October’s budget we get a snapshot of what might happen to the finances of central government over the next three years.

Fiscal Forecasts to 2016

The bottom line shows an improvement in the Exchequer deficit from €11.3 billion in 2013 to just under €3 billion in 2016.  This is achieved through a continued contraction of gross voted current expenditure (€51.1 billion to €48.6 billion over the four years), a slowdown in the rate of increase of debt servicing costs (Central Fund) and an increase in Tax Revenue at a good clip (€37.8 billion to €44.0 billion).  Non-tax revenue declines slightly because of the decline of fees from the ELG scheme.

Overall, total current revenue of central government (tax revenue plus non-tax revenue and departmental receipts) is expected to be €57.7 billion in 2016 (within €2 billion of the 2007 level in nominal terms).  Although tax increases have been introduced for 2014 (full-year property tax, DIRT increase, pension levy increase etc.) and further tax increases are planned for 2015, the increase in current revenue is heavily dependent on a return to a growth this year and also an upswing in inflation (CPI inflation is currently 0.3%).   The Outlook projects cumulative nominal growth of 11.3 percent from 2014 to 2016 (nominal GDP: 2013 €166bn; 2016 €185bn).

In 2016, current revenue is projected to be around €9 billion greater than the expected level of gross voted current expenditure of €48.6 billion (down from €55.7 billion in 2009 and that’s just the nominal reduction)).

From 2010 (-€6 billion) to 2016 (+€9 billion) there will have been a €15 billion improvement in the difference between gross voted current expenditure and current revenue.  That is a massive turnaround – if it happens – and almost fully reverses the collapse that took place from 2007 (+€10 billion) to 2009 (-€6billion).  We tumbled rapidly down the lift shaft and have been slowly climbing back up the stairs while hampered by the injuries from the fall, some almost fatal.

This €9 billion excess in 2016 of current revenue over voted current expenditure will cover a large portion of the Central Fund Services expenditure (mainly debt service costs and contribution to the EU budget) meaning there would be a current budget deficit of around €2.7 billion in 2016.

The capital budget balance varies quite widely over the four years from a deficit of almost €2.5 billion expected this year to a position of being almost in balance in 2016.  It can be seen that voted capital expenditure is projected to be largely unchanged (it would be hard to get it much lower) such that the capital balance changes are caused by volatility in Capital Resources.

This usually comprises close a billion in receipts from the European Agricultural Guarantee Fund (or Fonds Européen d'Orientation et de Garantie Agricole (FEOGA) en francais) which in turn is paid out to farmers under non-voted capital expenditure.  Capital Resources have been bolstered recently by receipts from the sale of some of the banking assets accumulated during the bank bailout.  In 2013, there was €1.3 billion from the sale of Irish Life and €1.0 billion from the sale of contingent capital notes in Bank of Ireland.

No such receipts are planned for 2014 and 2015 but the large improvement in the capital budget shown for 2016 is because some receipts from the banks are included.  Capital Resources increase from €1.6 billion in 2015 to €3.6 billion in 2016.  Why?

The Minister for Finance holds €1.6 billion of contingent capital notes in Allied Irish Banks and a further €0.4 billion in PTSB.  These were provided to the banks in 2011 as a capital buffer as part of the PCAR exercise.  They are five-year notes and thus expire in 2016 and the return of the €2 billion is included in the 2016 capital receipts.  The €1 billion provided in the same manner to Bank of Ireland was returned in early 2013 via the sale of the BOI contingent capital notes to private investors.  Will similar sales be possible in AIB or PTSB?  Will they be able to raise private funds to repay the public funds? [On a related note, the NTMA  in its 2013 Business Review valued the banking assets held by it in the directed portfolio of the NPRF at €13.1 billion.]

If we exclude these “once-off”receipts from the contingent capital notes (I hope these “once-off” receipts will be of a similar frequency and magnitude to the “once-off” payments) the Exchequer balance is projected to improve from €11.3 billion in 2013 to €4.9 billion in 2016.  That is nearly three times the rate of improvement of the past three years but still leaves us €5 billion short of paying our way in overall terms.

The improvement to date and the planned improvement to come seem to be enough to keep participants in the sovereign bond market on side.  There are lots of moving parts (banks, central banks, currencies, swaps, deficits, prospects etc.) but at the moment the five-year yield on Irish government bonds is almost identical to equivalent yield on UK Treasuries. 

Ire v UK 5 yr yields

1 comment:

  1. As usual, another great explanation of what's actually happening. It's a pity you don't post everything on Irisheconomy blog where it would get a much wider audience.