Budget 2020 – Austerity is out, spending is in - Capital Economics
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Budget 2020 – Austerity is out, spending is in

UK Economics Focus
Written by Paul Dales
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The coordinated fiscal and monetary stimulus announced by the Chancellor and the Bank of England today shows that policymakers are pulling out all the stops to ensure that the coronavirus results in the economy following a path over the coming quarters that looks more like a “V” than an “L”. But arguably the longer-lasting legacy of this Budget is that the austerity of the last decade is being replaced with a desire to spend that could last just as long.

  • The coordinated fiscal and monetary stimulus announced by the Chancellor and the Bank of England today shows that policymakers are pulling out all the stops to ensure that the coronavirus results in the economy following a path over the coming quarters that looks more like a “V” than an “L”. But arguably the longer-lasting legacy of this Budget is that the austerity of the last decade is being replaced with a desire to spend that could last just as long.
  • The Chancellor, Rishi Sunak, built on the measures announced by the Bank of England this morning by announcing a fiscal stimulus of £30bn (1.4% of GDP) in 2020/21. Put into context, that’s twice the size of the stimulus we expected, it eclipses the stimulus implemented in 2008 at the height of the financial crisis and it is the largest, longest-lasting stimulus since 1992.
  • £12bn (0.6% of GDP) of it was made up of a package of measures designed to support businesses and households during the disruptions caused by the coronavirus. That’s a one-off boost that is not expected to be repeated in future fiscal years. And it builds on the extensive measures announced by the Bank of England first thing this morning. (See here.)
  • The remaining £18bn (0.8% of GDP) ticks off some of the policies promised in the Conservative Party’s December election manifesto, such as more spending on the NHS, a reduction in taxes raised from national insurance contributions and £7bn (0.3% of GDP) of extra public investment.
  • Perhaps more significant is that even in future years when the £12bn coronavirus package drops out, the Chancellor more than filled the hole with yet more spending and investment. Indeed, the Chancellor announced extra public investment of a whopping £100bn over five years, although the Office for Budget Responsibility has judged that in reality only £83bn of that is achievable.
  • So this Budget is about much, much more than a temporary coronavirus package. Instead it is a very clear sign that the austerity of the past decade is out and more government spending and investment is in.
  • Despite this, Sunak stated that he has stayed within the new fiscal rules laid out last year by his predecessor Sajid Javid. But that’s mainly because the economic assumptions don’t include the hit to GDP growth from the coronavirus. As and when they do, we estimate that the £12bn surplus in 2022/23 on the current budget will vanish leaving Sunak perilously close to breaking the fiscal rules. That’s probably why he pledged to review the rules in the autumn.
  • In normal times, a much bigger fiscal stimulus than we had expected would prompt us to revise up our GDP growth forecasts. But this big boost is coming at a time when there is going to be a big drag from the coronavirus. And the package won’t prevent the economy from being very weak in Q2 and Q3, with a mild recession possible. A worst-case scenario could involve a 5% fall in GDP. (See here.)
  • That said, the monetary and fiscal stimulus put in place today by the Chancellor and the Bank of England, and the broader shift from austerity to spending, leaves the economy well placed to recover late in 2020 and to perform pretty well in 2021.

Budget 2020 – Austerity is out, spending is in

In the first Budget of the new government and the his first Budget as Chancellor, Rishi Sunak delivered a temporary big fiscal stimulus to cushion the blow to the economy from the coronavirus and also a longer-lasting stimulus that will support the economy further ahead.

The policy measures

The centrepiece of the Budget was the package of measures to support households and businesses in the wake of the coronavirus, which was the second prong of a coordinated policy response after the Bank of England’s moves earlier today.

The headline was the Chancellor’s commitment that the NHS will have “whatever it needs” to combat the coronavirus. But there were also more specific measures such as the cancellation of business rates for small firms and grants of up to £3,000 for firms too small to pay rates, which together will cost £3bn. He also made it easier for those on low-incomes to claim sick pay and said that the government would refund sick pay to businesses at a cost of £2bn. Temporary changes to the benefits system and a £500m hardship fund for local councils to distribute were also announced. These measures cost about £7bn in 2020/21. Together with an emergency fund for the NHS worth £5bn, the total fiscal policy response to the coronavirus is worth £12bn.

This complements this morning’s announcement from the Bank of England of a cut in interest rates from 0.75% to 0.25%, a new term funding scheme to support lending to SMEs and a reduction in bank capital requirements, which in total could boost lending to non-financial firms by almost £300bn. (See here.) And following the theme of disaster management, the Chancellor also announced extra funding of £5.5bn for flood defences.

On top of that, the Chancellor fulfilled some of the Conservative Party manifesto pledges and splashed some cash. He made good on promises to spend more on the NHS (at least £1bn in 2020/21) and cut taxes by raising the NICs threshold for employees and the self-employed from £8,632 to £9,500 in April 2020, the latter at a cost of about £2.1bn in 2020/21. And he also froze alcohol and fuel duty at a cost of £0.3bn and £0.5bn respectively.

But the biggest spending announcements were saved for infrastructure where he set out a massive plan focusing on roads, railways, housing and broadband. Almost all of this will be allocated in future spending announcements, but the Chancellor highlighted that there would be an extra £27bn for roads, £12bn for housing and £5bn for broadband.

He did raise a bit of money too. As expected, Sunak kept the rate of corporation tax at 19%, gaining him £4.6bn in 2020/21, and increased the immigration health surcharge, netting him an additional £0.2bn. And rather than abolishing entrepreneurs’ capital gains tax relief, he revised down the limit from £10m to £1m, which could bring in £0.2bn.

The net effect is a package worth £30bn (1.4% of GDP) in 2020/21, of which £12bn is temporary spending on coronavirus and £18bn is more permanent. In future years, more spending raises the cost to £35bn-£42bn. (See Table 1.)

Table 1: Key Measures: Cost (-)/Yield (+) (£bn)

 

20/21

21/22

22/23

23/24

24/25

Spending measures

         

Unallocated spending

-15.1

-40.9

-46.6

-49.7

-64.8

Covid-19 response

-12.0

Infrastructure

-3.3

-4.3

-6.2

-8.1

Farm support

-2.7

Schools & health

-2.5

-2.7

-2.8

-2.8

NICs threshold increase

-2.1

-2.2

-2.3

-2.4

-2.4

Building safety fund

-1.2

Fuel duty freeze

-0.5

-0.5

-0.5

-0.6

-0.6

Employment allowance

-0.4

-0.4

-0.5

-0.5

-0.5

Alcohol duty freeze

-0.3

-0.3

-0.3

-0.3

-0.3

Pension allowance

-0.2

-0.3

-0.5

-0.6

-0.7

Revenue raisers

         

Cancel corporation tax cut

+4.6

+6.1

+6.7

+7.1

+7.5

EU contributions

+4.3

+5.0

+7.1

+11.3

+14.6

Tax compliance measures

+0.3

+0.9

+1.1

+1.1

+0.6

Entrepreneurs relief

+0.2

+1.1

+1.5

+1.7

+1.8

Immigration surcharge

+0.2

+0.4

+0.4

+0.4

+0.4

Red diesel relief removal

+1.6

+1.6

+1.6

Total Policy Decisions

-29.9

-36.4

-38.5

-41.2

-41.9

Source: HMT. Not an exhaustive list. Numbers may not sum.

Forecast misses coronavirus hit

Unfortunately the Budget didn’t provide a very clear picture of how these measures will influence the fiscal figures as the OBR’s forecasts for the economy are based on outdated assumptions. Indeed, as the OBR finalised its economic forecasts on 18th February when the coronavirus was limited to China, it has not incorporated the impact of the spread to the UK. So the economic and fiscal forecasts, for 2020 at least, look better than they really are.

That’s why the OBR’s forecasts are not hugely changed from the March 2019 projections. GDP growth in 2020 was revised down from 1.4% to 1.1%, reflecting the economic slowdown at the end of last year and the weaker global outlook as the coronavirus hit China. But 2021 was revised up from 1.6% to 1.8% due to the fiscal boost from the rise in public investment and the rise in government spending announced in last September’s Spending Round. (See Table 2.)

Table 2: Real GDP Forecasts (% y/y)

 

2020

2021

2022

2023

2024

OBR Mar 19.

1.4

1.6

1.6

1.6

OBR Mar. 20

1.1

1.8

1.5

1.3

1.4

Capital Economics*

0.7

2.0

1.6

1.5

1.5

Sources: OBR, Capital Economics

Table 3: OBR & Capital Economic Forecasts for 2020 & 2021

 

2019

2020

2021

Outturn

OBR Mar. ‘19

OBR Mar. ‘20

CE

OBR Mar. ‘19

OBR Mar. ‘20

CE

GDP

1.4

1.4

1.1

0.7

1.6

1.8

2.0

Productivity per hour

0.0

0.7

0.9

0.3

1.1

1.2

1.6

Household spending

1.4

1.8

1.1

1.1

1.9

1.2

1.9

Govt. Spending

3.6

1.7

3.7

4.9

1.6

2.8

2.3

Fixed Investment

0.4

1.8

-0.8

0.5

1.9

3.4

3.6

Stockbuilding, % cont.

0.1

0.0

-0.1

-1.2

0.0

0.1

-0.8

Domestic Demand

-1.7

1.6

1.1

0.4

1.7

2.0

2.6

Exports

8.2

1.7

-0.6

-3.0

0.2

-0.5

1.5

Imports

-2.1

2.1

-0.2

-3.2

0.6

0.4

3.6

CPI Inflation

1.8

1.9

1.4

1.4

2.0

1.8

1.9

Sources: OBR Economic & Financial Outlook, Capital Economics

Further out, the adjustments were minimal, but GDP growth was pulled down slightly due to a more pessimistic assumption on the effect of Brexit. The OBR now estimates that a free trade deal will reduce potential GDP by 4% in the long run compared to remaining in the EU. Only a third of that hit is incorporated into the forecast, as a third has already happened and another third is likely to take place beyond the OBR’s forecast horizon.

Meanwhile, the net migration assumption was pulled down from 190,000 a year to 124,000 by 2024, although the impact of this on employment and therefore GDP growth is fully offset by higher participation and a lower unemployment rate.

While the OBR didn’t incorporate the hit from the coronavirus into its forecast, neither did it account for the double-barrelled policy response from the Bank of England and the Treasury’s £12bn coronavirus package. In fact, because of the other £18bn fiscal boost, the OBR decided it was more likely interest rates would stay at 0.75% rather than be cut to 0.50% as the market had assumed when the OBR finalised its forecast. The Bank has already cut rates to 0.25%. And the £12bn coronavirus package means fiscal policy has been loosened by more than the OBR expected. So that could cushion some of the downward effects from the coronavirus.

Even so, our GDP forecast for 2020 is lower than the OBR’s, and even then we think the risks are on the downside. But beyond 2020, we suspect that GDP growth will be faster than the OBR expects. (See Table 3.)

The fiscal forecasts

Given the slightly softer economic backdrop, the consequence of more government spending is higher public borrowing. The public sector net borrowing (PSNB) excluding public sector banks measure was revised up by a total of £93.9bn over the next five years. The 2020/21 figure was revised up by £14.6bn, from £40.2bn to £54.8bn.

Table 4 compares the OBR’s new fiscal forecasts with those published in December. This shows that only a small proportion of the upward revisions to borrowing reflected forecast changes – such as the weaker outlook for earnings growth and household spending.

The Chancellor received a helping hand from lower debt interest payments, which reduced borrowing by £7.4bn on average a year. The fiscal savings from leaving the EU also reduced borrowing by about £8bn a year. Those factors added £2.3bn to borrowing in 2020/21.

Table 4: Changes to PSNB Ex. Forecasts (£bn)

 

19/20

20/21

21/22

22/23

23/24

1. Mar. 19 forecast*

47.6

40.2

37.6

35.4

33.3

2. OBR forecast changes

0.4

2.3

5.1

3.6

1.5

3. Pre-policy forecast (1+2)

48.0

42.5

42.7

39.0

34.8

4. Policy measures

-0.6

12.3

24.0

22.5

25.4

5. Mar. 20 forecast (3+4)

47.4

54.8

66.7

61.5

60.2

Sources: OBR, Capital Economics. *Restated March 2019 forecast published in December 2019.

But it was the policy measures that accounted for about 85% of the rise in borrowing of £12.3bn in 2020/21 and by £25.4bn by 2023/24. Taken as a whole, the Budget was the largest planned sustained giveaway at any fiscal event since 1992, with the rise in borrowing expected to surpass that following the 2008/09 financial crisis. (See Chart 1.)

Chart 1: PSNB (% of GDP)

Source: OBR

The extra public investment spending takes it to its 3% cap under the existing fiscal rules and leaves it at a level not seen on a sustained basis since the 1970s. (See Chart 2.)

Chart 2: Public Sector Net Investment (% of GDP)

Source: OBR

And that’s based on the OBR’s assumption that about 20% of the total rise in public investment of around £100bn over five years will go unspent (the OBR thinks this is more likely to be £83bn in reality). This reflects past experience when governments attempt to ramp up capital spending quickly. (See here.)

Meanwhile, the near-term borrowing figures would be higher still if the OBR had incorporated a hit to GDP from the coronavirus. And the OBR’s 2020/21 borrowing forecasts do not include the Chancellor’s coronavirus-countering fiscal package worth £12bn.

Once the OBR lowers its GDP growth forecasts, the public finances will look worse. So while the Chancellor was still able to claim that the “current” budget rule in 2022/23 is met with a margin of £11.7bn, in reality there may be no surplus at all. (See Chart 3.) It was no surprise, then, that the Chancellor announced a review of the fiscal framework ahead of the next Budget in the autumn.

Chart 3: Current Budget (£bn)

Sources: OBR, Capital Economics

Even before that, net debt as a share of GDP is no longer falling and instead stabilises at 75%. At some point, the Chancellor may eventually come under more pressure to put the public finances on a more sustainable path over the medium term. But with the immediate priority to mitigate the impact of coronavirus, that’s an issue for another day.

Conclusion

Overall, today’s package of measures was the biggest sustained giveaway in almost 20 years. This won’t prevent the economy from stagnating or experiencing a mild recession in Q2 and Q3. But it will help to it bounce back in 2021.


Paul Dales, Chief UK Economist, +44 20 7808 4992, paul.dales@capitaleconomics.com
Ruth Gregory, Senior UK Economist, +44 20 7811 3913, ruth.gregory@capitaleconomics.com
Thomas Pugh, UK Economist, +44 20 7808 4693, thomas.pugh@capitaleconomics.com
Andrew Wishart, UK Economist, +44 20 7808 4062, andrew.wishart@capitaleconomics.com