UK public sector debt set to rise sharply
Tue, Nov 25 2008, 05:59 GMT
by Trevor Williams
A slowing economy & tax cuts mean that borrowing will rise
This is undoubtedly the toughest Pre-Budget Report (PBR) that labour has had to deliver since it took office in 1997. For a start, this is the first recession the government has experienced – although one was only just avoided in 2002, helped by increased public spending. But this time, the fiscal position is much less favourable, with a budget deficit of 3% of gdp compared with a surplus of 1½% of gdp in 2000 before the sharp economic slowdown began in 2001.
The UK and world economy face huge challenges, the likes of which the financial markets in particular have not seen since the 1930s. In normal circumstances, slower economic growth should lead to slower growth in tax receipts and faster growth in government spending, resulting in increased government borrowing, but with the current financial crisis the fiscal deficit will be even larger. This means that the deficit will worsen due to the deteriorating economic environment - and the announcement of additional measures to prevent the slowdown from being even more severe - and measures already announced to help offset the threat of the credit crisis. Hence, we focus on what the Treasury’s forecasts will be given the change in the economic environment and the additional fiscal measures that are likely to be announced.
Economic slowdown is worsening the fiscal position and will be acknowledged…
Slower UK economic growth is already impacting the government’s borrowing requirement. As chart a shows, tax receipts are rising more slowly than spending, and below what the Treasury forecast in the March Budget. Overall in October, receipts were rising by 0.3% in the year but spending was up by 5.1% (against expectations in the March 2008 Budget of 4.6% growth in receipts and 4.8% in spending). This gap is evident in net public sector borrowing, which in October was £37bn and £16.9bn higher than in the same period last year. This compares with a full official borrowing projection of £43bn for the fiscal year ending in March 2009, with five months remaining, see chart b.
We expect the reality of weaker economic growth to be acknowledged in the PBR, with cuts in the previous projections taking them into line with market consensus, or lower, in order to build in some scope for further bad news. Chart c illustrates the extent to which the economic situation has deteriorated since March. The chart shows that the market consensus is for UK growth of 0.8% this year and for a fall of 0.9% in 2009. We would not disagree with the current consensus view, although recent trends suggest that the bias of risks are skewed to the downside of this central view, there is also a wider than usual range of possible outcomes given the uncertainties. Inflation will likely be sharply revised higher for this year and lower for next. One key aspect of interest will be whether the Treasury view will be in line with that of the Bank of England, which is looking for growth to fall by around 1 ½% in 2009, and inflation to drop below 1% by the end of that year, see chart d.
…but a package of new measures will also be announced…
Although the scale of new measures to be announced is uncertain, what is certain is that the total will be large. The boost may be as much as 2% of gdp, which is the amount that was mentioned at the G20 meeting in the US recently. This would amount to about £28bn. This could be a combination of tax cuts aimed at small businesses and the low paid and spending increases, aimed at projects that produce a future return or enhance economic productivity. And VAT rates could be cut as part of the measures. A package of this sort should in theory boost domestic demand by 2%, though its overall economic effect will be less than this. That would help to mitigate the economic downturn. It would not be surprising if there were measures to help the housing sector and, like in the US, some measures to back mortgages or to subsidise the social housing sector.
But there are also the announcements over the last seven months to take into account, and these could come to about £93bn. In May, there was £2.7bn, reflecting an increase in the tax free allowance to offset the effects of the abolition of the 10% income tax band, and later the postponement of the October fuel tax increase and that stamp duty will not impact on properties worth less than 175,000, and the various plans to help the financial services sector through the credit crisis. However, some of these measures should not be included in government debt, as they are equity stakes and so should produce an income stream in future, so could count as investments, and are planned to be short lived.
…and changes in the fiscal rules…
As a consequence of these changes, we suggest that the golden rule, to borrow only to invest over the cycle, and the sustainable investment rule, to keep government debt below 40% of gdp, will probably be abandoned and replaced with strict guidelines to get the budget back into balance in the medium term, i.e. after the current economic crisis is over. This will result in a budget deficit in the current fiscal year of around £70bn in our view and possibly £90-100bn plus in 2010/2011. That would take the fiscal deficit to around 5% of gdp this year and to some 6½% in 2010/2011. But total UK debt is starting from a very good position relative to other countries, see table 1, even though it does exclude PFI projects. However, as chart d shows, it will get worse very quickly.
…and greater gilt issuance These measures will mean a big increase in gilt issuance.
We estimate that it could rise to nearly £140bn this year and £160bn the year after. This may have implications for the slope of the yield curve. Although much of this is already expected in the financial markets, so should not lead to a dramatic effect in the shorter term. There will be immense interest about the duration of the debt, short, medium or long and index linked or not. Gilt yields may not necessarily rise, depending on demand from the private sector for funds and on inflation trends. But the issue of whether this will in the long run lead to ‘crowd out’ private sector borrowing will be a key one for some, as it implies weaker long term growth. Whatever the outcome, this is one PBR that will not be boring.
