The Fiscal Cost of Tackling Coronavirus Nick Keeling

Some startling but perhaps not unexpected numbers have been bandied about over the last couple of days. As the Office for National Statistics published the full year 2019/20 figures for the public sector finances, forecasts from thinktanks and economists highlighted the possible path for government debt.

The ONS reported a rise in the government borrowing for financial year 2019/20 to £48.7bn, up £9.3bn on the previous year and £1.3bn above the OBR’s forecast. Given the much-hyped end of austerity ahead of and following the general election, at face value this wasn’t a particularly large rise. However, the ONS was at pains to point out that the figures did not fully reflect the effects of coronavirus, as the estimates used for the latter months of the year will not have included the government’s policy response – so treat with caution was the message. The OBR stated that borrowing for March could be revised significantly higher.

Any revision to the 2019/20 figures will still pale in comparison to 2020/21. Despite the late year impact of coronavirus and the on-going impact of Brexit (remember that?), these figures essentially represent a look back at the pre-coronavirus world – just a month into the new financial year and the economic outlook is worlds away from what we could have expected a short time ago. The lock-down, both here and globally, and the government’s overwhelming but necessary fiscal response will prompt borrowing figures for 2020/21 that would have given even John McDonnell nightmares.

In its statistical release, the ONS rather dryly stated that coronavirus is “expected to have a significant impact on the UK public finances”. Other bodies have more leeway. The director of the Institute for Fiscal Studies suggested to the BBC that the budget deficit could be as high as £260bn in 2020/21, while the Centre for Policy Studies suggested a deficit a hair above £300bn (15% of GDP!). As noted above, not unexpected. After all, government spending is increasing massively as it funds its various rescue packages, while tax revenues have plummeted during the lockdown. It is clear that, as a percentage of GDP, total government debt will exceed 100%.

HM Treasury has responded with plans to raise £180bn through gilt issuance in the three months to July, adding to the £45bn already borrowed/scheduled for April. While the DMO expects this rate of borrowing to slow during the rest of the year, full year issuance is currently scheduled at around £340bn. This compares to £156bn announced in the Budget in March.

Of course, the elephant in the room is the length of the lockdown and the speed of the post-lockdown recovery. Will the government’s packages need to offer support for longer than three months? Will tax revenues recover quickly after the lockdown ends and, importantly, will virus outbreaks reoccur requiring more spending/restrictions? The latter scenario raises the spectre of significant increases in government borrowing not just this quarter/year, but perhaps in future quarters/years as well. A deficit of £300bn may be just the start of an incremental creep upwards in deficit forecasts.

The actual question is whether we should be concerned about the increase in debt. The Bank of England helpfully expanded its asset purchase programme by an extra £200bn, basically the size of the government’s additional borrowing – the government issues gilts, investors buy gilts, investor sell gilts to the Bank of England. Quite neat. And it could continue – after all, if government tax revenues are not recovering, it means the economy remains weak, perhaps necessitating further monetary stimulus by the Bank…

Perhaps the exceptional money growth created by central banks should have us concerned about inflation. The deflationary impact of the economic stop will be significant this year, but it will pick up in subsequent years, if only because oil prices will rise from current extremely low levels. Given the likelihood of subdued consumer demand for a prolonged period, we can be relatively sanguine about producers/retailers’ ability to pass on price rises. Financial asset price inflation is, however, another story.

With the Bank of England buying the bonds issued by the government and keeping rates exceptionally low, and with little signs of inflationary pressure, the sharp increase in government debt is unlikely to prompt a jump in government borrowing costs in the short term. Given that the cost of government borrowing affects most borrowing costs in an economy, this is a modicum of good news in these troubled times. And it further supports our long held ‘lower for longer’ view for UK interest rates.