The Institute for Economic and Social Research, in its quarterly economic commentary published in June, argued for increased government capital spending in the current environment of very low interest rates.
He recognized the need for prudent management of current spending to reduce the budget deficit and put public finances back on a sustainable basis after the sharp increase in public borrowing in 2020-2021 due to the Covid-19 pandemic.
However, he believes that public borrowing is a viable option for financing “critical capital” projects given the expected high growth rate of the economy over the next few years and the likely continuation of the very low cost of financing. sovereign debt.
Increasing public capital spending can help address bottlenecks and infrastructure deficits in areas such as climate change, healthcare, technology and, in particular, supports ESRI, the housing, which would have a positive impact on the long-term productivity and competitiveness of the economy.
The government seems to have taken this advice into account in its latest medium-term projections for public finances.
In its April budget outlook update, the Ministry of Finance forecast a sharp drop in the budget deficit to 1.2% of GDP by 2023, with public finances approaching budget balance by 2025.
However, in its July update, the ministry recalibrated the government’s medium-term fiscal framework to include additional spending to “increase the supply of housing and other critical infrastructure”.
As a result, the government now plans to run significantly higher budget deficits over the next five years.
The budget deficits forecast for 2024 and 2025 now amount to around 7.5 billion euros, or 1.5% of GDP. That’s well above the deficits of € 3 billion in 2024 and just under € 1 billion in 2025 shown in last April’s update.
Obviously, some fear that this will further increase the high level of public debt and increase annual interest payments.
However, with strong growth expected in the coming years, public debt ratios are expected to decline further.
Annual debt interest payments are also expected to remain very low, aided by the fact that debt maturing with higher annual coupon payments is replaced by new debt with much lower interest rates. Governments are also able to lock in on very low interest rates for a long time.
Indeed, the Irish authorities can issue 10-year bonds at negative interest rates, while 30-year bonds have a yield of 0.6%. These very low financing costs are the direct result of the ECB’s lax monetary policy.
The ECB’s official rates are set at -0.5%, while it is also engaged in large-scale purchases of government debt or quantitative easing (QE). These accommodating policies should remain in place over the next few years.
Markets do not expect the ECB to start raising rates until 2024, with rates remaining negative until 2027. At the same time, ECB bond purchases are also expected to continue over the next few years.
Thus, the Irish government has the opportunity to contract long term debt at very low interest rates for the purpose of productive capital investment in the coming period.
Long duration and low interest rates are essential for debt sustainability, as well as the high rate of growth of the economy.
This means the government will not be faced with a wall of maturing debt that might be difficult to refinance in a short period of time, or large annual bills for interest payments.
The real challenge will be to ensure that the borrowed funds are invested wisely.
- Oliver Mangan is Chief Economist at AIB