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The government debt avalanche to come

There will be an explosion in government debt issues around the world as tax income contracts rapidly and state spending surges in response to the sharp and deep economic contraction now underway in most places.

calculator, calendar and coins

John Redwood

in Features


There will be an explosion in government debt issues around the world as tax income contracts rapidly and state spending surges in response to the sharp and deep economic contraction now underway in most places. It is difficult to put figures on it because we do not know how long the shutdowns will last and just how much tax revenue will be lost. Early attempts to provide indications suggest it will typically be of the order of 10% of GDP for many countries, assuming some return to more normal trading later this year. In the case of the USA, the government was planning a budget deficit of 4.9% of GDP before the crisis began, and has now announced a $2 trillion package of measures, some 10% extra of GDP. This may not be the end of the impact on the deficit, because of course there will be a revenue shortfall that could add to its size. There will also be additional spending under existing programmes brought on by a big increase in unemployment and sickness claims and the need for additional state services.

In the UK, where the budget proposed a 2.3% budget deficit there have been various measures announced to allow more state support to companies and individuals hit by the closures, and additional spending on health programmes. The government published and enacted a new Contingencies Fund permission which allows Ministers to spend up to an additional £260bn this year, compared to the original Contingencies allowance of just over £10bn.  This sum, at around 11% of GDP, is the nearest to an official forecast of what might be needed. The gilt requirement prior to the virus policies was to borrow an extra £58bn from the market in 2020-21, whilst also borrowing another £98bn to replace retiring debt. It is likely on the Contingencies Fund figures that this issue programme will expand substantially to say, £350bn, including the replacement bonds.

The big issue that will determine just how much debt has to be raised is how long the shutdown of much of these economies continues. We commented last week that President Trump’s wish to reopen the US economy on April 12 was unrealistic. Today he accepts that it will not be before the end of April. In Italy and Spain, where the progress of the virus is said to be more advanced, there is still no sign of early plans to start to return things to normal. Work is continuing to produce reliable tests which can be produced in high volume to see who has had the disease, as they could be allowed to return to work as soon as they have passed the test. It is also possible that various countries may conclude their health systems reach the point where they can cope with the volume of patients, allowing more people to return to work with progressive relaxation of the controls. China is the only country that has permitted substantial relaxations, where economic activity is now recovering. There the recovery is taking time to build up, with many migrant workers still in the wrong place, some supply chains still disrupted, and people still cautious about going out for entertainment and leisure in potentially crowded places.

It is likely economies will sustain a large loss of tax revenue as a result of the temporary closures, aggravating the deficits. The Central Banks of the advanced world seem well aware of the need for governments to have access to large sums of money at low interest rates, and so they have made clear their wish to facilitate low-cost borrowing at scale. The Eurozone is still a concern, despite the more relaxed approach to budget deficits and the expanded QE programme, because badly affected countries like Italy, Spain and Greece start with high levels of debt and do not have the same relations with their Central bank as countries with their own institutions enjoy. Whilst Mrs Lagarde does seem now to want to limit spreads between different national bond rates within the zone, there will continue to be tensions over the extent to which the zone as a whole should stand behind the growing debts of its weakest members.

Share markets still face a weight of bad news as companies start to make statements about their worsened prospects. Meanwhile, the oil price has fallen again, with no signs that Saudi Arabia and Russia wish to relax the pressures they are exerting against high-cost shale oil production in the USA. A lower oil price is good news for inflation and real income amongst the oil-consuming countries, but in this climate, it is bad news for debt markets that have financed dear oil, and a further knock to general confidence levels.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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