Fiscal costs of crisis may be greater than OBR predicts - Capital Economics
UK Economics

Fiscal costs of crisis may be greater than OBR predicts

UK Economics Update
Written by Ruth Gregory

With the Office for Budget Responsibility’s government borrowing forecasts only including the cost of just one of the extra four months of the Job Retention Scheme and no medium-term scarring effects of the crisis, borrowing is likely to end up being quite a bit higher. We forecast that the budget deficit will reach £340bn (17.5% of GDP) in 2020/21, over £40bn more than the OBR expects.

  • With the Office for Budget Responsibility’s (OBR) government borrowing forecasts only including the cost of just one of the extra four months of the Job Retention Scheme and no medium-term scarring effects of the crisis, borrowing is likely to end up being quite a bit higher. We forecast that the budget deficit will reach £340bn (17.5% of GDP) in 2020/21, over £40bn more than the OBR expects.
  • With the number of government measures to cushion the impact of the crisis still rising by the day, the OBR has once again been forced to update its forecasts for government borrowing and debt. Its latest forecasts include part of the four-month extension to the Job Retention Scheme to 31st October announced by the Chancellor this week, which it estimates will cost an extra £14bn. That would bring the total cost of the scheme to £63bn in 2020/21. Admittedly, furloughed employees receiving funds will still have to pay income tax and NICS, so the government will claw back some of the funds. But the net cost of the scheme may still be around £50bn. What’s more, the OBR now thinks that the government will be forced to pick up the tab for £5bn of business loan write-offs this year.
  • As a result, the total cost of the Chancellor’s coronavirus policy interventions has increased by £19.5bn to an eye-watering £123bn (5.6% of GDP) in 2020/21, with a whopping 40% of that spent on the CJRS. Accounting for this and after some tinkering to the fiscal forecasts, the OBR has raised its borrowing forecast for 2020/21 by £25.5bn to £298.4bn (15.2% of GDP). Public sector net debt is projected to rise to 95.8% of GDP in 2020/21, up from 94.6% of GDP previously.
  • We suspect that actual borrowing will be even worse than this for two reasons. First, since the Chancellor has yet to put the flesh on the bones on the operation of the CJRS beyond July, the OBR has not factored in the additional costs in the final three months of the scheme. Our assumption that the government may pay 40% on average in August, September and October (i.e. half as much as the 80% subsidy provided in recent months), suggests the scheme could cost up to £21bn more, or a jaw-dropping £84bn in total. Even subtracting the £17bn or so the government may receive in tax revenue, the net cost of the scheme could amount to around £67.2bn (3.0% of GDP), rather higher than the £50bn estimated by the OBR.
  • Second, the OBR’s fiscal forecast is based on a relatively optimistic economic recovery. The OBR’s forecast for a 35% peak to trough fall in GDP looks reasonable enough. But the rapid subsequent rebound in growth does not. We expect GDP growth of 10.0% in 2021 compared to the OBR’s 17.9%. (See Chart 1.) That means the deficit may be more like £340bn (17.5% of GDP) for 2020/21, over £40bn higher than the OBR expects. That would be broadly in line with the Treasury’s “base-case” estimate of £337bn (17.4% of GDP) leaked yesterday, but below its “L-shaped” scenario, in which it envisaged the deficit rising to a whopping £516bn (26.6% of GDP). (See Chart 2.)
  • Now may not be the time to worry about how to pay for all this. It is essential the government steps in to support the economy in its hour of need. Even so, some are fretting over how high taxes will need to rise in the future and how far spending will need to be cut. For our part, with interest rates likely to remain low for a long time and the Bank of England set to continue hoovering up gilts, we think that the government can cope with much higher levels of debt. So it may not be the case that this crisis is immediately followed by a prolonged period of austerity like after the Global Financial Crisis.

Chart 1: GDP Forecasts (% y/y)

Chart 2: Public Sector Net Borrowing, 2020/21

Sources: BoE, OBR, Capital Economics

Sources: HMT, OBR, Capital Economics


Ruth Gregory, Senior UK Economist, +44 7747 466 451, ruth.gregory@capitaleconomics.com