Statement on the Economy

to Dáil Éireann

by Minister for Finance, Mr. Brian Lenihan T.D.

Thursday 29^th January 2009

Introduction

I welcome the debate that has taken place over the last two days. It is clear from the contributions by deputies from all sides that there is now recognition of the scale of the difficulties we face. That is very encouraging because the manner in which we respond to our current economic difficulties will have a crucial bearing on the length and severity of the downturn.

The agreement we have reached with the social partners on a framework for stabilising our public finances means we can now move forward on the basis of a shared analysis of the economic crisis we now face. I welcome in particular, the acceptance by the social partners of need for immediate expenditure savings of up to €2 billion this year as a credible response to our parlous fiscal position and their commitment to work with government over the next five years to bring the General Government deficit below 3%.

I know there is much tough talking yet to be done on the detail of how those savings can be achieved. The Government has had its discussions on the matter and we have identified very clearly the need to make reductions in our pay roll costs. We also share a determination that all sectors of our country should contribute in accordance with their ability to do so and conversely that the most vulnerable are insulated from the worst effects of this recession.

The importance and value of this consensus at a time when many other countries are experiencing industrial unrest and social unrest should not be underestimated. It sends out a powerful signal to international investors and to the markets that we are capable of managing our way out of the most serious economic downturn in 80 years.

But time is of the essence. The latest figures confirm that economic activity has gone into reverse, with GDP declining by an estimated 1.4 per cent last year, the first decline in a quarter of a century. This year, GDP is projected to contract by 4.0 per cent, which would be the sharpest decline in activity ever recorded. Looking towards next year and a further – albeit more modest – reduction in activity is forecast. In other words, three successive years of contracting activity are in prospect, something which has never happened before.

The level of employment has declined for the first time since the early 1990s. As a result we have seen a substantial increase in unemployment, with the number on the Live Register rising substantially. Of particular concern is the pace at which the Live Register is deteriorating. Rising unemployment is the most serious challenge we face.

The Government and the social partners and indeed, I am sure all of the Deputies opposite are committed to working together to maximise employment and to help those who lose their jobs. We are working to maximise opportunities for re-skilling and re-training. Many of the initiatives in this area were identified by the Taoiseach in his remarks yesterday.

We are facing an extremely difficult set of economic circumstances and it is clear that we are in for a difficult number of years. The reversal of our economic fortunes stems, in the first instance, from the correction in the new house building sector. This year, completions of new housing will amount to around 20,000 units, compared to around 90,000 units completed in 2006. Because of its importance to the economy, lower levels of activity in this sector are exerting a major drag on overall activity and the effects of the housing market correction have now spread to other sectors of the economy.

Internationally, an economic slowdown has been underway for some time, reflecting the impact of financial market turmoil which first surfaced following the collapse of the market for sub-prime mortgages in the US. The effect of this has been to restrict access to credit and to weigh on confidence in our main export markets.

However, the global financial crisis intensified dramatically last autumn, reinforcing the global economic downturn. As a result, the outlook for the global economy has deteriorated significantly in the space of just a few months, and international forecasting agencies are revising downwards their projections for world growth. The European Commission published revised forecasts last week showing that growth in the UK, the US and the euro area will decline significantly this year. In fact, this year will be the first year since the Second World War in which activity in the world’s advanced economies, as a group, will decline!

In other words, we are in a truly global recession, the scale of which has not been seen for a very long time.

From our perspective, the deterioration in the international economic environment will weigh on our export performance, which is the life-blood of a small open economy such as our own. Exchange rate developments, especially recent movements in the euro-sterling rate, are also unhelpful. Most exposed are small and medium-sized firms whose competitiveness position has been adversely affected by sterling weakness. Given our land border, movements in the sterling rate have elevated cross-border shopping to levels not seen for a long time, with adverse implications for our Exchequer position. Contrary to some of the suggestions in this House yesterday, changes in the VAT regime in both jurisdictions have had little, if any, impact on cross-border shopping decisions.

A number of speakers referred to a loss of confidence among the international investment community; I am acutely aware of this and the need to restore that confidence is a top priority

Let me put the deterioration in the public finances into context: tax revenues last year were nearly 14 per cent below 2007 levels with those tax-heads most closely aligned to the housing and international financial markets being worst affected. Lower levels of tax revenue mean that we are not collecting enough revenue to finance the level of public expenditure that we have seen in recent years. As a result we are now borrowing significantly to fund for day-to-day spending, as well as totally funding our capital expenditure through borrowing. In the absence of further policy action, a General Government Deficit in the range of 11 – 12 per cent of GDP is in prospect for each of the years to 2013.

That position is simply untenable. In the first instance, we must eliminate borrowing for day-to-day spending. The first step towards that goal is the €2 billion savings, the details of which will be announced next week. Next year, we need to make a further adjustment of €4 billion and a proportion of that will have to come from tax. The Commission on Taxation will report in the early Autumn and that report will inform our deliberations on next year’s budget.

We need to broaden our tax base. The most recent projected Revenue data covering approximately 2.4 million income earners on their records shows that

Ø                  38% are estimated to be entirely exempt from Income Tax.

Ø                  The top 20% of income earners pay 77% of all Income Tax.

Of these:

Ø                  The top 2.5% of income earners pay one third of all income tax

Ø                  The top 6.5% of income earners pay half of all income tax

Ø                  The top 12.5% of income earners pay almost two thirds of all income tax.

This data shows that the income tax system is highly progressive.

We have a strongly pro-enterprise system of taxation and, in Budget 2009, I re-affirmed the Government’s commitment to the 12.5 per cent rate of Corporation Tax and to maintaining and enhancing our pro-business tax policies. In addition, the recently passed Finance Act includes a number of very significant changes to the R&D tax credit scheme as well as a number of other pro-business tax measures. It is important that we maintain that element of our tax system so that we can continue to attract investment into this country and nurture our indigenous sector.

We have agreed with the social partners that whatever taxation measures are to be introduced will be informed by the principles of fairness with a higher proportion falling on higher incomes and that they will support the productive sector of our economy so that we can keep Ireland competitive. Again, this shared approach will boost confidence at home and abroad.

It is also important that we do not lose sight of the very significant fiscal stimulus that is being provided, through the measures taken in the October Budget to protect incomes at the lower levels as well as through the maintenance of an historically high level of public capital investment. Capital investment, in particular, provides a significant fiscal stimulus while at the same time boosting the productive capacity of the economy and thereby providing the basis for future gains in living standards. We are also continuing to invest heavily in education, skills and training.

Productive investment in infrastructure and in the skills of the population will held us to restructure the economy to target the next wave of economic growth. The Framework for Economic Renewal launched by the Taoiseach last December sets out our agenda over the next few years of how we will re-orientate and reprioritize the business of Government to achieve the goal of building a Smart Economy which will help underpin our economic future. The Government is working to re-position the economy to be able to achieve sustainable, export-led growth when the global economic climate improves.

On a more positive note, the recent interest rate reductions by the ECB – 2¼ percentage points since October – will provide some timely support to the economy. In addition, weak global demand has resulted in a sharp fall in commodity prices. Oil prices, for example, have recently fallen below $50 per barrel from their peaks of nearly $150 per barrel in July.

These and other developments have resulted in an easing of inflationary pressures. This is to be welcomed as it supports people’s real incomes. Most analysts expect inflation to turn negative in the first quarter of this year, and for the year as a whole, CPI inflation will decline by somewhere in the region of -1¾ per cent. In the short-term, declining prices are, for the most part, a positive development, although it would not be desirable to see the emergence of a situation in which declining prices began to feed into expectations of further price reductions.

Turning now to the issue of competitiveness and many of the contributions focused on the need for improvement in this regard. The Government is well aware of the importance of competitiveness for our economic well-being and our goal must be to maintain our position as an attractive destination for inward investment and to position the economy to be able to take advantage of the global recovery when this emerges. We must also be cognisant that national competitiveness is a shared responsibility, not only of Government but of all society and the social partners. Becoming more competitive will require each of us to play our part and work together to this end.

Notwithstanding the need to underpin the sustainability of the public finances, the Government has and will continue to take steps to support competitiveness.

In addition, the Government is continuing to prioritise productivity-enhancing investment under the National Development Plan. Capital investment spending is being maintained at 5 per cent of national income, very high by international standards. Investment in education, skills and training is also being maintained at high levels in line with the Government’s strategy of re-positioning our economy further along the value-added chain.

Banking Sector

A well functioning financial system is a key ingredient of our economy and the Government has provided decisive action in this regard.

The Guarantee scheme, which the Government put in place on 30 September 2008, continues for a period of 2 years. The scheme was put in place to remove any uncertainty on the part of counterparties and customers of the systemically important, credit institutions. The Government’s objective in taking this action was to maintain financial stability for the benefit of depositors and businesses and in the best interests of the Irish economy.

It is generally accepted that international capital market expectations in relation to capital levels in the banking sector have altered. Though Irish banks are capitalised above minimum European regulatory requirements, high loan provisions or write-offs, whether already acknowledged or expected in the next few years, mean that the markets now expect that banks should have a higher level of quality capital. This expectation was reinforced when the UK carried out their recapitalisation scheme, targeting this higher level. Other European countries have followed suit.

Significant falls in the share prices of Irish banks pointed to the capital market’s belief that the Irish banks were undercapitalised. The Government’s plan to recapitalise is intended to stabilise the Irish financial system and secure its funding base.

The recapitalisation of Allied Irish Bank and Bank of Ireland announced in December included a Credit Package under which the banks committed to, inter alia,

• provide at least an additional 10 per cent capacity for lending to small to medium enterprises in 2009;

• provide an additional 30 per cent capacity for lending to first time buyers in 2009;
• assist householders who are in arrears on their mortgages;
• introduce a €100m fund to support environment friendly investments with a view to reducing energy usage, facilitating switching to renewable energies with a view to reducing Ireland’s carbon footprint.

Discussions are ongoing with the two banks in relation to the recapitalisation. Discussions are also continuing in relation to the capital requirements of our other financial institutions.

Everybody in this House is aware of the nationalisation of Anglo Irish Bank and the reasons for this, and I don’t need to elaborate today. Suffice to say that the immediate impact of the Act which was signed into law last Wednesday is to provide certainty to all of Anglo’s depositors and other customers, across all of the bank’s operations in Ireland and internationally, that the bank is secure and stable and will continue to conduct its business on normal terms. The day-to-day running of Anglo will continue as normal and all Anglo employees remain employed by the company. All borrowers from the bank remain subject to the same terms and the new board of Anglo will place a particular focus on ensuring that all debts are fully pursued by the bank in a commercial way, as any other bank would.

The Government is committed to providing a platform for a well regulated, profitable banking industry of high repute in Ireland that operates in a national and international financial services environment. Our vision for the banking sector is that the banks will serve borrowers, small and medium sized enterprises and all stakeholders in an honest way and ensure that customers and consumers in particular are treated in a reputable and respectable way. The Bank Guarantee Scheme, recapitalisation and the credit package and the nationalisation of Anglo Irish Bank should address these objectives.

The nature and thrust of Ireland’s regulatory regime needs to adjust to the new realities. Lessons will be learned from mistakes made and from the international experience of the recent period of worldwide financial disruption. Work has begun on forging a new model to govern the conduct and behaviour of the financial sector both here and internationally.

Conclusion

We are in the midst of a very sharp global recession the likes of which has not been seen for a very long time. From an Irish perspective, the turmoil internationally has been exacerbated by a correction in the construction sector and we have seen unemployment rise rapidly as a result. All of this has put large strains on the public finances.

But it is also important to remember that notwithstanding current difficulties, our medium term economic prospects remain positive and our economy has the capacity to grow at a relatively healthy pace once the current difficulties are overcome. However, the achievement of this potential is contingent upon implementing the right decisions now to lay the foundations for recovery.

That is what we in Government are doing. With the social partners, we are working to put the public finances on a more sustainable footing and to improve our cost competitiveness so that we are suitably placed to take advantage of the global economic recovery when this emerges.

Thank you.