Hamish McRae: Despite the prevailing gloom, we can look for signs of economic light

Economic Life
Click to follow
The Independent Online

Our public finances are going to be bad beyond belief, but our economy might do somewhat less badly than the latest dire official forecasts suggest.

The first half of that sentence is incontrovertible, so let's get that sorry tale out of the way now. We have just got the end-February numbers for the public accounts. This is usually a good month for receipts as a lot of tax scheduled to come in by the end of January is included then. This February, instead of there being a surplus on the public accounts there was a deficit. Compared with the previous year, our finances are a catastrophe.

It will, I am afraid, get much worse. The deficit for this year will be somewhere between £90m and £100m, but for next year I could see it going to £150m – more than 10 per cent of GDP. Only a small portion of that would be the result of the special measures introduced to boost the economy; the bulk is the structural deterioration in tax revenues.

There is an obvious pressure from rising unemployment, which has the double-whammy of cutting revenues and boosting welfare payments, and this will get much worse. We probably have at least another year of rising unemployment, if this recession follows the pattern of previous ones. But even without that, the revenue side of the equation would be in trouble.

Tax revenues will be disappointing for the next two to three years at least. Obviously capital gains tax will bring in much less until the markets recover, but more mainstream revenues are being savaged too. It is really only now, as revenues fall, that we can see how heavily we have been relying on tax from high earners and on profitable corporations to balance the books. Now high-earners are seeing falls in their income or having to put more into their pensions, or both.

As for company taxation, the profits of the financial sector have been largely wiped out, while those of manufacturing are in terrible shape too. It is, I am afraid, going to get much worse. For the first half of this financial year, revenues were still running above the level of the previous one; all the deterioration has happened in the second half.

That bodes ill for the coming fiscal year. People are quite unprepared for how bad things are (I was told the Treasury officials who oversee revenues are aghast). The question really will be how much political cover the Government can extract from the G20 meeting on 2 April to justify the deficit it will have to disclose in the Budget three weeks later. The pitch has to be: "We are running a huge deficit to be sure, but look how other countries are doing so too".

The problem with that is that our fiscal deficit will probably be larger than even that of the US and almost certainly much larger than any of the big European countries.

And yet, despite all this, our relative economic performance (as opposed to our fiscal performance) may not be too bad. The new International Monetary Fund forecasts, the ones that show the world economy contracting this year, reveal the UK as having the worst recession of the G7 countries, with growth remaining negative through 2010 as well as 2009. If that proves right, it would mean a longer and deeper recession than any other G7 nation; not good. But is it right?

There is little evidence to support this statement, but it may actually turn out that we come through the downturn in not too bad a shape. Have a look at the growth forecasts in the bar charts, which come from Goldman Sachs. If they are right, the UK is not only going to have a less serious recession than the other large developed nations; it will return to not-too-bad growth next year.

For what it is worth, my own instinct is that the Goldman forecast for this year will turn out to be closer than the IMF one, but the recovery in 2010 will be more muted than these numbers suggest. My guess would be the IMF is wrong to expect a minus next year, but the plus will be less than 1 per cent. But rather than take sides, let's just note three reasons for pessimism and three for modest optimism.

The pessimistic case would run like this. First, the public spending numbers are so bad that policy will have to be tightened at the end of this calendar year. So VAT will have to go back to 17.5 per cent, or even increased to 20 per cent, in January 2010. Second, the squeeze on banks and other home lenders is so intense that they will not be able to increase their loans for two or three years, delaying any house price recovery – one effect of these very low interest rates is that they are having difficulty attracting retail deposits because they offer such dreadful rates. And third, our household debt burden is so high consumers will spend several years getting this under control and won't have much money to spare.

The optimistic case would be the flip side of these points. So, one, it would be that the measures the Government and Bank of England have taken are so extreme that it would be astounding if they did not have some effect at boosting demand. Two, it is possible to have a recovery of sorts with a flat housing market. That happened from 1992 onwards to 1996, when the last house price recovery began, particularly if you have an undervalued exchange rate as we did then and have now. And three, our consumers have been pretty resilient so far, and the fall in interest rates will enable the mortgage borrowers who do remain in work to rebuild their savings.

There is a bigger point here about the world of official forecasts. Up to now, all the forecasters have been busily downgrading their numbers. What is happening this year is far worse than any forecaster expected a year ago. Almost all thought that 2009 would be better than 2008. The few of us who warned that 2009 would be the really tough year were on our own. Our own Treasury has been among the most ridiculously optimistic. But sooner or later, the forecasters will start upgrading their forecasts, acknowledging that for once they have been too pessimistic. This often happens at this stage of the cycle, for we are close to the point of maximum gloom right now.

It is even conceivable that the dip in share prices last week marked the bottom of the equity cycle, pointing to an economic turning point in about six months' time, though that feels premature. There is a lot more stuff to happen and I worry about the quality of the recovery as and when it eventually is secured. But even if the present bout of policies on offer fails, the self-healing powers of the world economy should be robust enough to get growth moving before the end of 2010. Meanwhile, though it is childish and annoying to talk of "green shoots" of growth, it is realistic to look for signs of the economy bottoming out, even if those signs at the moment remain very weak.

Comments