Closing bell: Over-doing the cuts? Keep in mind our credit-rating masters

Published on Wednesday 15 September 2010 17:11

Debt is a pretty straightforward concept.

Party A, a debtor, owes something to party B, a creditor. There's nothing very remarkable about this relationship, which can persist for extended periods without anyone getting very stressed about it.

There's no moral dimension here, whatever some of my forebears might think. Party B does not occupy some moral high ground and party A has nothing of which to be ashamed - as long as, that is, no-one strays beyond the limits of prudence and sustainability.

Most of us probably reckon we should be able to spot when an A or a B starts to step over the line. And there is no shortage of external agents ready and willing to start kicking up a fuss; no party A exists that is so big or so powerful that it can borrow to excess without getting into trouble.

At the personal level finding your credit card blocked is a stark message; at the corporate level a slip down the credit ratings concentrates minds; at the level of national government we have the headmasterly presence of the International Monetary Fund (IMF), from which a poor report is at the least an embarrassment. And above all else we have the markets - the lenders, the agglomeration of party Bs - who by their actions have the last word.

The conventional wisdom is that the UK is grossly over-indebted. According to research by the Economist/McKinsey, total UK debt amounts to 466 per cent of gross domestic product (GDP), a ratio beaten only by Japan. Within that total, government is a relatively small offender yet the pressure to tackle the deficit is overt and extreme.

Nothing in economics, of course, is as uncomplicated as it looks - 466 per cent is a startling figure but that is gross debt; it ignores the assets side of the picture. UK debtors may be having their collars felt by the bank manager but taken as a whole UK households, for example, are in much better balance than the headline suggests.

Even so it comes as a bit of a surprise to see reports from the IMF arguing that the public finances in many countries that are causing concern - including the UK - may be nothing like as close to their theoretical debt limits as we think. In round figures the UK could theoretically sustain a public sector debt to GDP ratio nigh on double the current projection for 2015 which, on the face of it, raises questions about the upcoming spending (or not-spending) round.

So has the IMF gone mad or are governments completely wrong to be ladling out austerity? Well neither, actually.

The IMF's calculations take into account the widest range of factors in assessing a country's ability to deal with debt, including its past record, its economic performance and flexibility, the robustness of its "business model", the efficacy of tax collection and the power of rioters in the street.All good, valid stuff but note that word "theoretical".

The world we live in is a practical one; theory defines what is possible but harsh practicality dictates what can actually be done. We should not frighten ourselves too much by looking only at gross debt and ignoring the assets side; we should take some comfort from that theoretical cushion identified by the IMF. But theoretical cushions won't lend us the money while we sort ourselves out; for that we need the markets.

Markets are often perverse, but generally they do a pretty good job at monitoring the relationships between parties A and B. Those arguing that the UK should back off on the hair shirt stuff and go for some kind of southern European, debt-laden lifestyle should look at the bond markets. As a credible deficit-cutter the UK government (that's you and me, by the way) can borrow extremely cheaply, something for which we all should be deeply grateful. For the alternative, just look at Greece.

I've written before about the obstacles to deficit reduction when all economic agents have the same agenda and it remains to be seen how it will all pan out. But whatever the IMF's backroom boffins dream up, it really does still need to be done.

• Peter Bickley is a consultant economist