Wednesday, January 24, 2018

Revisiting the budget and economic forecast

No one can accuse the current UNC administration of presenting a bold vision for the future. It came to office on a wave of disenchantment with the Manning regime for attempting to implement too big a vision. Instead, it offered wider pension benefits to the over 60s, increased social spending with a promise to cut big projects (read as the smelter project and the OPVs) and to ensure that there were no new taxes (the axe the tax campaign). In addition, it offered the promise of greater consultation and the politics of inclusion and indicated that it had both the intellectual capacity and a plan to revive the economy.

It kept its promise and cancelled the smelter and the OPVs, but immediately reneged on the promise of pensions for all over 60 as it quickly realised that this proposal was both imprudent and unsustainable. In its first budget, the administration bemoaned an empty treasury, identified the need for stabilisation as a platform for economic growth and the importance of managing the debt to GDP ratio. By the second budget, it had given up the pretence of running a balanced budget indicating that the economic fundamentals were good and posted a deficit of $6.5 billion in 2012. By which time the economy had registered four quarters of decline ending with a new low of -3.6 per cent in the second quarter of 2012.

Enter a new Minister of Finance, Larry Howai, who attempted to talk up the economy by reciting the strength of the economic fundamentals at the end of 2012. Except that the fundamentals were virtually identical to what was inherited in 2010. Whilst signalling the need for adjustment, the new minister then presented the largest expenditure budget ever and an increased deficit. He also noted the debt to GDP ratio has moved from 36 per cent of GDP to approximately 51 per cent of GDP and is still climbing, all in the wrong direction. But the fiscal deficit of 6 per cent of GDP in 2012 was not enough to reverse the declines experienced in the energy sector, hence the four consecutive quarters of decline.

Indeed, the 2013 budget was optimistically based on the assumption "that policy measures agreed within the Euro area would be adopted, as would be the implementation of a credible medium-term fiscal plan in the United States. These policy actions would constitute a significant step towards putting the European Union on firmer ground and restoring sound growth rates in the United States."

On November 23, the Eurozone budget talks broke down inconclusively as the richer countries have called for budget cuts. This instability threatens to prolong the current recession in the Eurozone into 2013 and beyond.

Further, the proposals to stabilise the banking sector are yet to be implemented. Similarly, whilst President Obama might have won the election, he has yet to win the budget debate and avoid the automatic spending cuts that now have to be negotiated. The outlook is anything but positive at this stage and at variance with the budget assumptions.

Meanwhile, the Monetary Policy Report for October 2012 released by the Central Bank documents the declines in economic output for the last two quarters of 2011 and the first two quarters of 2012 ending with an annualised decline of -3.6 per cent in the quarter ending June 2012. Yet it surprisingly defers to the minister and forecasts an overall GDP growth of one per cent for 2012.

In other words, the bank expects growth in the last two quarters of 2012 will be large enough to wipe out the declines of the first two quarters and end up with a positive result for 2012. To achieve this, the economy will have to grow on average by three per cent in the last two quarters to attain a positive one per cent growth rate for 2012. It is noteworthy that the Central Bank released these figures within four weeks of the budget speech. All things being equal, shouldn't this information have been available to the Minister when he was making his presentation to Parliament? Or was it?

Notwithstanding the positive announcements by the Prime Minister and the Minister of Energy, we are at least five years away from first gas or oil production in any of the new finds. Additionally, whilst these finds are encouraging, they amount to no more than the addition of one year's reserves at the current usage rate. This is not a windfall gain, though it does lead to increased confidence.

The reality may be difficult and painful to accept and it is this: that the current expenditure profile leaves the fiscal position in a structural deficit and cannot be sustained. Further, the current public sector wage settlements are in excess of GDP growth and in line with inflationary trends. This means that national productivity is declining and with it, our competitiveness.

The economy is fragile and the shock absorbers both in the public and private sectors are showing signs of wear and tear. Whilst the banking sector may have surplus liquidity, the saving rate is declining as households draw down their financial reserves. The omens are not propitious for a return to sustainable growth soon. Mr Howai will soon have to report the results of the reviews intimated in the budget speech. Expect expenditure cuts.

Mariano Browne is a

former minister of finance