Comment: Getting back to basics at Chevening

Click to follow
It is Chevening time. This weekend the Chancellor and his Treasury advisers gather at Chevening, the grace and favour mansion in the Downs above Sevenoaks, Kent, which is usually used by the Foreign Secretary, but once a year is 'lent' to the Chancellor for this annual think-in ahead of the Budget.

It has the veneer of fun. The Treasury minions do their walks round the lake, pretend to get lost in the maze, and generally act as though country weekending is the way they usually spend their time rather than tending their gardens in Ealing and Wimbledon. But of course it is never much fun in the library, where the formal sessions take place, and where this year the mood will be bleaker than usual. It is back to basics: the Treasury has to set about balancing its books.

Much of the discussion about the size of the fiscal deficit has been in terms of percentages of gross domestic product: how UK experience compares with that of the US and Germany, what is acceptable at this stage of the economic cycle, how much of the deficit is cyclical and how much structural, and so on. Nothing wrong with that - intellectually it is the sensible way to discuss the problem. But there is also a more practical way of looking at the Government's finances, which runs like this.

This fiscal year, to the end of March 1993, the central government will spend some pounds 261bn. It will receive in tax about pounds 223bn. The gap will be about pounds 38bn. Next year, if nothing else changes, that gap will have grown to between pounds 45bn and pounds 50bn, and on present projections, would stay at around that level for the next four years. To bridge it, the Government has to borrow, and it simply could not borrow enough to cover the gap.


To see why it cannot borrow enough, look at the size of the inflow of funds into UK financial institutions, mainly the life assurance companies and pension funds. The broker BZW calculates that institutional cash flow in the coming year will be pounds 37bn, and points out that the institutions have never put more than two- thirds of their new money into gilts - throughout the 1980s the proportion was less than 40 per cent, and in the late 1980s they were net sellers. Two-thirds of pounds 37bn is about pounds 25bn, or only half of the Government's funding needs. While some funds can be raised from UK individuals, and foreign financial institutions can also be expected to buy some gilts, the practical objection to a deficit of this order is devastating. Even if it could be financed in year one (which is doubtful), it would be at the mercy of British and foreign financial institutions. Sooner or later they would force a change of policy.

On the other hand the recovery is still extremely fragile, and will still be in March when the Budget is announced. It really would not be sensible to hit it with a large increase in taxes at this stage of the cycle.

In practice the only way that the Government can make a credible pitch to the financial community is to show a clear path towards a fiscal deficit of pounds 10bn or less by the second half of the 1990s. In other words it has to show that policy has already changed. What do the markets seek?

First, they need to see a start in the deficit-reduction programme next year. That does not mean that the projected public sector borrowing requirement for 1993/4 has to be lower than the outturn for 1992/3. That would be a very demanding target, because the effect of recession on the Government's finances lags the recession itself. But if, for example, the PSBR was projected to rise from pounds 38bn to pounds 48bn, the markets would want to see perhaps pounds 4bn taken out.

Second, the markets want to see new revenue streams established. These do not need to raise much in the first year, but they need to be in place to help balance the books as the economy expands. The obvious candidates include extending the VAT net, some increase in National Insurance contributions, some form of environmental taxation, increased use of charges on government services, and so on. This ought to be a practical exercise, rather than an ideological one: how to get more revenue with the least possible economic damage.

Third, the Government needs to think about financing the deficit in clever ways. There are two aspects to this. One is to push as much capital spending as possible off the Government's own accounts. In theory it might seem to make little difference whether the state owns office blocks or leases them. But if the financial markets prefer to make funds available by taking over leases of buildings instead of buying gilts, then so be it. Companies operate with a variety of different forms of finance; so, too, should governments.


The other aspect of financing the deficit is to increase the proportion of index- linked stock on offer, maybe even converting a large portion of the debt into index-linked. The Government can achieve a much lower interest rate and so cut the cost of running the debt, in exchange for guaranteeing the principal in real terms. If inflation is really to stay down this makes financial sense for the taxpayer. It would be akin to the big debt conversion programme of the 1930s, when, for example, the coupon on War Loan was cut from 5 to 3.5 per cent.

Fourth, the Chancellor should set out a planned programme for raising foreign currency loans from the international banking community. UK credit-worthiness is remarkably high. The fact that the last such loan, the ill-fated support package for sterling, was squandered on Black Wednesday should not discourage a return to the same source. But this needs to be set out as an ordered programme over perhaps three years, rather than a series of one-off ventures. Such foreign currency loans help to finance the external deficit, as well as the Government's one, and if, as is quite possible, the pound recovers over the next two or three years such funds could prove cheap money.

In all this the Government would merely be doing what any well-run multinational company with a large but hopefully temporary cash deficit would do. It would first take steps to balance its books. Then it would assess its total financing needs over a four or five-year period. Then it would tailor its financial needs to make the most of the capacity of the international financial system. It is not particularly clever; it is plain common sense.