Hung parliament would fuel UKcrisis

Allister Heath
IT was certainly impeccable timing. A note yesterday from Morgan Stanley predicting fiscal carnage in Britain in the event of a hung parliament was released just hours before a ComRes opinion poll revealed a slump in the Tory vote. The chances of no party gaining overall control of the House of Commons had suddenly increased; an interesting piece of research had turned into a must-read. <br /><br />It is obvious that a hung parliament (the first since 1974) would make it extremely difficult to tackle the poor state of Britain&rsquo;s government finances, which is why Ronan Carr, an analyst at Morgan Stanley, believes a UK gilts and sterling crisis could be a very real possibility in 2010. This is hardly Morgan Stanley&rsquo;s central forecast but the fact that the firm is now openly floating the possibility of such a disaster shows just how low the UK&rsquo;s reputation has fallen. It is not Dubai that is worrying the more forward-thinking strategists &ndash; it is the possibility of a major, supposedly civilised nation such as the UK being engulfed in a debilitating debt crisis. <br /><br />Growing fears over a hung parliament are likely to weigh on sterling and gilts in the months ahead; it would also increase the probability that some of the rating agencies will remove the UK&rsquo;s AAA status, Carr believes. The situation is already dire: our deficit is among the worst in the world at 13.3 per cent of GDP in 2010; the Treasury is predicting net government debt will hit 79 per cent of GDP in 2013-14; the Bank of England could soon own a third of the gilt market. <br /><br />In an extreme situation, Carr predicts, a fiscal crisis could lead to domestic capital flight, severe pound weakness and a sell-off in UK government bonds. The Bank of England may feel forced to hike rates to shore up confidence in monetary policy and stabilise the currency, threatening the recovery. In such a scenario, Carr thinks sterling would crash by at least 10 per cent on a trade-weighted basis, the cost of insuring government debt on the credit default swaps market would surge and gilt yields would shoot up by at least 1.5 percentage points. It would cost less for firms such as BP, GlaxoSmithKline and Tesco to borrow on the debt markets than it would for the government.<br /><br />The only good news is that UK equities may gain on balance from the slump in sterling. Just 35 per cent of UK stock market revenues come from the UK; 43 per cent come from other developed regions and 22 per cent from emerging markets. Around 47 per cent of UK market earnings are derived from companies that report in dollars; shareholders would gain if the pound slumped against the greenback, though it would be scant consolation&nbsp; for a bankrupt nation. We are not there yet, thank goodness; I still think we won&rsquo;t be lumbered with a hung parliament. But food for thought nevertheless.<br /><br /><strong>LATEST FROM CHINDIA </strong><br />Britain and Dubai may be struggling but some countries just cannot seem to be able to stop growing. India yesterday reported economic growth of 7.9 per cent in the past quarter, far above forecasts. It was an excellent result, even if growth will probably slow down a little this quarter as a result of a weak monsoon. China, meanwhile, enjoyed growth of 8.9 per cent during the same quarter. While we are rightly obsessed with the state of our public finances, in the rest of the world the sustainability of Asia&rsquo;s recovery is a much more pressing concern. &nbsp;&nbsp;&nbsp; &nbsp;<br />