A bleak growth and fiscal outlook

Azad Zangana, European economist at Schroders, assesses the Chancellor’s Autumn Statement and concludes it offers little in the way of support for the overall economy in the near term

With the coalition completing half of its term in government, the Chancellor was under pressure to deliver more measures to stimulate growth in his Autumn Statement. Facing a faltering economy largely knocked off course by external factors, George Osborne had little room to manoeuvre, especially as the Office of Budgetary Responsibility (OBR) had judged the government to be unlikely to meet its target to have debt as a share of GDP falling between 2014/15 and 2015/16.

The main headline from the Chancellor’s statement was the downgrade of the UK growth forecast from the OBR. Growth for 2012 has been downgraded from 0.8% (March Budget 2012) to -0.1% (in line with our forecast), while the forecast for 2013 was cut from 2% to 1.2% (Schroders forecast is 1%). Indeed, the OBR has downgraded every year until 2017, with the cumulative downgrade worth 3.7% in real terms.

“It will be important for the Chancellor to give a positive report in the spring Budget as further fiscal slippage caused by weak growth from here could result in the loss of the UK’s AAA rating.”

As a result of the downgrades to growth, the OBR also downgraded the government’s ability to raise tax revenues and raised its forecast for the deficit and debt in cash terms and as a share of GDP. The deficit and debt numbers have been complicated by the previous transfer of the Royal Mail pension scheme to the public sector (announced at the last Budget), and the latest move to bring on the public balance sheet the assets and liabilities of Bradford & Bingley and Northern Rock Asset Management.

In addition, the Treasury recently announced the transfer of the proceeds from the Bank of England’s Asset Purchase Facility – the quantitative easing scheme – in order to reduce borrowing needs while these proceeds existed.

Netting out all these distortions, the OBR judges public borrowing will fall from £126bn in 2011/12 to £120.3bn this financial year. This represents a £400m upward revision to the budget deficit forecast. For future years, the fiscal slippage is more pronounced as growth downgrades are compounded. Between fiscal year 2012/13 to 2016/17, the OBR forecasts an extra £104.6bn worth of borrowing.

The Chancellor announced further reductions in non-investment departmental spending, some of which will be spent on infrastructure spending. In addition, the Chancellor outlined additional spending cuts for 2016/17, which allow him to meet his main fiscal rule of cyclically adjusted current borrowing in balance (or surplus) over the next five years.

Though the OBR has judged the Chancellor to be on track to meet his primary target, the supplementary target of debt falling between 2014/15 and 2015/16 is judged to be unlikely. Government debt as a share of GDP is now forecast to peak in 2015/16 – one year later than previously forecast – at 79.9% of GDP (3.6% of GDP higher than forecast back in March).

However, Osborne has heeded advice from the International Monetary Fund and Bank of England and has decided not to chase this target by announcing more near-term austerity. Instead, he stated he will allow the automatic fiscal stabilisers to work and focus on reducing waste in government, along with clamping down on tax and benefit cheats.

Taken at face value, the policy measures announced today represent fiscal tightening of £6.5bn. However, included in this figure are the £3.5bn expected to be raised from 4G licence auctions and £4.9bn worth of spending cuts for 2017/18 not previously announced. If we exclude the 4G licence money and the 2017/18 announcements, we find a £2bn giveaway for the next five years. This is unlikely to make much of a difference to the economy overall.

Policy changes include:

• a reduction in pension tax relief from £50,000 to £40,000 a year, and a further reduction in the lifetime size of the pension pot that will receive tax relief to £1.25m;
• an extra £235 rise in the planned increase in the personal allowance (also to apply to higher-rate payers);
• a planned 3p increase in petrol duty in January scrapped;
• an additional cut in corporation tax rate to 21% from 2014/15;
• a two-year temporary increase in the annual investment allowance from £25,000 to £250,000;
• an uprating in working-age benefits capped at 1% for three years from 2014/15; and
• an uprating of higher-rate tax thresholds limited to 1% for three years from 2014/15.

Overall, the Chancellor’s Autumn Statement offers little in the way of support for the overall economy in the near term. The minor re-prioritisation of public spending away from current departmental spending and towards public investment is welcomed and the tax measures for businesses could help boost investment in the medium-term.

However, the Chancellor has missed an opportunity to go further and lock in long-term near record low borrowing costs to help support badly needed infrastructure spending in the UK. The use of government guarantees is useful but the scale of projects so far remains too small to have a significant impact.

Finally, the latest downgrades to growth and public finances are likely to raise questions once again about the government’s coveted AAA sovereign debt rating. It will be important for the Chancellor to give a positive report in the spring Budget. Further fiscal slippage caused by weak growth from here could result in the loss of the UK’s AAA rating.

DECEMBER 2012