MNI INTERVIEW: UK Debt Stabilisation Insufficient - NIESR Head

The UK government needs to not only start running budget surpluses to keep debt-to-GDP steady but must come up with a credible strategy to get it on a downward trajectory, National Institute of Economic and Social Research director David Aikman told MNI, adding that markets will be disappointed if this is lacking from the upcoming budget.

Without swift action to reduce the debt-to-GDP ratio there is a risk it could spike to 120% within five years from about 100% today, given that there is an asymmetric risk of future shocks pushing debt higher while windfalls do not bring debt down, Aikman said in an interview.

A small surplus is required just to stabilise the debt ratio, as liabilities are being driven higher by the difference between the natural interest rate and trend growth (r-g), he said.

“If r-g is one, we need a 3% turnaround in primary deficit as a proportion of GDP” just for debt stabilisation, Aikman said. Reducing debt would require running an even larger primary surplus. (See MNI INTERVIEW: UK Needs To Slash Spending Share Of GDP- Chadha)

MANIFESTO COMMITMENTS

Chancellor of the Exchequer Rachel Reeves is under intense pressure to raise more revenue and to carry out fiscal consolidation in her Nov 26 budget.

Reducing the debt ratio will require breaking Labour Party manifesto pledges and increasing income tax, Aikman said. “The realistic risk is bond yields jump” if market participants perceive that the government is merely “tinkering around the edges” with smaller revenue-raising measures.

“If that's the world we're in, where the bond yields jump up, we'd have to have an emergency budget again six months later,” he said.

OBR PRODUCTIVITY FORECAST

The Office for Budget Responsibility is reportedly set to downgrade its forecast for productivity growth before the budget, and, while Aikman agreed that the current estimate is widely seen as over-optimistic, he expressed wariness “about forcing the OBR to pick the consensus” of independent institutions' forecasts. (See MNI INTERVIEW:  OBR's Productivity Outlook Realistic - Miles)

“You set up these bodies; you put experts in charge. As long as they’re clear and transparent and we can have a debate about these things, that’s probably the best way to make policy,” he said.

The uncertainty over productivity growth casts doubt over the precision of the government’s fiscal forecasts in relation to its borrowing rules, and underscores the importance of substantial measures to reduce debt, Aikman cautioned.

BOE SHOULD HALT GILT SALES

The gilt yield curve is at the top of the advanced economy sovereign debt range and Aikman believes that the Bank of England could help by halting active gilt sales as part of its quantitative tightening programme rather than just slowing them. (See MNI INTERVIEW: QT Raises Yields, BOE To Slow Sales- RF's Smith)

“I would even go as far as halting active sales or substantially slowing anyway,” he said, noting  that this would be in line with the BOE’s mandate “to support the government's economic policies, including ensuring that the gilt market is functioning properly.”

Although “the Bank would like the balance sheet to be much smaller,” Aikman reckoned that the BOE has underplayed the impact of its asset sales on yields, with its August Monetary Policy Report estimating that QT had only resulted in a “modest increase” of 15-25 bps.

The effect could be considerably greater, Aikman said, citing work by former BOE Monetary Policy Committee member Kristin Forbes and Fed adviser Wenxin Du.

“You're taking away a buyer from the market who is buying at any price … and they're selling to people who are much more price elastic … I'd rather assume it's a bigger effect,” he said.