According to S&P Global Ratings, the United Kingdom requires stronger economic growth to stabilize its debt levels. Britain’s new Prime Minister Keir Starmer, who recently embarked on a two-day tour of the four nations of the United Kingdom, emphasized the need for robust economic measures during an interview at the Senedd in Cardiff on Monday. S&P Global noted that the UK government’s efforts must stimulate sustainable growth to address its national debt, a significant concern for financial analysts.
The International Monetary Fund (IMF) ‘s annual assessment of the UK economy suggests that the incoming Labour government could raise revenues through carbon and road usage taxes as it seeks to grow the economy and stabilize public debt. Based on consultations with UK authorities, the IMF report warns of difficult tax and spending choices ahead. The government could also consider broadening the value-added tax base or the inheritance tax and reforming capital gains and property taxation.
The report emphasizes that “Absent a substantial boost to potential growth, stabilizing debt will require difficult tax and spending choices.
Labour, led by Keir Starmer, won a landslide election on July 8, 2024. In the lead-up to the elections, the UK’s near 100% debt-to-GDP ratio has become a significant concern, as noted by rating agencies. Despite the nation’s stretched finances, all political parties promise to address public service deficiencies and invest in infrastructure without raising key taxes.
The market panic that ensued when then-Prime Minister Liz Truss pledged substantial spending in 2022 is a caution against overly radical fiscal policies. S&P’s Frank Gill commented, “We are interested in the balance between revenue and expenditure adjustments, enabling the new government to improve the underlying fiscal position.”
With a relatively modest 1.3 percentage point of GDP primary budget deficit anticipated this year, the UK is not as distant from a debt-stabilizing balance as G7 peers like the U.S., France, and Italy. However, questions about the sustainability and composition of fiscal consolidation remain.
Fitch raised its AA- UK rating outlook to “stable” in March, aligning it with Moody’s but still a notch below S&P’s AA rating. Fitch’s projections assumed a delicate balancing act between policy priorities and the need to reduce risks to public finance sustainability.
Focus on stabilizing public debt
The UK’s debt-to-GDP ratio, more than double the 48% median for ‘AA’ rated countries, underscores the importance of this balance. Economic growth, which has averaged just 1.6% annually over the past decade, must increase significantly to prevent further rating downgrades. Challenges to achieving higher growth include net migration, labor market participation, and productivity growth issues.
There is ongoing debate about potential changes to the UK’s self-imposed fiscal rules, which mandate a reduction in public sector debt as a share of GDP over five years. Some Labour officials have suggested significant reforms are unlikely due to market sensitivities. With government debt issuance projected to be the second-highest on record at 278 billion pounds in the 2024-25 financial year and last year’s interest bill on Britain’s debt reaching 111 billion pounds, approximately 4.4% of GDP, fiscal prudence is paramount.
However, the 10-year gilt yield, a measure of the government’s borrowing costs, has dropped from last year’s highs to just over 4.1%, offering some reassurance. European-based rating firm Scope is concerned about maintaining the pound’s status as a global reserve currency amidst rising alternatives like China’s yuan. Scope’s Dennis Shen emphasized the importance of a stable government and credible budgetary policies, suggesting enhanced access to the EU Single Market could aid this effort.
Additionally, the issue of raw sewage pollution from privatized water companies has become a contentious election topic. Investors in big water firms, such as Thames Water, are pulling out due to the significant funds needed to address the problem. This could potentially lead to government intervention and further complicate the UK’s fiscal situation. Gill from S&P noted, “If that has to be funded, it would be reflected in their fiscal assessment.
Will it be enough to change the UK rating? I would doubt it, because it’s really a confluence of factors.”
