DUBLIN (Reuters) - Ireland is planning to push through spending cuts and tax hikes totaling 6 billion euros next year, the toughest budget in the country’s history, in a last-ditch effort to convince investors it is not on the verge of financial meltdown.
With Irish borrowing costs breaching record highs every day this week, Finance Minister Brian Lenihan is battling to turn the tide of market opinion and avoid the risk of a Greek-style bailout.
“What I have to do here and now is to ensure that the country gets the budget that’s essential for our economy and our own self-respect in the world,” Lenihan said on Thursday.
The risk premium investors demand to hold Irish paper over benchmark German bunds stayed at the latest record peak of 543 basis points despite Lenihan saying he was frontloading some 40 percent of the 15 billion euros in adjustments he is targeting between now and 2014 to tackle the worst deficit in Europe.
With his parliamentary majority dwindling and many investors still skeptical about growth prospects, Lenihan has a fight on his hands to get borrowing costs down to more sustainable levels by January, when Ireland plans to tap bond markets again.
If borrowing costs by then are still three times more expensive then Germany’s, Lenihan may be forced to seek external assistance.
“I would describe this as one of the four or five hurdles they have to get through ... and it’s crossed but that doesn’t mean we have reached the ‘Promised Land’,” said Eoin Fahy, chief economist with Kleinwort Benson Investors.
“There are a lot of barriers ahead still so I am not surprised that the market has not reacted strongly to this,” said Fahy, adding that if the 2011 adjustment had been less than 6 billion euros, spreads would have widened further.
Lenihan doubled the amount of pain he estimated was needed to get Ireland’s finances in order last week, citing higher borrowing costs and weaker growth prospects.
He said on Thursday he now expected Ireland to grow 1.75 percent next year, largely due to the export performance of Irish-based multinationals, from an original growth projection of 3.3 percent.
Lenihan’s revised forecast is below the median forecast of 2 percent in the latest Reuters poll.
But some investors were still skeptical about Lenihan’s projections given spluttering global growth and the fiscal pain ahead.
“I think they’re on the right track in terms of what has to be done but they may find it has more of a detrimental effect (on growth) than they’re expecting,” said Oliver Hogan, economist at CEBR said.
“We would be a bit dubious on the plausibility of achieving the growth projections.
Lenihan said he expected next year’s adjustment, which will be weighed more on the spending side, would cut the deficit to 9.25-9.5 percent of GDP next year and to 2.75-3 percent of GDP in 2014, the deadline he has agreed with Brussels to get the shortfall under control.
The budget deficit is set to blow out to a jaw-dropping 32 percent of GDP this year due to the one-off inclusion of a mammoth bill for bailing out Ireland’s banks. Excluding the bank bill, the deficit will be nearly 12 percent of GDP this year.
Lenihan got a vote of confidence from European Central Bank president Jean-Claude Trichet, who said Ireland’s plans should be sufficient to solve its debt crunch.
“The 15 billion ... are not in our view insufficient but of course you have to be alert permanently and stand ready to do all that is needed,” Trichet told a news conference in Frankfurt. “But I have no negative appreciation of the 15.”
The EU, which is anxious to avoid a melt-down in Ireland that could jeopardize the single currency, said the 6 billion euros target was appropriate.
“This provides an important anchor for financial markets and also underlines the Irish authorities’ commitment to putting public debt on a sustainable downward path in the near future,” the EU Economic and Monetary Affairs Commissioner Olli Rehn said.
Lenihan will flesh out the measures he will implement between now and 2014 later this month and will try and push through the first of the four austerity budgets on December 7.
The government’s ability to pass the budget has been dented by a wafer-thin parliamentary majority, which is expected to shrink to just two after a lower-house by-election on November 25. Analysts say the budget is still likely to be passed but the risk of an early parliamentary election in the first half of 2011, when Ireland wants to tap debt markets, is now growing.
Ireland’s credit spread remains well below the levels of between 800 and 1,000 bps experienced by Greece just before it sought an international rescue package in May, but still suggested the market saw a significant chance Ireland would eventually have to seek a bailout or restructure its debt.
Editing by Mike Peacock, Ron Askew