NOW that the date of the next election has been set, it is important for us all to understand the role the international debt markets may have in determining the success of the next government in bringing the country’s public finances back into balance.
Watching Channel 4’s debate between the potential Chancellors, it might have been surprising to see so much agreement between these political adversaries.
Indeed, there was so much agreement that the Liberal Democrats’ Vince Cable described the event as a “love-in” between the main political parties. The heated rhetoric before the debate seemed to suggest that the economic policies of the parties were markedly different.
In fact, whichever party wins the next election will need to implement sweeping cuts to government spending and higher taxes.
The main reason behind the requirement to implement harsher fiscal tightening than that witnessed during Mrs Thatcher's government of the early 1980s is the growing level of government borrowing in the UK economy. In this coming financial year, Britain is set to borrow £167bn.
That is an enormous sum by anybody’s standards and is equivalent to around £1 for every £4 the government spends on schools, hospitals, police, etc.
This figure represents close to 12% of national income.
In addition, the increase in borrowing will almost triple the cumulative debt owed by the British government from £527bn in 2007-08 to a projected and eye-watering figure of £1,400bn in 2014-15. It is calculated that the UK will borrow more in the four years following on from 2008-09 than in the whole of history since William the Conqueror.
Unfortunately, governments seeking to borrow money from the international debt markets over the next few years may find that lenders of the money (mainly pension funds, insurance companies, sovereign wealth funds and banks) are far more particular about who they lend the money to and the interest rate they expect to receive. The crisis impacting on the UK economy is also affecting other developed world economies, and these countries will be forced to compete for the limited supply of funding from global investors.
As a result, bond markets could force governments to be more financially radical, even if they don't believe that it is good for the economy or good for their chances of re-election.
Greece is a good example of a country that has been forced into fiscal responsibility as a result of the financial crisis. By the end of this year, Moody's estimates that government debt will exceed GDP (the total income of the economy) by 20% and debt interest payments will account for 15% of government revenue. Unless the Greek government follows through on the tough austerity measures that it has announced so far, the rate of interest it pays on its 10-year bonds will need to rise from the current level of 6.5% in order to attract new lenders.
The lessons are clear for the next UK government. Present a credible plan to re-align government spending with revenues as soon as possible after the election and ensure the plans are implemented. Failure to carry out either of these actions could see interest rates on ten-year bonds rise significantly above their current level of 4% over the next couple of years.
