So Moody’s has downgraded the UK. This country’s sovereign debt has dropped one notch from AAA, the lowest possible credit risk, to AA1. For the first time since 1978, Britain has lost its triple-A rating.
The markets saw this coming. All three major credit ratings agencies – the others being Standard and Poor’s and Fitch – have had the UK on “negative outlook” for some time, suggesting a downgrade would follow if the economy deteriorated further. Well, GDP contracted by 0.3pc during the last three months of 2012, we learnt a few weeks ago, as Britain flirts with triple-dip recession.
Little wonder that the Moody’s downgrade notice issued on Friday night pointed to “continuing weakness in the UK’s medium-term growth outlook”. The government’s fiscal consolidation programme faces significant “challenges”, the agency noted, with our public sector huge debts “unlikely to reverse before 2016”. Again, this is nothing financial analysts didn’t already know.
Although long foreseen by investors, in the political market place this downgrade is nothing short of a bombshell. Over the coming weeks and months, it is set polarize the national debate over our ghastly fiscal dilemma even more.
In Labour’s eyes, Moody’s verdict, inevitably, is a “humiliating blow” to George Osborne, the Chancellor having repeatedly said that retaining AAA-status was “the key test of this government’s economic and political credibility”. Her Majesty’s opposition wants “urgent action to kick-start our flat-lining economy” – a euphemism for even more spending, presumably financed by more borrowing – presenting the downgrade as proof that Tory “austerity measures” have curtailed growth by “cutting expenditure too far and too fast”.
Increasing numbers of Conservatives, in stark contrast, protest that Moody’s move highlights that Osborne’s fiscal consolidation is too timid, with growth strangled by higher than ever state spending and related taxation. It is certainly the case that, for all the austerity rhetoric, public spending continues to spiral upward.
Government expenditure in January was 4.1pc above that of January 2012, we learnt last week, and benefit spending was 8.4pc higher. During the first ten months of the fiscal year, current spending was 5.9pc up on the same period in 2011/12, but net investment (the kind of state expenditure we perhaps need to grow right now) was lower.
The Institute for Fiscal Studies now judges that UK borrowing will exceed official targets by “almost £7bn” during 2012/13, with the government adding £128bn to the national debt this year, more than in 2011/12. I’m not saying that fiscal consolidation is easy. But something has to change.
While ministers have long talked of “paying-down the deficit” the real issue is the UK’s outstanding stock of debt. As the news agenda splits hairs about single-digit million measures and disappointing 4G spectrum auctions, we all lose sight of the most important fiscal fact. Between now and 2016, even if Britain’s austerity programme is implemented in full (a big if), our national debt will balloon to around £1,600bn – over five times what it was at the turn of the century, and three times more than in 2008. This is a massive debt burden, all of which must be serviced year-in-year out, with interest payments draining funds available for vital public services and requiring even higher taxation.
For some time, the UK government has spent more on debt service each year than on defence. It won’t be long before we spend more on state interest than on education – an absurd situation and testament to our fiscal mismanagement. Then, of course, we have to pay back the borrowing itself.
So we’re not only leaving our children and grandchildren a vast debt pile, allowing ourselves the luxury of state largesse at their expense. We’re also, in the meantime, squandering on interest precious resources that should be channeled towards preparing them for the intensively competitive global market in which they’ll live.
Everyone in this country, whoever they vote for, should be ashamed and concerned by such realities. Consider, also, that this gargantuan £1,600bn public debt doesn’t include public sector pension obligations of another £1,200bn or so – the bulk of which will be paid, over time, directly from future taxation – or other multi-billion pound hidden government liabilities, not least those related to the disgraceful private finance initiative.
The UK government has shown more fiscal responsibly than many others. The United States lost its AAA status last year, as did France, joining much of the rest of the eurozone. Among the world’s leading economies, only Germany and Canada now boast the coveted triple-AAA.
In truth, though, we’ve been a bit less irresponsible. With the state now accounting for around half of annual GDP, the answer – at least the long-term answer – can’t be more government spending. This is particularly so, given that the borrowing we’d need to fund that extra expenditure could spark the destructive chaos of a fully-blown creditors’ strike.
Something far more radical is now needed. The state must do much less, and do it better. I don’t view this as a party political or an ideological statement. It is an expression of arithmetic reality and common sense.
Moody’s agrees. Yes – all the ratings agencies stamped corporate junk bonds as safe in the run-up to the sub-prime fiasco, so pocketing hefty consultancy fees. Their views on commercial bonds remain discredited, and rightly so. When it comes to national accounts, though, these guys can still add up. Any “fiscal loosening” by the UK would risk another downgrade, a part of the Moody’s fine-print which didn’t feature in Labour’s response. And another downgrade could follow, the agency added, if it sees “a reduced political commitment to fiscal consolidation”.
Our political classes, privately at least, often view the general public as a little bit thick. In my view the British people, while often distracted by trivia, we’re only human after all, are very far from stupid. Most of us know, deep down, that we can’t go on as we are, that more borrowing and spending won’t work and down that path lies national ruin.
In next month’s budget statement, Osborne needs to use the political shock of the first downgrade in 35 years to move away from political calculation and incrementalism, taking significant steps to re-cast our public sector so it can provide the basic services we require, and protect the needy, but on a realistic and sustainable basis. If he did that, laying out a vision of a leaner, more accountable state, with resources more targeted on the genuinely needy, and the quangocracy stripped away, the majority of the public would back him. And, at that point, Labour would also change its tune.
Despite being foreseeable, this downgrade could still lead to some aggressive selling of sterling this coming week. On a nominal effective basis (against leading trading partners), the pound has already lost 7pc since September. Signs last week that the Bank of England could soon print more money quickened the pace of that drop.
That’s why Treasury ministers, keen to see the trade-boosting, debt-debasing effects of a lower pound, may view this downgrade as not so bad after all. The danger is, though, that the rope slips and a sly gradual depreciation escalates into currency freefall, the pound over-shooting far below its fundamental value. We’d then have an inflation spike, stagnating investment and an even deeper economic slowdown.
So forget about covert currency wars. This Moody’s downgrade should be a political call to action for us genuinely to live within our means.