IHS Global Insight Perspective | |
Significance | Although the U.K. economy is still mired in deep recession, the substantial and rising public finance deficits meant that the chancellor was unable to announce any major new initiatives to try to boost recovery prospects. Indeed, he was under pressure to set out details as to how the public deficits will be reined in over the coming years. |
Implications | Public spending will be squeezed very hard over the medium term, while the rich will face a rising tax burden. |
Outlook | The chancellor is relying heavily on a sharp economic recovery over the medium term. If this fails to materialise, further major corrective fiscal measures will be needed to bring the public finances back to a long-term sustainable position. |
Chancellor of the Exchequer (Finance Minister) Alistair Darling yesterday delivered his budget for fiscal year (FY) 2009/10 with the economy mired in deep recession and the public finances in dire straits. Indeed, data just released show that the current budget deficit surged to £53.3 billion (US$77.2 billion; 3.6% of GDP) in FY 2008/09 (April 2008-March 2009) from £5.3 billion in FY 2007/08. Meanwhile, the Public Sector Net Borrowing Requirement (PSNBR) nearly trebled to a record £90.0 billion (6.3% of GDP) in FY 2008/09 from £34.6 billion in FY 2007/08. This was £12.4 billion more than the £77.6 billion forecast by Darling in last November's Pre-Budget Report (PBR).
Weakened Public Finances Prevent Major New Stimulus Measures to Boost Economy
The state of the public finances clearly precluded any significant new stimulus measures in the budget to help the economy out of recession. Although the chancellor announced that the budget would represent a fiscal easing of 0.5% of GDP this fiscal year, many of these measures had already been announced in last November's PBR. Further ahead, the focus is on trying to rein in the public finances, with the chancellor indicating that fiscal tightening measures will amount to 0.8% of GDP each year from FY 2010/11 to FY 2013/2014. Even then the PSNBR is still expected to be up at £55 billion in FY 2013/14 (5.5% of GDP).
Specifically, the chancellor forecasts the PSNBR to jump to an eye-watering £175 billion (12.4% of GDP) in FY 2009/10, before retreating to £173 billion (11.9%) of GDP in FY 2010/11, £140 billion (9.1% of GDP) in FY 2011/12, £118 billion (7.7% of GDP) in FY 2012/13 and £97 billion (5.5% of GDP) in FY 2013/14. The current budget deficit is projected to soar to £132 billion (9.3% of GDP) in FY 2009/10 and £137 billion (9.4% of GDP) in FY 2010/11, before moderating to £111 billion (7.2% of GDP) in FY 2011/12, £91 billion (5.6% of GDP) in FY 2012/13, and £74 billion (4.3% of GDP) in FY 2013/14. Net public investment is seen rising from £37.7 billion in FY 2008/09 to £44 billion in FY 2009/10 as some spending is brought forward to boost the economy, before then retreating to £36 billion in FY 2010/11 and £22 billion in FY 2013/14.
As a result, public sector net debt (including the costs of stabilising the banking sector) is projected to rise from 46.5% of GDP in FY 2008/09 to 59.0% of GDP in FY 2009/10, 68.4% of GDP in FY 2010/11, and 79.0% of GDP in FY 2013/14. It is then forecast to stabilise in FY 2014/15, before starting to retreat in FY 2015/16.
Growth Forecasts Look Optimistic
Furthermore, there must be very serious doubts about the government's ability to keep within its sharply raised public deficit targets. The chancellor has forecast that the economy will contract by 3.5% in 2009, followed by GDP growth of 1.25% in 2010 and 3.5% in 2011. Darling sees long-term trend growth at 2.75%. The chancellor expects the economy to start growing by the end of this year and then to increasingly strengthen, helped by improving global economic activity, low inflation, and the stimulus measures that have been enacted.
IHS Global Insight believes that these forecasts are mildly optimistic in the near term and very optimistic in the long term. We currently expect GDP to contract by 3.8% in 2009 and then to edge down by a further 0.2% in 2010. We then see GDP rising by 1.7% in 2011. This assumes that the economy will contract throughout 2009, albeit at a reduced rate as the year progresses. We suspect that the economy will only essentially stabilise in the early months of 2010 before recovery develops gradually. We also suspect that 3.5% is far too optimistic for growth in 2011, especially given the substantial fiscal tightening that will be required.
We also have serious doubts about Darling's forecast of a trend growth rate of 2.75%. With extended substantial corrective fiscal action needed, the financial sector unlikely to return to the growth rates seen in recent years, and significant productive capacity currently being lost, we believe that trend growth will be 2.5% at best, and very possibly only 2.25%. Clearly, if growth is significantly lower than the chancellor forecasts, it will increase the risk that his public finance targets will be missed, thereby requiring additional tightening measures further ahead.
Moreover, although the chancellor can justifiably point to the very serious hit that economies are currently taking worldwide, and the sharp GDP contraction that is being widely experienced, the fact remains that the United Kingdom's public finances are in a particularly bad way because they entered the recession in such a poor state. This was due to the government prioritising for an extended period the improvement of public services—particularly health and education—through increased investment and spending.
The chancellor made great play about the past measures that the government has taken to support the financial sector and to boost the economy (the £20-billion stimulus package in last November's PBR) as well as the action taken by the Bank of England in slashing interest rates and engaging in quantitative easing. However, the state of the public finances means that there is no money in the pot for further major help.
Outlook and Implications
Consequently, measures to help the economy in the near term are necessarily limited. They include a £1.7-billion package to protect jobs and help the unemployed, giving motorists £2,000 to scrap cars that are more than 10 years old and replace them with new models, and extending the stamp duty holiday on properties worth £175,000 or less. Meanwhile, loss-making companies will be able to reclaim taxes made on profits in the last three years up until November 2010.
Further ahead, the focus is on reining in the public finances, with measures centring on squeezing public spending even harder, taxing the rich, and making greater efficiency savings. Indeed, public spending is targeted to rise by just 0.7% a year in nominal terms from 2011, compared with the 1.2% growth rate that had been set out in November's PBR. This will mean a substantial cut in real terms. In addition, the government is looking to raise £9 billion in efficiency savings by 2012.
Meanwhile, those earning more than £150,000 a year will face a 50% tax rate from next April (up from the current level of 40% and higher than the 45% rate set out in last November's PBR). In addition, pension tax relief will be restricted for people earning over £150,000. The tax-free allowance will be restricted for people earning over £100,000. It was also announced back in last November's PBR that employers' and employees' national insurance contributions would be raised by 0.5 percentage point from April 2011.
Other tax increases see the duty on alcohol and tobacco rise by 2% as of midnight last night, while gasoline (petrol) duty will increase by 2p per litre in September and then by 1p a litre above inflation each April for the next four years. Meanwhile, Darling confirmed that the value-added tax (VAT) rate will be put back up to 17.5% at the end of 2009 after it was cut to 15.0% in December 2008.
The chancellor desperately needs growth to surprise most people on the upside. If it does not, it is likely that both he and any successor will have to announce more rigorous fiscal tightening measures for some time to come.