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Should we worry about the public debt?

In April the OBR published a ‘reference scenario’ which predicted that tax receipts will fall by £130bn in 2020/21 against the Budget projection and spending will be £88bn higher. Public sector net borrowing (the deficit) will rise to its highest level since WWII at £273bn in 2020/21, or 14% of GDP. This was revised upwards in May 2020 to reach £300bn in 2020/21.

Year-to-date (£billion) graph, year 2019-20, 2020-21 and reference scenarion

The latest ONS data for April 2020 shows that government borrowing reached £62bn in April 2020, £51bn more than in April 2019. This is the highest monthly borrowing since records began in 1993.

Immediate term impact

In the immediate term, the increase in public debt should not be too concerning:

  1. There is simply no alternative to rapidly increasing government spending in order to support businesses, jobs and financial markets. Without these automatic stabilisers and discretionary support measures, the economy would be caught in a negative feedback loop, which would simply increase the pressure on the public finances over a longer period.
  2. For the time-being at least, government borrowing costs are at record lows and the market has shown a continued appetite to purchase government debt, helped somewhat by central banks purchasing assets and keeping yields low. The Debt Management Office (DMO) recently issued £3.8bn of three-year gilts at yields of negative 0.003%, and there was still demand for these gilts among investors.

    This is in stark contrast to the yield on Greek debt in the wake of the sovereign debt crisis in May 2011, in which three-year bonds yielded 24% and ten-year bonds yielded 10%.
  3. There is little change in the amount of debt interest payments the nation is ultimately making and government payments on debt interest as a share of revenues has remained broadly flat at 3.6%. This gives the Chancellor room to manoeuvre within the 6% cap set by his predecessor, Sajid Javid.

Long term impact

In the long-term, there is a risk that over time, the market starts to question the sustainability of the UK’s debt, particularly if the economic effects of the pandemic last for longer than expected.

If this happens, the government’s borrowing costs will rise, making the debt even less sustainable and risking a solvency crisis. In this case, the government will have to send a signal to markets that they are committed to controlling their deficit through decisive action to increase taxes or reduce spending.