MNI INTERVIEW: UK Needs New Fiscal Metrics For Gilt Investors

Introducing a wider range of targeted fiscal indicators to complement the UK's pass-fail fiscal rules would help the government focus on metrics which matter to the overseas investors who account for a growing share of the gilt market, the Institute for Fiscal Studies' Ben Zaranko told MNI.

Non-partisan think tank IFS has proposed a traffic-light system to evaluate the fiscal picture, rather than just judging it by the current rules, which require a balanced current budget and for public sector net financial liabilities to fall as a percentage of GDP by the third year of the rolling forecast period. While the precise metrics to be included in the traffic lights, which the IFS intends to incorporate into its response to the government’s spring statement on March 3, have yet to be finalised, Zarenko said they would provide a broader view of the structure of UK debt as well as its size.

"I think that we should pay more attention to our relative position [compared to other advanced economies] in terms of borrowing costs at the moment," Zaranko said, amid a shift in the buyers of gilts towards more international investors including hedge funds.

"We've not got as many people who are going to buy gilts regardless, which I think means the government does have to think more about what those new buyers care about," he said in a phone interview. (See MNI INTERVIEW: Must Tackle Hedge Fund Debt Risk - BIS's Gelos)

Zaranko said there should be less concern about "parochial, precise metrics ... in the fiscal rules, because international investors care about a much broader set of things and want to compare like with like across countries."

UK BORROWING COSTS

Even though the UK has a relatively high debt-to-GDP ratio, it is already planning a bigger consolidation than other developed economies including France and Italy, Zaranko said, "but our borrowing costs are still high compared to those countries." (See MNI INTERVIEW: UK Debt Stabilisation Insufficient - NIESR Head)

"We're not really a fiscal outlier. We're not actually the worst behaved kid in the class, but we're still treated as if we are.”

Ppart of this spread might be because the Bank of England has conducted active bond sales more aggressively than other central banks, Zarenko said. Furthermore, unlike U.S. treasuries gilts are not denominated in a global reserve currency, and unlike the case with European bonds there is no transnational central bank underpinning the system.

While Zaranko advocates a more holistic set of fiscal indicators, he does not believe the rules can be changed at the moment. "There are clearly costs to changing the rules, and you should have a very high bar changing them."

"I think that we should be cautious in the near term" about the message a change to the rules would send, he added, though he noted that the government has given itself the ability to suspend the rules in a crisis.

"They appear quite constraining because they're very precise, very numerical, but then you do have the discretion to just abandon them if a shock comes along, and this government's written explicitly that there's an escape clause," he said.

SMALL HEADROOM

The current fiscal rules are set by the government and assessed on a pass-fail basis by the official fiscal watchdog, the Office for Budget Responsibility, against its central forecast. The OBR said the government had a 54% chance of meeting the fiscal mandate after the Nov 26 budget, with GBP22 billion of headroom (0.6% of GDP) in the central scenario.

The government has been criticised for leaving small headroom against its rules, forcing abrupt policy changes in response to routine forecast changes, such as GBP5 billion in proposed welfare cuts last spring.

"The policy volatility and the erratic and the reactive decision making has been driven mainly by having these very sharp numerical rules, and aiming to meet them almost exactly," Zarenko said. "I think that problem would be largely addressed if you could maintain a bigger buffer." (See MNI INTERVIEW: UK Fiscal Gap Needs Simple Tax Hikes - King)