Student loans the last nail in the coffin of the fiscal rule - Capital Economics
UK Economics

Student loans the last nail in the coffin of the fiscal rule

UK Economics Update
Written by Andrew Wishart

The implementation of a change to how student loans are classified in the public finances, on top of a jump in government spending so far this year and the 2019 Spending Round, means the Government’s fiscal target is dead in the water. But this shouldn’t cause investors to take fright or prevent the Chancellor, Sajid Javid, from supporting the economy however Brexit turns out.

  • The implementation of a change to how student loans are classified in the public finances, on top of a jump in government spending so far this year and the 2019 Spending Round, means the Government’s fiscal target is dead in the water. But this shouldn’t cause investors to take fright or prevent the Chancellor, Sajid Javid, from supporting the economy however Brexit turns out.
  • The release of August’s public finances data on Tuesday 24th September will be the first time that the ONS treats a portion of student loans as spending rather than lending, thereby pushing up government borrowing. The rationale is that as much student debt is never repaid and instead is eventually written off, it makes sense to treat some of it as spending grants instead of as loans. The portion of student loans treated like this will be based on expected future repayments. The ONS expects this will add about £12bn (0.6ppts of GDP) to public borrowing each year. (See Chart 1.)
  • We highlighted the implications of this back in December (see here). But since then, two other factors have also conspired to push up government borrowing. First, if the larger-than-expected rise in spending in the first four months of the current fiscal year continues through to the start of 2020/21, borrowing would be £8.6bn above the OBR’s forecast. Second, in the 2019 Spending Round the Chancellor announced a £13.4bn increase in government spending in 2020/21 compared to previous plans. So the OBR may have to raise its forecast for cyclically-adjusted borrowing in 2020/21 from £18.9bn in March to £52.8bn in the Budget. (See Chart 2.) That would be above the Government’s target of cyclically-adjusted borrowing being below 2% of GDP in 2020/21 (equivalent to a deficit of about £45bn).
  • At first glance, this suggests that there is little fiscal firepower. But while the Chancellor will have a presentational issue in the 2019 Budget, there are two reasons why the implications for the economy and the financial markets are small. First, fiscal rules are more political than practical, and Javid implied in his Spending Round speech that he will soon change them. He might raise the target to 2.6% of GDP (or £59bn) to adjust for the change in student loan accounting. In that case, borrowing might sneak below it.
  • Second, there would still be little reason for investors to worry about debt sustainability. As debt is a cash measure, it doesn’t matter if student loans are spending or lending. And even if borrowing increases for other reasons, based on the economy growing at a moderate 3.5% pace in nominal terms, unless the deficit breaches 2.9% of GDP the debt-to-GDP ratio would carry on falling. What’s more, in the US where the debt ratio is rising, the bond market hasn’t batted an eyelid.
  • On top of a rise in government spending this year and the further increase in 2020/21 announced in the Spending Round, the change to how student loans are treated in the public finances statistics is the final nail in the coffin of the Government’s fiscal rule. But this won’t prevent a fiscal stimulus. If there isn’t a no deal, the Chancellor still has some wiggle room. And if there is a no deal Brexit, just like after the financial crisis, investors would presumably prefer the Government to support the economy than stick dogmatically to its fiscal rules.

Chart 1: Public Sector Net Borrowing (£bn)

Chart 2: Cyclically-Adjusted Borrowing in 2020/21 (£bn)

Sources: ONS, OBR, Capital Economics

Sources: OBR, ONS, Capital Economics, HM Treasury


Andrew Wishart, UK Economist, +44 20 7808 4062, andrew.wishart@capitaleconomics.com