Saturday, November 5, 2011

Is the UK like Greece and Italy?

With all the turmoil in the Euro, how likely is the UK to face similar debt crisis as Greece, Italy, Spain and Ireland?

On some measures there is a disturbing similarity.

Public sector debt as % of GDP


Facts on European debt crisis

    Annual Budget Deficit
  • The UK's budget deficit is one of highest in EU (after Greece and Ireland's 2010 budget deficit)
  • The UK economy is very closely linked to the Eurozone; if Europe enters a recession, this is likely to adversely affect the UK economy.
  • Despite recent growth figures there are signs that the UK economy is stuck in an economic slowdown.
However, I don't think we need to fear becoming the next Greece, Ireland or Italy. This is why
  • Bank of England is willing to act as lender of last resort - buying bonds in a liquidity shortage. Markets have greater faith in countries who have independent Central Bank who is is willing to buy government bonds. If Italy experiences temporary difficulties in selling government debt, there is no Central Bank to step in. They have to go through the whole rigmorole of going to the EU asking for loan. But, this loan usually involves interminable political wranglings. Understandably, markets fear there is no mechanism to deal with liquidity shortages. Therefore, investors are less willing to hold debt held by Eurozone economies.
Bond yields have stayed low in UK
    • euro

    Bond yields on EU Debt

  • Low Interest Payments. UK Debt interest payments are manageable at only around 3% of GDP (£48bn)
  • Longer debt maturity. The UK has a higher % of debt denominated on bonds with long maturity (e.g. greater than 10 years) therefore there is less pressure to sell new bonds.
  • Historical national debt. As a % of GDP, UK public sector debt has been higher in the past. (National debt facts)
  • Spending Cuts. Markets have been reassured government is committed to reducing structural deficit.
  • Greater Flexibility. The UK has greater flexibility than Eurozone economies. Whilst the UK government cut spending leading to unemployment and lower demand, at least UK Central Bank have been able to pursue quantitative easing to provide some monetary stimulus. Also, the UK has benefited from the depreciation in sterling which helps to boost domestic demand.
It doesn't mean the UK economy is safe. The debt to GDP ratio will only improve when the UK economy returns to its long run trend rate of growth. However, it would require a very sharp deterioration in the UK economy for us to face the challenges facing some of the Euro member countries.


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