The UK Public Finances continue to underperform the economy

A feature of the modern era is that way that the establishment economic debate has changed. There was a spell post credit crunch that we were told that fiscal deficits were a bad idea and most countries then set about trying to reduce them. The UK headed on that road although the reductions in the deficit came more slowly than promised and the surplus that was supposed to be achieved now somehow found itself some 3/4 years away. More recently there has been a shift in favour of fiscal stimuli both generally and in the UK. Even Mario Draghi of the ECB (European Central Bank) was at this game yesterday.

Fiscal policies should also support the economic recovery, while remaining in compliance with the fiscal rules of the European Union………At the same time, all countries should strive for a more growth-friendly composition of fiscal policies.

This is of course the same ECB which has enforced exactly the reverse in places like Greece and still supports the Growth and Stability Pact that even Germany ignores! Also Mario has driven many bonds including corporate ones into negative yields but still has the chutzpah to proclaim this.

so far we haven’t seen evidence of bubbles.

Although should Portugal be downgraded later it will fall out of the ECB QE criteria and would be forced to head in the opposite direction.

The UK

The impact of the vote to leave the EU was likely to have two impacts according to the Institute for Fiscal Studies. First a gain.

In principle, the UK’s public finances could be strengthened by that full £14.4 billion a year if we were to leave the EU. However, the EU returns a significant fraction of that each year. The amount varies, but on average our net contribution stands at around £8 billion a year.

But as they forecast a weakening of the UK economy there was also a loss depending on how much it weakened.

We estimate that if NIESR has broadly the right range of possible outcomes for GDP, then the budget deficit in 2019–20 would be between about £20 billion and £40 billion higher than otherwise.

Earlier this month The Times waded into the issue with a claimed leak of cabinet papers that actually turned out to be the pre vote Treasury analysis.

The net impact on public sector receipts – assuming no contributions to the EU and current receipts from the EU are replicated in full – would be a loss of between £38 billion and £66 billion per year after 15 years, driven by the smaller size of the economy.

There are obvious issues looking so far ahead and depend on the assumptions made. What we know so far is that the UK economy has not been plunged into a recession as some claimed but here at least we expect an impact next year as inflation rises in response to the lower UK Pound. Although of course indirect taxes gain from inflation on the one hand and index-linked Gilts mean the government pays out more so the picture is as ever complex.

Today’s numbers

Actually one is left wondering whether the proposed plan for an easing of fiscal policy in the UK is already in play.

Central government expenditure (current and capital) in September 2016 was £57.2 billion, an increase of £2.4 billion, or 4.3%, compared with September 2015.

As we look into the detail we see that expenditure is indeed higher but that there was another factor at play.

debt interest in September 2016 increased by £0.9 billion, or 34.6%, to £3.3 billion;

This initially looks odd because as I pointed out on Tuesday UK Gilt yields remain extraordinarily low in spite of the efforts of the Financial Times on Monday to convince us that the end of the world is nigh. Of course it may be but not this week (so far)! However just as I was remembering that September is a “heavy” month for index-linked Gilts Fraser Munro of the ONS kindly reinforced my thoughts.

We are seeing the recovery of the RPI impact on the uplift on index linked gilts and pushing up interest.

So we are already seeing costs arise from higher inflation and I do hope that fans of higher inflation will admit this rather than parking it at the back of their darkest cupboard.

Actually revenue growth was not to bad at 2.6% but the increased expenditure meant this.

In September 2016, public sector net borrowing (excluding public sector banks) was £10.6 billion; an increase of £1.3 billion, or 14.5% compared with September 2015.

This meant that the official plan to chop another £20 billion or so of UK annual borrowing is struggling so far this financial year.

In the financial year-to-date (April to September 2016), public sector net borrowing excluding public sector banks (PSNB ex) was £45.5 billion; a decrease of £2.3 billion, or 4.8% compared with the same period in 2015.


Over this period the debt interest position is much more favourable showing that we will continue to benefit from low conventional Gilt yields ( assuming they stay low) but see an upwards push from index-linkers from time to time. Those of you with longer memories will recall that several years ago I suggested that if the UK was to borrow it should be via conventional Gilts when Jonathan Portes was arguing we should use index-linked ones. If you take his forecasts going forwards ( inflation and maybe a recession) you will see why.

What about the national debt?

An objective of the previous Chancellor George Osborne has been achieved again but of course to late for him.

This month debt as a percentage of GDP fell by 1.0 percentage point compared with September 2015. This is the fourth successive month of debt falling on the year as a percentage of GDP and indicates that GDP is currently increasing (year-on-year) faster than net debt excluding public sector banks.

The official numbers tell us this.

Public sector net debt (excluding public sector banks) at the end of September 2016 was £1,627.2 billion, equivalent to 83.3% of gross domestic product (GDP); an increase of £39.5 billion compared with September 2015.

However these are different to what is the usual international standard so here is that version.

At the end of the financial year ending March 2016, UK government gross debt was £1,651.9 billion (87.8% of GDP).

Unfortunately those numbers are from further back but whilst the total is rising the percentage ratio to GDP has also been falling.

Term Funding Scheme

The new bank assistance scheme of the Bank of England will raise the national debt but reduce borrowing.

that (all else being equal) Public Sector Net Debt will be increased by the liability relating to the creation of the central bank reserves and Public Sector Net Borrowing will be decreased by the net interest flows relating to the TFS loans and central bank reserves.

So far it amounts to £1.279 billion.


We find ourselves noting yet again that the UK fiscal performance is disappointing. Or at least it was under the old plan! Maybe now borrowing a little extra is considered a success. Of course this means that the room for extra borrowing by the Chancellor Phillip Hammond in the upcoming Autumn Statement declines. Oh what a tangled web and all that. Also because we have had economic growth we have seen our national debt to GDP ratio fall as growth exceeds borrowing.

The next challenge will come in 2017 as inflation continues to pick up and the UK faces a benefit as indirect taxes are on nominal not real spending but also a loss as it will have to pay extra on index-linked debt. The government could win as the ordinary person loses but the bigger picture depends on economic growth. If we continue to grow then there will be a range of choices,if we do not then it will get harder. Meanwhile it is hard not to have a wry smile at one of the reasons for the increase in government expenditure both in September and in the fiscal year so far.

along with subsidies and contributions to the EU


19 thoughts on “The UK Public Finances continue to underperform the economy

  1. As interesting as ever, Shaun.
    I would say that deficits are unlikely to come down much, because:
    1. QE has made it so much easier to borrow;
    2. The entire political dialogue is about whether “austerity” should end (although I am not sure whether government spending has actually fallen);
    3. Politicians like to spend money;
    4. No-one is stopping them (where are the bond vigilantes?);
    5. The central banks seem to be signalling that they are running out of ammunition and are actually encouraging deficits.
    6. The media dialogue is so poor. Why, for example, when introducing programmes about the NHS being underfunded, don’t commentators point out that 75% of the whole cost is not covered by taxation? Or the whole of education, police and defence?
    I don’t think that 1% of the population has any idea just how large the deficit is.

    • Hi James and thanks

      As to QE I think that its biggest success has been to allow governments to spend more via cheaper borrowing costs. This “independent” move would never have been allowed if the poltiicians had been explicitly in charge.

      As to the bond vigilantes a lot of bond desks were closed -usual sense of timing as the last year was a good one for those who remained- and I guess those that remain simply front-run the central banks these days.

    • Excellent !
      The elites seem to have wandered off into a world of their own, where everything is rosy and, by using jargon, they can both pretend to be above the plebs and fool the mainstream media…

  2. Inflation does not raise Govts. payout on index-linked bonds, as the money is worth the same amount less; that’s the purpose of index-linking, no-one loses, no-one gains.
    However term rate bonds lose value with higher inflation, and become relatively cheaper to repay.
    That’s the real reason govts are so keen on inflation, and deflation nutters.

        • if inflation goes from 2% to 8%, interest costs increase 400%.

          Or to express interest costs another way, the NHS budget is 4.5% of GDP. 90% national debt multiplied by 8% is 7.2% GDP.

          What are you going to cut to pay additional interest costs ?

        • If inflation costs are 100% (over term) then an index-linked bond of face value £1m would be paid out at £2m, BUT because of inflation, that £2m is only worth the original £1m, because of inflation, SO it’s as easy to pay the final £2m at the end of the term, as the original £1m was at the start.
          This is not complicated stuff, simple arithmetic, unambiguous and unarguable, so what’s the difficulty?

        • The difficulty is your unspoken assumption that wages increase in line with inflation, which they have only done sporadically since 2009.

          If wages don’t pace inflation then Government is faced with falling tax revenue adjusted for inflation (although there is some rescue from VAT receipts as they will pace inflation until things become too expensive as wages fail to pace inflation along with the further inflationary effect of VAT and demand collapses) and either has to increase income tax/national insurance contributions, issue extra debt or make spending cuts to bridge the gap or a mixture of all these avenues.

          Your argument suggests that the Government can simply issue unlimited debt, print money to repay the debt and spend in unlimited amounts with no hazard. Google the Weimar republic to find out how that approach ended.

        • Indeed my argument does rely on that premise, however, with the exception of housing, the price of which I’d think we’d all agree had been grotesquely distorted, I believe that’s fair, especially in the longer term.

        • Interest is paid twice annually, not at term. If you want to check this -> read the terms and conditions of index linked bonds on the DMO website.

  3. Hi Shaun
    Great piece as usual.
    The often repeated tale of Chancellor Dennis Healey going cap in hand to the IMF I think in 1976 seems strange in regard to our current plight.
    Yeas we had inflation in the teens but public sector debt was less than 60% of GDP and private sector debt negligible.
    We now have a situation of a rapidly depreciating currency a fraction of the manufacturing capacity we had then and a heavily indebted nation,if gilts start to sell off as foreign investors decide it is not good to hold gilts which pay a pawltry return in a currency that is not a store of wealth then we could be i real trouble very quickly,as the monetary and financial system is based on confidence that could evaporate very quickly.

  4. Shaun,
    I hear the Chinese Yuan now included in the SDR of central banks and that other major currencies have reduced weighting as a result (US$ reduced from roughly 43% to 41%). Perhaps the reduced £ weighting and early wire from Asia could possibly account for the flash crash pounding ?

    • Hi Chris

      That officially took place at the beginning of the month with central banks being aware for some time. So maybe a nudge downwards for the UK £ in 2016 but I doubt if it all happened on one night/morning.

      Meanwhile though this is happening as I pointed out on the 10th of this month.

      “David Ingles ‏@DavidInglesTV Oct 21
      Chinese currency is falling further. USD/CNY now past 6.75 (very close now to the “peg” during the GFC when China was saved the world)”

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