Monday, December 14, 2009

Debt Planning and Debt Panic

When should we panic about the level of national debt?

Greece recently had its credit rating downgraded from A- to BBB. This year Greece had an annual budget deficit equal to 12% of GDP. Unfortunately, this is a rather similar level to the UK budget deficit. So does that mean we could face a similar fate to those reckless Greeks? - facing a credit downgrade, higher interest rates and a loss of investor confidence?

Firstly, there are a few differences.
  1. The total level of Greek National debt is much higher than the UK. The current level of Greek government debt is 113% of GDP. The forecast for 2010 is 125% of GDP, and the EU fear it could rise to 135% of GDP by 2011. (Beware of Greeks bearing government bonds, could well become an oft-repeated joke)
    By comparison the UK public sector debt doesn't look too bad (59.2% of GDP - though we are doing our best to try and catch up...)
  2. Greek debt reflects a long term structural deficit. The level of borrowing cannot be explained away by financial support for banks or a mild recession. The UK's debt is more geared towards cyclical fluctuations and the figures look less damaging when financial bailouts are excluded. (total national debt is 49% of GDP, excluding financial bailouts). However, there is no guarantee that a return to growth will restore faith in UK public finances. The recession has certainly hit tax revenues, but, there is uncertainty when, if ever, they will recover. The UK finances deteriorated very rapidly in the recession, but, the deficit is not just cyclical but also structural.

Do you Have a Plan To Reduce Debt?

Ireland has one of the largest budget deficits in the World (14% of GDP this year). But, it has been going about reducing the deficit with a vigour which is the envy of other European countries. As the Economist says (link)
WHEN the Irish finance minister, Brian Lenihan, in effect cut the pay of public-sector workers earlier this year by introducing a special 7% pension levy, he confessed that Ireland’s European Union partners were amazed at the muted public reaction. There would, he said, have been riots in France.
The ability to cut public spending and raise taxes gives investors confidence in buying debt. The problem Greece may have is a credibility problem. They have a long history of getting into debt, and markets are more suspicious of their ability to repay. It's not just how much debt you have, but, whether markets have faith you are likely to restore public finances without resorting to printing money.

For example, cut public spending in Greece and we could have a return to the riots of a few years ago.

A key issue for the UK is do we have a credible plan to reduce debt? At the moment, all the talk, is wait until after the general election. That is fine, but, after the general election, we really will need to give concrete plans.

When it's Good to Borrow

High levels of Debt certainly creates economic problems. But, reducing deficits too quickly can cause additional problems. The problem with panicking over debt is that we may create even worse problems. (see: Causes of Great Depression)
  • In a recession, borrowing is necessary. Trying to reduce a deficit in a recession can cause a further fall in economic growth and a further fall in tax revenue. Promoting growth is one of best ways of promoting future tax receipts.
  • To finance investment in economy. If you invest in new roads, communications, education e.t.c. It may help the economy be more productive and grow faster. This can help improve tax revenues in the long term.
    However, if you are borrowing to finance pensions and welfare benefits there will be no improvement in productivity

No comments: