MacroScope

A tale of two budgets

By Mike Peacock
October 15, 2013

 

It’s deadline day for euro zone member states to submit their 2014 budget plans to the European Commission for inspection and we’re waiting on Italy and Ireland.

Having survived Silvio Berlusconi’s attempt to pull the government down, Prime Minister Enrico Letta’s coalition has to overcome differences on tax and spending policy.
The aim is to agree a 2014 budget that reduces labour taxes by some 5 billion euros but also undercuts the EU’s 3 percent of GDP deficit limit, so spending cuts will be required.

Rome has a chequered track record in that regard. The cabinet will meet at 1500 GMT to try and agree a comprehensive package. A Treasury source said the scale of tax cuts would be dictated by how much the various government ministries are prepared to forego.

The better news is that a modest return to growth is expected next year and borrowing costs remain low by the standards of 2011 and 2012.

Ireland is on course to exit its bailout programme by mid-December and may even eschew a financial backstop from the EU to help it make the transition. But that does not mean its problems are over. It needs growth to pick up markedly to bear down on debt while its banks are still beset with bad property loans. We already know Finance Minister Michael Noonan expects growth to accelerate to 1.8 percent in 2014 from 0.2 percent this year, which will help to bring the budget gap down to 4.8 percent of GDP.

Dublin has been tasked by its EU/IMF lenders with reducing its budget deficit to 5.1 percent of GDP next year and they have grudgingly cut it some slack by agreeing it can ease up on austerity a little, reducing a package of spending cuts and tax rises to 2.5 billion euros from the 3.1 billion which had been demanded. It’s hard to better the verdict of ratings agency Fitch: “Ireland will exit the Troika programme as a highly indebted country with modest medium-term growth potential. This implies that keeping debt on a declining path will require a large primary surplus for an extended period.”

Greece is in line with a 2014 plan that promises a return to growth after six years of recession and a hefty primary surplus which could unlock negotiations about some further form of debt relief, though its plan to rollover existing bonds has been given short shrift. France has said it will take an extra year, until 2015, to bring its budget deficit below the EU limit of 3 percent of GDP. Spain will aim to hit its fiscal targets without resorting to more tax rises, having raised taxes and slashed spending last year, and is also forecasting a return to growth.

Euro zone ministers discussed on Monday how to pay for a clean-up of broken banks with divisions again laid bare. With Ireland and Spain quitting bailouts designed to prevent a banking collapse, Paris, Madrid and Rome want the euro zone’s ESM rescue fund to act as a backstop for unstable banks in the euro area, in time for the European Central Bank’s stress tests some time in 2014. Germany wants conditions attached to any ESM involvement to prevent the costs being foisted on her.

Tellingly, with German coalition talks dragging on, German Finance Minister Wolfgang Schaeuble was absent.

 Talks between Angela Merkel’s CDU and the centre-left SPD ended on Monday with an agreement to hold a third round of exploratory talks on forming a grand coalition. Today she invites the Greens back in for a second round. The betting is that it will be the CDU and SPD who fall into bed together in the end, but with an entire policy slate to negotiate, it won’t be done for many weeks yet, leaving euro zone reform policies, particularly the formation of a banking union, adrift.

This is big stuff. If the ECB’s health check of banks reveal problems and bank shareholders, creditors and large depositors can’t fill the gap, national government help may be required and if that is insufficient, what then? An answer to that question is needed fairly urgently. A deal is supposed to be signed off by an EU leaders summit in December but if that slips, the harder deadline that the European Parliament must vote through any deal before it faces elections in the spring hoves into view.

All 28 EU finance ministers hold an Ecofin meeting today. Britain continues to insist it will not be subject to the regulatory arm of banking union.

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