Dark clouds over global economy overshadow ‘giveaway’ budget

The global economy has taken a dark turn over the past week. Christine Lagarde, the managing director of the International Monetary Fund, has said that global growth is forecast to be at its weakest since the height of the “great recession” in 2009.

Speaking before to the IMF’s 2015 annual meeting, Ms Lagarde said: “The prospect of rising interest rates in the United States and China’s slowdown are contributing to uncertainty and higher market volatility. There has been a sharp deceleration in the growth of global trade. And the rapid drop in commodity prices is posing problems for resource-based economies.

“In addition, medium-term growth prospects have become weaker. The ‘new mediocre’ of which I warned exactly a year ago — the risk of low growth for a long time — looms closer.

“Why? Because potential growth is being held back by low productivity, population aging, and the legacies of the global financial crisis. High debt, low investment, and weak banks continue to burden some advanced economies, especially in Europe, and many emerging economies continue to face adjustments after their post-crisis credit and investment boom.”

Ireland was the fastest growing economy in the EU last year and, according to EU Commission forecasts, it will be the fastest growing again this year.

Next Tuesday’s budget will be the final one before the general election, which will either be held next month or in the spring.

The re-election prospects of the government hinge on convincing voters that it can improve their stardard of living or at least manage the economy better than the opposition parties. This presents a huge conundrum for the Fine Gael/Labour coalition.

The government has signalled that it will introduce a package of €1.5 billion of spending increases and tax cuts — split evenly — in the budget.

The consensus growth forecast for this year is roughly 6 per cent, which is almost twice the rate of the next fastest growing economy among the 28 members of the EU. This suggests that the government is in a position to preside over the country’s first “giveaway” budget in over seven years.

The Economic and Social Research Institute (ESRI) recommended in its autumn economic outlook that the government introduces a neutral budget, with no net increase in spending, because of the economy’s growth momentum. It added that the most prudent strategy open to the government was to pay down debt.

There is considerable merit in this argument. Ireland is still a highly indebted country: gross debt is roughly 95 per cent of GDP and the economy is still running a budget deficit.

If the global economy deteriorates further, high-debt economies will be the most vulnerable, as governments will not have the fiscal space to respond.

The uncertain global economy could also have implications in the near term.

Take, for example, the planned flotation of 99.8 per cent state-owned AIB. Michael Noonan, the finance minister, has said on a number of occasions that he expects to recoup the full €21 billion of taxpayers’ money used to bail out the bank.

It is expected that 25 per cent of AIB will be sold next summer through an IPO, but as the past few days have shown, it is not possible to predict with any certainty whether market conditions will be favourable. Denis O’Brien, the telecoms entrepreneur, had to postpone the flotation of Digicel this week because of market turbulence.

From a purely economic perspective, the government should remain conservative in terms of setting its budget, but political considerations will prevail. It needs to offer sweeteners to voters to enhance its re-election prospects.

At a broader level, this is the biggest challenge facing the eurozone. Electorates across the continent have had enough of austerity. The temptation is for governments to loosen the purse strings, but that will put them on a collision course with the EU Commission. Since the ratification of the Fiscal Stability Treaty, all member states are bound by tough new spending rules.

The government’s plan for a €1.5 billion giveaway just about meets the commission’s approval, but Sinn Fein’s proposals to increase current and capital spending by €2.1 billion would certainly fall outside the new guidelines.