On the evening of Friday, September 22nd, the credit ratings agency Moody’s downgraded the UK’s credit rating. Admittedly, it was only by one notch. But coming as it did hard on the heels of Theresa May’s grand speechin Florence, it was a shattering blow.
Credit ratings agencies lost much of their lustre in the financial crisis of 2008, when they were revealed to have been complicit in the mispricing of complex financial derivatives – the “toxic waste” that brought down some of the world’s largest financial institutions. So it is tempting to dismiss Moody’s action as pointless and its analysis as economically illiterate. I confess that I have done so myself, in the past. But this time, Moody’s is on the money. It tells a story of a tragically weakened government struggling with a legacy of policy errors from previous governments as well as the growing likelihood of a chaotic and potentially disastrous Brexit.
Moody’s gives two main reasons for the downgrade:
- The outlook for the UK’s public finances has weakened significantly since the negative outlook on the Aa1 rating was assigned, with the government’s fiscal consolidation plans increasingly in question and the debt burden expected to continue to rise;
- Fiscal pressures will be exacerbated by the erosion of the UK’s medium-term economic strength that is likely to result from the manner of its departure from the European Union (EU), and by the increasingly apparent challenges to policy-making given the complexity of Brexit negotiations and associated domestic political dynamics.
Unsurprisingly, most commentary has focused on the second of these, and tended to ignore or downplay the first. But in fact the two are inextricably linked.
According to the ONS, the UK’s fiscal deficit currently stands at 2.3% of GDP and its public debt (excluding publicly-owned banks) at 88% of GDP. George Osborne had planned to eliminate the deficit completely by 2020 and run an absolute surplus thereafter to reduce public debt over time. Of course, ratios to GDP depend as much on the path of the denominator as the numerator: even if the absolute amount borrowed reduces, debt and deficits can still rise in relation to GDP if GDP falls. But until recently, GDP forecasts were buoyant: notwithstanding the Brexit vote, the UK economy was still expected to turn in GDP growth of 2% or more.
Those forecasts have now degenerated substantially. This is from the second section of Moody’s analysis:
Growth has slowed in recent months, with average quarterly growth of just 0.26% in the first two quarters, versus an average of 0.6% over the 2014-2016 period. Private consumption has slowed sharply and business investment has been weak since 2016, most likely linked to the Brexit-related uncertainty. While future years may see some recovery, Moody’s expects growth of just 1% in 2018 following 1.5% this year and 2.25% on average in recent years.
Ouch. And no, this is not merely a minor setback which Britain will quickly transcend on its path to the “sunny uplands”:
More importantly for the UK’s credit profile, Moody’s does not expect growth to recover to its historic trend rate over the coming years.
Brexit will make Britain poorer. Permanently.
Clearly, if GDP is not going to rise as much as previously expected, then debt and deficits will not fall as fast in relation to GDP as previously expected, even if government spending and revenues remain broadly the same. Ceteris paribus, therefore, Brexit thus threatens the UK’s fiscal position
The disastrous 2017 election further weakens the UK’s fiscal position:
…..the government has yielded to pressure and raised spending in several areas, including for health and adult social care. It also agreed to above-budget pay increases for some public sector workers. While these additional expenditures will be funded out of current budgets, the pressure to continue to increase spending in the coming years is likely to remain high, in particular on health care and the public sector wage bill.
In addition, in order to secure a working parliamentary majority, the new government agreed a ‘confidence and supply’ arrangement that increases public spending by GBP1 billion for Northern Ireland. It also abandoned a pre-election promise to review the costly so-called “triple lock” on state pensions after 2020. Overall, Moody’s expects spending to be significantly higher than under the government’s current budgetary plans and higher than the rating agency expected when the negative outlook was assigned in June 2016.
The minority Conservative government is breaking spending limits all over the place in order to hold on to power. I criticised George Osborne’s slash and burn approach to government finances, but this is no better. Giving in to spending demands to prevent a backbench revolt is hardly a responsible approach to managing public finances. It smacks rather of desperation. Theresa May, it seems, will do “whatever it takes” to prevent Jeremy Corbyn from becoming Prime Minister.
Government revenue, too, is compromised by the Tories’ desperation to keep Labour out:
At the same time, revenues are unlikely to compensate for higher spending. Earlier this year, the government abandoned a planned increase in national insurance contributions for the self-employed. Instead, the government has become reliant on highly uncertain revenue gains from tackling tax avoidance to fund tax cuts….
No government in history has ever managed to repair the fiscal finances by clamping down on tax avoidance. This is not a reason not to do it, of course. But it is a reason not to rely on it.
Adding in the effect of a weak government being forced to increase spending and failing to raise the anticipated revenues, Moody’s anticipates that the deficit will remain at or above 3% in the coming years. Debt/GDP will continue to rise, peaking at 93% in 2019.
All in all, this adds up to a poor economic outlook and worsening fiscal finances. This is the reason for the downgrade. To be sure, the current fiscal forecasts are at least realistic, unlike Osborne’s. But as Moody’s says, repeated revisions to government targets don’t exactly inspire confidence.
Moody’s is no longer confident that the UK government will be able to secure a replacement free trade agreement with the EU which substantially mitigates the negative economic impact of Brexit.
Wait, haven’t we always known this?
Apparently not. Moody’s seems to have had its head in the sand. Belatedly, it recognises that the obstacles the UK government set up from the start – such as refusing to accept the jurisdiction of the ECJ – have rendered a new free trade agreement all but impossible. The window of opportunity is closing rapidly, there is as yet no substantive agreement on any of the EU’s showstoppers, and therefore little prospect of significant progress on trade before the UK leaves the EU in March 2019.
But even if trade were up for discussion, there is no way any new agreement could come close to matching what the UK currently has as a full EU member. According to Moody’s, Brexit “would likely impose additional costs, raise the regulatory and administrative burden on UK businesses and put at risk the close-knit supply chains that link the UK and the EU.” The UK’s vital services sector is particularly at risk: Moody’s warns that “differences of outlook between the UK and the EU suggest that the most likely outcome is now a rather more limited free trade agreement which may exclude services.”
Putting it all together, Moody’s concludes:
Aside from the direct impact on the UK’s credit profile, weakening growth prospects are likely to exacerbate the government’s evident fiscal challenges. And this is likely to be happening during a period in which policymakers will be increasingly distracted by the twin challenges of sustaining a domestic political consensus on how to operationalise Brexit and reaching agreement with EU counterparts.
UK policymakers will spend all their time working out how to implement a policy that will make Britain considerably poorer and substantially weaken its fiscal finances. Lovely.
Of course, the UK government hit back. A spokesman from the Treasury, quoted in the Financial Times, said this:
The assessments made about Brexit in this report are outdated. The prime minister has just set out an ambitious vision for the UK’s future relationship with the EU, making clear that both sides will benefit from a new and unique partnership.
So Theresa May’s grand aria will make all the difference. Unfortunately the head of sovereign ratings at Moody’s doesn’t think so. “I’ve read the speech and it doesn’t change our view at all”, he said on the BBC’s Today programme, downgrading Mrs. May’s credibility to junk.
I criticise Mrs. May’s government, but I am equally critical of a Labour party whose tax and spending plans are every bit as unrealistic as those of the desperate Tories. Brexit will make Britain poorer. Neither party as yet shows any willingness to admit that the prosperity they have promised the British people is completely incompatible with any sort of Brexit. The British people are being systematically deceived by blue and red politicians alike.
Ever since the referendum, the UK has been engulfed in a deep political crisis. Indeed, it started long before the referendum. It is a crisis of lies and dishonesty which is rapidly destroying all trust in the political establishment.
Moody’s says (I paraphrase), “Thank goodness for the UK’s institutions, because its politicians can’t be trusted.” The downgrade itself does not matter, and I would be the first to dismiss calls for further austerity measures to bring the deficit and debt down in relation to GDP. We know now, all too well, how disastrous fiscal consolidation can be in a weakening economy. But the picture that Moody’s paints, of a weak and untrustworthy political establishment and an economy entirely dependent on the soundness of institutions that are increasingly under political pressure, is shocking. This, even more than Brexit, threatens the future of the UK.
Where have the honest and courageous politicians gone? Whatever happened to doing the right thing, not merely the most popular thing? Who will speak up to avert the coming disaster?
The Lord said, “If I find fifty righteous people in the city of Sodom, I will spare the whole place for their sake.”27Then Abraham spoke up again: “Now that I have been so bold as to speak to the Lord, though I am nothing but dust and ashes, 28what if the number of the righteous is five less than fifty? Will you destroy the whole city for lack of five people?”“If I find forty-five there,” he said, “I will not destroy it.”29Once again he spoke to him, “What if only forty are found there?”He said, “For the sake of forty, I will not do it.”30Then he said, “May the Lord not be angry, but let me speak. What if only thirty can be found there?”He answered, “I will not do it if I find thirty there.”31Abraham said, “Now that I have been so bold as to speak to the Lord, what if only twenty can be found there?”He said, “For the sake of twenty, I will not destroy it.”32Then he said, “May the Lord not be angry, but let me speak just once more. What if only ten can be found there?”He answered, “For the sake of ten, I will not destroy it.”