Inflation threat to Irish EMU entry

Date: 09/01/1997

By Fiona nic Aodha

Ruairi Quinn has every reason to be pleased. For he, it seems, has developed a touch worthy of Mr Midas.

As chairman of an emergency meeting of EU finance ministers in Dublin in December, he won hearty applause for putting the seal on an elusive deal to prevent member states from overspending once they join Europe's single currency bloc.

Now Ireland's finance minister is coming in for yet more praise, after figures released last week showed the government's finances to be in their healthiest state for over 20 years, largely because of an exceptionally strong tax take.

Borrowing, the figures showed, ran to just 580 million ecu, or 1.2&percent; of gross domestic product well below the original government target of 970 million ecu and comfortably within the 3&percent; of GDP limit needed to qualify for monetary union.

What is more, on a day-to-day basis, the government ran a surplus last year, which means Quinn is well placed to deliver significant tax concessions in the budget which is due to be unveiled on 22 January.

It is an option which is bound to be tempting given that popular faith in Ireland's coalition government has reached new lows of late, following a series of scandals the latest involving a supermarket mogul, a minister and a large cash payment. A little bit of money might go a long way towards soothing public discontent ahead of next year's general election.

A reduction of 1-2&percent; in the standard 27&percent; income tax rate is widely anticipated. The government is also expected to broaden the standard rate tax band and to increase a number of allowances.

But, before adding fuel to an already hot economy, the government should think twice about the long-term implications of stoking up inflation.

This year, the EU will begin separating the wheat from the chaff to decide which of the 15 member states may join the single currency from the start date of 1 January 1999.

And while Ireland looks in good shape on most fronts, the central bank has warned that it may fail the inflation test if fiscal vigilance is not practised.

According to the bank's forecasts, Irish inflation measured by Union standards will rise to 2.5&percent; in 1997. That is below the expected 2.5 to 3&percent; mark needed to qualify, but the bank has warned that there is “little room for manoeuvre”.

The Irish currency has been hovering below the one-for-one level with the British pound for several months, fuelling concern among economists that inflation could take off this year as the price of raw materials imported from the UK rises.

The latest credit figures, which show consumer borrowing on the up, have provided little comfort on the inflation score.

Government spending, meanwhile, is running ahead of target, with expenditure set to climb by 4.7&percent; in real terms this year, twice the original limit laid down by the government.

“In themselves, tax cuts of 250-400 million ecu would not be so bad,” said Riada stockbrokers' economist Padhraic Garvey. “But added to a generous wage agreement, historically low interest rates, a booming economy and excessive government spending, they could prove the straw that breaks the camel's back.”

Davy stockbrokers' chief economist Jim O'Leary also chastised the government for its short sightedness, warning it could end up spending its way into penury.

“It will end up with a bloated public expenses total,” he said. “If they cannot control spending in times of rapid economic growth, what hope is there for recessionary times?” he said.

Right now, the government can afford to be extravagant, safe in the knowledge that huge tax revenues will ensure that Ireland meets the Maastricht borrowing requirements.

But it cannot expect the country to continue to grow at a rate of 7&percent; for ever and when the economy slows down, the government of the day will be forced to cut spending or increase taxes at a time when such moves are least wanted.