Rishi Sunak faces tough decisions in the coming years as officials warned his borrowing plans are unsustainable, while the Government’s record mountain of debt raises the risk of an interest rate shock trashing the national finances.
The Chancellor is keen to keep borrowing and spending to avoid smothering any economic recovery, but analysts fear he is building up problems for the future.
Government borrowing will rise to almost £400bn this year, the OBR estimates, and stay at £100bn or more each year all the way out to 2025-26.
Richard Hughes, the new head of the Office for Budget Responsibility (OBR), said Sunak must find tens of billions of pounds by the middle of the decade even to cover day-to-day spending without borrowing, let alone other costs such as investment.
“While the Chancellor’s spending review has made a £10bn downpayment on that adjustment [by trimming future non-Covid spending], a further £20bn to £30bn will be needed to meet the loosest conventional definition of balancing the books, and arrest the rise in the underlying debt-to-GDP ratio by the end of the forecast horizon,” he said.
There has been little urgency to crack down on spending because of the depth of the crisis and the ultra-low borrowing costs paid by the Government.
But officials fear that risks will grow the longer the borrowing spree continues.
“While the Government has not struggled to borrow what it needed to fight the virus and mitigate its economic effects, it has in the course of doing so already accumulated a stock of debt three times higher than we had 20 years ago. While the interest rates we’re paying on that debt are one-sixth of what they were at the turn of the century, there is no guarantee that they will remain so,” says Hughes.
“Indeed, history warns that interest rate rises can happen much faster than debt can fall.”
Economists expect the Chancellor will end up spending more than he has pencilled in, meaning even more tough decisions in future.
“Rishi Sunak has been spending truly astonishing amounts of money this year and plans to continue to do so next year in response to Covid. Yet this was a spending review in which he reduced planned spending into the future, cutting more than £10bn per year from departmental spending plans next year and for subsequent years,” says Paul Johnson at the IFS.
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He adds that more Covid spending may be needed beyond that planned for next year. “It seems more likely than not that spending will end up significantly higher than set out today, and so borrowing in 2024-25 will be considerably more than the £100bn forecast by the OBR. Either that or we are in for a pretty austere few years once again, or for some significant tax rises.”
The Chancellor has taken few steps in this direction.
The international aid budget has been trimmed from 0.7pc of GDP to 0.5pc, for instance, and a minority of public sector workers will have their pay rises paused - a larger share, made up of NHS workers plus those earning less than £24,000, will still get salary increases.
These modest steps can be seen as a sign to markets that the Chancellor has not forgotten the basics of financial planning, according to Mel Stride, chair of the Treasury select committee.
“They are early reveals of the difficult things he will have to do on spending and tax further down the line,” he says. “[Sunak] has got to signal, not least to the markets, that the Government is serious about tackling the deficit when it is right to do so, and now is not the right time. But at the same time he doesn’t want to suck animal spirits out of the economy.”
However, restoring balance is not simply a matter of cutting spending back to old levels after the pandemic has passed.
Firstly, tax revenues have taken a battering, and may be slow to recover.
The OBR expects the economy to be 3pc smaller in 2025 than it would have been without the pandemic, as official estimates point to a record plunge in GDP this year.
As a result its forecast for income tax, for instance, is about £20bn a year lower than it was back in March, indicating that even in 2025 the Government will be short of funds.
Secondly, spending pressures are rising regardless of Covid.
“When we think about the long-term, we think about the pressures from an ageing population, and in particular the pressures we have seen over many decades in the health system where cost pressures typically put upward pressure on spending that Governments in the past have accommodated,” says Andy King, a member of the OBR's budget responsibility committee, when asked if there is any chance of the books being balanced even many years in the future.
“So all of the projections we have produced in the past would show the deficit - on unchanged policy - on a rising path, an unsustainable position.”
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