Morning Briefing 7/7/21

Wednesday, 7th July 2021 09:16 - by Mark Palmer and Ben Timms

The Office for Budget Responsibility has been crunching some numbers, which Rishi Sunak is going to want to take note of: In their biannual fiscal report, the OBR have said that an extra £10bn a year for three years will be required on public services to manage the fallout from the pandemic.

The money would go towards health, education and transport, with the lion’s share of that going towards health, specifically maintaining the test and trace programme, continuing the vaccine rollout and booster programmes, and also dealing the with record NHS backlog. Education spend is on catch-up programmes and transport funding is filling in the huge gaps for public transport operators that aren’t receiving the fare revenue to cover their operating costs.

The £30bn a year required to make this happen is a drop in the ocean compared to what the OBR consider the costs to the government of getting the UK to it’s 2050 net-zero carbon emissions pledge: They calculate the cost of this could add another 21% of GDP’s worth of debt over the next 30 years – or £469bn in today’s money. Interestingly, a lot of this wouldn’t be borrowing for fresh projects, but to cover the revenue losses on fuel duty.

The OBR warn that taking swift and concerted global action now will be much cheaper than wasting time until the turn of the next decade and then having to take much more radical steps thereafter – in the latter scenario we’d also find ourselves more exposed to ‘potentially catastrophic risks’ the longer we wait and these, though unknown, would invariably have a large financial cost attached to them.

Based on the above, borrowing more seems to be an inevitability but with the cost of borrowing is likely to rise, taking on extra debt seems like a risk the government might not be too comfortable with: At the moment the debt pile is incredibly cheap to service, costing less than 1% of GDP, but a 1% rise in interest rates would cost another 0.5% of GDP to just keep the debt ticking over.

We’ve also got a problem that the current debt pile is made up of short duration and inflation linked bonds, which means that refinancing maturing debt will become more expensive and if inflation does take off, then we’ve got even more problems (and if you ‘solve’ inflation by raising rates, you’re back to increasing your debt service costs).

Previous governments will have welcomed inflation because it diminishes the real value of an existing debt, but Rishi Sunak is seemingly in the unenviable position of needing to grow the debt pile and hoping inflation doesn’t take hold. Tax rises, anyone?

US treasury Secretary Janet Yellen is said to be pushing for a higher global corporation tax threshold than the 15% that has been agreed by 130 countries in the OECD. Ms Yellen and several other G20 countries find themselves also staring at a burgeoning debt pile and are drawing the conclusion that this is probably the only way to pay for it.

For now though, G20 finance leaders will meet in Venice this weekend and will endorse the 15% minimum as a starting point – though it won’t be formally signed off until later in the year and will be contingent on the Biden administration putting in some fairly rigorous US tax overhauls ahead of that.

Staying with the cost of debts: The Washington Post has an interesting piece on what rising US interest rates could mean for emerging market economies. They say that over the course of the pandemic these countries have seen debt piles swell to $86 trillion, up by almost 15% since March of last year, and are likely to continue to climb as countries have to spend to get back on their feet.

These countries have a triple whammy to deal with if the US raise rates: 1, their borrowing will largely be in USD and increase their debt service costs. 2, refinancing debt will become more expensive as the relative returns being offered by developed economies with higher rates will become more appealing and these countries will have to compete by offering more favourable terms. 3, if the US Dollar strengthens versus their domestic currency, then taxes collected in local currencies may be worth less in US dollar terms and therefore won't go as far towards covering interest payments -this in turn might hurt their credit ratings and further raise borrowing costs.

This amount of possible default risk isn’t something that these countries can solve alone and will be a discussion point at this weekend’s G20 meeting. Currently there is a suspension on debt servicing costs for developing countries repaying debt to governments, but this expires at the end of the year and didn’t cover repayments to non-government creditors (which is the vast majority). This is a subject that won’t be going away by itself, and we’d expect (read: hope) to hear more about possible solutions to this in the months ahead.

Away from debt and briefly to markets: It’s been a slow start to the week following the 4th July weekend market holiday in the US. Things have got off to a reasonable start in Europe this morning, though Spain’s IBEX35 index is trailing the Italians’ FTSE MIB index very slightly after what was a very long night of football.

It’s Coming Home.

This article was taken from Hamilton Court FX.

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