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UK Coronavirus Measures Add to Fiscal Cost, Consolidation Plan to Come

The UK’s (AA-/Negative) latest announcements regarding its coronavirus response add to the large fiscal deterioration stemming from the pandemic, Fitch Ratings says. The UK government has said it plans to address the resulting challenges to public finances, although details of its medium-term fiscal strategy have yet to be announced.

Chancellor Rishi Sunak said on Wednesday that the government was entering the second phase of its economic response “to protect, support and create jobs” following the lockdown that began in late-March. The new ‘Plan for Jobs’ includes payments to employers that retain workers currently furloughed under the existing Job Retention Scheme (which will be wound down by end-October) or hire new employees or trainees, a temporary reduction in value-added tax for some hospitality and tourism businesses, and a temporary increase in the stamp duty threshold for residential property purchases.

The chancellor’s announcement underscores how the pandemic will keep upward pressure on spending in the UK and elsewhere. The government estimates the potential cost of the new measures at GBP30 billion, or 1.4% of GDP. Moreover, Mr Sunak said that the UK had spent GBP49 billion to support public services since the onset of the crisis, which is GBP33 billion higher than the independent Office for Budget Responsibility estimated in June. We estimate the direct cost of fiscal policy measures since March at GBP184 billion (8.3% of 2019 GDP).

Fitch has updated its UK fiscal projections following the latest policy announcement, and also incorporated our reduced 2020 GDP forecast in last month’s Global Economic Outlook, in which we forecast a 9% economic contraction this year, compared with 7.8% previously. We now expect the fiscal deficit to widen to 15%-17% of GDP in 2020, around 3.5pp wider than our June forecast. The deficit then narrows to 8%-10% by 2022 as the economy recovers.

Our forecasts assume a total fiscal cost from the Plan for Jobs of GBP21 billion, or 0.9% of GDP, because the job retention bonus is unlikely to be paid to the employers of all furloughed workers (9.4 million as of 5 July). The final cost of the VAT and stamp duty cuts will depend on how far these measures boost consumption in the affected sectors and the broader economic recovery, and we assume slightly lower costs from those measures. We assume the cost of infrastructure investment, which was previously announced but has been brought forward, at 0.3% of GDP, consistent with the government, reflecting the strong political emphasis on infrastructure spending.

Risks to our fiscal forecasts include the possibility that the cost of the new jobs plan is closer to the government’s maximum estimate. Conversely, fiscal deterioration may be less than we forecast if the policy response succeeds in boosting private spending, employers rehire a large number of furloughed workers, and the stamp duty cut stimulates the housing market.

Our forecasts do not factor in additional discretionary fiscal stimulus measures beyond this year. But political pressure to increase spending (particularly on public services and infrastructure) implies that expenditure will only decline gradually relative to GDP. Additional risks to growth would arise if widespread lockdowns were reintroduced, or in a ‘cliff-edge’ exit from the Brexit transition period.

Our new deficit and growth forecasts imply a larger increase in UK debt/GDP, with the ratio rising to about 106-110% this year and 117%-120% by 2022. Medium-term fiscal consolidation prospects will be factored into our sovereign rating analysis. The chancellor said that the government would put public finances “back on a sustainable footing,” with plans due in a budget and spending review this autumn.
Source: Fitch Ratings

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