Waiting for public spending
October 15th, 2010
Some commentators and market participants are waiting to see the results of the UK government’s review of public spending. There is no need to wait for the Big Picture, as that was set out clearly in the summer Budget from the new Chancellor. Next week may produce some interesting detail for those who follow particular sectors and shares, with winners and losers. That is detail we do not need as Index investors. If you want to know the totals and think through the likely impact on the economy, the numbers have already been set out in the Red Book.
Contrary to much of the comment, current public spending rises every year between 2009-10 and 2014-15 in cash terms. It will go up from £600 billion last year, to £692.5 billion in 2014-15, an increase of £92.5 billion. Capital spending will be cut substantially, leaving the overall combined total of current and capital spending up by £68.2 billion.
If the government gets its own inflation rate down to 2% and keeps it there for the five years, then current public spending increases slightly in real terms. If the government is less successful in controlling wages and prices, then there could be a small real cut in current spending. Their pay freezes and proposed substantial cuts in the administrative overhead should allow small overall real growth in current spending.
We have some insight into the changes in departmental programmes from the public announcements so far. We know that the government plans to increase Health spending. It has announced a £7 billion increase in Education funding over four years for pupils from lower income homes. It has decided to increase pensions in line with the best of wages or prices, which should increase pension payments over the five years. Benefits generally are likely to increase with prices throughout the period. Overseas aid will increase, and the EU is seeking a 5.5% increase in its budget for next year. The UK’s contributions to the EU increase anyway, owing to the partial surrender of the UK rebate by the previous government. Debt interest will increase considerably as the government plans to borrow substantial sums in the next couple of years.
Some seem to think the government’s aim is to start repaying the national debt. This is not true. Over the forecast period to 2014-15 including this year the government will borrow an additional £451 billion, bringing the deficit down to £37 billion a year by 2014-15, from the £149 billion in 2010-11. The reduction in the deficit and the slowing of the debt build up partly occurs owing to the government’s decision to reduce the rate of increase in public spending it inherited. It partly occurs from the increase in tax revenue it forecasts.
Over the five year period tax revenue is forecast to rise from £479.7 billion in 2009-10 to £656.5 billion by 2014-15, an increase of £176.8 billion. By 2014-15 £0.9 billion of the increase is forecast to come from the CGT increased rate. £13.5 billion comes from the higher rate of VAT. Most of the rest is assumed to come from the favourable effects of growth on general tax revenues.
Because the UK public sector is used to more generous increases in cash and real terms this shift will result in some cuts in individual areas and a sense of difficulty as the public sector adjusts to trying to do more for the same or even more for less. The main media focus has been on specific cuts and may well continue to be.
The government’s announcements so far have reassured markets sufficiently to put UK government bond prices up and to remove the threat of a Greek style debt crisis. Markets should continue to give the UK some credit for seeking to cut the deficit substantially over the next four years. They are also likely to watch growth rates very carefully, as the deficit reduction programme rests heavily on increased tax revenue from a more buoyant economy. The Office of Budget Responsibility which produced the growth forecasts assumes 1.8% in 2010-11, followed by 2.4%, 2.9%, 2.8% and 2.7% in the following years. This would be a good performance for a mature economy with as much public and private debt as the UK.
We continue to prefer faster growing areas of the world for our main equity investment.
