Debt burden: People walking past stalls in west London. The UK is more susceptible to sudden debt-sustainability concerns because the pound, unlike the dollar, is not the world’s dominant reserve currency. — AFP
LONDON: From the financial crisis to Russia’s invasion of Ukraine, Britain has borrowed and spent its way out of every jam. The bill for that is becoming a worry all its own.
The UK’s public debt load has soared by more than 40% to almost £2.6 trillion (US$3.4 trillion or RM15.8 trillion)) since the pandemic struck, leaving the country owing more than its entire annual economic output for the first time since 1961.
A heavy reliance on index-linked bonds at a time of high inflation also means Britain will pay more to service liabilities than any other advanced economy.
While big spending has helped the Conservative-led government cushion the political blow of recent setbacks, it threatens to damp investment and send the UK into a negative spiral that could last years.
Last month, the Office for Budget Responsibility warned that debt could balloon to more than three times gross domestic product over the next half century without action.
The outlook has reignited questions about the UK’s credit rating, especially after Fitch surprised Wall Street and the White House by stripping the US government of its AAA status.
A UK downgrade would undermine Prime Minister Rishi Sunak’s effort to rebuild Britain’s fiscal credibility after his predecessor, Liz Truss, triggered a bond-market crash a year ago by promising huge unfunded tax cuts.
The pressure is being compounded by a sell-off in bonds amid aggressive rate hikes by the Bank of England (BoE) to quell inflation. The yield on the 10-year benchmark this week rose above 4.7% to its highest since 2008. The UK bond market is among the developed world’s worst performers this year.
Sunak and his main rival for the prime minister’s job after an election expected next year – Labour leader Keir Starmer –have few options. Economic growth is forecast to remain flat through next year, the National Health Service is stretched to breaking point and the tax burden is already at a 70-year high.
“There is not an easy way out of the current situation,” warned Maxim Rybnikov, lead UK sovereign analyst at S&P Global Ratings. “The fiscal picture is weighing the rating down at the moment.”
The three main credit-rating firms are due to update their assessments of the UK over the next four months.
Moody’s and S&P Global Ratings are scheduled to make their announcements on Oct 20, with Fitch following on Dec 1.
Mike Cudzil, a portfolio manager at Pacific Investment Management Co, said the US downgrade served as a reminder that “risks related to deficit spending and debt sustainability, which tend to lie dormant, can arise and spark concerns.”
Unlike the United States, the UK has no unblemished status to lose.
Moody’s and Fitch stripped the country of its top rating a decade ago, followed by S&P in June 2016, days after Britons voted to leave the European Union.
The UK still enjoys an investment-grade rating with all three agencies.
Sunak has made reducing the country’s debt burden one of five key pledges, despite near daily calls for tax cuts and spending increases to boost the stagnant economy. Chancellor of the Exchequer Jeremy Hunt will next have a chance to address the issue in an autumn budget statement expected in November.
The most recent ratings action for the UK was positive: S&P revised its outlook to stable from negative in April.
But Moody’s and Fitch, which highlighted the UK’s inflation-linked debt dilemma in a report last month, have kept the country on a “negative” outlook since Truss’ “mini-budget.”
While the risk of another downgrade is unclear, investors say the impact on UK assets could be more severe than it was for the dollar and US Treasuries, perennial safe havens.
“The UK is more susceptible to sudden debt-sustainability concerns because the pound, unlike the dollar, is not the world’s dominant reserve currency,” said Sam Zief, head of foreign-exchange strategy at J.P. Morgan Private Bank.
“Debt sustainability doesn’t impact markets until it does.”
Index-linked gilts were first issued in the 1980s under then-Prime Minister Margaret Thatcher, as the country struggled to clear the mark of taking an International Monetary Fund loan in 1976. — Bloomberg
