Bill Jamieson: Downgraded credit rating the real indicator of UK's political demise

Published on Saturday 23 May 2009 14:12

IN THE midst of a crisis of confidence in the UK parliament and consternation in the Commons comes a spooky warning of a credit rating agency downgrade on our public debt.

Could it get any worse? "Very possibly" is the verdict of credit rating agency Standard & Poors. Last week it downgraded the UK as a sovereign risk from "stable" to "negative" – the first time it has done so in 31 years. It puts a question mark on how long we will retain the coveted "Triple A" credit rating status. And that, rather than the expenses crisis, is the real indictment of Britain's political system – one that has built voter support through spending bursts and giveaways and now finds itself paralysed in the face of billowing debt and borrowing.

However, need we worry that much? Is this not the same credit rating agency that ranked all that toxic US mortgage debt – now worth 25 cents on the dollar – as "triple A"? What credence can be placed on its judgments?

The S&P downgrade matters because it could cause nervous overseas investors to dump sterling and drive up the cost of debt as buyers of government bonds seek a higher return to cover the increased risk. News of the downgrade pushed up yields in the gilt market on Thursday.

True, the damage in the UK debt market was muted. But this is because investors have already factored in a gloomy outlook.

So what did the latest Standard & Poors judgment actually say? And what importance should we attach to it?

The ratings agency has put the UK's sovereign credit rating on "negative outlook". This, it says, signals "the potential direction of a rating, typically over a period of up to two years". By contrast, being put on "negative watch" (which is worse) is often the signal for a ratings agency downgrade in a few weeks or months.

How does the UK compare with other countries? Across the EU 15 and Group of Seven major industrial economies, countries with a public debt to GDP ratio above 90 per cent of GDP do not have top level credit ratings – that is, a top rating across all three major ratings agencies. What concerns S&P is the prospect that the UK's ratio of net public debt to GDP will come close to 100 per cent of GDP.

"We base our opinion", it says, "on our updated projections of general government deficits in 2009-13. These projections reflect our more cautious view of how quickly the erosion in the government's revenue base may be repaired, the extent to which the growth in government spending can be curtailed, and consequently the pace at which historically high fiscal deficits are likely to narrow."

The agency has used updated estimates of potential gross fiscal cost of state support to the banking system. It now reckons this to be in the range of 100 billion to 145bn, or 7 to 10 per cent of GDP by 2013. A government debt burden if sustained at that level would not in S&P's view be compatible with an "AAA" rating.

It says the budget figures unveiled last month underpinned its view that the UK public finances are deteriorating rapidly – and at a faster rate than the agency had previously assumed.

Citigroup UK economist Michael Saunders said: "Although the government talks of its aim to shrink the fiscal deficit eventually, the ratings agency seems to have little hope that serious measures to put the fiscal position on a sustainable path will be announced before the next general election."

The depth of the debt problem was highlighted with figures released just minutes after the publication of the S&P report showing the worst April on record for the UK public finances. The Treasury revealed that it had borrowed 8.5bn during the month compared with 1.8bn in the same month last year.This brings the deficit over the most recent 12 months to 93.4bn. Just a year ago the figure stood at 37bn. This has caused some to question whether the government might now miss its forecast for borrowing of 175bn this financial year.

And the political crisis at Westminster has brought a further worry that the government's preoccupation is now totally focused on surviving the MPs' expenses debacle rather than on the economy.

The revised figures for UK GDP released on Friday gave no comfort that the downturn might have been less severe than initially thought, still less fed hope over "green shoots" of recovery. The figures confirmed GDP plunged by 1.9 per cent quarter-on-quarter and 4.1 per cent year-on-year – the largest quarter-on-quarter drop since 1979 and the largest year-on-year decline since 1980.

As well as the decline in household spending, the figures show that wages and salaries fell by 1.1 per cent in the quarter, the largest decline on record. As an example of what is increasingly happening in the private sector, Honda workers agreed a pay cut of 3 per cent this week in order to save jobs.

This backs up the cautious assessment of the Bank of England's deputy governor, Charles Bean, in a speech last Thursday that while economic data from around the world suggested the economic contraction was slowing, there were still powerful reasons for concern. But while UK domestic demand looks destined for only sluggish growth this year and next due to rising unemployment and the low to zero pay rises, hopes now rest on a revival in the global economy to help the UK.

Barclays economist Peter Newland, in a seminar for Barclays Wealth clients in Edinburgh last week, gave a cautiously upbeat tour d'horizon, with hopes pinned on a revival in UK exports and investment spending. However, he added, because of the need for households to reduce debt levels and boost savings, "it will take four years for UK GDP to recover to its peak".

These concerns should return to centre stage in any cooling of the furore over MPs expenses. A general election in October looks increasingly likely. This would have two advantages from an economic point of view. First, it would mean an incoming government would have a mandate to take the tough decisions necessary and to begin work immediately with a sobering Pre-Budget Report in November.

The second is that the public mood as a result of the exposures of MPs expenses largesse and tax avoidance may be more favourable to spending cuts and in particular a scythe being taken to the quangocracy. A cut in the size and cost of government would not only chime with the public mood but also give some comfort to those ratings agencies and buyers of UK debt that the country is not finished yet.