Professor John McHale:

It is a pleasure to be here. On behalf of the Irish Fiscal Advisory Council, I thank the committee for providing us with this opportunity to discuss our most recent assessment. The council views interactions with this committee as integral to its work and considers they have proven to be extremely valuable. Other members in attendance with me today are Mr. Sebastian Barnes, Professor Alan Barrett, Dr. Donal Donovan and Dr. Róisín O'Sullivan. The council secretariat is also present: Ms Rachel Joyce, Mr John Howlin and Mr Diarmaid Smyth, head of the secretariat and chief economist.

Today, I will cover our fifth assessment report, which was published on 22 November. The report is written in line with the mandate of the council set out in the Fiscal Responsibility Acts 2012 and 2013 and also with the memorandum of understanding between the council and the Department of Finance.

The main purpose of the report is to assess the macroeconomic and budgetary projections set out by the Government in budget 2014, including the appropriateness of the overall fiscal stance. It also considers compliance with the budgetary rule set out in the Fiscal Responsibility Act. Moreover, the report sets out the process involved in the council's endorsement of the macroeconomic forecasts underpinning budget 2014. This is a new function with which the council has been tasked since our last appearance before the committee. Given its importance to the reformed budgetary process, I am keen to take this opportunity to expand on it a little. Arising from new EU requirements, the council was asked to independently scrutinise and endorse, if appropriate, the macroeconomic projections underpinning budgets and stability programme updates. This is a significant change in Ireland's budgetary architecture and should help to improve the accuracy and transparency of official forecasts. The council has developed forecasting methods and analytical capacity to support this function.

The council's endorsement is based on whether the forecasts are within an endorsable appropriate range, taking into account the methodology and the plausibility of the judgments involved. The range reflects the high degree of uncertainty surrounding economic forecasting and is informed by the council's work on gauging the historical level of macroeconomic uncertainty. As part of the endorsement exercise, the council expressed a significant reservation about one element of the macroeconomic forecasts prepared for budget 2014. The reservation related to the implied quarterly profile for consumption spending. However, following clarifications by the Department of Finance of the assumptions relating to data revisions, the council's assessment was that the forecasts were within its endorsable range.

It is important to make a distinction between the macroeconomic forecasts endorsed by the council on which budget 2014 is based and the post-budget macroeconomic forecasts. The latter take into account the impact on the economy of subsequent decisions taken as part of the budget process, including any changes to the planned aggregate consolidation, and are not endorsed by the council. The mandated role of the council in this instance is to provide an independent assessment of these final forecasts in the subsequent fiscal assessment report.

On a post-budget basis, the Department of Finance is projecting real GDP growth of 0.2% in 2013, rising to 2% in 2014. Growth this year is being depressed by several factors, including a background of ongoing balance sheet repair, budgetary consolidation and weak demand in Ireland's main trading partners. The pharmaceutical patent cliff is reducing the growth of net exports as well. While there is evidence of improving growth momentum in the second half of this year, which should carry over to next year, uncertainties relating to these elements mean that the risks to the forecasts are tilted to the downside for 2014.

Good progress continues to be made on the fiscal position and in bringing sustainability to the public finances and restoring the borrowing capacity of the State. In budget 2014 the general Government debt-to-GDP ratio is projected to peak at 124.1% this year before declining by approximately ten percentage points over the period to 2016. The general Government deficit is forecast to be below the excessive deficit procedure, EDP, ceilings for 2013 and 2014 and at the deficit ceiling for 2015. These budgetary projections are assessed to be appropriate but are contingent on the delivery of significant expenditure savings and achieving the projected acceleration in economic growth. Additional risks stem from contingent liabilities associated mainly with the banking sector. The decision to reduce the planned fiscal adjustment in budget 2014 has eliminated the previously existing margin of safety relative to the key Stability and Growth Pact deficit ceiling for 2015 of below 3% of GDP. An analysis based on historical growth forecast errors suggests that the probability of breaching the 3% ceiling has risen from an estimated one in three in our previous report to an estimated one in two, assuming there are no changes to planned adjustments for budget 2015.

The setting of fiscal policy during the crisis has required a difficult balancing of the need to support domestic demand and employment, the need to restore the State's creditworthiness and the need to put the public finances on a sustainable path. While the Government faces a trade-off between demand support and creditworthiness in the short to medium term, reducing the perceived risk of default and unstable debt dynamics is critical to laying a stable foundation for longer-term growth and employment. The fiscal adjustment programme undertaken to date is working in terms of stabilising the public finances and restoring the creditworthiness of the State. Market perceptions of sovereign default risk have fallen sharply. Simulations indicate that in the absence of fiscal adjustment from 2008 to 2013, this year's deficit would have been close to 20% of GDP, with the debt ratio close to 106% of GDP and rising.

The Government's planned fiscal stance for 2014 and 2015 is assessed to be conducive to prudent economic and budgetary management. However, the council remains of the view that the most appropriate policy for budget 2014 was to continue with the previously planned adjustment of €3.1 billion rather than the reduced amount of €2.5 billion. This higher adjustment would have created a greater margin of safety in meeting the EDP deficit targets in a highly uncertain growth environment and would have reinforced credibility gains from successfully delivering on previously announced adjustment plans.

There should be no reduction in the Government's previously announced adjustments of €2 billion for 2015. Additional adjustments may be required to ensure the target is achieved if growth projections are reduced or other contingencies raise the projected deficit for 2015. Any future upward revision in growth projections should be used to reinforce credibility by providing a margin of safety to ensure the EDP deficit target of 2.9% is complied with in 2015.

Projections extended to the end of the decade indicate that the most difficult phase of the adjustment, which has involved large nominal expenditure and revenue changes, should be broadly complete by 2015 or 2016. Modest increases in nominal expenditure should be feasible post-2016 while meeting all domestic and European fiscal rules. However, the extent of the tightness of the fiscal stance should not be underestimated, as the scope for real expenditure increases will be limited. Significant risks also surround this scenario given the length of the projection horizon.

Given the fragile international financial environment, the council would have supported an application for a precautionary credit line. Provided it had come with reasonable terms and conditions, such a facility would have provided valuable additional protection against any renewed funding pressures as Ireland moved to exit the EU-IMF programme.

I thank the committee for providing us with the opportunity to attend today. We look forward to taking the committee's questions and hearing the views of members.