The Brussels decision that profits from the euro changeover must not be used in calculating national budgets shows that Irish public finances cannot be adjusted through 'creative' measures, writes Austin Hughes
As any observer of Irish summer weather will tell you, it never rains but it pours. Anyone studying the deterioration in the Irish budget situation might use the same adage in the wake of yesterday's decision by EuroStat, the European Statistical Agency, which adds significantly to the headache facing Charlie McCreevy in his efforts to ensure that Ireland's budget position remains sound.
At first glance, the direct impact of what may seem to some to be another obscure and arbitrary European decision might appear to be fairly limited. However, the signals sent by yesterday's decision are important. They underline that the use of "imaginative" approaches to improve worsening budget positions will not be tolerated by Brussels. For Mr McCreevy, this ruling could make the immediate task of framing next year's budget a good deal tougher, but ultimately that may be no bad thing.
The background to the EuroStat conclusion may come as a surprise to some. It is widely recognised that the euro changeover had a harmful impact on Irish consumer prices and many businesses experienced a significant rise in costs in the course of preparation for the introduction of the single currency.
What is less generally recognised is that governments right across Europe realised significant profits from the changeover. This is because not all of the old national notes and coins were returned to be translated into euro, resulting in windfall profits for the governments who had issued those notes and coins.
EuroStat decided yesterday that these profits could not be included in the standardised European measure of states' budget positions for 2002. It is important to recognise that this is a measurement issue. The ruling does not mean the money will be taken away from the Irish exchequer. Furthermore, because the euro changeover was a once-off event, this decision doesn't mean that budget figures for future years will suffer a similar deterioration.
Instead, we are talking about an adjustment that will worsen the standardised EU measure of the budget out-turn in Ireland and elsewhere in 2002. This measure, which is termed the General Government Balance, is used to assess whether countries are running budget policy in accordance with the Maastricht treaty.
The EuroStat ruling is important for several reasons. The impact on Ireland's budget out-turn in 2002 will be significant. Mr McCreevy had pencilled in some €610 million of extra revenues that will now be excluded from EU calculations. Although the Minister has repeatedly said that he will deliver a budget surplus this year, this ruling makes a sizeable deficit more likely.
EuroStat's conclusion would have attracted little attention if Ireland's economic climate were still as strong as it was a couple of years ago. When Mr McCreevy presented the 2001 Budget, he predicted that in 2002 the General Government Balance would be in surplus to the tune of around €4 billion. This year's out-turn will likely be a deficit in the region of €1 billion, some €5 billion poorer than Mr McCreevy's earlier estimate.
The point to be emphasised here is that yesterday's ruling comes at a time when the trend is clearly not Mr McCreevy's friend. With public spending now rising at rates in excess of 20 per cent per annum and tax revenues falling, it doesn't take a particularly pessimistic imagination to envisage circumstances within a couple of year in which Ireland's budget position could threaten the borrowing limit of 3 per cent of GDP set out in the Maastricht Treaty.
THE EuroStat ruling, at a stroke, worsened the EU calculation of Ireland's budget outturn for 2002 by €610 million. This change sets the context in which the recently announced €32 million saved on overseas development aid or the €15 million generated by higher university charges must be seen. It implies that we may become very used to announcements of cutbacks and higher charges for public services in the months ahead.
A key implication of yesterday's EuroStat decision is that the looming adjustment facing the Irish public finances cannot be achieved through "creative" budget measures. Instead, substantial cutbacks in spending or increases in tax revenues may be required. The early recognition of this reality may be no bad thing. Expectations will have to alter considerably in a post-boom economy and any cosmetic measures that delayed this process could substantially increase the eventual scale of adjustment the Irish economy requires.
There may well be a school of thought that says Europe should not be allowed to make rulings such as yesterday's by EuroStat or that the decision itself is flawed. In regard to first point, it is vital that common and transparent forms of measurement should prevail across the euro area to allow meaningful comparison and analysis of each state's economic performance. It is also important that these standards are seen to be decided by objective bodies such as statistical agencies rather than national governments.
Yesterday's decision seems to be reasonable in terms of the spirit of the Maastricht Treaty. Underlying the decision is the notion that large once-off gains from the currency changeover are quite different in essence from the spending and revenue-raising decisions of governments that European budget measures are intended to capture. In practice, the changeover profits are a financial transaction that represents an alternative means of funding a given budget position.
At a time when concerns about corporate accounting are weighing heavily on financial markets and on the outlook for the global economy, yesterday's ruling by EuroStat has much to commend it. If that seems like cold comfort for Mr McCreevy, it should be recognised that the emerging message from these problems in other areas is that the Irish public finances are more likely to remain on a sound footing if policymakers concentrate on taking tough decisions rather than seeking cosmetic solutions.
Austin Hughes is chief economist at IIB Bank