A catastrophe made in Downing Street
WE are moving ever closer to the day of reckoning. As if another set of dreadful public finance figures yesterday wasn’t enough, the markets were also rattled by S&P’s decision to cut the outlook for the UK’s sovereign credit rating from stable to negative. Years of fiscal profligacy during the boom years are finally catching up with Gordon Brown; it beggars belief how anybody ever believed his claim to economic literacy and prudence.
For the time being, Britain retains its AAA rating, unlike Spain and Ireland, which were downgraded to AA+ earlier this year. A UK downgrade is not imminent but will depend on whether the next government comes up with a credible plant to regain control of the situation; David Cameron will be under pressure the moment he enters 10 Downing Street next year.
The last time S&P placed the UK on negative credit watch was after the last recession in 1993, as Simon Ward of Henderson New Star reminds us. The AAA rating was maintained, however, and the outlook raised to stable in August 1995 after the then government took deeply unpopular steps to slash the budget deficit.
Rating agencies discredited themselves during the boom years, failing properly to assess and measure risk, especially in the property-related derivatives market. So it would be tempting to dismiss S&P’s tentative move yesterday as irrelevant, especially given that it didn’t actually downgrade the UK. But such complacency would be a terrible mistake: rating agencies may not have been able to grasp the complexities of a dodgy sub-prime mortgage in Tucson but even they understand that the UK public finances increasingly resemble that of a banana republic. The figures are truly frightening; anybody who managed their own finances in the way Brown has been would be bust by now.
Central government revenues plunged 9.5 per cent year on year. Astonishingly, revenues in April this year were below receipts in April 2006 – in other words, the tax take has gone back more than three years, even though spending is reaching record highs. Central government spending rose 5.3 per cent year on year, with the public sector continuing to grow at the same rate as during the good years, oblivious to the fact that there simply no longer is enough economic activity to support such elevated levels of expenditure. No wonder Citigroup expects the budget deficit this year to hit a staggering £185bn-190bn, about 13.3 per cent of GDP.
Yet gilts being printed to pay for this are largely being purchased by foreign investors or indirectly by the Bank of England via quantitative easing (QE). Holdings of sterling in global reserves have risen from £49bn in late 2003 to about £203bn by the last quarter of 2008, the biggest percentage rise of any currency. And over the past 12 months, overseas investors bought a net £64bn of gilts, compared to £39bn by the UK non-bank private sector and £35bn for UK banks. If foreigners go on a buyers’ strike, or when QE ends, yields will have to shoot up, pushing up borrowing costs for everybody.
The private sector is finally doing less badly. But progress is being threatened by the catastrophic state of the public finances, which could soon trigger crippling tax hikes and inflation. Forget the looting of taxpayers by MPs via their expenses; the real scandal has been the gross economic mismanagement by this government since 1997.