Investments  

What do high UK government debt levels mean?

What do high UK government debt levels mean?

In his annual spending review, chancellor Rishi Sunak revealed the UK government borrowed £246bn in the first six months of its financial year – which was to the end of September 2020 – while the total borrowing figure will be more than £300bn for the year.

Those numbers are record highs for the UK in peacetime, and contribute to an overall national debt of just more than £2tn. 

The deficit is the amount of extra net borrowing a country needs to do each year to finance itself; the debt is the total net amount of all of the previous years’ deficits that have not yet been repaid. 

The GDP drop this year, at 11 per cent, is the worst for centuries.      

But while the headline data looks bleak, Mr Sunak has two strong positives to work with.

Key points

  • The government is borrowing record amounts for peacetime
  • Interest rates are very low and all governments are in the same position
  • Some debt can be inflated away over time

The first is that bond yields – that is, the interest rate paid on the debt – is the lowest it has ever been, with some bonds trading at a negative yield.

The second advantage for Mr Sunak is that the economic malaise is not unique to the UK, so every other major economy is also issuing bonds in vast quantities at this time, so the UK was not alone in increasing its debt issuance in 2020. This helps to keep the yields lower as it means that investors in government debt will not have the option of fleeing one stricken country’s debt for another.

The interest rates the taxpayer will pay on the money borrowed this year are way below those previous generations had to endure, with all bonds the government issues with a maturity of up to five years presently trading with a negative yield. 

UK government bonds with a maturity of 20 years currently have a yield of 0.83 per cent.

Return on capital 

Having to make lower interest payments on the debt brings a range of benefits to the budget.

In the first instance, as a portion of the debt is held by overseas investors, minimising the interest payments owed on the debt means less sterling being moved abroad by those investors, which should help to preserve the value of sterling; maintaining this purchasing power for imported goods prevents inflation from rising too steeply.

But the more significant benefit to the government from paying a lower rate of interest is that it makes many more infrastructure projects viable. 

For example, the interest payable on a 10-year UK government bond is currently 0.3 per cent. If the government borrows £1bn and uses the cash to develop an infrastructure project, the extra economic activity, and revenue coming to the government from the taxes paid by workers who may otherwise have been claiming benefits, needs only to exceed the interest payments for the project to pay for itself.

Bank on it 

There are many reasons yields are so low, prime among them is the vast ‘savings glut’ that has built up in Asia. 

As those economies become more prosperous, local populations have saved more rather than spent, and the accrued capital has been invested in, among other things, developed market government bonds.