Economics Cliff TaylorA few months ago it appeared that Budget 2004 could be a particularly nasty vintage. Tax receipts were weak, spending was growing and the international economic recovery had been "six months away" from at least two years.

(Economists have become a bit like parents travelling with children, continually promising them that the destination is "around the next bend".)

The Department of Finance, of course, is continuing to bang the drum of fiscal penury. But the last few months have seen some stabilisation in the State's financial position and the more positive international economic indicators will also help. It won't be an easy Budget - not by a long way. Current spending growth will have to be hauled back a bit further, if any cash is to left for capital investment. Even with this, the Government will struggle to maintain infrastructure spending.

It won't be too pretty, but neither should it be hugely painful for taxpayers, even if the non-indexation of tax credits and the standard rate band leads to a higher burden.

So what has changed? First, the economy - and particularly the jobs market - has held in fairly well against a difficult international backdrop.

There are still factors affecting tax returns which are not entirely clear - the weakness of income tax receipts, for example, does not sit with recent figures showing rising employment levels, even when account is taken of lower bonuses and overtime.

But, allowing for the normal bumps and turns, the tax trend has stabilised considerably. The Department of Finance is so far sticking to its prediction that end-year tax returns will be up to €500 million below schedule. But Minister of State Willie O'Dea, speaking on radio last weekend, hinted that this might be revised down. And, with returns for the first eight months just €284 million behind schedule - €500 million appears the upper limit of any shortfall, unless self-employed tax returns due in November are very poor, or there is a big fall-off in corporation tax. On the other side of the State's balance sheet, current spending is running roughly on target and capital investment spending is below target, although some of this may be due to the timing of some sizeable expenditures.

Meanwhile it wouldn't be Christmas unless Dr Michael Somers and the National Treasury Management Agency weren't able to give the Minister for Finance a "prezzie" of a couple of hundred million saving on projected national debt payment.

Add the two sides together and it is possible that Charlie McCreevy will not be too far off meeting his Budget Exchequer borrowing target of €1.89 billion. Certainly the figure looks unlikely to rise much over €2 billion. Under the EU measure - the general government deficit - the money paid to the National Pension Reserve Fund is excluded and on this calculation borrowing is set to be a respectable 1 per cent of GDP. Under the rather arcane cash accounting practice used by the Government, the Exchequer slate is wiped clean at the end of the year. So the opening Budget position Mr McCreevy faces will be based on expected revenue and spending trends for next year.

What happens over the closing months of this year will provide important clues about what the Department of Finance will pencil in to the budgetary arithmetic for 2004. But broad economic trends are obviously also a key factor, as the more rapidly the economy grows the more buoyant will be tax revenues.

Recent figures do suggest the worst may be over for the world economy. Equity markets are certainly coming around to believing this as corporate profits show a recovering trend in many sectors.

That said, the recovery may be slow and patchy. Already there are fears about a "jobless" recovery in the US, while the big euro-zone economies remain flat. The financial imbalances built up during the boom years - particularly the US current account deficit - may also hinder recovery. In particular a falling US dollar would threaten European prospects.

If the growth trend is upwards at all, this will be of some benefit to tax revenues and will allow Department of Finance officials to write in projections for next year somewhat rosier than would have looked possible before the summer. Such is the volume of tax receipts - amounting to about €31.5 billion this year - that even a small percentage improvement in their growth rate can have a significant impact in cash terms, thus easing the budgetary arithmetic. Higher growth also helps on the spending side by reducing unemployment payments.

All this does mean that it is happy days for Mr McCreevy. The Government's financial position will remain tight even when the economy picks up a bit; the boom days are over and as the latest Goodbody stockbrokers analysis points out, the move to becoming a net EU contributor will hit the exchequer over the next five years.

The challenge for Government is to demonstrate a strategic approach. Last year, following the Election, the Budget showed all the signs of a hastily contrived package to balance the books through excise rises and the now infamous "stealth" taxes.

On the expenditure side, the essential manoeuvre was to apply the brake quickly and slow spending growth from pre-election boom levels to the 6-8 per cent range which should be sustainable in the long term. This has been achieved, albeit thanks to an unwelcome fall-off in capital spending. And the current spending slowdown has had clear political consequences through its impact on services in areas such as health and education.

Now the Government needs to show that it has a strategy for the public finances for the rest of its term of office. Benchmarking is a bad start, offering pay increases without, it appears, much hope of commensurate productivity improvements.

Much has been written about this subject in this column and elsewhere and despite the political fuss of the last week it appears that the Government will pay the money. This will create difficulties in the Budget by leaving less money for the non-pay spending. as well as proving a longer-term burden.

The net result of this must not be a squeeze on capital spending. Instead a multi-year approach to funding and planning projects must be a centre point of the budget. This should involve a strategy which covers a variety of financing from borrowing to public-private partnerships to use of some pension reserve fund money.

Economic management is about choices and finding the best use for resources. So flush has the Exchequer been up to last year that the coalition partners were able to dodge the hard decisions. The next Budget will show whether they have the ability and the energy to plan for more frugal times.