Taoiseach Brian Cowen and Brian Lenihan have made it clear they are targeting more cuts

THE holidays are almost over. And by Wed­nesday afternoon, by the time the first post-summer cabinet meeting has broken up, ministers might well feel like they've never been away.

The last two years have been so traumatic for the coalition that it has become jaded to talk about this being crunch time. This time last year, for example, the government was facing into the second Lisbon referendum, the renegotiation of the programme for government, the Nama legislation and the toughest budget in the history of the state.

There aren't as many hurdles to clear this time around, but it won't be lost on the assembled ministers that in exactly three months' time Brian Lenihan will be standing up to deliver a budget that with each passing day seems to assume even greater significance.

Last week's announcement by credit rating agency Standard and Poor's that it had downgraded Irish debt, and the huge differential between what the Irish and German states have to pay to borrow money on the international markets, only served to emphasise how critical the coming months will be.

The financial markets are jumpy and any signal that Ireland is wavering from its commitment to deliver another €3bn in savings in the December budget would undoubtedly see the yield that investors demand to hold Irish bonds rise even further. As it is, the current rate of 5.7% for 10-year bonds is so expensive for the state that it is close to being unsustainable given the amounts that will have to be borrowed to fill the still huge gap between spending and revenue.

To be fair, there is no reason to believe the government will deliver anything less than the €3bn figure. Ministers understand that it is a bottom line that is simply non-negotiable for the reasons already outlined. It's just that getting to that €3bn figure is going to be hugely, hugely difficult and will involve considerable pain and political fallout.

Last year, €1bn of the cuts came from reducing public service pay – under the Croke Park deal that isn't an option this year. It's also going to be more difficult to justify repeating last year's across-the-board cut in welfare payments given the likelihood of a return of inflation in 2011 and the fact that a second such reduction would be asking a huge amount of those affected. The old-age pension will probably again escape any pruning – mainly for political reasons – but some other very hard decisions are going to have to be made.

Both Lenihan and Taoiseach Brian Cowen have made it clear that the emphasis will be on cuts rather than tax increases. But the difficulty in cutting €2bn of current spending (€1bn in reductions have already been ear-marked for the capital budget) means that some tax increases are inevitable.

And the focus of those increases is likely to be the 50% of the workforce that currently pays no tax whatsoever. That figure is unprecedented in the OECD and is clearly unsustainable, but that won't protect the government from accusations that it is targeting low earners when it moves to change the situation in December's budget.

It remains to be seen whether government backbenchers have the stomach for such politically unpalatable decisions. Their record over the past couple of years suggests that they will huff and puff but won't blow down the 30th Dáil. And the prevailing view around Leinster House is that the government will just about have the numbers to get through the budget and to the end of the year.

The situation be­comes more complex after that. The three by-elections – which the government is surely certain to lose – will have to be held at some point and with a number of government TDs facing health issues and the risk of further defections a la Mattie McGrath, it seems more likely that the government will simply run out of numbers at some point rather than fall over any major dramatic issue.

But for now at least that is not a pressing concern for the cabinet. Politicians tend only to worry about short-term issues and there are plenty of those. Along with trying to politics-proof the budget, it will also be desperate to bring some degree of certainty to the black hole that is Anglo Irish Bank.

It's clear that the problem of putting a final price on Anglo is a factor in the markets' nervousness about Ireland. But establishing the total final bill is an impossible exercise because of the difficulty in valuing the bank's assets.

The government is currently in negotiations with the European Commission with a view to signing off on a restructuring plan for the bank and the hope is that will provide greater clarity – and reassurance for the markets – on what Anglo Irish Bank might ultimately cost the state. It will also dictate whether the bank is to be wound down or the management's option of a 'good bank/ bad bank' is to be adopted.

As if that isn't enough for the government to worry about, it will also have to make decisions about the level of cover the state will continue to offer the banking system when the guarantee scheme runs out.

And while all this is going on, it cannot afford to ignore Albert Reynolds' old maxim about the little things tripping you up. The controversy last week over motor tax on commercial vehicles is a perfect example of this.

The resumption of opinion polls in September will also heighten tensions particularly if the two government parties continue to struggle. (It could also, by the way, stir things up in Fine Gael.) The Greens have remained resolute in backing the tough medicine up to now but some figures have been talking about spreading out the pain over a longer period and, if such a view takes hold, it is certain to lead to tensions between the two government parties.

Ultimately, the fear of hanging separately should ensure that Fianna Fáil and the Greens hang together until the end of the year and beyond. But even if that proves to be the case, they will be under no illusions about what awaits them in the months ahead. Only one thing is certain: the summer holidays will soon be a dim and distant memory.