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In the Eurozone, 2014 Budget Debates Heat Up


Summary


Ireland and Portugal, two recipients of bailouts from the European Union and the International Monetary Fund, will present their 2014 budgets on Oct. 15. While the new budgets probably will include spending cuts and tax hikes, austerity measures are likely to be less harsh than in previous years. Dublin and Lisbon are attempting to balance social stability against fiscal consolidation efforts as they prepare to return to financial markets in early and late 2014, respectively.

Elsewhere in the European Union, debates over national budgets for 2014 have been particularly contentious in the Netherlands and Italy, two countries with fragile ruling coalitions. France, meanwhile, is looking for a balance between demands at home and abroad.

Analysis


On Oct. 8, the European Commission accepted Ireland's plan to implement tax and spending increases worth 2.5 billion euros ($3.39 billion), instead of the 3.1 billion euros originally agreed upon with the troika (the commission, the European Central Bank and the International Monetary Fund). Ireland emerged from its recession in the second quarter of this year, when its economy grew by 0.4 percent from the previous quarter due to a rebound in exports and a rise in consumer spending. However, quarter-to-quarter growth rates are volatile, and the Irish economy is still fragile.

Irish unions and business associations are demanding that Dublin take some pressure off consumers by not increasing taxes next year. Additionally, the Labor Party -- a junior partner in the government coalition -- wants the ruling Fine Gael party to ease austerity. Support for Labor has been dropping in opinion polls, forcing the party to adopt harsher anti-austerity rhetoric.

The crisis has taken a severe toll on the Irish population. According to Eurostat, seasonally adjusted unemployment in Ireland was 13.6 percent in August, down from 14.7 percent the year before but above the 12 percent eurozone average. While the Irish have been relatively calm during the crisis -- there have not been large protests such as those in Greece or Spain -- the Irish are leaving the country due to high unemployment. According to Ireland's statistics office, 89,000 of the country's 4.6 million people emigrated between April 2012 and April 2013 -- a 2.2 percent increase from the previous 12 months. Almost two-thirds of these emigrants were Irish citizens, most of whom were of working age.



Ireland is also facing economic constraints. On Oct. 2, the Irish Central Bank revised down its growth forecasts for 2013 and 2014. Dublin brought its deficit down from 13.4 percent to 7.6 percent of gross domestic product between 2011 and 2012, but this is still considerably above the EU target of 3 percent. Weak economic growth will make it hard for Dublin to reduce its deficit without increasing taxes or reducing spending.



Moreover, Ireland's bailout ends in late December, but Dublin will request a precautionary credit line from the European Union to ensure a soft return to debt markets. Stratfor expects Ireland's lenders to grant Dublin the credit line, but it will come with conditions -- which means that the Irish government's ability to abandon its current policies will be limited.
Portugal's Dilemmas

Portugal is in a more complex situation than Ireland. Lisbon reduced its deficit from 10.2 percent of gross domestic product in 2009 to 6.4 percent in 2012. But Portugal sank into a deep recession, with unemployment peaking at 18 percent -- the third highest rate in the eurozone -- in early 2013. Unemployment fell to 16.5 percent in August, and Portugal emerged from its recession in the second quarter of the year, but the Portuguese economy remains fragile (according to Lisbon, the economy will contract by 1.8 percent this year).

Portugal is expected to end its bailout program in June 2014 and expects to fully return to financial markets at some point after that. Like Dublin, Lisbon will probably request a precautionary credit line next year, but the troika will visit Portugal three more times before the current program ends. Negotiations will be lengthier and slower than with Ireland, and Lisbon will be under more pressure than Dublin to meet its fiscal targets. Lisbon is expected to take its deficit below 3 percent of gross domestic product by 2015.

The government is also dealing with continued challenges from the Portuguese Constitutional Court. In the past two years, the court blocked several austerity measures proposed by Lisbon, including plans to eliminate vacation and Christmas bonuses for government workers and pensioners, as well as parts of a labor legislation reform package. This has forced the government of Prime Minister Pedro Passos Coelho to delay some measures or to find additional ways to reduce public spending. In recent weeks, Lisbon has been asking the troika for more time to meet its deficit targets -- a concession the troika has already made twice. Moreover, the coalition government went through a severe political crisis in July, after Passos Coelho's minority partner, the Democratic and Social Center-People's Party, heavily criticized austerity measures. Portugal will have less room to maneuver than Ireland when negotiating with its lenders and trying to ease austerity measures.






Other Debates in the Eurozone

The budgets for 2014 are proving controversial elsewhere in the eurozone. In the Netherlands, the government led by Prime Minister Mark Rutte is struggling to get support from the opposition to approve the budget, which includes roughly 6 billion euros in austerity measures. Rutte's coalition government controls the lower house of the parliament but needs support from the opposition in the senate.

While an agreement is likely, the Dutch will have a hard time approving promised changes to pensions and the labor market. On Oct. 8, the senate blocked a pension reform proposal that was central to the government's efforts to reduce public spending. The Netherlands has backed the EU push for fiscal consolidation measures in the bloc's peripheral economies, but as the economic crisis spreads north, Rutte is struggling to implement reforms at home due to a weak economy and fragmented political environment. The spending cuts the Netherlands will introduce will likely be insufficient to ensure that the country meets the EU deficit target, and this will weaken the European Union's credibility in enforcing such targets.

Budget discussions are more complicated in Italy, where the government of Prime Minister Enrico Letta has been on the brink of collapse since its inception in April, due to the very fragile alliance between the center-left Democratic Party and the center-right People of Freedom party. This situation has been made worse by the legal problems surrounding former Italian Prime Minister Silvio Berlusconi, which have created virtual paralysis in the Italian Parliament because of Berlusconi's repeated threats to withdraw his party's support for Letta.

Rome wants to eliminate taxes on households, such as the controversial real estate tax, to boost consumption. To improve competitiveness, Italy also wants to reduce social contributions paid by Italian firms (some of the highest in the world). However, the government would also have to find ways to finance the country's oversized public sector. The 2014 budget will probably be a difficult compromise between the contradictory agendas of the center-left and the center-right and is not likely to substantially improve Italy's economic situation, which is largely a consequence of the country's political fragmentation.

France is also looking for a balance in its 2014 budget. In late September, the French government presented a budget that would reduce the country's deficit principally through public sector cuts of around 15 billion euros and some 3 billion euros of increased tax revenues. Since coming to power, the government of Francois Hollande has relied mostly on tax hikes -- instead of spending cuts -- to improve its fiscal situation. This approach has been criticized by business lobbies, which consider France's fiscal pressure excessive. At the same time, left-wing factions within the government oppose massive spending cuts in the public sector. The European Commission recently gave the French government two additional years to meet its deficit targets, but Paris and Brussels have been clashing over the European Union's recent allegations that the Hollande government is not applying structural reforms.

The promise of intervention in sovereign markets by the European Central Bank was crucial in bringing some stability to the eurozone in late 2012. This situation, combined with the gradual acknowledgement by leaders in the European Union that austerity measures were not producing the expected results, led eurozone nations to reduce the pace of structural reforms in 2013. While member states are supposed to respect EU criteria on deficit and debt, the European Union has long encountered enforcement problems, and the credibility of control mechanisms such as the excessive deficit procedure (according to which Brussels monitors and eventually punishes non-complying countries) is weak.

Without extreme pressure from financial markets, and with a more lenient EU Commission, national governments are not as pressed to apply reforms as they were in the previous stage of the crisis. However, their ability to please voters is limited, since they do not have room to increase spending in light of slow growth and lower government revenues. While this relative softening of austerity measures has reduced the risk of social instability in the short term, it is also preventing some countries from applying reforms needed to restore their lost competitiveness in the long term. This dilemma, which does not have a simple solution, will shape the debates over the 2014 budgets in the coming weeks.

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