Oireachtas Joint and Select Committees
Tuesday, 6 September 2016
Committee on Budgetary Oversight
Analysis of Economic Forecasts: Central Bank of Ireland
We are joined at today's public hearings by Dr. Gabriel Fagan, who is the chief economist of the Central Bank of Ireland. He is accompanied by Mr. John Flynn and Mr. Terry Quinn of the Central Bank's economic analysis division. They are very welcome. Dr. Fagan will deal with the macroeconomic outlook for Ireland, including potential risks to growth, which is an issue that we have been discussing.
Before we begin, I ask members and witnesses to turn off their mobile telephones because they interfere with the sound quality of the recording of proceedings of the committee. I want to advise the witnesses that they are protected by absolute privilege in respect of the evidence they are to give to this committee. If they are directed by the Chair to cease giving evidence on a particular matter and they continue to do so, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given. They are asked to respect the parliamentary practice that, where possible, they should not criticise or make charges against a Member of either House, a person outside the House or an officials by name or in such a way as to make him or her identifiable. I ask Dr. Fagan to make his opening statement. I apologise for the brief delay earlier.
Dr. Gabriel Fagan:
I will give a brief summary of the outlook for the economy as the bank sees it. While a wide range of available indicators confirm that the economy is performing well, two factors have made it more difficult to get a clear picture of the performance of, and the outlook for, the economy. I refer first, to the recent large revisions to the Irish national accounts, particularly the very large upward revision to the values of GDP and GNP in 2015, and second, to the outcome of the Brexit referendum in the UK, which has introduced significant risk and uncertainty to the outlook for the economy.
Although recent GDP and GNP measures significantly overstated the growth of domestic economic activity in Ireland in 2015, this should not overshadow the tangible improvement that has taken place. A wide range of more reliable domestic spending and activity indicators suggest that the domestic economy is continuing to expand at a reasonably healthy pace. In particular, consumer spending has continued to grow at a relatively strong pace, supported by solid gains in employment and increasing earnings. Investment, net of intangibles and aircraft, has also been contributing to strong domestic demand, with both core machinery and equipment and construction investment recording double-digit annual growth rates.
A better reflection of what is happening in the domestic economy is provided by the underlying domestic demand indicator that was developed recently by economists in the bank. This is defined as the sum of personal expenditure on goods and services, net government expenditure on goods and services and investment excluding aircraft and intangible assets. This measure grew at a strong pace, close to 5%, in 2015. The strength of the domestic economy was also reflected in an increase of 2.5% in employment. These underlying developments present a more accurate picture of the underlying growth dynamic of the domestic economy.
However, estimates and indicators such as these are merely rough approximations. In view of the distortions now associated with the conventional GDP and GNP aggregates, there is a need to develop more meaningful commonly agreed measures of the level of Irish economic activity that accurately mirror developments in the economy. In this context, the bank welcomes the CSO's initiative in establishing a consultative group that will consider, among other things, the potential for the development of new indicators that will enhance our understanding of the Irish economy. This group will be chaired by the Governor of the Central Bank.
Looking ahead, any assessment of the outlook for the economy is further complicated by the outcome of the Brexit referendum in the UK. The economic impact of Brexit on Ireland is difficult to estimate with precision. It is clear, however, that the impact on the Irish economy will be negative and material in the short and longer terms.
The long-term economic impact of Brexit on Ireland will be influenced by the nature of the withdrawal agreement between the European Union and the United Kingdom. The nature and scale of the eventual macroeconomic impact will reflect the extent to which the exit arrangements bring about changes in free movement of goods, services, capital and labour. Trade, foreign direct investment and the labour market are the key channels for the macroeconomic effects of Brexit. Any agreement which keeps UK access to the Single Market largely intact would have a more limited impact but the scale of the impact could be much more significant under more restrictive agreements.
In the short term, adverse effects on the Irish economy, as well as the UK and broader European economies, arise mainly from the macroeconomic, financial and currency market effects of Brexit-related uncertainty. An important element of this uncertainty revolves around the nature of the long-term relationship between the UK and EU, how long it will take to work out that relationship and how it will impact in the interim. This heightened uncertainty is likely to dampen consumer demand and, in particular, investment decisions by firms. While the economy has become less reliant on the United Kingdom for trade over recent decades, the UK remains a particularly important market for many indigenous firms. Some sectors, particularly agrifood, clothing and footwear, and tourism, continue to have a high dependency on the UK and, consequently, could be affected disproportionately.
The Central Bank’s latest forecast was published in our quarterly bulletin on 27 July and covers the years 2016 and 2017. As well as taking into account information from the latest economic indicators, the forecasts are based on a set of technical assumptions regarding variables such as exchange rates and foreign demand. Importantly, the forecasts incorporate an estimated negative effect of Brexit on the economy, amounting to -0.2 percentage points in 2016 and -0.6 percentage points in 2017. Overall, we forecast GDP growth rates of just under 5% in 2016 and 3.6% in 2017. We see continuing employment growth, with total numbers employed expected to rise by around 70,000 over the two years. Unemployment is expected to decline towards 7%. Supported by continued solid gains in employment, underlying domestic demand is projected to grow by 4% this year and to slow to 3% in 2017. This slowdown reflects a projected negative impact from Brexit-related factors, some normalisation of the catch-up growth seen in earlier years and a fading of the positive effects of lower oil prices on household real incomes.
Notwithstanding this slowdown in domestic demand, the outlook for the economy remains broadly favourable, with unemployment set to continue to fall further. While the forecasts I have presented are deemed to be the most likely outcome given the available information, they are subject to risks. At the current juncture, the risks are clearly weighted to the downside. This reflects the possibility of a more adverse Brexit impact on the UK economy, a larger spillover to the broader international economy or the potential for more negative domestic confidence and labour market effects than we have incorporated into the forecasts.
Dr. Fagan places great store in consumer spending as a measure of real growth in the economy. What is his reaction to figures showing VAT returns running under profile for two months in a row? In July, VAT returns were €292 million under profile and they were a further €285 million under profile in August. Income tax returns for July were also running €99 million under profile, although they were higher than in July 2015. Is a domestic slowdown taking place sooner than the Central Bank of Ireland expected?
With regard to the figure provided on underlying domestic demand, is an international comparison available showing where Ireland stands in respect of other countries or is this a Central Bank figure?
On the issue of credibility, as we try to identify the strength of the economy, what are the Central Bank's views on recent figures, which emerged from nowhere, showing a growth rate of 25% last year? The Central Bank tries to forecast underlying domestic demand. Is work being done on producing a credible mechanism for measuring real growth or decline in the economy?
Dr. Gabriel Fagan:
I will take the second and third questions and will leave the first question for my colleague. With regard to the underlying domestic demand, that is a measure that has been developed within the bank specifically to take into account the distortions we have seen, not just in 2015 but even in previous years with regard to GDP. It is not a widely used international measure. However, from the available data, we could construct such a measure but I am pretty sure that when we do that, the comparison of Irish growth with the growth elsewhere in the euro area will clearly show much stronger growth performance using this indicator than in the rest of the euro area. With regard to credibility, we are at an early stage. The group has just been set up by the CSO, chaired by the Governor and that group is going to try to tackle precisely the issues identified by the committee such as how one can come up with credible measures of what is going on in the Irish economy. We will await the outcome of that group but in the meantime available indicators, whether in underlying domestic demand, employment growth and so forth, confirm the story we have presented in the bulletin.
Mr. Terry Quinn:
I will address the issue of VAT and income taxes being somewhat behind profile. The slightly weaker VAT receipts are a little bit surprising given the strength in retail sales, car sales, etc. Similarly the income tax receipts from the labour markets are performing quite well and there is quite strong growth in employment. The VAT receipts are a little bit surprising but I would not be overly concerned. The profile that is published around the time of the budget is a guide and an estimate. One can get timing issues that can sometimes mean that revenue grows a little bit faster than expected at some points in the year and slower than expected at other points. I think it is too early in that one needs to look at the underlying indicators which are still quite positive. It may not be the case that VAT is behind target at the end of the year. The VAT target for this year is just under €13 billion so the slippage in that context is not huge. I would not be too worried about it. Overall actual tax receipts are growing strongly. They are ahead of profile overall, albeit mainly accounted for by corporation tax.
Given the recent figures from the census, there is clearly very significant growth in the numbers of young people and older people, which puts a lot of strain on the big spending Departments. I am concerned about capital investment infrastructure and I would like the witnesses to set out their thoughts on that. Clearly, we require a lot of investment in schools, third level, training and skilling people and productivity to grow the economy in the future. We also have enormous difficulties and huge unmet demands with regard to housing. I was a little bit taken aback by the letter, published last evening, from the Governor of the Central Bank to the Minister for Finance. While I understand the tone of prudence in the letter, I was very surprised to see the Governor suggesting that because of risk factors, we would lower the requirement in relation to reducing debt levels below the EU standard of 60%. The Governor did not pick a figure but if this was adopted as an immediate policy in this budget, quite a lot of people would describe it as putting a noose around our neck at a time when we have significant population and demographic pressures and when we have real needs that can only be met partly by a sustained cycle of capital investment. I do not know if the witnesses can comment on this but one of the hangovers from the collapse has been that capital investment in Ireland has not as yet recovered.
We are able to borrow money at the moment at historically extraordinarily cheap rates. We have demographic pressures. While I know the letter was the Governor’s, I would like Mr. Flynn, if he could, to comment on why he is looking for what would appear to be a significant reduction from the 60% target to an even lower target in respect of debt. In the context of risk factors and so on, I would like him to comment on the European Commission’s ruling in respect of Apple and how that might affect Ireland and the kind of risk factors he mentioned and the markets' perception of Ireland.
Mr. John Flynn:
In terms of the demographic pressures and the pressures on funds for public investment, the Stability and Growth Pact rules are there and do not specifically make any exemptions for public investment. Those rules are designed to ensure the long-term sustainability of the public finances and as such sustain a country's ability to invest in public services. They do not dictate the level of public expenditure. That is a matter of choice for the countries. For example, the expenditure benchmark rule states that, in the absence of discretionary changes in taxation, spending should increase in line with the country’s trend potential to grow. In other words, spending plans should be consistent with available resources but the country makes its own choice.
Dr. Gabriel Fagan:
Perhaps I could add a few words to the suggestions made by the Governor in his letter and give the committee some background. First, the 60% is not a target, it is a ceiling. If the country has a lower debt, it is still meeting that ceiling. The main motivation in the Governor’s mind was that judging from the experience of the economy in the past ten to 20 years, this is a very volatile economy and, therefore, there is a need to have in place sufficient buffers so that when an adverse shock hits the economy, we are in a position to respond to that with fiscal policy. In the past when adverse shocks hit the economy, we had to have fiscal contraction, tightening of fiscal policy, which exacerbated the cyclical situation, worsened unemployment and so forth. That is the underlying motivation for the idea of a long-term debt target, to put in a buffer so that when adverse events happen to the economy, we can respond with fiscal policy without violating the rules.
The second point is that this is not a short-term suggestion. We already have our fiscal rules and budgetary plans. This is more a case of asking what we can do over the long term. Once we have reached a budget, which is more or less balanced in structural terms, the 60% target, where do we go? It comes in there. It does not say next year take fiscal measures to hit a debt target. Third, it should be noted that under reasonable assumptions on growth, which are very reasonable, simply maintaining a balanced budget will lead to significant falls in the debt ratio over time, so it will not necessarily require any additional fiscal consolidation.
The point of my question is the impact on low levels of capital investment arising out of the crisis which almost everybody is anxious to see increased in the context of demographic pressures. The Governor writes in his letter that while the European fiscal framework prescribes a target ceiling for the stock of public debt - and he uses the figure - at 60% of GDP, there are compelling reasons to develop a national target for the stock of public debt. I am taking the figure from him. He continues that the indications are that is to be significantly lower. In the context of our present situation, I would like a clearer explanation.
I would like a clearer explanation. I understand the question of risk and so on, and we are all anxious to allow for that. However, we have compelling demographic pressures, for example, the whole area of education and population trends, younger and older. Moreover, there is extraordinary pent-up demand for housing of all kinds. We do not yet have a properly functioning credit market. My question really is about how we get the kind of public investment that we require to sustain growth. I acknowledge there is plenty of room there.
The Central Bank representatives also mentioned the Stability and Growth Pact. In the context of the pact and the 25% growth figure, what is their calculation now of the fiscal space? I would be interested to know whether the Central Bank has recalculated that figure.
Dr. Gabriel Fagan:
I fully acknowledge Deputy Burton's arguments regarding the need for building up capital stock in a number of areas of public infrastructure, especially in housing. However, the rules, as they are laid out, do not impose restrictions on the composition of expenditure. To some extent we can address those issues by re-balancing expenditure, for example, from current to capital expenditure. Other alternatives include revenue raising measures. The rules do not tell us that we cannot spend on capital expenditure. They hold that we must adhere to the broad benchmark. That leaves many choices which are political in nature. The Central Bank cannot say that the Government should reduce this type of expenditure and increase another type of expenditure. That is not the mandate of the Central Bank. However, we should note that within the rules there is scope for the restructuring and re-balancing of expenditures and, if necessary, revenue raising measures to fund additional expenditures, if that is deemed desirable.
Mr. Quinn will address the question on the fiscal space.
Mr. Terry Quinn:
The expenditure benchmark rule is central to estimating the fiscal space. It is grounded on the estimate of potential growth in the economy. Estimating that figure is the responsibility of the Department of Finance. It is determined under an agreed harmonised methodology.
Deputy Burton is right. It should be acknowledged that the harmonised methodology used to estimate potential output faces significant challenges in the light of the revisions to the national accounts. The way we deal with those distortions arising from the national accounts revisions is essentially a matter for the Department of Finance, presumably in consultation with the European Union and the Irish Fiscal Advisory Council.
It is clear that the actual level of activity in the economy and the potential growth rate on which the expenditure benchmark rule and the estimate of the fiscal space are grounded is far lower than 26.3%. It would be folly to plan on the basis of a growth rate of 26.3% or anything like it. I am sure the Department is trying to take that into account to arrive at a reasonable estimate of potential growth and, on that basis, the fiscal space will be estimated. However, that is not for us to do.
I want to ask about Apple and the associated impact, if any. Obviously in the short term it will not have an impact but there may be intangible issues around perceptions of Ireland and so on. Does the Central Bank have a view?
Mr. Terry Quinn:
The Apple decision reflects what is essentially the legacy of previous taxation law, and that actually has changed. In a sense that happened some years ago. To some extent, the increase in corporation tax receipts in the past two years reflects that and so it is already in the base. There is not really any sense that the change has had an impact on foreign direct investment and the attractiveness of Ireland for FDI in recent years. We are still attractive. The reasons we attract significant amounts of FDI are still in place. Perhaps, though, the uncertainty arising from the ruling is relevant.
It will be appealed so it will not be clear how it will pan out for several years, and that is unhelpful. The fact that it is reflecting the impact and legacy of previous legislation which has in turn been changed suggests that it is unlikely to have significant impact in the long term.
Cuirim fáilte roimh na finnéithe go dtí an coiste. An chéad cheist relates to a submission we have received from the ESRI. I will quote it first and then ask for the bank's view. It states:
[I]t is difficult not to mention proposed cuts in the Universal Social Charge in the context of discussing the need to maintain the breadth and stability of the tax base. The USC has many desirable features as a source of revenue – progressivity, transparency and stability to mention three. For this reason, we are unconvinced that moves to abolish the USC are wise.
It goes on to state: "[The] point has come into sharper focus because of the potential vulnerabilities associated with Brexit and the Apple tax decision." What is the bank's view on the position of Government in terms of abolishing or substantially cutting the USC from the tax base?
Dr. Gabriel Fagan:
Basically, as a matter of mandate and as a matter of our responsibilities, the bank does not make views known or take views on details of fiscal policy. We certainly have views regarding the overall stance of fiscal policy and the path of deficits and debt but we do not get involved in detailed discussions regarding tax policy or compositions of expenditure. That is not the function of a central bank. Those are political decisions to be made by legislators and not the Central Bank. Essentially, we would not have a particular view that we articulate on this matter. It really is outside the domain of our responsibility.
Without going into the specifics, would the Central Bank have a view on the stability of the State if a Government were to start eroding the tax base and creating vulnerabilities? Would the Central Bank remain mute on that issue?
Dr. Gabriel Fagan:
The Governor has already made points in this regard and we have already expressed the need to maintain a solid tax base as well as the need to ensure that temporary revenues are not used as a basis for creating permanent expenditure. That is in the broad sense. However, we would not get involved in very specific aspects of taxation or expenditure policies.
Dr. Fagan may have the same answer to my next question. The ESRI also states in its submission to this committee that it produced a report last year on the mortgage insurance scheme. That report states:
Through our analysis of the effect of tax breaks, we would argue that any tax breaks aimed at developers will have little effect on supply if the first three factors [that is, lack of finance, the planning system and lack of infrastructure] are the dominant factors in constraining house and apartment building. The uncertainty around whether these factors are operating or not creates a risk that any tax breaks would simply lead to a transfer of tax revenue from the state to developers without any significant effect on supply.
That is the ESRI's view. We know that the Government will announce in the budget a help-to-buy scheme - whatever that may mean - and that it will be backdated. What is the Central Bank's view on such a scheme?
Dr. Gabriel Fagan:
Again, this faces the issue of the responsibilities of the Central Bank, which are not regarded as including the setting of individual tax rates, policies or incentives. As I have stated, we do not want to comment on the details of policy, but in general I think we all agree that the fundamental problem with the housing market in Ireland is a problem of supply. There is inadequate supply. The Governor has mentioned in his letter that any measures taken by the Government to address housing problems should try to avoid exacerbating the distortions that are seen in the market. My essential point, without commenting specifically on the detailed proposals of the ESRI, is that the best way forward is to focus on the supply side in the housing market rather than stimulating demand for housing.
I know Dr. Fagan is the chief economist in the Central Bank, and obviously we are talking about a different era, but I get a wee sense of déjà vu. I sat on the banking inquiry with a number of members of this committee and we had Central Bankers and staff coming in saying they had issued letters saying the tax breaks should be broad despite the fact that the Government had reduced the tax base substantially and relied on property-related transactions. With regard to the schemes that were introduced affecting the property sector, they were able to point to letters that said the Government needed to be careful about distortions.
Has the Central Bank learned its lesson and will it speak up if it believes a certain policy that is to be introduced by Government would have a material distorting effect on the property sector or will it continue with the policy it has had over the past decade, which has been to remain mute on these issues and issue broad cautious statements that could be interpreted differently depending on which way one came down on the issue?
Dr. Gabriel Fagan:
We have a process whereby each year the Governor writes a letter to the Minister setting out his concerns. If the Governor were to come to a view that certain policies were damaging to the economy, I am sure he would be more than willing to make that known. We have the Governor's letter. He has outlined his immediate issues and concerns and that is as far as we go at this stage.
Dr. Fagan talked about the new process the Central Bank has developed in terms of measuring the economy and the need to have a credible measure. I assume Dr. Fagan believes the current way we measure GDP is not credible. Can he also tell us for how long he believes that method has not measured our economy in a credible manner?
Dr. Gabriel Fagan:
It is very important to clarify at the start that when the CSO compiles these estimates of GDP, it is doing so in compliance with international rules. It basically does not have a choice. We are not saying the CSO is doing something wrong. The rules are such that the CSO numbers are, in the sense of the rules, correct. The issue is that Ireland is a small open economy with a very large multinational sector where big transactions can have major effects on the economy, so it is very difficult to analyse the economy. If one looks back, even before the last revision from the CSO we were having problems with a whole range of things, including contract manufacturing and redomiciled firms. Back in the 1980s I was working in the bank as an economist and we were also encountering difficulties with transactions relating to multinationals. It is a longstanding problem. It became very acute with the release we saw relating to 2015, but this problem results from the fact that the rules that are written for the standard economy, like the US, may give rise to indicators that may be less useful, if not sometimes unhelpful, for understanding what is going on in an economy like Ireland. That is why we think this group that is set up by the CSO and chaired by the Governor will have an opportunity to make significant progress in coming up with indicators that will be much more helpful in this regard.
Whatever measure it comes up with will not be internationally accepted. We will basically have our own home-baked way of measuring the economy, yet in relation to the application of the fiscal rules, our comparisons in terms of OECD data are with our European colleagues. We will be using measures that everybody in this room believes are not credible and will, therefore, give us a very distorted picture in respect of how we comply with the rules into the future. Is that not the core of the problem?
Dr. Gabriel Fagan:
If everything goes well with this group, we will have a good set of domestic measures, which will give us a much more accurate reflection of what is going on in the domestic economy than looking at headline GDP. Of course that may not automatically be used by other foreign agencies, but there is nothing to stop the Irish authorities from trying to put forward, over time, the idea that supplementary indicators could be used, consistent with this. The first step is to get ourselves a set of indicators that give us a good idea of what is going on in the economy. Then maybe we can think of trying to persuade other countries to look at those, to compile their own, and perhaps to supplement the existing indicators at an international level.
May I ask a final question? Every month the Central Bank issues on its website the number of qualified investor alternative investment funds that have been registered with the Central Bank. Over the past few months we have been drilling down into the accounts of some of those funds. Dr. Fagan will be aware that if they are foreign-owned, they are completely tax-exempt in Ireland.
However, they own a huge amount of property in the capital city in particular, as well as right across the State. Given the huge number of qualified alternate investment funds that are being registered and the fact that, between them and section 110 companies, they have bought up a third of all commercial properties in the capital in the past three years, does the witness believe that this is distorting the property market and that action needs to be taken?
Dr. Gabriel Fagan:
I do not think I am in a position to comment on that. It is a somewhat different area of the Central Bank. What I will say is that we have made quite significant progress in measuring the activities of these firms in the past year or so. We have carried out a major data collection exercise on special purpose vehicles, covering an area of the balance sheets of these entities of perhaps €300 billion. Therefore, we are starting to try to get to grips with the measurement and with what exactly is going on in this sector. However, it is early days in terms of establishing the latter. We are working on trying to build up a very good statistical measurement of what is going on. In terms of the policy, that is an area that is outside of my narrow remit of economics.
I welcome Dr. Fagan and his team. I have a number of questions for Dr. Fagan that require short answers in order to establish - before I get to my substantive question - whether we are on the same page. In his opening statement, Dr. Fagan referred to the recent GDP figures and he said that they included very large upward revisions to the value of GDP. Would it be fair to say that the word "distortion" could be used instead of the term "revisions"? Would "distortion" be an accurate word to use?
Dr. Gabriel Fagan:
No. What I am saying is that the CSO has revised its figures in line with international standards. The problem is that, in line with those standards, these headline numbers give a misleading picture of what is happening in the economy. It needs to be supplemented by other indicators. This is what the group that is working with the CSO-----
However, Dr. Fagan went on to say that a wide range of available indicators, from the labour market to consumer spending and investment - excluding aircraft and intangible assets - confirm that the economy is performing well. He is saying that the CSO should exclude aircraft and intangible assets. If that is the case, does he accept that the inclusion of aircraft and intangible assets had a distorting effect on the tangible growth that the he wants to see as the real figure?
Dr. Gabriel Fagan:
Just to clarify, we are not suggesting that at all. What we are saying is that we have GDP numbers produced by the CSO which are compiled in accordance with international standards. Those numbers, in that sense, are correct. The CSO has followed the international rules and has come up with the numbers it has come up with. The point we are making is that if one wants to understand what is going on the domestic economy, looking at those numbers will give one a misleading picture. In the context of terminology, it is better to recognise that the CSO is following the rules. It is following the international practice. It does not have any choice in that regard. It has now taken this initiative to produce other indicators. In the past, we also tried to produce indicators we thought would provide a more accurate reflection of what is going on in the domestic economy.
In response to Teachta Pearse Doherty, the witness said that we need to get a new set of indicators. Would that new set of indicators have any grounding with EUROSTAT, for example? Has the Central Bank had any engagement with EUROSTAT? Would the latter value those figures in the same way as it would the figures that were published, which were either distorted, or, in the words used by Dr. Fagan, revised?
Dr. Gabriel Fagan:
As far as my understanding goes, we are working with the CSO and the other participants in the group to produce a set of indicators which are relevant to and useful for the analysis of the Irish economy.
There is, potentially, a later stage when we would establish any such indicators. We would decide that they were useful and could even be applied to other countries. The CSO and others would be able to get engaged and to consult EUROSTAT to see whether the latter wanted to take some of them on board. At this stage, however, we are just developing the indicators and we first need to establish that they are doing the job we want them to do.
My final question is similar to one of Deputy Burton's questions earlier. It concerns the letter from the Governor of the Central Bank to the Minister for Finance of 4 August, saying:
[While] the European fiscal framework prescribes a target ceiling for the stock of public debt (at sixty per cent of GDP), there are compelling reasons to develop a national target for the stock of public debt. First, the target stock of public debt naturally varies across countries in line with different risk exposures: the volatile nature of the Irish macro-financial system and the history of crises suggests a debt target that should be materially below the appropriate level for a larger, more stable economy.
Dr. Fagan gave his answers to this point earlier on. We know the debt-GDP ratio but if he is suggesting a lower percentage of GDP, on what GDP figures would it be based? Would the GDP figures include aircraft leasing and intangible assets or would they exclude them? I want to be fair to the Governor but I read from the letter that he is saying we should lower borrowing in excess of the rules. At a time when there is a dearth of capital investment across the board, that is a worry. Can Dr. Fagan explain the logic of the Governor's statement that it should be materially lower than the appropriate level for a larger, more stable country?
Dr. Gabriel Fagan:
In the first question on the debt-GDP ratio, the Deputy makes a very interesting point. If GDP does not give an accurate reflection of production in the economy, debt-GDP may be a misleading indicator. The Irish Fiscal Advisory Council has addressed this issue and come up with alternative denominators. Instead of looking at debt to GDP they look at another indicator which is linked to the revenue-generating capacity of the economy. I am sure the group chaired by the Governor can make further progress in the area of alternative indicators.
In his letter on the medium-term debt target, the Governor is talking about the longer term. He is not talking about the next few years but about what happens to the economy after we achieve a balanced budget and the 60% target. He is not saying there has to be fiscal contraction but that we need to bear in mind the fact that the economy is subject to severe volatility in comparison with other countries. What is right for Germany may not be right for Ireland and that should be borne in mind. To achieve a lower debt ratio than 60% in the circumstances that are likely to prevail would not require major cutbacks or fiscal consolidation. Maintaining a balanced budget for a period of time would allow for a fall in the debt-GDP ratio towards the medium-term target.
I understand that Dr. Fagan is limited in what he can say about the Apple ruling. The report is couched in fairly moderate language but if one adds what he has said to what is said in the European ruling it is a fair summation to say that the activities of tax-dodging multinationals are making our economy very vulnerable.
They even mean we do not really know what is happening with the economy because according to the European Union, they are tax dodgers. That is what I think they are and these tax dodgers have now put us in a position in which we do not really know what is going on in the economy and they are making us vulnerable to any shifts or changes that could result from their activities or decisions to move profits or investment elsewhere. Is that not a fair summary? Is it not an obvious follow-on from the EU ruling, which should be of interest to the Central Bank and to everybody, that there must be other companies which are doing the same thing? The whole point of the ruling was it certainly was not something that would have been available to the majority of companies but we all know there must have been other companies that were doing this.
Depending on which way one looks at it, it may hit us as another shock if it was not just Apple. Should we not also be looking into the possibility that it is not €13 billion but is a hell of a lot more? Can the witnesses also confirm that if the activities of these tax-dodging multinationals have artificially inflated the GDP and growth figures, this also means it is not simply in the year of the 26% jump in growth that Ireland will be obliged to pay a much bigger contribution to the European Union but that we have been overpaying to the European Union all along? I seek the witnesses' views on this because it seems to be a logical follow-on from what they said, namely, we have been forking out money to the European Union disproportionately for quite some time because of the distortion created by multinationals essentially tax dodging in this country.
Mr. Terry Quinn:
We are not actually saying that because in a sense GDP is probably overstating the growth in the economy last year that we do not actually know what is happening in the Irish economy. We talked earlier about alternative indicators and the indicator of domestic demand to which we refer suggests an economy growing last year by 5% or 6% a year. While that is not 26%, it is more reflective of what is happening in the economy. It is not that we are saying we do not know what is happening; we are saying that GDP is not necessarily a good indicator of the underlying position.
The mandate of the Central Bank is to be conscious of and to make recommendations about possible shocks. Is that not right? The Central Bank stated there is uncertainty as a result of the €13 billion. Is there not a risk of a shock, if you want to put it in those terms? I would have thought it was fairly likely. I would consider it a massive windfall and we should just take the money but from the point of view of knowing the picture, should we not look into the possibility that it may be much more than €13 billion?
Is it likely that this will be the consequence? Why has the Central Bank repeated the assertion that we have changed the rules on the double Irish when we have not done so? It will run for the next five years. The double Irish is still available and, therefore, the potential for the distorting effect and uncertainty about tax owed to the State will continue for the next five years.
Mr. Terry Quinn:
The Apple ruling relates to a legacy issue and it is very clear the estimate reflects a period of time. I am not sure of the exact dates but I think it is from 2002 or 2003 to 2014. It does not mention the current tax base, it is looking at the past. We really cannot speculate on whether there are other issues out there. It is not really appropriate and is beyond our mandate.
Surely Mr. Quinn is not saying the distorting effect is limited to 2014. I am genuinely asking. If I follow the logic of what Mr. Quinn has said, the distorting effect predates 2014 and it goes back some time.
Mr. John Flynn:
They relate to the basis on which GDP was calculated. This issue has arisen because the basis on which GDP is calculated has changed, so there has been a move in the statistical methodology to measure GDP from one version of measurement to a new version, which treats things differently. This issue has arisen, essentially regarding 2015, as a result of this.
This has been summer of real reputational damage to the economic side of the Irish State. We have the Apple case, a massive revision of our GDP figures and a third lesser, but not insignificant, issue was the failure of some of our clearing banks to pass the EU stress tests. They were among the few banks on the warning lists in the stress tests which took place earlier in the summer. In its economic analysis, had the Central Bank expected the situation of our banks to be as it was in the stress tests? In the letter the Governor of the Central Bank sent to the Minister for Finance, he states the credit cycle remains subdued and this is reflected in the current zero value of the countercyclical capital buffer. I would appreciate if the witnesses would explain what exactly is a zero value of a countercyclical capital buffer? In the Central Bank's economic analysis, how does it see the state of our banks and the credit environment affecting our economic prospects? I will ask more questions later if possible.
Dr. Gabriel Fagan:
The Deputy's second question is more straightforward. The countercyclical capital buffer is part of the new macro prudential framework which now exists in Europe and the essential idea is to act against the credit cycle. When credit is booming banks are required to have higher capital ratios and when credit is weak it is possible to lower these ratios. The Central Bank, as the macro prudential authority, is responsible for setting these countercyclical capital buffers for Ireland. On the basis of all of the analysis we have up to now, we have set these capital buffers at zero. We are stating that on the basis of our evidence there is no sign of credit overheating in the Irish economy, which would warrant a requirement for banks to hold much more capital against it.
I do not know whether that explains the question. Of course, all over Europe countries are required to set counter-cyclical capital buffers. Most have set it at zero. I think, prior to Brexit, the UK set its counter-cyclical capital buffer at 0.5, but it has since reduced it to zero. Therefore, this is part of the new European macro-prudential framework which it is hoped aims at least to mitigate the problems that were seen with credit cycles in the past.
On the stress test, it is important to say that there was no pass or fail, in contrast to previous stress tests. The relative performance of the Irish banks in the stress test reflected two or three facts. One was that the shocks implemented in Ireland were higher than elsewhere. That reflects the methodology of calibrating the shocks, which is based on historical performance. Ireland is a volatile economy so one would have larger shocks in Ireland than in other countries.
The second element is that, despite the enormous improvements that have been made in terms of restoring bank profitability and reducing the level of non-performing loans, NPLs, the level of non-performing loans in Irish banks is still high relative to those in other countries. In a stress test that would have the implication that Irish banks would be more severely affected. The last consideration is that technically it is a static balance sheet exercise, based on the balance sheet at the end of December 2015.
Were the banks surprised? Not necessarily because we are all aware of the issues of the very high level of NPLs. In the context of the IMF's financial sector assessment programme, FSAP, we had also carried out a number of stress test exercises which were published. In that sense, we were not surprised or shocked by the results. However, the important point to understand about the stress test is that, as I said, there is no pass or fail. There is no automatic response. The stress test provides information to supervisors who will use that along with a whole pile of other information they use, in the context of what is called the supervisory review and evaluation process, SREP. Basically, it is dealing on a bank-by-bank basis, looking at what actions banks need to take in terms of securing their capital position, capital guidance and so forth. That is the status of the stress test.
One of the other interesting thrift figures in the summer was the returns being ahead or behind profile in some cases. One of the major profiles ahead of it was the Central Bank's own surplus income to the State, about €170 million or a 19% increase. Can Dr. Fagan explain where that is coming from? Are there any risks that the Central Bank assesses itself, or indeed potential that there would again be further above-profile incomes coming on the Central Bank's own balance sheet?
I have one final question on that. I heard Dr. Fagan say to Deputy Doherty that he cannot advise political decisions around individual tax measures. From his economic assessment, however, on a broader outline if the investment choice, let us say, was between either investing in capital infrastructure here, current spending or reductions in tax income, is there one that he would favour, given the macroeconomics and given that we have a zero value counter-cyclical capital buffer in our banking system? Leaving aside the actual measure, does Dr. Fagan have any economic assessment about whether the investment should be in capital, current or tax reduction measures? Can he provide an assessment in that broad strategic sense as to where he might prioritise, if he had the choice?
Dr. Gabriel Fagan:
On the surplus income, there are essentially two important main components of that. One might be called the net interest margin of the Central Bank, the difference between the interest earned on our assets and the interest paid on our liabilities. That is one component.
The second component, and a very important one in the past year or so and maybe looking forward, is the capital gains made by disposals of part of the special portfolio, the IBRC related bonds. There have been quite significant capital gains as we disposed of parts of that portfolio. These are then passed on to the Exchequer as part of the surplus income. There is a restriction in the rules at to what the Exchequer can do with that, so it cannot necessarily finance current expenditure from those capital gains, but that is part of the EUROSTAT rules.
The nice thing, in a way, is that the surplus income of the bank is remitted to the Exchequer in the following year. So, in a way, for the year 2016, we know what the surplus income is, so there should be no particular shocks there. For 2017, that will depend on the 2016 surplus income. We are not finally through the year so we cannot give the committee a definitive answer there but it is very unlikely that it will turn out lower than it was in 2016. Basically, in the short term - 2017 and 2018 - we would not be seeing significant risks but having said that, it has to be stressed that a lot depends on the policy with regard to the speed of sales of the special portfolio. Depending on how fast sales take place and the price at which the sales take place, that will influence the capital gains.
Dr. Gabriel Fagan:
If one is looking at the macro-economic impacts of different measures, there are model simulation results. There are actually people in the bank doing that sort of work and we are maybe going to publish a paper pretty soon which will compare the impacts of different instruments on the macro-economy. That is one thing. The other, of course, is that the macro-economic effect is just one component when one is judging a policy measure. The Deputy knows as an elected representative that one does not just consider the macro effect of a policy, but also the welfare considerations and considerations like equity. These are matters where political judgment comes into play which the Central Bank would not necessarily be in a position to contribute on. In terms of macro effects and simulations, we have done some work on that.
Following on from what Deputy Calleary asked about VAT and income tax, Mr. Quinn was answering and mentioned that perhaps there was no need to start worrying yet. At what point does one get worried? It seems coincidental to me. In my personal life, I do a bit of trade with the UK and it seems to be very clear to anyone operating a business with the UK that there has been an immediate knock-on effect from Brexit, despite what some members might think. It seems that what were termed an "unexpected" VAT reduction and an "unexpected" income tax reduction have happened to coincide with Brexit. Is there a relationship there? At what point is it correct to get concerned? Do we look at three months or are we looking at six months if we have a continuous downward movement in VAT returns? It seems clear that when retail sales are strong and unemployment is at a reasonable rate, if it looks and quacks like a duck, it generally is one. Is it a duck? Is it Brexit that is causing that?
Mr. Terry Quinn:
The VAT and income tax receipts reflect activity in the economy just before the Brexit decision. They are not necessarily an indicator of a Brexit effect. One would have to wait a few months to see that. For example, VAT receipts for January and February reflect what happens in the final quarter of the previous year. It is not activity in January and February. These numbers relate to July and August. The receipts are for July and August but refer to the period just before Brexit.
We have tried to incorporate an estimate of the Brexit effect on the Irish economy in our forecast. We have taken approximately 0.2% off our projection for 2016 and 0.6% for 2017, which are significant enough revisions. Nonetheless, one is still left with a projection for GDP growth this year of just under 5% and just over 3.5% for next year.
That projection, in the context of last year's revisions in the national accounts, treats it as a level shift. It is not implying any change in the underlying trajectory of growth. While it is true that in the past two months VAT receipts have been a little bit weaker than expected, in the context of a target of €13 billion for VAT receipts this year, it is not really that significant. We are still ahead of target for the year as a whole. It is probably not wise to read too much into monthly data. Typically one would tend to take a view every quarter on trends. I would certainly wait until the September numbers are released before getting too concerned one way or the other.
Thank you. I have a few questions which I will rattle through now and then the witnesses can address them. The first is on the Anglo Irish Bank promissory note which I believe has budgetary implications. The Central Bank has taken a different payment schedule to the minimum that was agreed or the profile that was negotiated on the night it was voted through. I appreciate that the witnesses will not have the figures with them today but I ask them to supply to the committee the figures showing the minimum profile that was agreed as part of the Anglo Irish Bank promissory note deal in terms of €500 million per year that had to be sold off and so forth as well as figures on what the Central Bank has actually done. My understanding is that it has been turned into sovereign debt significantly ahead of requirement. I also ask the witness to provide the committee with data on the implications for the fiscal space if Ireland were to take the decision to pause these payments.
I pose my second question in the context of the vulture funds and the decision that has been taken to close down the section 110 status they are using to avoid paying taxes on economic activity and profits generated on such activity in Ireland. I know the Central Bank has written a paper on shadow banking and has raised various concerns because, as Deputy Boyd Barrett said earlier, nobody really knows what is going on. Neither the Central Bank nor anyone else knows the risks. We do not really know what is happening in the shadow banking world. The Central Bank is beginning to collect data on the special purpose vehicles, SPVs, but obviously there is a whole other piece to it which the bank, as I understand it, has not even started looking at as it is currently focused on trying to get its head around the SPV area.
One very serious area of potential tax avoidance, again on economic activity entirely within Ireland, is the real estate investment trusts, REITs. I am being told that while local landlords are paying an awful lot of tax on rental income, which is subject to PRSI, USC and so forth, some REITs are using similar tax avoidance mechanisms essentially to offshore all their profits. I imagine this is something the Central Bank has an opinion on, certainly within the context of its examination of the shadow banking sector. Does the Central Bank have a view on this? Is it something the bank is looking at and can it advise this committee on it? I and my colleagues will be looking for data on the projected impact of closing down the vulture fund loopholes on the fiscal space. I would like to know if the Central Bank has a view on the same question for the REITs.
My third question is on lending rates in Ireland. The commercial sector is paying significantly more for loans here than in Germany or France. The banks have told the finance committee in previous years that this was because of their own costs of lending and that the margin that Irish banks are making is no higher than anywhere else. If lending rates can be brought down, I imagine we will see significantly more private sector investment, economic growth and job creation.
Does the Central Bank have a view on how the State can help the commercial banks reduce their average costs of capital so they can pass on those reductions to businesses in Ireland for lending?
I will finish with a technical question. Dr. Fagan referred at some length to the new calculation and to the fact that we try to understand what is going on in the Irish economy. GDP is "C+I+G+(X - M)". We are using "C", consumer spending; some of "I", commercial investment minus aircraft leasing and intangible assets; and "G". So "C+I+G" is there with "I" adjusted. If I understand correctly, the bank has taken out the "(X-M)" bit, which is net exports. That makes sense to me if they are multinational net exports because they do not necessarily reflect what is happening in the real economy in Ireland. Why has the bank taken out "(X-M)" for the indigenous sector? It seems that this piece is a legitimate area for consideration for real economic activity in Ireland.
Dr. Gabriel Fagan:
In respect of the special portfolio, the minimum schedule is publicly available information so we can certainly make that available to Deputy Donnelly. I am not sure about the extent of sales from the portfolio but I will put Deputy Donnelly's request to my colleagues who work on that and see if they can put together information for him that would address his question. I am not sure if we can have much analysis on the impact of these portfolio sales on the fiscal space but I would not want to promise Deputy Donnelly something we could not deliver.
The last question raised by Deputy Donnelly concerned GDP and the underlying domestic situation. His point is correct. If we were trying to construct a measure underlying GDP, it would be wrong to exclude all exports and imports or net trade but that is not what we are trying to do with this measure. This is a measure of underlying domestic demand. Domestic demand is defined as consumption, investment, change in stocks and Government consumption. That is the usual measure and we are saying that it is completely distorted. It is misleading when one looks at that number. One gets a more accurate picture when one extracts these components so that is what we are trying to do. We are not saying that it is an alternative measure of GDP. Rather, it is an alternative measure of domestic demand - what sort of demand is in the domestic economy.
The other questions on shadow banking are slightly beyond what we were thinking of here. The Central Bank is engaged with the Financial Stability Board in Basel as part of a global effort to identify and monitor the shadow banking system not just in Ireland but worldwide so it is part of an ongoing international engagement. As Deputy Donnelly said, we have made major progress in terms of SPVs but that still leaves other elements that need to be addressed. This is an ongoing project that is targeted in collaboration with international partners. Hopefully, we will make progress on that.
I do not have information about the point concerning REITs that was raised by Deputy Donnelly. I am not saying it is right or wrong but we simply do not have any information on that.
When can we expect the new indicators that will be developed and when will the committee have access to that information?
What buffers are in place and what buffers do we need to put in place in respect of Brexit? Is a plan in place? What will happen in the short to medium term over the next couple of years? Dr. Fagan spoke about the uncertainty of Brexit and said it is essentially a waiting game. We are sitting back to see how the negotiations that have not yet commenced will pan out. In the context of budget 2017, what factors do we need to consider or can this budget assist in providing protections in the face of that uncertainty and the subsequent actions that flow from the negotiations, if and when they happen?
Does Dr. Fagan and his team have an opinion or view about whether the tax base is broad enough? Is it something we can address in budget 2017?
Some 40% of tax revenues come from income tax. What are the witnesses' views on that? Is it sustainable and broad enough? Are there changes we can make in budget 2017, which is our focus? Can the witnesses offer any opinion or recommendations to the committee on how we might gender-proof the budget, avoid the label of a regressive budget and address some of the negative impacts of recent years on young people, including the stresses they are experiencing in terms of accessing housing, education, finance and things that have been identified over the past year?
What short to medium-term factors should the committee be considering for budget 2017 to address our objective as a country to create a stable economy?
Mr. Terry Quinn:
The Governor is chairing a group looking into alternative supplementary indicators for developments in the Irish economy. They are expected to report sometime in November.
In terms of Brexit, the committee should take account of the implications of Brexit in its forecasts. It should deal with Brexit by incorporating it into its forecast for growth in the economy over the next few years. That forms part of the budgetary process.
In terms of gender-proofing the budget and whether it is regressive or progressive, our concern is with the overall fiscal stance and the fiscal rules. We really do not get into the specifics of policy in this regard. It is not that we do not individually have views on it but it is not the role of the Central Bank to get into that kind of detail.
In terms of long-term planning for our targets, the key issue is stability and underlying that is sticking to the fiscal rules. It is important to have a proper understanding of the underlying potential growth rate in the economy and to plan on that basis. The key factor there is to plan on the basis of what is a reasonable estimate of the sustainable growth rate in the economy.
I have some follow-up questions. In terms of Brexit, what buffers are currently in place and do we need to do more to protect ourselves? That was not addressed. Separate from the outcome of Brexit there was a period of uncertainty. What can we do in budget 2017 to address that?
Mr. John Flynn:
The best way to think about the buffers in terms of forecasting is to be cautious in approach, to try to factor in as much as the committee can on the basis of what it knows and to be conscious that there is likely to be downside risk here. In terms of framing policy, the committee should think of things that way and adopt a cautious approach.
We published numbers in our previous bulletin in which we looked to estimate the impact of Brexit but we said there was a lot of uncertainty around it. We signalled that the uncertainty and risks were to the downside and that in terms of forecasts for the UK or euro area economies, things could turn out worse than expected. In terms of the transmission of the effects of Brexit into the Irish economy, things could turn out worse than expected. The committee should be conscious that there are downside risks in addition to downward revisions of forecasts on that basis.
I have a follow-up question on that point. Mr. Flynn used the word "caution" and advised us to be cautious in our approach to dealing with this and buffering against the impact. Is that a suggestion that we should somehow not invest as much in capital and tighten up and restrict what we do or should we be doing the opposite of that? Should we be looking to capitalise on the potential benefits of this to our economy in terms of attracting greater investment?
As was pointed out by previous speakers, we have a difficulty, particularly in the capital, with office space and accommodation. What is the view of the Central Bank on what we should spend to deal with Brexit? Should we look to invest further to attract greater investment?
Dr. Gabriel Fagan:
This is within the broad framework of what we have said, that we do not really get into the details of fiscal policy, how tax revenue is raised and the composition of taxation revenue and expenditure. These are matters outside our mandate. While we comment on the broad fiscal stance and how it relates to the overall cycle, it is not within our mandate, in essence, to comment on the details of public finances.
Is our taxation system a risk to the economy? Prior to the crash many accusations were made that the tax base was not broad enough, and moves were made to address this. It is within the remit of the Central Bank to examine the risks posed by our taxation system, such as whether it is broad enough. I assume it is a discussion the witnesses have probably had with colleagues.
Mr. Terry Quinn:
When the crisis hit, it revealed that the tax base was too narrow and that we had been making permanent decisions on expenditure based on funding which was temporary and volatile. As a general point, it is prudent to make plans and have a tax base which is not overly dependent on volatile revenues, and we make this point. Beyond this, we could have a broad based tax system which differs quite significantly, and we will not get into the detail as to how much revenue specifically should be raised under various tax heads. This is really a matter for the Government. Underpinning the general principle that we should run prudent and sustainable public finances is that we should not be overly dependent on volatile tax revenue.
There has been much talk on Brexit and the risks associated with it. A specific issue with regard to the next 12 months is the currency movement which has come about as a result of the Brexit vote, and the impact on the economy of near parity between sterling and the euro. It is possible there are opportunities. I am interested to hear the thoughts of the witnesses on the risks in this regard.
A number of committee members have referred to the figure for headline GDP, which is an important accepted indicator. With due respect to ourselves as a country and the Central Bank, working on our own model is an important exercise but I presume that some of the many other open vulnerable small economies must have experienced similar situations to ourselves, including among our EU partners. Has any collaborative work been done? There would be much more strength in a model devised collectively by small open economies such as our own as an alternate statement of GDP. Let us face it, the headline GDP figure has been devised by the big boys for the big boys, which most reflects the way in which their economies work.
Given our current circumstances, however, we might not be successful in selling a formula that we devise for ourselves regardless of how good it is. To what degree has the Central Bank examined international models or asked the central banks of other small, open economies about what they have done?
Dr. Gabriel Fagan:
I thank the Deputy for his questions. Regarding GDP, the Central Bank is involved in a number of international committees within the context of the ECB, including the statistics committee, and the CSO is closely engaged with EUROSTAT in discussing statistical issues. In a way, the Deputy's question is one for the CSO, as it relates to how the CSO might make colleagues from other countries aware and link with them in developing indicators, given the international statistical institutional set-up. At this point, we need to develop our own indicators. If we assess them and they turn out to be effective, we will have a strong case in telling other countries that are facing similar problems that they can use them. Regarding EUROSTAT and other international organisations, if one is to understand economies, one needs supplementary indicators. That would be the way to go, but the first step is to try to get our own indicators up and running.
On currency and movement in the exchange rate, the depreciation of sterling is undoubtedly a negative factor in the Irish economy. To some extent, we have incorporated this and our Brexit estimates in our forecasts of, as Mr. Quinn mentioned, -0.2% this year and -0.6%. These include foreign demand and exchange rate effects. I agree with the Deputy that this is adverse for the economy. We have tried to take it into account in so far as we can. In future, there may be even more dramatic movements in sterling, for example, further depreciations. This is not to be ruled out and we would have to reassess the impacts on the economy.
In terms of expenditure, I am bothered that we always discuss percentages of GDP, targets, etc., without dealing in depth with the types of expenditure that are more acceptable than others. We are losing out by not considering productive expenditure and the types of expenditure in which the country engages.
I appreciate that there is only so much that the witnesses can say but, in terms of Europe and meeting targets, it seems to be a bland system, in that one cannot exceed X% of GDP, for example, without loosening the constraints on certain types of expenditure. Given the state of the economy in 2011, being back to where we are now is a miracle. A factor that brought about a transformation in business was the reduction in the rate of VAT in the tourism sector to 9%. Perhaps I am wrong to ask the witnesses about this, but is there a role for the Central Bank to examine and comment on certain issues in a way that gives a steer to the Government and Europe?
We always seem to focus on percentages, with no in-depth consideration of the effect. I would welcome a comment on that issue.
Another area is that of pensions, something in respect of which people of my vintage would have more of an interest than others. People's health has improved considerably. Some pension funds are in dire trouble and we are still operating on the basis that people can retire at 62 or 65 despite the fact the qualifying age for the old age pension is being pushed out to 67. Perhaps the witnesses would comment on what could be done to protect the concept of pension funds in order that they do not end up in serious difficulty.
My final question relates to an issue on which there has been little discussion during this session, namely, the effect of Brexit on Northern Ireland and the Republic. Brexit could have serious consequences, both negative and positive. Are the witnesses aware of any work being done on what we should be looking to do and preparing for in the context of the negotiation of arrangements between the British and Northern Ireland, the Republic and Europe? It is not too long ago that thousands of people from the Republic were crossing the Border every week to do their shopping in Northern Ireland. I remember that well. There are stark problems facing us with regard to the Border in that it will be under the control of the UK, which will be outside the European Union. Is any work being done to evaluate the likely impact on us in this regard?
Mr. Terry Quinn:
On the Deputy's comment regarding the focus on ratios and rates of change, etc., versus looking at the composition of spending and taxation, one does not preclude the other. The sustainability of the public finances is part of our remit. One way of addressing that is to look at ratios and the rate of increase of expenditure relative to the sustainable growth rate in the economy and at the level of debt relative to national income. These are important indicators in assessing the safety and sustainability of the public finances but we are not precluded from looking at the composition of spending and making a judgment as to the appropriate allocation of those resources. It is beyond our remit to comment further and we are reluctant to do so.
On pensions, to the extent that there are long-term demographic pressures on the public finances, they have implications for budgetary planning and keeping the public finances safe and so, obviously, account must be taken of them. I do not wish to comment beyond that on the issue.
In regard to Brexit and its implications for Northern Ireland, there are certain sectors of the Irish economy that are more exposed to the risks of Brexit, namely, indigenous firms that trade more in the UK market. This is also the case for Northern Ireland. It is probably a region of the UK that will be more adversely affected by Brexit than others. This must be borne in mind. In terms of how to deal with that, I believe it is a matter for Government. It is not an area that the Central Bank can comment on further.
Before we finish I have a question on inflation and the eurozone target of 2%. There have been negligible rates of inflation for quite some time and the latest figure is 0.2%. What is not being done that could be done with respect to the budget or in acting in consort with our European and eurozone colleagues to stimulate a greater level of inflation in the economy? What is the impact of the reduced or negligible level of inflation in terms of economic growth and figures? I am seeking a brief overview rather than too much detail.
Dr. Gabriel Fagan:
In a sense, the mandate for delivering what we call price stability in the euro area belongs to the European Central Bank. It is a monetary policy. Ultimately, inflation is a monetary phenomenon so it involves monetary policy. If inflation is too high or low, monetary policy is the main instrument to address it. Unfortunately, from this perspective we have a governing council meeting on Thursday and as part of the rules of engagement, Central Bank officials have a quiet period in advance of such meetings. Central Bank officials are requested not to comment on monetary policy issues so as not to provide disturbing signals and so on. Therefore, we are not really in a position to speak about monetary policy issues at this moment.
To follow Deputy Chambers's points, will the recent increases in corporation tax be a feature we can count on as a committee in advising the framing of next year's budget? Is the witness confident the corporation tax levels will be maintained and possibly increase?
Mr. Terry Quinn:
The Governor of the Central Bank addressed that in his pre-budget letter. It is an example of where one must be cautious. The increase in corporation tax receipts have been quite substantial over the past few years. Other tax heads have performed quite well also but not to the same extent. One must be cautious and that is part of the general advice.
We have always had the interest in asking that the tax rate would be paid and we could count on that contribution from the business sector. There have been recent revelations but they do not take away from the fact that this has always been an ambition of many people in this House. The witness is really saying we cannot count on recent gains in corporation tax so therefore there could be a big hole in the 2017 figures.
Mr. Terry Quinn:
No. If the Deputy considers when the public finances went into serious reverse during the crisis, one of the tax heads most adversely affected was corporation tax. It is one of the more volatile tax heads. When a tax head is growing quite strongly but has a history of being somewhat volatile, one must be a little bit more cautious in relying on that particular source of revenue. It does not mean anything beyond that.
The letter of the Governor of the Central Bank to the Minister for Finance is a pretty depressing document. It seems to be imposing straitjackets on us that are not there at present but that he wants us to embrace. I write to the Governor occasionally about the mortgage rules and I wonder about the impact of those lending rules on the construction industry or the young families in private rented accommodation who are paying huge monthly rents. They could pay a similar mortgage because they are a two-income couple, etc. Is it not the case that the Governor and the bank's policy is preventing those families from acquiring homes and is holding back the construction industry? The bank, as an organisation, is acting as a dampener on growth for the economy.
Dr. Gabriel Fagan:
I am not familiar with the precise modalities. We are in the process of evaluating the mortgage rules. We have had a public consultation. We have received 50 submissions from different organisations and individuals. We are going through and analysing these inputs. We are conducting quite an extensive analysis of the available data to assess the impacts of the rules on various criteria, whether they are meeting the objective of enhancing financial stability and what are the side effects such as the ones the Deputy may have mentioned. We intend to come out with the outcome of that review at the end of November. Pending that, be reassured that there is a lot of ongoing work in the bank at the moment to address the issue of assessing these rules.
I am sure Dr. Fagan will agree that it is an area in which the Central Bank could directly make an impact in terms of construction and alleviating the ongoing desperate shortage of homes in this country.
Dr. Gabriel Fagan:
That is pre-judging the outcome of the review. The review will certainly address the impact of the rules on the housing and rental markets and on construction but I do not think we should pre-judge the outcome of the rules. As I say, we will review all of the evidence, take into account the 50 submissions that have been received and then we will report in November on the outcome of those deliberations.
In terms of the point the Governor made about the debt, it is thanks to the revision and so forth that we are coming under 80% again. Is he advocating that we have a debt to GDP ratio like the one we had before the crash? Would it be 25%? What is he talking about? Is 60% the rule? We are heading back - and Deputy Barrett made the point - after a colossal effort being made by the people of this country who bore the brunt of the European banking collapse towards the 60% rule. Dr. Fagan's presentation referred to the positive improvements that have been made. Why place another cross on the backs of the Irish people in terms of the debt?
Dr. Gabriel Fagan:
I do not know whether the Deputy was here when we discussed this matter earlier but the basic motivation is as follows. First, the 60% is not a target but a ceiling. Therefore, one could have a figure lower than 60% and meet the EU obligations. The second point to bear in mind is that the Governor is talking about a longer-term target. He is not saying do this in 2017 or 2018. He is basically saying, "once we make progress". It looks very likely that we will have a budget balance in 2018 and a falling debt ratio. I do not know when we would reach 60% but it may not be that far away. It might be 2019, 2020 or thereabouts, so we will have achieved those rules. The question then is, where do we go from there given that we have met those targets? The point the Governor is making is that if we look at the experience we have had, the volatility of the Irish economy, and at what happened during the crisis, we want to have a margin of manoeuvre if a very bad shock hits the economy in the future, which will happen at some point in time. We will be in a good position to say we can stimulate the economy, relax fiscal policy and tackle the problem without violating European rules. That is where the Governor is coming from. He suggests we get a level of debt which is sufficiently low that will provide a buffer so that the fiscal policy can respond to adverse shocks. In the past, there was no such buffer and, as a result, one had to have a contractionary fiscal policy at a time when the economy was going into recession, so one was making things worse.
There was also the fact the Central Bank did not do its job. When one looks back on it, that was part of the issue.
I wish to ask a final question that constituents often put to us. GDP has been spoken about a lot since I have come in here. We are now at €245 billion or whatever it is for 2015, with a plus 26%. Dr. Fagan's predicted growth of 4% or 4.7% for 2016 and more than 3% for 2017. Is that on top of the 26%?
Dr. Gabriel Fagan:
Yes, we are up at that level, €245 billion, or whatever, as Deputy Broughan said, so basically we have growth of 4% this year and then 3.6% next year from that level. Do not forget that when we talk about growth, we are talking about real growth. To actually get the numbers, we have to add on the inflation and the price deflator effect, which, as Deputy Broughan has pointed out, is not necessarily very large.
I thank the Deputy, Dr. Fagan, Mr. Flynn and Mr. Quinn. With the agreement of the committee, and apologies to Dr. McDonnell, I think we should take a comfort break. We will return at approximately 4.20 p.m.