UK PBR - recipe for a downgrade?

Posted by Izabella Kaminska on Dec 09 14:55. 10 comments.
Analyst reaction to the UK’s pre-Budget report, announced on Wednesday, has begun to make its way into the FT Alphaville inbox.
Analyst reaction to the UK’s pre-Budget report, announced on Wednesday, has begun to make its way into the FT Alphaville inbox.
Here’s a small selection, starting with Monument Securities’ Marc Ostwald, who sees the report as nothing less than a recipe for a downgrade:
So what do we have:a) no material changes in the PSNB and GDP forecasts, though we will get an extra £5.1 Bln of Gilt issuanceb) no plans to cut expenditure other than the £5.0 Bln of ‘efficiency savings’, which always never really materialize. Without expenditure cuts, and without substantial cuts in public sector employment, fiscal consolidation is not going to happenc) a 0.5% hike in NI contributions from 2011, which is a taster of things to come, but doubtless only justifies increasing NHS and other social security spending.d) a totally gratuitous £550 Mln tax on bank bonuses, which will obviously make an enormous dent in a £178 BILLLION PSNB this year and £176 Billion next yeare) some tinkering with the cost of the bank bail-out that ostensibly reduces the cost to £50 Billion from £60 Billionf) the forecasts for GDP for 2012 onwards still look as unrealistic as they did in April.As Mr Lewis observed at the time: “The Chancellor is relying on economic growth to do most of the work in curbing the deficit. If that growth fails to materialise, or is not on the scale the Chancellor expects, the public sector debt ratio could, on his plans, end up well above 100% of GDP.” Mr Darling still appears to be engaged in a holding operation, being content to postpone to another day the tough decisions that he or others will have to adopt to restore fiscal stability.Message for ratings agencies: is it not about time the UK went onto ‘outlook negative’ - why wait for the election? The rally in Gilts over the past hour may well proved very short-lived, and is probably being driven by some deferred purchases related to last Monday’s hefty coupon payments in what are seasonally thin volumes. To be frank, I would rather own Irish Gilts at +180 bps, given theirs is a far more serious effort to address their fiscal deficit!
Meanwhile, here’s the ever timely Howard Archer of IHS Global Insight, who complains the report is mostly a political rather than economic endeavour (his emphasis):
OverviewThis is very much a political rather than an economic Pre-Budget Report, which is hardly surprising with a general election due in the first half of 2010 and the Labour government still substantially behind in the polls.Indeed, in many respects on the economics front, it seems fiscal matters are largely on hold until the general election is out of the way, when whoever is in power will really have to get to grips with returning the public finances to a sustainable state.The dire state of the public finances meant that there was little scope for the significant sweeteners that would normally be enacted ahead of a general election. However, there are headline grabbing policies taxing bankers and the rich which the government hope will obviously appeal to most voters but which in actual fact will raise relatively little extra revenue and will broadly cover some limited additional spending on measures including helping the young jobless, small companies and people in danger of losing their homes.Indeed, the political nature of the Pre-Budget Report was highlighted by the Chancellor indicated that the money raised from taxing bankers’ bonuses would go towards the extended measures to help the young and old unemployed get back to work.While the Chancellor is committed to more than halving the budget deficit to 5.5% of GDP by 2013/14, with the commitment reinforced by the Fiscal Responsibility Bill, he has only put a limited amount of meat on the budget deficit cutting bones.With a general election due in the first half of 2010 and the economy still in a highly fragile state, it is no surprise that the Chancellor has held off from any significant fiscal tightening in 2010/11. Indeed, the Chancellor indicated that the measures are neutral overall for 2010/11. The government has repeatedly commented that to slam on the fiscal brakes now would be “madness” and would risk derailing recovery. Mr. Darling is clearly hoping that the markets and the rating agencies will give the government the benefit of the doubt over their plans and details announced so far to bring down the deficit substantially from 2010/11.The ForecastsGrowth: The Chancellor forecast that GDP would contract by 4.75% in 2009 and then grow by 1.0-1.5% in 2010. These projections are realistic and fully defensible. Further out, the Chancellor expects the economy to grow by around 3.5% in 2011 and 2012. While these forecasts are not inconsistent with those of the Bank of England, we suspect that these forecasts will prove too optimistic, not least because of the substantial fiscal tightening that will occur. Admittedly, it is frequently the case that economies experience robust growth once recovery gets underway from a deep recession, but we suspect that a number of factors will hold back growth for an extended period. In addition to tight fiscal policy, this includes the need for consumers to rein in elevated levels of debt and extended muted bank lending as banks repair their balance sheets. If growth in 2011 and 2012 is less than 3.5%, it will make it will obviously have negative repercussions for the PSNBR.Public Sector Net Borrowing Requirement (PSNBR): The Chancellor modestly raised the PSNBR forecast for 2009/10 to £178 billion (12.6% of GDP) from the £175 billion expected in the budget back in April. This looks too low to us. The PSNBR jumped to a record £86.9 billion during the first seven months of fiscal 2009/10 from £33.6 billion a year earlier, and at the current rate of deterioration, the PSNBR is heading for around £215 billion in fiscal 2009/10. Even allowing for a slowdown in the rate of deterioration due to the likely return to economic growth in the fourth quarter, January’s rise back up in VAT from 15 to 17.5% and the recent marked slowdown in the rate in claimant count unemployment, it seems the PSNBR is more likely to be at least £190 billion, and could well be higher still.The PSNBR is now seen edging down to £176 billion (12.0% of GDP) in 2010/11 and to £96 billion (5.5% of GDP) in 2013/14. The 2013/14 projection for the PSNBR is £1 billion below the £97 billion forecast back in April, which almost seems symbolic of the government’s commitment to bring down the deficit. The PSNBR is seen falling further to £82 billion (4.4% of GDP) in 2014/15.Main Measures While the government has re-stated its commitment to more than halve the PSNBR to 5.5% of GDP by 2013/14, we are not much more the wiser about how exactly this will be achieved. Looking past the populist tax on bankers’ bonuses, the major tax announcement is that all employer, employee and self-employed national insurance contributions will rise by a father 0.5 percentage point from April 2011. However, nobody earning under £20,000 will pay more.The Chancellor confirmed that VAT would rise back up from 15.0% to 17.5% from 1 January but did not make any further changes. There had been speculation that he could announce that it could rise to 20% further out, or the coverage be widened. He also froze the Inheritance Tax threshold at 325,000 On the spending side, the Chancellor announced that the spending plans for 2010/11 would remain unchanged to avoid damaging recovery prospects, and confirmed that the squeeze would start from 2011/12.However, it is still not clear how the pain will be shared among the various departments. All public sector pay rises will be capped at 1% from 2011, while he announced £5 billion of savings from spending programmes.
And last, here’s the British Bankers Association’s chief executive Angela Knight on the matter of bonus taxes:
“The Chancellor’s comments on bonuses were well trailed and we now await the details.“This new tax has to be set in the context of commitments already made. The UK’s banks have already agreed to observe pay restraints where bonuses are mostly deferred and paid in shares. We are already well ahead of the other G20 countries in doing this.“Viewed from abroad, those foreign banks which reward their UK staff with contractually-agreed bonuses are likely to be the hardest hit. London may well look to them now like a significantly less attractive place to build a business. “We must repeat that only concerted international agreements will succeed in reforming remuneration in the financial sector.”