Fitch Warns Scale Of UK Fiscal Challenge 'Formidable'
LONDON (MNI) - Fitch Ratings says in a new special report that following an unprecedented economic and financial shock, the scale of the United Kingdom's (UK) ('AAA'/Stable Outlook) fiscal challenge is formidable and warrants a strong medium term consolidation strategy - including a faster pace of deficit reduction than set out in the April 2010 Budget.
The report examines the scale of fiscal adjustment necessary to put UK public finances on a sustainable medium term path, and considers the outlook for fiscal policy consolidation in the run up to the June 22 emergency budget.
Fitch says that:
"The UK's 'AAA' rating is supported by its strong policy institutions, advanced, diversified and flexible economy, exceptional financing flexibility and historical track record of fiscal consolidation. However, the rise in public debt ratios since 2008 is faster than any other 'AAA' rated sovereign and the primary balance adjustment required to stabilise debt is amongst the highest of advanced countries. The primary deficit is nearly twice as large as that seen in previous episodes of fiscal deterioration in the UK in the 1970s and early 1990s.
"Existing medium term fiscal consolidation plans - set out most recently in the April 2010 Budget but essentially unchanged since the March 2009 Budget, despite a substantial decline in deflation risks since then - are un-ambitious. In particular, they only achieve public debt stabilisation at the end of the medium term horizon and are based on arguably optimistic growth assumptions. Furthermore, planned expenditure cuts in the April 2010 Budget were not articulated in detail, undermining their credibility.
"Fitch notes that the new coalition government has acted very quickly to establish fiscal consolidation as its top policy priority and has announced immediate additional tightening measures of 0.4% of GDP in the form of spending cuts and an emergency budget scheduled for 22 June 2010.
"Given downward revisions to last year's deficit outturn and the spending cuts now being implemented by the coalition, it is highly likely that the 2010-11 deficit target will be lowered from the 11.1% April 2010 Budget figure - indeed this must now be done to adhere to the recently passed Fiscal Responsibility Act, which mandates that borrowing must fall every year to 2014.
"However, while likely, it is not obvious from current policy statements that the new government will adopt lower deficit forecasts throughout the medium term. A clear policy agenda already exists for tax cuts in a number of areas and it is possible that the new Office for Budget Responsibility will deliver a more pessimistic assessment of the economic outlook, which would offset the impact of stronger discretionary tightening.
"While a similar deficit reduction path to that set out in the April 2010 Budget, but based on more realistic growth assumptions might be viewed as more credible, it would still run the risk of leaving the UK as something of a standout relative to the deficit targets of other advanced country sovereigns, the US ('AAA' / Stable Outlook) notwithstanding. With other European sovereigns strengthening their fiscal consolidation plans and market concerns about sovereign risk in advanced countries increasing, both the size of the UK deficit currently projected for 2011 and the failure to reduce it to 3% of GDP within five years are striking.
"A more ambitious deficit reduction path - with borrowing 1% lower than the April 2010 Budget throughout the medium term - would result in an earlier peak in debt to GDP and a clearly declining debt path within the medium term horizon. This would help in going some way to restoring 'fiscal space', or a cushion against future shocks. Achieving such a path purely on the basis of further spending cuts, would imply unprecedented real declines in primary spending.
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