THE FRIDAY INTERVIEW/Joaquin Almunia, EU commissioner:WHEN EU economic and monetary affairs commissioner Joaquín Almunia met Brian Lenihan in Brussels for talks in September he couldn't believe what he was hearing.
"He told me the public deficit in Ireland would be as high as 5 per cent this year. I just couldn't believe it. The fall in the revenue side in the budget has been very, very rapid. Huge," says Almunia, whose job is to monitor EU states' finances to ensure the smooth functioning of the euro currency.
For years, successive Irish finance ministers were toasted in Brussels as magicians, who managed to transform a moribund economy into a vibrant EU role model. Between 1987 and now, public debt fell from 113 per cent to 25 per cent of gross domestic product (GDP). While other EU states suffered budget deficits in the early years of this decade, Ireland ran a surplus, peaking at 3 per cent of GDP in 2006.
But the boom years are gone and Almunia will shortly trigger an EU excessive deficit procedure against the Government for allowing its budget deficit to balloon way out of control.
"It is absolutely clear a deficit of 5.5 per cent this year is an excessive deficit and this will trigger the opening of an excessive deficit procedure immediately after the publication of our economic forecasts next week," says Almunia, who blames an over-reliance on construction, housing and foreign investment for the Irish downturn.
The EU stability and growth pact commits EU states to avoid excessive budgetary deficits by keeping their budget deficit to GDP ratio below a 3 per cent limit, and maintaining their debt/GDP ratio below 60 per cent. Almunia indicated this week he would be flexible because of the severity of the financial crisis, enabling some governments to escape the excessive deficit procedure if they can prove their budget deficits are exceptional - caused by the financial crisis - and temporary.
But the sheer scale of the budget deficit in Ireland means the Government cannot avoid punishment. "Unfortunately the level of 5.5 per cent or above 6 per cent next year is not close to the reference value of 3 per cent so we cannot use the exceptional circumstances clause," says Almunia, who under the procedure will draw up a list of policy recommendations for the Government to follow to correct its budget deficit.
Under the terms of the pact, the Government could be fined if it fails to bring its deficit below the 3 per cent ceiling over three or four years, although, in practice, this has never happened before.
"The stability and growth pact is not about fines. It is not about blaming member states for the sake of blame," says Almunia, when asked if the pact is toothless. "In some cases it is about peer pressure, trying to use the European dimension and multilateral surveillance to push governments to adopt the adequate responses. . . It also supports governments to implement policies, which in some cases are not very popular."
Almunia says he is still evaluating Mr Lenihan's emergency Budget but indicates that EU states need to avoid tax cuts and spending increases in the current climate. He also highlights the need for a change of culture in Ireland and other states when it comes to regulation, financial supervision and attitude of the public to risk.
"I think financial supervisors have committed errors in the past years but they are not the only ones to blame," says Almunia, who cites big global imbalances that created excessive liquidity, regulatory weakness and irregular patterns of growth in certain economies - for example overreliance on construction - as contributory factors.
The housing bubbles in Spain, Ireland and Britain caused people to binge on credit. "There are many people who deserve support to buy a house but there are risks to incentive schemes that encourage citizens and households to take on excessive levels of risk," says Almunia.
"It is a question of consumer protection, financial literacy and a question of regulation to establish some limits in the access to financial products."
The EU has proposed redesigning the regulatory architecture for the financial system. Reform of the IMF and the World Bank are on the agenda of a global summit this month. Yet differences remain in Europe, and even within the EU executive, over the level and scope of regulation, with Almunia's colleague, internal market commissioner Charlie McCreevy, consistently opposing regulation of hedge funds.
"It is obvious that the light touch approach that prevailed in the past is now changing. I know many supporters of this approach in the past that now have a different idea, including Charlie," says Almunia, who describes the huge losses incurred this week by hedge funds betting on the share price of German car firm Volkswagen as "dangerous".
But he says care needs to be taken to ensure there is no overshooting of regulation in the financial sector. The economy needs a dynamic financial system and the real question now is how we want to regulate? Do we regulate institutions or activities, he asks?
Almunia also warns against a euro zone "economic government", along the lines of a proposal floated last week by French president Nicolas Sarkozy last week. This new structure would see EU leaders of euro zone states meet regularly and create a president position - probably Mr Sarkozy - to provide political direction. The proposal emerged after the extraordinary eurogroup meeting held in Paris this month.
"I think the meeting in Paris was a success and was the origin of the adequate response to the crisis. But this does not mean that these types of meetings should take place once a month. This was an exceptional meeting in exceptional circumstances," said Almunia, reflecting fears that Sarkozy wants to undermine the independence of the European Central Bank (ECB). "Without independence a central bank would not be credible."
Almunia says the ECB has emerged as the world's most respected central bank during the crisis while the euro has provided a safety net for euro zone states, prompting applications to join from Iceland and Poland and interest from Denmark.
"Indeed if Ireland were not a member of the euro area, the situation [the Irish banking crisis] would have been extremely serious," says Almunia, who notes that the Government's late-night decision to guarantee bank borrowings effectively forced the EU to create a co-ordinated response to the crisis.
It remains to be seen whether the EU and global response to the financial crisis can avert what some economists predict could be a 1930s-style recession. Almunia admits the situation is bad but is more confident about the future. "We are facing a very, very difficult situation with the broad financial crisis now spreading to the real economy in the majority of the EU states and industralised countries," he says. "But I think the duration of the slowdown cannot be compared to the 1930s because now we know much better how to react to these kinds of shocks. And secondly, states, the public sector, central banks and financial regulators and supervisors are much better equipped than in the 1930s."
He even predicts a recovery in Ireland. "Looking ahead I am convinced the Irish economy will recover and will continue to be a success story. Ireland has had deficits of 8 per cent in the past and then surpluses of 3 per cent. So adjustment is possible."
