Massive debt write-off could be only way to save economy, warns OBR boss
A massive write-off of toxic Covid debt may be the only way to save the economy from stagnation as thousands of businesses struggle to survive, the new head of the spending watchdog has warned.
Repayments on £45bn of taxpayer-backed loans could be linked to companies' revenue, said Richard Hughes of the Office for Budget Responsibility (OBR) - with any money outstanding after a set timeframe simply cancelled.
Mr Hughes said that firms of all sizes may otherwise drown due to the weight of debt borrowed to get through lockdown, derailing the recovery before it even has a chance to begin.
Government schemes such as the Bounce Back Loan programme have allowed businesses to borrow lifeline cash from their bank, with taxpayers covering at least some of the lender's losses if the money is not paid back.
However, it is feared that this support could switch from being a vital short-term boost to a long-term millstone as recovery begins in earnest.
Speaking to MPs on the Treasury Select Committee, Mr Hughes said: “The longer the crisis goes on for, the more likely it becomes that Government-guaranteed loans become less of a facilitator of the recovery and more of a burden, because firms have built up large stocks of debt which they will struggle to write off.
“The more that debt is a burden on companies, the less they will invest.”
One solution could be to turn the Government guarantees into a student loan-type system, he said, with companies paying a share of their revenues over several years.
Those which have still not paid the loans back over a set period could have the rest written off. Mr Hughes suggested that 5pc of companies' revenues could be taken each year.
He said: “I’ve advocated making the repayment of these debts earnings-contingent, so that firms aren’t being asked to pay back more than a percentage of their turnover in a given year, so these debts don’t become a burden on their ability to invest."
This would likely lead to multi-billion pound losses for the taxpayer, but Mr Hughes said that the state should expect losses in any case.
Hong Kong offered guaranteed loans in the SARS outbreak, which was far smaller than the Covid-19 pandemic, and around 10pc of borrowers defaulted on their debt.
He said: “SARS was a very short, sharp shock to the economy of Hong Kong. This has already proven to be a virus of longer duration and greater severity, so you would expect more of those loans to be called."
Business groups backed the idea for a student loan-type scheme but called for it to be based on profits rather than revenues.
This would mean that companies would only pay when they are making money again. In a revenue-based system it is likely that companies such as high street shops would suffer because they have high turnover but low profits.
Edwin Morgan, of the Institute of Directors, said: “Our figures suggest corporate debt could cast a shadow over investment plans for some time.
“We’ve called for a student loan-style system, by which firms pay back as they recover. Profit is a much better indicator of business recovery than revenue, particularly with adjustment costs kicking in. The profits-based approach also benefits from simplicity, as it could potentially latch onto the existing corporation tax.”
Mike Cherry at the Federation of Small Businesses said: “If, as seems likely, there will be a significant number of small firms unable to start repayments in a year’s time, then the option of a longer-term payback period akin to the student loans system should be seriously considered.
"The fairest and most targeted measure of a small business’s ability to pay would likely be profit. A small firm in a low-margin sector could have a relatively high turnover, but would have a lot of pressure on that money to pay the bills, so would lose out under a system which was based on assessing turnover compared to a high-margin business.”
Charging a percentage of profits is likely to be resisted by the Treasury due to fears companies would game the system to keep repayments down, for example by artificially inflating their costs.
Mr Hughes said the Covid recession is likely to be shorter and less deep than initially feared, but still enormous in scale.
He said: “What high-frequency data has told us so far is that we reached the nadir of economic activity a lot faster than we thought. April seems to have been the low point and activity started recovering in May.
“The thing to bear in mind is that what matters less is how quickly things went down on the down slope or how quickly they are starting to recover, but actually how far are we are going to get back the 25pc loss of output that we have already faced.”
Activity fell by around 25pc rather than the 35pc previously anticipated, he said.
Bank of England Governor Andrew Bailey also said there are signs of recovery.
In a speech to schoolchildren, he said: “We are seeing the economy come back now somewhat. The restrictions are beginning to be lifted and as they are we are all starting to do things and that is bringing some activity back.
“But there is a long way to go. We’re very worried about jobs. We think it is likely that more activity will return, but more jobs will not return necessarily immediately.”
The OBR's latest forecasts suggest GDP will fall by between 10pc and 13pc this year, meaning the economy will suffer a hit at least twice as large as during the financial crisis.
