“Countries don’t go bust”, Walter Wriston, chief executive of Citibank (1967-1984), famously said. Yet of all the economic risks in the next few years, none may be as consequential as the accumulation of debt.
Governments often find it easier to increase their debt than having to face the voters’ wrath over austerity or recessions. At the end of the 1980s, UK public debt to GDP stood at 27 per cent. Thirty-odd years later it is 104 per cent and projected to rise to 108 per cent by 2028.
Debt has a habit of becoming onerous in a non-linear way. It may take years of build-up and only days for a credit event to unfold. Investors who are today happy to take on government debt for a yield could quickly trigger a sell-off and shut a country off from the global financial system.
Britain, a G7 country, experienced a market run on its debt after the 2022 September "mini"-Budget.
At 104 per cent is the UK in trouble? And if so what is the remedy?
The answer is complex. Debt sustainability depends on several factors:
- Who’s the creditor?
- Does the country have monetary autonomy?
- What is the maturity?
- What are the terms?
The UK scores well in most of these categories.
Yet governments know that one cannot borrow at an increasing pace ad infinitum. Debt tends to produce more debt at a faster pace and eventually weakens the country’s political position against its creditors.
If a government chose to reduce the debt, how would it go about it? There are three commonly accepted methods:
- Austerity: reducing social spending and other activities that don’t improve productivity.
- Inflation: Running inflation at a higher rate than the growth of debt will reduce the value of debt in real terms.
- Super-charging growth: increasing GDP faster than increasing debt. This requires targeted tax cuts and debt to be deftly invested in activities that generate faster growth, as opposed to social spending.
Austerity is usually forced upon a country by creditors or due to tight market conditions. Cost-cutting creates resentment and damages a government’s chance for re-election.
Some argue that debt could be inflated away. The idea is that if debt remains stable and inflation reduces the value of the pound, then real debt levels would be reduced and nominal GDP levels would rise.
However, the notion is misguided. The Office for Budget Responsibility chair Richard Hughes said last July that average debt maturities are significantly lower than in the past, from seven to around two years. Because of low maturities, higher interest rates feed into government spending much more than in the past.
More importantly, a lot of UK debt is inflation-linked, roughly 25 per cent – one of the highest among developed countries. Higher inflation would simply increase government payouts, lowering growth.
Pro-growth governments usually prefer the third method: tax cuts to spur growth. On the back of lower lending figures in December, there has been increased talk of tax cuts ahead of the general election, being funded with debt of course.
Given the current levels of debt, is such a tax cut palatable?
The long and short of it is 'mostly yes'.
The UK is presently running a 5.6 per cent deficit, higher than most of its peers. However, at 104 per cent the UK’s public debt to GDP is lower than the average of developed economies, running at 113 per cent.
Debt tends to be viewed in a comparative fashion, as many investors are forced by their mandate to hold some fixed income. So if everyone owes, investors who have to buy debt simply prefer the strongest among borrowers.
Tax cuts that spur growth are usually welcome, not feared by markets. However, governments need to be careful. If there’s one thing investors hate, it's surprises – as Kwasi Kwarteng found out.
'Talk of' is really code for 'testing the water'. If there’s an adverse market reaction, it is easy to deny 'talks' ever taking place. So far, 'talks of' tax cuts haven’t had an effect on gilt rates. Should this continue, and assuming global markets are calm around the time of the actual announcement, then increased borrowing to spur growth is not prohibitive.
And as long as all debt globally continues to grow, then the UK’s fiscal position is not in real danger, for the time being at least.
George Lagarias is chief economist at Mazars
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