Ireland to bust EU rules with 6.5% deficit

Ireland, the first European Union country technically in recession, is planning to abandon European Union fiscal rules next year. Dublin is projecting the largest budget deficit in 20 years, as the economy slows amid a housing slump and international credit crunch.

Announcing the budget for 2009, Brian Lenihan, finance minister, said the general government deficit would be “just above €12bn” next year, 6.5 per cent of gross domestic product. Under the stability and growth pact rules, countries have to keep borrowing to less than 3 per cent of GDP through the economic cycle.

Mr Lenihan said the “the international credit crisis has compounded and deepened the downturn in our construction sector and led to a fall off in consumer ­confidence”.

Irish public finances, in surplus for nine of the past 10 years, have deteriorated by 7 percentage points.

Mr Lenihan said economic output would contract by a further 1 per cent next year, after declining 1.5 per cent this year. Public debt is set to rise from 25 per cent of GDP – one of the lowest rates in the European Union – to 44 per cent next year.

The worsening state of the public finances comes amid growing expectations that Dublin will have to follow other EU governments and inject capital into its banking sector, adding further to public debt.

Two weeks ago Ireland offered to guarantee the liabilities of its banks, which Mr Lenihan said on Tuesday had “safeguarded” the bank sector.

But brokers say that with Irish bank shares failing to benefit from the price lift across Europe this week, the markets believe some form of recapitalisation will be unavoidable.

In the first official hint that equity injections by the government might be on the cards, Pat Neary, the Irish regulator, told a parliamentary committee on Tuesday that “the rules of the game are changing internationally”.

He said: “Market expectations could push other banks to seek equity injections, irrespective of whether or not they continue to meet their regulatory requirements”.

With the Irish construction boom over, Christopher Wheeler of NCB stockbrokers calculates the collective bad debt charge of the three main Irish banks could reach 350 basis points of average loans in 2009 and 2010. He calculates the banks would need €14bn ($19bn, £11bn) of new equity to achieve a core tier one capital ratio of 9 per cent. This would put them broadly in line with UK banks under London’s recapitalisation scheme.

The budget included a 1 per cent income levy on those earning up to €100,000 a year and 2 per cent over €100,000. Ministers are taking a 10 per cent pay cut in “solidarity” with ordinary taxpayers. Mr Lenihan reassured foreign investors that the 12.5 per cent corporate tax rate was “not for changing upwards.”