Britain’s “Credibility Gap”
On the face of it, it is clear why Standard & Poor’s has cut Britain’s debt outlook from “stable” to “negative” for the first time in decades and threatened to strip us of its cherished AAA rating for the first time ever. After all, new stats show that government borrowing surged fivefold in the year to April, while tax receipts slumped 10%.
S&P warned that the UK’s ratio of debt to GDP could be about to double to 100% and stay there – and they might be right. On the other hand, these are the same people who brought you triple-A rated collateralised debt obligations, rock-solid Icelandic banks – and failed to predict any of the financial crises of the past 20 years. Ratings agencies always accentuate the book and exaggerate the bust, and this latest offering is typical of their output: a risible piece of guesswork.
That said, it’s not too hard to spot the gigantic hole in the UK’s public finances, and it doesn’t help that the Bank of England’s quantitative easing strategy has meant that it’s busy buying back the Government’s own debt from lenders – underpinning and distorting the price of gilts. Ernest Saunders went to prison for doing something similar.
S&P aren’t saying anything that hasn’t been well documented by any number of other worthy bodies – including the IMF. The S&P downgrade matters, because if we lose our AAA rating, our problems will be much worse. Foreign investors buy two-fifths of our government debt, and many of them are only allowed to hold paper with a pristine rating. That’s scary.
Given the current political disarray, it was no surprise that the Treasury couldn’t come up with a convincing response to S&P. They need to – and fast. When it comes to getting people to lend money, Britain has historically relied on two factors: its strong and stable governance, combined with a history of paying our debts back. There is no fundamental reason why that can’t continue. Even the chasmal fiscal deficit of 12.4% projected for 2009-10 is affordable as a one-off, but only if investors are told how the Government is going to pay them back eventually.
Instead, Britain is suffering from a credibility gap. With the expenses scandal and uncertainty over the state of the election causing political paralysis, and neither party remotely clear about their future tax and spending plans, the UK looks financially exposed and politically weak, and that’s perfect ground for ratings agencies to wreak their usual havoc.