Key Messages
Covid-19 has had a very severe impact on the Irish economy, but activity has picked up since May. Recent developments have been broadly consistent with the Mild to Central scenarios set out by the Council in May. While the number of new cases of Covid-19 moderated over summer months, an increase in cases has been evident of late, as has happened elsewhere, and risks of a more pronounced resurgence remain high. Unemployment rates for those aged 25–74 peaked at 26.5 per cent in April but they remain high at 12.6 per cent as of August. Underlying domestic demand looks to have been lower by over 18 per cent in the second quarter of 2020 compared to the fourth quarter of 2019. Yet early estimates suggest a strong pick-up in activity in the third quarter and the impact thus far has been somewhat less damaging than assumed in April’s Stability Programme Update (SPU) 2020.
The macroeconomic outlook remains exceptionally uncertain. Risks of further waves of the virus, lasting economic damage on some sectors of the economy and a no-deal Brexit remain. While short-run developments in the economy have been less adverse than considered in the Council’s Severe scenario, risks of severe outcomes remain in the coming months. There is substantial uncertainty surrounding the path for the economy and health risks. There could be a further upsurge in transmission of the virus. If this occurs, regional lockdowns and perhaps even further nationwide lockdowns could be introduced to manage health risks. In addition, UK trade deal negotiations with the EU could fail to be completed by the end of this year. That raises the prospect of a “no-deal Brexit”, which would see substantial tariffs and other trade barriers introduced between the UK and EU Member States such as Ireland in 2021. This would dampen demand in sectors that have helped to sustain the economy during the Covid-19 crisis, including in agri-foods and pharma-chem.
The Covid-19 crisis has led to a sharp rise in government spending and a falloff in certain taxes. There are considerable uncertainties about the impact of the Covid-19 crisis on the public finances for this year. A substantial deficit of €24–€30 billion (13–17.4 per cent of GNI*) is likely for 2020. This is more than the projected €23 billion set out in April’s SPU 2020. The upward revision mainly reflects how the original forecast did not include provisions for an intended stimulus launched in July as well as other policy measures. However, revenues have thus far performed better than projected in the SPU thanks to continued outperformance in corporation tax and the progressive nature of the income tax system. Ireland’s debt ratio is likely to be around 120 per cent of GNI* this year, well above the pre-Covid-19 crisis level.
While the path for the economy is highly uncertain, the Covid-19 crisis can be thought of in terms of three broad phases. (1) The first phase is the “immediate crisis” when health risks are high and economic activity is suppressed on a significant scale. (2) The second “recovery phase” is when health risks have diminished but unemployment remains high and the economy has yet to recover its pre-crisis levels of activity. (3) The new normal or “steady state” that the economy finds itself in over the medium-term phase will see the economy eventually settle on a new growth path. This phase is likely to see government debt-to-GNI* ratios near post-financial crisis historic highs, given the extraordinary but warranted budgetary supports introduced in earlier phases. Low interest rates will help to make higher debt ratios manageable. Each phase requires a different policy response.
At present, the economy remains somewhere between the first immediate crisis phase and the second recovery phase. While some sectors have survived through the crisis thus far relatively well, others face ongoing challenges. Many businesses, including those in the tourism, hospitality and retail sectors, face ongoing restrictions due to health risks. It is still unclear at this stage how much lasting damage will result from the crisis.
The Government should continue to support business and household incomes through the Covid-19 crisis. The government has to date provided sizeable fiscal supports to households and businesses to cope with Covid-19’s impacts on the economy and society. Temporary and targeted budgetary supports should remain broadly in place to support vulnerable workers and businesses for as long as is needed, even if there may be scope to adapt them as circumstances evolve. If such measures were removed too early, it would lead to a strong contractionary force on the economy and risks lasting damage to businesses, employment prospects and regions.
The July stimulus introduced by the government is welcome to support disrupted sectors and demand. The second recovery phase of the Covid-19 crisis will see unemployment remaining very high. Measures such as the Employment Wage Subsidy Scheme, the Pandemic Unemployment Payment, along with any investment stimulus will be helpful to support incomes and employment.
Budget 2021 should ensure that there is a substantial multi-year stimulus in place for 2021 and beyond to continue targeted support measures and to support demand. Given the high uncertainty around Covid-19 and Brexit, putting in place an appropriately-sized contingency would help manage risks. Even though government debt ratios will be high, a stimulus is warranted to support the economy’s return to a strong growth path. The Council considered an illustrative €10 billion stimulus phased over several years in its May 2020 Fiscal Assessment Report. Since SPU 2020, tax cuts and additional spending of approximately €9½ billion have been announced for 2020, with some €2 billion announced in the July Stimulus for 2021. While the required size of stimulus should depend on more up-to-date information, the Government should be prepared to provide further targeted stimulus to address the demand shortfall and support supply. Efforts to restore employment including activation measures and a focus on investment, which has higher impacts on activity, should be prioritised. As in Budget 2020, an appropriately-sized contingency should be put in place to cover the costs of a failure to reach a trade agreement between the EU and UK. This should also cover Covid-19-related contingencies including support schemes beyond next March and additional stimulus measures should economic damages associated with Covid-19 prove more severe.
While fiscal adjustment is likely to be needed after the Covid-19 shock, this should not happen before a recovery is well-entrenched. The supports to the economy being provided by the Government are sizeable but they should be temporary and targeted so as to lessen the lasting economic damages of the crisis. The debt ratio is likely to peak and remain at high levels, but debt servicing costs can remain relatively low given low interest rates. Once the economy and employment recovers, fiscal adjustment should be feasible without a return to severe austerity.
In the medium term, the Government will need to balance competing pressures.These include a weaker underlying budget position, the need to reduce public debt, rising ageing costs, reducing the overreliance on corporation tax, addressing climate change and meeting social objectives as set out in the Programme for Government, particularly around health and housing. In part, any further stimulus could be used to alleviate some of these future challenges, such as on climate and housing. However, addressing these challenges is complicated by commitments not to increase a substantial part of the tax burden and to maintain large spending items. Strengthening Ireland’s approach to medium-term budgeting would help to manage these competing pressures.