The UK’s public finances – a source of perennial debate amongst politicians, think tanks, economists and investors – are in focus like never before. Covid-19 has ushered in a period of unprecedented public spending, funded in the main by large amounts of debt.
Government borrowing – money it needs to borrow to pay for spending obligations which are not covered by tax receipts – was reported last week as hitting £303.1bn in the year to March. That figure is nearly £205bn higher than the previous year.
Borrowing hit £28bn in March alone, a record monthly high. Often likened to a mountain, the UK’s debt monolith is viewed by some as a terrifying and unnavigable edifice. A Mount Doom, glowering ominously, portending calamity.
The latest UK quarterly debt figures published last week make for uncomfortable reading. General government gross debt was £2.2 trillion at the end of December 2020, equivalent to 104.5 per cent of gross domestic product (GDP) and 13.7 per cent above the average across EU states. The figures also put the last economic downturn into perspective. Our indebtedness as a proportion of GDP is also around two-and a half times higher than at the height of the Global Financial Crisis in 2008.
Taken at face value, the numbers are both eye-watering and a cause for concern. There will likely be more hand wringing and discussion around the historic nature of this debt – the largest accrued during peacetime (unless you interpret Covid as a war, as some do at least figuratively).
Britain’s national debt has grown 418 per cent since 1995, far faster than its European neighbours, and far outstripping economic growth of 94 per cent. The biggest contributor has been the Global Financial Crisis, which hit the UK much harder than it did Europe and prompted huge borrowing. Britain now owes $44,559 per person, the ninth highest figure in the world.
During 2020, the British government borrowed almost $8,500 per person to combat the pandemic and its economic impact. It will continue to see debts rise for the next few years in cash terms, but they will become smaller relative to national income more quickly than for the rest of the world.
However, not all is doom and gloom. Funding costs are exceptionally low, making the debt, at current interest rates, eminently serviceable. In 2020, the UK paid an average interest rate of 1.7 per cent across all its borrowings, down from 7.1 per cent in 1995. According to our recently published Sovereign Debt Index, this is going to fall even lower, dropping to just 0.7 per cent in 2022. Britain’s $27bn interest bill in 2022 will be half the level in 2019, even though debts will be more than 50 per cent higher.
At the end of 2020, the effective yield on UK bonds (the rate at which the country can now borrow) was just 0.33 per cent. This has risen a touch as investors anticipate an economic recovery. The UK is unique in that it has an exceptionally long payment profile for its bonds, meaning it has significantly lower refinancing risk than its peers. Half of British government debt is not due for repayment until after May 2030, years later than all other major industrialised countries. The weighted average maturity date is even longer at May 2035.
The Bank of England will also remain an active player in the markets for many years to come, so bond yields are likely to rise less than the anticipated large rebound in the UK economy would otherwise imply. The Bank of England knows that the UK government needs to refinance its record level of debt, so is incentivised to keep interest rates low across the yield curve. And there is also high demand from investors for bonds too.
The companion of such low interest rates is low inflation, which ensures that today’s debts will persist rather than shrink in relative terms from mountains to molehills as incomes and prices rise.
To reduce its debt burden, the UK government appears to be advancing policies to stimulate economic growth whilst strategically trimming spending and raising taxes. With the cost of finance so low it will have breathing room to do so. Combine this with some healthy indicators which suggest a major economic rebound in the UK, care of pent-up demand and the successful vaccination programme, and the debt mountain doesn’t seem as insurmountable as first it appears.