The UK Public Finances hint at a strong underlying economy

Yesterday saw the IMF join the chorus expecting better economic times ahead.

The cyclical upswing underway since mid-2016 has continued to strengthen. Some 120 economies, accounting for three quarters of world GDP, have seen a pickup in growth in year-on-year terms in 2017, the broadest synchronized global growth upsurge since 2010…….Global growth for 2017 is now estimated at 3.7 percent, 0.1 percentage point higher than projected in the fall. The stronger momentum experienced in 2017 is expected to carry into 2018 and 2019, with global growth revised up to 3.9 percent for both years (0.2 percentage point higher relative to the fall forecasts).

Part of this was due to revising the US economy upwards( ~0.4%) due to the Trump tax cuts. This was obviously so painful to the IMF that it could only get some relief by revising the UK down a little in 2019. In reality the UK is likely to be pulled higher too by the global upswing as even Lord O’Neil formerly of the Vampire Squid now admits. From the BBC.

Britain should prepare for a much more economically optimistic 2018 because global growth is better than predicted.

That’s the argument of Lord Jim O’Neill, the former Conservative Treasury minister and Remain supporter.

He said Britain’s growth forecasts are likely to be upgraded as China, the US and Europe show increased activity.

Fair play to him for having the courage to correct past mistakes and the only worrying part of all this is that too many establishment groups and figures are telling us the future is bright! Just look at their track record……

PFI

Moving to the public finances there has been a fair bit of news on the Public Finance Initative or PFI front post the Carillion liquidation which I looked at on Monday last week.  The National Audit Office pointed out the scale of the issue late last week.

There are currently over 700 operational PFI and PF2 deals, with a capital value of around £60 billion and annual charges for these deals amounted to £10.3 billion in 2016-17. Even if no new deals are entered into, future charges which continue until the 2040s amount to £199 billion.

These schemes have brought some benefits but they have also brought problems mostly because the real rationale as I have pointed out many times was this.

However, most private finance debt is
off-balance sheet for National Accounts purposes.

The politicians doing this in effect get a benefit such as a new hospital but shift the burden of paying for it into the future and thus worsen the future public finances.

Unlike conventional procurement, debt raised to construct assets does not feature in government debt figures, and the capital investment is not recorded as public spending even though it is for the public sector.

In essence the projects are driven by the rules of our national accounts ( more specifically avoiding being measured….) rather than any economic gain.

PFI can be attractive to government as recorded levels of debt will be lower over the short to medium term (five years ahead) even if it costs significantly more over the full term of a 25–30 year contract.

You don’t say!

Today’s Data

The news opened in positive fashion.

Public sector net borrowing (excluding public sector banks) decreased by £2.5 billion to £2.6 billion in December 2017, compared with December 2016.

There were strong performances on the receipts side with Income Tax receipts up by £700 million and VAT ( a sales tax) up by £600 million. There are hints there of underlying economic strength and of course the higher VAT receipts give a rather different picture to what we were told by the retail sales numbers. On the expenditure side there was something to give a wry smile in the circumstances.

In December 2017, the UK’s net contribution to the European Union (EU) was £1.2 billion lower than in December 2016.

Okay why?

December can see atypical payments between member states and the EU. December 2017 saw a credit to the UK of £1.2 billion following the adoption of agreed amendments to the 2017 EU budget which reduced the size of the 2017 budget and adjusted member states’ contributions to reflect updated economic forecasts.

Or maybe someone has a sense of humour as it will all come out in the wash anyway. Also we need to note that a regular feature was still there as debt costs were higher by some £500 million which will be mostly driven by higher payments on index-linked Gilts affected by the fact that the Retail Prices Index has pushed over a 4% annual rate of growth.

Perspective

This too as you might imagine was given a boost by the December data.

Public sector net borrowing (excluding public sector banks) decreased by £6.6 billion to £50.0 billion in the current financial year-to-date (April 2017 to December 2017), compared with the same period in 2016.

This means that the first rule of OBR Club had yet another good year in 2017 as you will note from its November review of the state of play. The emphasis is mine.

That said, the public finances have performed better than expected. The ONS has revised borrowing in 2016-17 sharply lower, relative to its initial estimate and our March forecast. And the deficit has continued to fall in the first half of 2017-18. We have revised borrowing down by £8.4 billion to £49.9 billion for the full year,

Thus the OBR is left in the awkward situation of hoping that the UK Self-Assessment season for Income Tax is a poor one. Such a view will not be helped by the December data being good although the data can be erratic.

Here is a breakdown of both sides of the ledger.

In the current financial year-to-date, central government received £504.0 billion in income, including £376.8 billion in taxes. This was around 4% more than in the same period in the previous financial year.

Over the same period, central government spent £538.9 billion, around 3% more than in the same period in the previous financial year.

As some of the expenditure increase is caused by the rise in inflation via its impact on index linked Gilts then we do indeed have austerity if you define it as expenditure rising by less than the rate of inflation.

What about the National Debt?

We come into the real lies, damned lies and statistics section here. But let me try and shin a little light. Over the past year it has risen but mostly that has been due to some credit easing ( Term Funding Scheme) by the Bank of England. Over the past year it has raised the National Debt by £89.1 billion and as you can see below this makes a difference to whether it is going up or down.

Public sector net debt (excluding both public sector banks and Bank of England) was £1,591.4 billion at the end of December 2017, equivalent to 77.2% of GDP, a decrease of £26.8 billion (or 3.6 percentage points as a ratio of GDP) on December 2016.

Sadly there is still a lot of manipulation and misrepresentation going on as the main cause of the fall is what happened to the Housing Associations.

As of the end of October 2017, English HAs’ net debt amounted to £65.5 billion, which from November 2017 is no longer to be counted as public sector debt.

It is rarely reported that we use a completely different system to that used by the ratings agencies and the Maastricht criteria so here is the latter.

general government gross debt was £1,720.0 billion at the end of March 2017, equivalent to 86.7% of gross domestic product (GDP); an increase of £68.1 billion on March 2016…general government deficit (or net borrowing) was £46.9 billion in the financial year ending March 2017 (April 2016 to March 2017), equivalent to 2.4% of GDP; a decrease of £29.0 billion on March 2016.

It is like a numerical equivalent of alphabetti spaghetti isn’t it?

Comment

As we try to peer through all the attempts to deceive us about the UK public finances then we get a perspective on this announcement from the UK government. From The Times.

Theresa May is set to authorise the creation of a rapid response unit to stop fake news spreading online.

The team, which will be based in the Cabinet Office, will be tasked with monitoring social media to identify and challenge disinformation.

Time for some Depeche Mode.

It’s too late to change events
It’s time to face the consequence
For delivering the proof
In the policy of truth

Never again
Is what you swore
The time before
Never again
Is what you swore
The time before

The reality is that things are getting better albeit we are still a fair way away from the “promised land” of a surplus which we should be used to by now. As ever it is just around the corner. As to the underlying economy even the CBI seems optimistic looking ahead.

The survey of 369 manufacturers revealed that optimism about both business conditions and export prospects improved at an above-average pace.

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.

Comment

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

 

Have our banks got better or instead have they got worse?

One of the fundamental issues of the credit crunch era is what to do about our banks? The Too Big To Fail or TBTF strategy has left us in a situation where the banking sector is one with a moral hazard at its core. Everybody now knows that there will be privatisation of profits and socialisation of any losses giving directors of banks something of a one-way bet. Heads they win and tails we lose (with them usually still winning). As this was implicit in the past rather than explicit as it is now we find that we may in fact be worse off contrary to all the official denials. After all we know what to do with official denials.

This privatisation of profits and socialisation of losses was most marked in the UK at Royal Bank of Scotland with its purchase of ABN-Amro as highlighted recently by Andrew Bailey of the Bank of England.

The low risk weights assigned to trading assets suggested that only £2.3 billion of core tier 1 capital was held to cover potential trading losses which might result from assets carried at around £470 billion on the firm’s balance sheet.

We know of course what happened next.

In fact, in 2008 losses of £12.2 billion arose in the credit trading area

This meant that for the rest of us a measure of the UK National Debt soared into the stratosphere. At the end of 2006/07 the UK’s National Debt to GDP ratio was an apparently fiscally conservative 36%. By the time we fully accounted for the various bailouts it was this in December 2010.

net debt excluding the temporary effects of financial interventions was £889.1 billion, equivalent to 59.3 per cent of gross domestic product (£2322.7 billion, equivalent to 154.9% including interventions).

First of all we have the impact on the headline figure and then boom! Apologies for those of a nervous disposition as our debt shot higher. I was one of the very few who covered these numbers and have written before of their many flaws but they give a ballpark idea of our potential exposure.

A Name Change

One of the most ominous developments in a situation is a name change as the Public Relations industry tries to solve the problem of a toxic brand by rubbing it out and introducing a shiny new one. On this road the leak prone nuclear reprocessing plant Windscale became the initially leak-free Sellafield. Well TBTF has made a similar journey as it is now called SIFI or Systemically Important Financial Institution.Do we feel better already?

Bills,Bills,Bills

These are of course fines but I think that the banks treat them as a bill just like the Destinys Child lyric or a cost of doing business. Yesterday saw Barclays and RBS  hit with these and we fined Barclays ourselves.

The Financial Conduct Authority (FCA) has imposed a financial penalty of £284,432,000 on Barclays Bank Plc (Barclays) for failing to control business practices in its foreign exchange (FX) business in London.

Whilst on the face of it seems like action there are various problems here. Current Barclays shareholders are paying for a problem which they really had no control over and of course may not even have been shareholders then. What about punishing those who did this? After all some were openly admitting to fraud.

“If you aint cheating, you aint trying”

Yet again there seems to be something of a shortage of criminal prosecutions as we wonder if any sort of banking financial crime would get a jail sentence. We do seem to treat other types of fraud such as benefits fraud much more harshly. From Poole Council’s website.

A Poole man was given a 12 month custodial sentence for stealing over £88,000 from the public purse.

Meanwhile there is the issue of whether the shareholders were in fact punished. From Adam Parsons of the BBC.

Shares then go up up 3.37% Means Barclays now worth £1.5bn more than it was before the £1.5bn fine.

Next if we look at the international issue is a wealth transfer from the UK to the United States as the fines from it to UK banks go on and on.

Barclays, which was involved from as early as December 2007 until July 2011, and then from December 2011 until August 2012, has agreed to pay a fine of $650 million;RBS, which was involved from at least as early as December 2007 until at least April 2010, has agreed to pay a fine of $395 million.

The US Federal Reserve fined them too for US $342 million (Barclays) and US $274 million (RBS). This is particularly awkward in the case of RBS which has of course the UK taxpayer as a majority shareholder. Exactly what guilt does the average UK taxpayer have?

Market Manipulation

Often forgotten in the melee is the impact on financial markets. We have seen that foreign exchange and interest-rate markets (LIBOR) have been rigged to the banks benefit which begs the question of what other markets have been? For example was it a coincidence that the oil price and indeed the price of several other basic commodities fell after many banks closed their commodity trading desks. By the time that central banks have manipulated so many markets too what is left.

Of course central bank market manipulation is treated as welcome rather than illegal but even Andrew Bailey of the Bank of England admitted that there seem to be “side-effects”.

On 15 October, 10 year US Treasury yields moved intra-day by around 8 standard deviations of preceding daily changes. On 15 January, the Swiss Franc moved by more than 30 standard deviations. For rough scale, an 8 standard deviation move should happen once every three billion years or so for normally distributed data.

Of course we had the flash crash in Euro area bond markets only recently.So what is proclaimed as making us safer is at best making markets more skittish.

What did governments do for revenue before they fined banks?

As the fine revenues pile up let us not forget that there were other type of fine imposed on the banks in the UK which were the bank payroll tax and the banks levy. As of the end of the 2103/14 tax year we had received some £8.8 billion. This has its issues as of course we were in some cases fining banks we then owned!

What we used to do was tax banks via Corporation Tax but receipts have collapsed from £7.3 billion in 2006/07 to £1.6 billion in 2013/14. There is of course a much wider problem with corporate taxation as companies shuffle money around the globe to avoid it. I saw an odd BBC interview with Bono and the Edge from the band U2 who apparently approve of this,well for their own affairs anyway! But conventional revenues like this from the banks took a heavy knock. So we now fine them which is often a sort of fining ourselves. are we fining the profits they have made from the cheap funding given to them by the Bank of England in a form of “round-tripping”?

Of course we could follow the American model and mostly fine foreign banks….

What about the regulators?

One more time we face the famous latin phrase.

quis ipsos custodiet custodes (Juvenal)

Who watches the watchmen? This is a very relevant question as time and time again we see evidence of “regulatory capture”. This involves regulators later moving to banks for example. From Sky News.

Barclays has hired the former chief executive of the Financial Services Authority (FSA), Hector Sants, as its head of compliance.

We are continually told “this time is different” and yet more and more scandals emerge. Perhaps the “exhaustion and stress” from which the newly knighted Sir Hector suffered was from the emergence of all the scandals on his watch.

Frankly regulators seem to have more enthusiasm for suppressing scandals than investigating them.

Comment

The essential problem is how much has improved over that past eight years or so? We get regularly told this both openly and more subliminally.  Yet we remain in a situation where as I discussed yesterday where interest-rate rises seem impossible and the housing market has been pumped up one more time to improve the balance sheets of the banks. As so often before we find ourselves asking what happens if we go in a recession again? After all the numbers keep getting larger. From Andrew Bailey.

Financial market activity has grown rapidly. There are many statistics that could be quoted, so to choose one, over the last 15 years, global bond markets have grown from around $30 trillion in 2000 to nearly $90 trillion today.

I fear that we have gone backwards rather than forwards after all the cavalry of the Vickers Report will not arrive until 2019. That is of course assuming that the cavalry do not suffer from regulatory capture on their amazingly slow journey.