2. UK Government debt and borrowing

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1 2. UK Government debt and borrowing How well do you understand the current UK debt position and the options open to Government to reduce the deficit? This leaflet gives you a general background to the current UK debt problems and a basic overview of the UK Government options with the use of diagrams and definitions to illustrate and simplify the information. It will be particularly important for you to understand this if you are intending to work in the public sector or in private sector industries that depend heavily on government spending e.g. construction and defence. The topics covered are: What is government debt? UK Government debt history UK debt in relation to other countries Concerns surrounding current debt levels Ways the Government can reduce debt The leaflet concludes with self assessment questions. Page 1 of 5

2 UK Government debt and borrowing UK Government debt has fluctuated quite significantly over the years since the end of the Second World War. What is Government debt? What is the UK Government s debt history? Government debt is not an abstract concept. Governments borrow money to spend on services and the debt has to be funded just like any other type of debt - and interest has to be paid on the money borrowed. The debt is funded by a combination of major financial institutions, pension funds, and other sovereign funds buying UK Government bonds, bills and gilt edge stocks. Interest is payable on the funds borrowed, with the interest rate being linked to a country s credit rating. The size of a government s debt is expressed as a percentage of its gross domestic product (GDP 1 ). Government debt peaked in the late 194s/early 195s at around 25%. This followed a period when the economy was in a very poor state following the ravages of war and at a time when the post-war Labour Government spent heavily on the new National Health Service, the education system and the nationalisation of industries such as steel, coal, rail and transport. The debt ratio then reduced steadily as industrial output increased and was further boosted when North Sea oil 1 Gross Domestic Product (GDP) is the total monetary value of all goods and services produced domestically by a country in each year. GDP growth is an indication of a country's economic health. revenues came on stream during the 198s. By the beginning of the 199s, it had reduced to 27%. During the 199s it rose again to around 45% in 1995/6 but it then fell back to 29% by 22 (see Figure 1). Since then, despite economic expansion, there has been another period of debt growth: by 27 the percentage against GDP increased to 37%, largely as a result of increased spending on health and education. Spending on public services actually rose by 54% in real terms between 1997 and 27. In 28 and 29, the effects of the recession began to be felt, tax receipts declined, expenditure on unemployment rose alongside continuing NHS and other public expenditure and, additionally, it was necessary to support the financial sector. Thus, by the end of 29, the general UK Government gross debt (this figure being the sum of central and local government debt) had risen to some 95 billion, equivalent to 68.1 % of GDP. (See Note 1 and Note 3 pg5). In the calendar year 29 UK government debt rose by billion or 11.4% of GDP. (See Note 1 pg5). In early 21 debt has continued to rise, albeit at a slightly lower rate than was envisaged by the UK Government when it produced its 21 pre-budget forecasts, in Page 2 of 5

3 GDP (%) part because unemployment had not risen to quite the levels expected. Nevertheless, for the financial year 29 21, the deficit is expected to be around 155 billion or approximately 11% of GDP, and total net debt will be close to 62.2% of GDP (See Note 2 and Note 3 pg5). UK gross UK debt GDP % to GDP Year Figure 1 showing UK gross debt to GDP percentage. Figures quoted from The Office of National Statistics published 31 March 21 The EU debt guidelines for Eurozone member countries (otherwise known as the Euro Area - the countries which have adopted the Euro currency as their sole legal tender) suggest that government debt should not exceed 6% of GDP or 3% annually, with the figures being assessed on an annual basis at the end of each country s financial end year (5 th April in the case of the UK). Despite the scale of the UK figures, with the UK annual debt to GDP percentage being very close to that of Greece (12.7%), which early in 21 sought support from fellow Eurozone members and the International Monetary Fund (IMF), the UK s overall gross debt to GDP figures (at circa7%) are still lower than many other developed countries based on estimated 29 data (see Figure 2). Paradoxically it is generally the most well developed countries that show the highest figures, with some of the poorest countries, who have limited capacity to borrow, showing much lower figures (see examples in Figure 3). Page 3 of 5

4 25 Developed countries gross debt % to GDP Japan Italy Greece US France Germany Canada UK Ireland India Spain Figure 2 showing developed countries debt in relation to their GDP percentage. Figures quoted from The Office of National Statistics published 31 March 21 3 Developing countries gross debt % to GDP Tanzania Nigeria China Uzbekistan Figure 3 show developing countries gross debt in relation to their GDP. Figures quoted from The Office of National Statistics published 31 March 21 Why are UK figures causing concerns? What is perhaps of greatest concern about the current UK figures is the recent, very sharp, rate of increase coupled with uncertainties about the willingness of the previous Government to tackle the underlying issues before the May 21 General Election. The current Government has explicitly made the lowering of the deficit its priority. Page 4 of 5

5 The UK currently has an AAA credit status, as assessed by international credit rating agencies such as Standards and Poors. AAA indicates the best quality borrowers, reliable and stable, and these borrowers are charged the lowest interest rates in relation to their particular type of debt. However, if the markets became uneasy about the UK s ability to service or ultimately repay its debt, as they have in relation to both Greece and Spain, that rating might fall, thereby pushing up the interest costs of servicing the debt. The current annual debt interest bill is already c. 35 billion, a figure now higher than the UK s entire defence budget. Market concerns about the level of debt could also impact on the sterling exchange rate, the rate at which the UK pound ( ) can be exchanged for another currency. Government debt can only be reduced by a combination of the following strategies: Figure 4 showing ways in which the UK Government can reduce debt Securing the appropriate balance between these somewhat conflicting three options, and deciding over what period to target any debt reduction in order not to actually damage the economy, is one of the key areas that currently divides the UK political parties. Note 1 - Figures from Office for National Statistics published 31 March 21. Note 2 Chancellor s Statement 23 June 21 Note 3 - The UK Government usually quotes gross debt figures but on occasions the figures are shown net of capital investment projects and at other times the figures additionally exclude so called financial interventions. Self assessment questions 1. What was the UK Government s gross debt at the end of 29? 2. What is the UK s current credit status and what is the significance of this? 3. What three options are generally available to a country seeking to reduce its overall government debt? 4. Briefly explain why government debt was 25% of GDP in the late 194s/early 195s. Page 5 of 5

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