Friday, April 30, 2010

Will the Debt Crisis Spread to the UK?

There is a concern that the EU sovereign debt crisis will spread to the UK.
  • Firstly, this year the UK budget deficit is forecast to be higher than both Spain and Greece. The OECD predict UK's debt will be 13.3% of GDP this year compared to 9.7% for Greece and 8.5% for Spain.
  • Confidence in the government bond market is plummeting. It means there is going to be extra scrutiny from investors; with market sentiment so fragile, foreign investors especially may be reluctant to hold bonds in any country with double digit annual borrowing.
  • A Hung Parliament is not Going to Help. The general election could well create a hung parliament with wrangling over coalition governments and how to deal with deficit. It would be hard enough to cut spending with a strong majority, but, with coalition partners it will be more difficult
Hopeful Points of UK
  1. We have More Longer Term Bonds. The UK has one of the highest percentages of long term bonds. The average debt maturity is over nine years. This means we need to refinance bonds less frequently. Long term bonds give greater stability in times of crisis. Though, we still have to sell many new bonds coming onto market. (see: National debt ceiling)
  2. Flexible Monetary Policy. At least we have an option of depreciating the exchange rate and pursuing quantitative easing if necessary. This should ensure we have greater flexibility in avoiding deflation, which would be very bad for bond market and economy. However, the UK economic recovery still looks fragile. It is not clear our monetary policy has delivered strong growth yet.
  3. Recovery in Finance Sector. The recovery in bank profits may be galling for many. But, it has left the Treasury with a paper profit on bank shares. When we bailed out the banks last year this looked hard to imagine. But, it definitely helps make our fiscal position look more attractive.
  4. No history of defaulting on debt unlike Greece.
  5. We have been through worse (national debt over 200% in late 1940s - see: Historical national debt). Though, I'm not suggesting we could cope with anywhere near those debt levels now. Many factors are different e.g. lower private sector saving rate.

1 comment:

Roberto said...

I have one correction and one query regarding the first main paragraph.

Firstly you correctly say "UK budget deficit" but then say "UK's debt will be 13.3%". Secondly I don't know where the figure of 9.7% for Greece's deficit comes from. The figure you quote in your previous article of 13.6% is more typical of the ones I have seen. Perhaps 9.7% is OECD's prediction for 2010, but if so I'd take that with a large pinch of salt :-(

Other than that it's a useful summary of the similarities and differences between the situation in the UK and in Greece.