Interest rates on new long-term government borrowing hit a 20-year high last month, following Kwarteng’s announcement of 45 billion pounds in unfunded tax cuts, on top of even more short-term relief for individuals’ and businesses’ energy expenses.
United Kingdom: The Institute for Fiscal Studies (IFS) said in research on Tuesday that British finance minister Kwasi Kwarteng has to make 62 billion pounds ($69 billion) in spending cuts or tax increases to prevent public debt from rising as a share of the economy.
Interest rates on new long-term government borrowing hit a 20-year high last month, following Kwarteng’s announcement of 45 billion pounds in unfunded tax cuts, on top of even more short-term relief for individuals’ and businesses’ energy expenses.
Kwarteng has attempted to recover market confidence by abandoning plans to eliminate Britain’s top income tax rate, saving 2 billion pounds, and putting up plans for new forecasts and debt reduction to October 31.
However, the IFS think tank, whose views on budget policy are frequently followed in the UK, said Kwarteng would face an uphill battle convincing markets that his plans will improve GDP to the 2.5% per year promised by Prime Minister Liz Truss.
“The Chancellor should not rely on over-optimistic growth forecasts or promises of unspecified spending cuts. To do so would risk his plans lacking the credibility which recent events have shown to be so important,” According to IFS Director Paul Johnson.
According to the IFS, British government borrowing is on track to reach 194 billion pounds this fiscal year and remain at 103 billion pounds in 2026/27, 71 billion higher than government analysts expected in March.
The IFS budget projections are based on rather pessimistic growth forecasts from Citi, which predicts that the British economy will grow by 0.8% per year on average over the next five years.
Even if the economy grew a quarter-percentage point quicker each year, the government would still need to tighten fiscal policy by 41 billion pounds for debt to shrink as a fraction of GDP, according to the IFS.
Debt interest will cost 106 billion pounds this year and 103 billion pounds in 2023/24, according to the IFS, due to the significant amount of cash raised in previous years by selling bonds that pay interest that rises in line with inflation.
“Such spending cuts could be done, but would be far from easy,” the IFS said.
Citi economist Ben Nabarro, who delivered the estimates alongside the IFS, said Britain was vulnerable to a loss of confidence due to its significant current account imbalance.
“The funding basis for that is becoming increasingly shaky,” he remarked. “Institutional credibility is essential for the UK, and any questions about that risk being extremely damaging.”
On September 26, the sterling sank to a record low of less than $1.04 against the US dollar, while many British government bonds experienced their most significant monthly drops on record.
Rising debt as a share of GDP was tolerable during economic crises, such as those caused by COVID-19 or the recent jump in energy prices, but it was not sustainable in the long run, according to the IFS.
“There are constraints that can bite. And it looks as if we are running up against them, perhaps for the first time in a long time,” According to the IFS.
If Kwarteng was unwilling to raise taxes, the IFS suggested that for the next two years, working-age benefits be increased in line with salaries rather than prices; public investment is limited to 2% of GDP rather than 3%, and spending on public services other than health and defence be cut by 15%.
