Summary
The UK's current Prime Minister, Boris Johnson, is under siege.
In early June he survived a vote of 'no confidence' with 148 MPs voting against him
Yesterday two senior ministers resigned; one of them was his Chancellor
In a speech before the 'no confidence' vote he commited to tax cuts should he win
This blog looks at the UK's public finances to provide some context for those proposed tax cuts.
In common with many governments the UK has increased its debt to GDP ratio over the past decade and a half
From around 40% in 2007 Debt to GDP now stands at over 100%
The UK also has an unusually high amount of Inflation-Linked Bonds
Introduction
In this blog post we look at the public finances of the UK. This is the first of two macro-economic analyses of the United Kingdom. This introductory post will lean on fiscal policy, looking at borrowing and taxation. The subsequent post will look towards monetary policy and the role of the Bank of England in setting its policy rate and the wind down of the Asset Purchase facility,
This analysis follows directly on from earlier studies which examined the different pressures facing the Federal Reserve and the ECB as they tackle inflation. These prior posts focussed on the different circumstances faced by these two central banks to explain their different policy responses to date.
Secular increases in Debt to GDP for G20 countries
In common with most G20 countries the UK has seen its level of debt increase significantly over the last decade and a half. Before the financial crisis its debt to GDP ratio was around 40%. Gordon Brown had instigated a ‘Golden Rule’ of borrowing only for future investment, not to fund current spending. The shock of the financial crisis and the Covid-19 pandemic has seen the level of UK Government borrowing increase to over 100% of GDP. While far from the most indebted country by this measure, the UK has seen its Debt to GDP grow faster than any other country in Europe than Spain since 2019.
Figure 1: Increase in UK Debt to GDP ratio
The composition of UK Govt Debt
Long dated and Index Linked
The UK does have a very long dated debt profile. In a previous blog post we drew attention to the fact that Italy would need to refinance €674Bn of its debt in 2022/2023. In contrast the UK has only £79Bn of debt maturing in 2022, with and additional £113Bn in 2023.
Figure 2: Maturity profile of UK Govt Debt
Significantly the UK has issued a large amount of index-linked Gilts, linked to UK RPI. While ordinarily inflation eases the burden of debt repayment this is not the case if the debt principal grows based on an inflation index.
Compounding your problems
The effect of compounding means that the long dated debt is of particular interest. £31Bn of linkers mature in 2029 (see figure 3 below). One hopes that RPI will decline from its level of 11.7%. Indeed the longest time that it has remained persistently above 10% is the three years from April 1979 to March 1982.
Nevertheless it is sobering to reflect that were it to stay at that level this would increase the principal of these Linkers maturing in 2029 to around £109Bn.
Figure 3: Maturity profile of UK Inflation-Linked Bonds
More sobering still is the fact that around £202Bn of very long dated issues mature between 2030 and 2072. Compounding means that the current RPI levels need to be tamed, or servicing the interest and principal on these issues will become more challenging.
An under-fire PM committed to tax cuts
The current UK Prime Minister is under pressure. He has just survived a bruising vote of no confidence from within his own party, with 148 of his MPs voting against him. And as I type the first draft of this blog has just lost his Chancellor and his Health Secretary. (A gift to bloggers?)
An obvious approach that he may consider is shoring up support within his party and with the electorate with a series of tax cuts. Indeed Boris Johnson promised this in a speech before the no-confidence vote in early June 2022. In the remainder of this blog we will set out the state of the UK public finances as clearly as we can to assess his room for manoeuvre.
Many countries in the world have seen levels of government borrowing increase over the past decade and a half.
Firstly in response to the great financial crisis and,
To fund stimulus programs to counter the effects of lockdowns to slow the spread of Covid-19
Both these effects are evident in the figure 1 above which shows the level of UK borrowing with respect to GDP.
Indeed the increase in UK government borrowing as a percentage of GDP from December 2019 to December 2021 was one of the highest in Europe, lagging only Spain as can be seen in the figure below.
Figure 4: Recent increases in Debt to GDP ratio for selected coutries
This has pushed UK indebtedness 14.6% above the EU average; less than Portugal, Italy, Greece, Spain and France; but above Germany, Ireland, The Netherlands and Sweden as can be seen in the figure below.
Figure 5: Debt to GDP ratios of UK and EU27
The debt maturity profile of the UK is shown in the figure 2 above. One can see that over half the outstanding debt is not due until the next decade at the earliest. Compare this to Italy which has a much shorter average maturity and €674Bn due in 2022 and 2023. However the picture is perhaps more complex than this suggests. As previously mentioned the UK does have a large amount of inflation-linked debt.
A large amount of RPI-Linked debt
According to the UK Debt Management Office Inflation-Linked Gilts comprise around 25% of the Gilt portfolio. Information from Barclays allows us to compare that with levels from other countries. The countries with the highest level of inflation-linked bonds relative to total debt outstanding are shown in the figure below.
Figure 6: Proportion of index linked debt for selected countries
One can see that the United Kingdom has a far greater proportion of its national debt linked to inflation. The inflation index used for these bonds is RPI, which is currently running at over 11% in the United Kingdom. The maturity profile of the UK's inflation-linked Gilts can be seen in figure 3 above.
UK debt interest: £2Bn a month in '07 to over £6.3Bn a month in '22
With 25% of the UK’s debt in the form of Inflation Linked Gilts the levels of inflation have a material impact on the interest payable on government debt. In the chart below you can see the monthly interest payable from the UK Treasury. In the run up to the financial crisis one can see that the average monthly interest was around £2Bn. With the increase in debt issuance that has risen steadily to over £6.3Bn in 2022.
Figure 7: UK Debt interest payments per month
In common with comparable governments the UK does not currently run a budget surplus. Borrowing is needed to fund public services. Over the calendar year of 2021 the UK had the second highest deficit as a percentage of GDP of all the G7 countries, as can be seen in the figure below.
Figure 8: 2021 G7 Government deficits
Conclusion
In the first part of this analysis of the UK public finances we have looked at the amount of sovereign debt outstanding
We’ve seen that (in common with comparable countries) this has increased markedly. Firstly in response to the great financial crisis and more lately with respect to the Covid pandemic
We’ve seen that the UK has a very large proportion of Index-Linked Gilts outstanding. In recent times this is perhaps of little consequence, but given the current surge in inflation it is becoming an area of importance.
The UK currently has a Prime Minister battling confidence votes in his party and resignations of senior ministers. In his speech before the confidence vote he laid out his plans for his remaining time in office should he win and committed to tax cuts.
Given the state of the UK finances his room for manoeuvre in this area is not zero, but it is limited.
One might therefore speculate that a desire to reduce taxation, at least in part, may be a reason for the resignation of his chancellor.