OBR: deficit could reach £273bn or more

ICAEW 15 April 2020: a report from the Office for Budget Responsibility (OBR) indicates that the fiscal deficit could increase to £273bn in 2020-21, but it cautions that this is only one of many plausible scenarios.

The OBR has produced its first analysis of the potential economic and fiscal impact of the coronavirus, based on a three-month lockdown followed by restrictions for a further three months. 

At the same time, the International Monetary Fund has warned that the global economic contraction underway is likely to be the worst since the Great Depression, dwarfing the financial crisis twelve years ago.  

In its ‘coronavirus reference scenario’, the OBR indicates that the UK economy could fall by 35% in the second quarter of 2020, before bouncing back to leave the economy 13% smaller in 2020 than in 2019. 

The consequence would be an increase in the deficit for the fiscal year ending 31 March 2021 to £273bn or 14% of GDP, while public sector net debt could be £384bn higher than budgeted for, reaching £2.2tn or 95% of GDP by the end of the fiscal year.

The OBR says that the economic impact of the coronavirus will derive much less from people falling ill or dying, than from the public health restrictions and social distancing required to limit its spread, severely reducing demand and supply at the same time. That means lower incomes, less spending and weaker asset prices, all of which reduce tax revenues, while job losses will raise public spending.

Once the crisis has passed and policy interventions have unwound, the OBR thinks that annual borrowing could return to roughly the Spring Budget 2020 forecast. However, net debt would continue to be much higher, potentially £260bn (10% of GDP) more than the baseline forecast by 31 March 2025. 

The OBR analysis assumes that increased public spending, tax cuts and holidays, loans and guarantees, and actions taken by the Bank of England, designed to support household incomes and to limit business failures and layoffs, will help prevent greater economic and fiscal damage in the long term. However, it warns that the longer the disruption lasts, the more likely it is that the economy’s future potential output will be ‘scarred’ with adverse consequences for future deficits and for fiscal policy.

The International Monetary Fund (IMF) now predicts that the global economy will contract by 3.0% in 2020, much worse than the 0.1% contraction seen during the financial crisis in 2009 and a cut of 6.3% from its previous prediction in January. The IMF prediction is based on a shallower, but longer recession than the OBR’s scenario for the UK. Overall, the IMF believes that the cumulative output loss in 2020 and 2021 from the pandemic could be as much as $9tn.

Alison Ring, Director, Public Sector for ICAEW, commented: “The analysis published by the OBR is not a forecast, but the scenario it presents is pretty startling; making clear that whatever actually happens, the damage to public finances from the coronavirus pandemic will be extremely severe.

“While the OBR suggests that the economy and tax receipts could recover relatively quickly, the additional debt burden will weigh on the public finances for many years for come.”

Fiscal deficit 2020-21: £55bn Spring Budget +£130bn lower receipts +£88bn higher spending = £273bn Reference scenario.  Net debt: £1,819bn +£384bn = £2,203bn.

This article was originally published by ICAEW.

ICAEW chart of the week: Forecast deficit doubles in a week

20 March 2020: Emergency spending measures added to Spring Budget measures drives forecast deficit for 2020-21 to double in a week.

Forecast deficit pre-budget £40bn + Budget £15bn = OBR forecast £55bn - base rate £3bn + Covid I £12bn + Covid II £20bn = Latest forecast £84bn

20 March 2020.   Chart research by Martin Wheatcroft FCA, design by Sunday.   ©ICAEW 2020
Source: HM Treasury, ‘Spring Budget 2020’, and emergency announcements on 11 and 17 March 2020.

Three fiscal events within a period of a week is pretty much unprecedented. Two of these were on Wednesday 11 March when an expansionary Spring Budget was accompanied by a £12bn package of emergency measures. Less than a week later, the Chancellor announced a £20bn package of additional financial support, together with an initial £330bn in loans and guarantees to keep the economy operating.

As the #icaewchartoftheweek illustrates, this means that the forecast deficit for 2020-21 has more than doubled, from £40bn before the Budget to £84bn now.

It looks increasingly likely that the fiscal deficit in the coming year will exceed £100bn, potentially by a significant margin. Just a 2% drop in tax revenues would be enough to take the deficit over that level, even before the impact on welfare spending of job losses and income reductions, or the cost of writing down any loans or guarantees that are not repaid. Further financial support packages from the Chancellor over the weeks and months ahead are also likely.

Sit tight. This is going to be a bumpy ride for the public finances.

This chart was originally published by ICAEW.

ICAEW chart of the week: Post-GE2019 fiscal deficits

With the General Election now complete, the Office for Budget Responsibility (OBR) was able to release a restated version of its March 2019 fiscal forecasts this morning, reflecting technical revisions to the way the fiscal numbers are calculated, in particular that of student loans. This enables us to update the numbers set out our GE2019 Fiscal Insight on the party manifestos as best we can, given that the OBR has not deigned to include either the changes to public spending announced in the Spending Round 2019 nor the tax and spending changes in the Conservatives manifesto.

As illustrated by the #icaewchartoftheweek, the revised baseline forecast for the fiscal deficit is now £50bn for the current fiscal year, followed by £59bn next year in 2020-21, £58bn in 2021-22 and 2022-23 and £60bn in 2023-24.

It was frustrating that the OBR scheduled their publication of these revised numbers for the first day of the General Election purdah period making it vulnerable – as happened – to being pulled. A day earlier and that would not have happened! Ideally, these revisions would have been published as soon as practical after the publication by the ONS of their revisions to historical numbers in September.

It would have been even better if the OBR had been able to update their economic forecast too, given that the current baseline is still based on an economic and fiscal analysis from nine-months ago. With weak economic growth over the first half of the financial year, it is likely that the OBR will cut its forecasts for tax revenues over the forecast period when it does get round to updating them, resulting in higher deficits – even before taking account of suggestions that the Conservative GE2019 winners plan to announce a splurge of more capital expenditures in the Spring Budget in February.

Unfortunately, we won’t see an updated long-term forecast until at least July 2020, when the OBR is scheduled to publish its next fiscal sustainability report on the prospects for the public finances.