UK heading for state spending and borrowing spree

London

BRITISH austerity is history. It is electioneering, of course, but it is still highly likely that UK state spending and borrowing will surge, regardless of who is in power after the Dec 12 general election.

Since the Bank of England (BOE) has kept interest rates unchanged at 0.75 per cent due to a sharp economic slowdown, sterling has slipped below its October peak of US$1.30.

At less than US$1.28, the lower rate does not only reflect some nervousness about the election outcome, but worries about potential fiscal irresponsibility.

The promises of the Conservatives are similar to the spending spree of the Tory government in the early 1970s.

The 1972-1973 "Barber Boom" of Anthony Barber, who was then Chancellor of the Exchequer, was followed by a jump in inflation, albeit partly caused by an oil price surge. The result was higher interest rates and a business and property bust in 1974.

In the past decade of austerity, the UK government's budget deficit has fallen from a peak of 10.2 per cent of gross domestic product (GDP) in 2009 to 1.9 per cent in 2019.

Since economic growth has been slow since the 2008/2009 financial crash, government debt which is currently 86.8 per cent of GDP is still well above levels a decade ago.

Sajid Javid, who hopes to remain Chancellor of the Exchequer, intends on pursuing Keynesian pump-priming policies to boost infrastructure.

In a speech in Manchester he promised to effectively rip up Tory fiscal rules. He pledged to spend up to 3 per cent of GDP, equivalent to £62 billion (S$108 billion), to revamp Britain's roads, railways, schools, hospitals and broadband networks.

Mr Javid said that he would take advantage of ultra-low interest rates and issue sovereign bonds to meet the expenditure. The yield on UK sovereign bonds with a 10-year repayment period is currently 0.8 per cent.

In real inflation adjusted terms, bond yields, the interest rate on long-term borrowings, are currently negative, Mr Javid said. This meant that it was a "responsible time to invest".

Contradicting himself, he added: "We must maintain spending restraint, (but) if we want growth to continue and get stronger in the future, we need to (take) the opportunity offered by those historically low borrowing rates."

Over and above Mr Javid's promises, Prime Minister Boris Johnson said that there would be major spending on the National Health Service, education, police, security and social services.

The aim of ministers, despite the BOE, Treasury and independent economist projections, is to ultimately repay the borrowing with tax revenue raise by a strong economy.

George Osborne, former UK Chancellor predicted, however, that a surge in borrowing would ultimately raise interest rates.

Nick Macpherson, former permanent secretary to the Treasury, has also been highly critical of the fiscal policy.

"The lot of a Treasury official - you spend 10 years at the coal face putting things right. You see a new government gambling it all, and to what end? Have the fiscal proposals of the two main parties ever been so incontinent? Borrowing to invest is only sensible if it does not result in ever-increasing debt."

The promises of Labour's Shadow Chancellor John McDonnell are even more reckless.

The UK's independent Institute for Fiscal Studies lambasted Mr McDonnell's immediate plans to almost double current public investment spending.

Moreover, he has promised a whopping £150 billion "social transformation fund" over the next five years.

This would be on top of the £250 billion for investment in green infrastructure over 10 years, and the re-nationalisation of railway, energy and water utilities that are estimated to cost around £196 billion.

Both Standard and Poor's and Moody's are concerned that Brexit uncertainty could cause a downgrade to the UK's debt rating.

If such an event occurs, UK bond yields would rise and raise the cost of government borrowing.