Tuesday, 28 April 2009

The UK budget: What is really going on…?

by Juan Pablo Painceira

The debate on the nature of the UK budget has been hot over the last week in all media. The main issues addressed are the taxation on the wealthy, Darling’s economic forecasts and the huge climb in public debt since October 2008. The rise to 50% taxation on the top income earners (over £150,000) has been called a revival of class war, a return to Old Labour policy or even a populist measure targeting the next election.

The UK growth forecasts of a fall of 3.5% and rise of 1.2%, respectively, for 2009 and 2010 have been ridiculed by many analysts. It does seem a bit unrealistic given that the IMF and consensus forecasts are a drop of 4% in 2009 and growth of only 0.3% in 2010. Besides, it is well known that governmental forecasts are always more optimistic than the market’s: if a finance minister forecasts less than the market for sure they should be fired! It’s all about information and expectations my dear! Surely we can all agree that growth forecast of 3.5% to 2011 is somewhat exaggerated. According to the debate in the media the other areas to focus on included a rise in the annual limit for tax-free ISAs to more than £10,000 - to come in from October 2009 for the over 50s; the stamp duty holiday for homes up to £175,000 is to be extended to the end of the year; and there will be more job help for the long term young unemployed.

The rise of public sector borrowing and, consequently in public sector debt have raised concerns about the sustainability of the UK’s finances over the coming years which is affecting the pound and is reflected in a possible downgrade by a rating agency from AAA. Since last Wednesday there has also been capital outflow from the Gilts with the benchmark yield Gilt-10 rising more than 20bp.

Basically, the economic debate on budget which has played out in the media has been whether the UK government has to cut more on public expenditure or to increase taxation in the coming years. It sounds familiar, doesn’t it? This is the same old debate re-heated.

What we haven’t heard so much about is the huge public exposure to the bank bail-outs which is around £1,000 bn. since the Northern Rock rescue. It’s off the agenda already?!?!

Or even the cuts in planned public spending, where the public sector, in particular the NHS is expected to generate savings, but which are being labelled efficiency savings.
It is a strange world where via a cut in spending, the system suddenly becomes more efficient and generates cash! We can only imagine how this will work at the micro level…

The Economist's reaction to the budget is at least harsh. They are calling for a more realistic budget where the government should say explicitly to the British nation that the costs for getting the UK out of the financial crisis and recession should be shared (or paid) by everyone, including you!

In the same rhythm, the IMF is just as concerned by the extension of fiscal stimulus in Spain, talking of the need for institutional reforms (mainly in the labour markets) in order to keep the sustainability of the Spanish long-term economic growth. There is no free lunch.

Yet for all the criticism, slowly events are potentially generating a situation and political environment where the fiscal adjustment could be implemented, the cost borne by the tax payer, perhaps with some neo-liberal reforms thrown in to convince us it won’t happen again. That way the fiscal expansion could be calibrated according to the needs of banking system and we can get back to business as usual…

For the time being…as we have addressed in past posts, it seems ‘plus ca change’… let’s see how the GDP predictions turn out and if they really have enough in the tank to plough on through…

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