Hamish McRae: Well, thank goodness we're not in the eurozone...but our debt is terrifying

Economic View
Click to follow
The Independent Online

Tomorrow, we get what would, under Gordon Brown and Alistair Darling, have been the Pre-Budget Report.

To remind you of the tone of these events, here is the start of Mr Brown's last PBR speech, on 6 December 2006: "This is my 10th Pre-Budget Report and under this government the 10th consecutive year of growth. I can report not only the longest period of sustained growth in our history, but of all the major economies – America, France, Germany, Japan – Britain has enjoyed the longest post-war period of continuous growth .... And this Pre-Budget Report drives forward the great economic mission of our time – to meet the global challenge, to unleash the potential of all British people, so that the British economy outperforms our competitors – and deliver security, prosperity, and fairness for all."

Well, it is all a bit different now, isn't it? We will not only get less of the bombast but also a diminished event. We are going back to the so-called "Autumn Statement", the precursor to the PBR prior to 1997, coupled with the forecasts for the economy, this time from the Office for Budgetary Responsibility, rather than the Treasury itself. Along with the Autumn Statement, George Osborne will be co-presenting the new "growth" paper which aims to help kick-start the crucial private sector growth.

But if Osborne does intend to downgrade the event from what was in effect a second budget, expect quite a bit of spin. He is a politician, too, and he will have some good news from the OBR: that this year the economy is growing appreciably faster than was forecast in the summer: around 1.7 per cent as against 1.2 per cent. And it is just possible that its forecast for the deficit this financial year will be a touch better too.

But there I am afraid the good news will end. We will have to wait and see but I would not be at all surprised were the OBR growth forecast for 2011 to be a worse than before. And given this faster growth this year, it is a bit worrying that the deficit is not coming down by more.

The main reason for caution next year is the fall-out from the Irish debacle. The eurozone's troubles are not over by any means, and though I personally think the currency will survive this cycle (though not the next downturn in another seven to 10 years' time) this will damage the UK. It is pretty clear that Portugal will need a rescue too, and as argued here before, Spain may well need one as well. If that were the case it would be just about doable. The president of the Bundesbank, Axel Weber, reckons that in a worst-case scenario another ¤140bn of loans might be needed, and I am afraid recent history would suggest that worst cases become actual cases. You can see this potential additional debt burden weighing on the euro last week. Gosh, we were lucky not to get ourselves mixed up in all that, and all credit to John Major and Gordon Brown for keeping us out.

The fall-out does, however, affect us in two ways. First, we lose exports. As you can see from the main graph, from Capital Economics, we export almost as much goods and services to Ireland as we do to France, and if you add in exports to Portugal, Greece, Spain and Italy, that is almost as much as all our exports to Asia. Even on favourable assumptions, those countries will not see strong growth for some years and it is possible something really nasty will happen.

The second reason for caution is finance. The smaller graph shows the extent to which UK borrowers rely on foreign banks. Spanish banks, mostly Santander, account for 14 per cent of lending to UK households. Now it happens that Santander is a well-run bank, but it is Spanish and this is increasing the cost of its capital when it has to go to the bond market. Irish banks account for 7 per cent of UK commercial lending. They are unlikely to be increasing that much, are they? German banks may well benefit from the eurozone's plight, for were I to be wrong and the eurozone to break up in the next three years, it would be much better to have a euro-denominated deposit in a German bank than in, say, an Irish one. But whatever happens, eurozone banks are not going to be flush with cash to lend to British companies and individuals over the next few years.

In any case, while Britain may have avoided being lumped in with the weaker eurozone economies, our borrowing remains at a terrifying level. As a percentage of GDP it is higher than Greece, Portugal, Spain or Italy, a legacy still to be dealt with and one that the previous government is still in denial about. The slightly better news tomorrow on the deficit, assuming it will indeed be slightly better, will come solely from a better cyclical position, and the structural deficit remains, at around 6 per cent of GDP, as bad as ever.

The other thing to look for tomorrow will be anything further about the breakdown of the deficit and in particular the way the savings in welfare reform allow higher spending by the departments. Government spending falls into two broad categories: the amount the various departments have to spend themselves and the amount they recycle in the form of welfare benefits, pensions and the like. The Item Club notes in a paper published tomorrow that thanks to these welfare savings the amount the Government has to spend on services is quite a bit higher than initially projected, and actually is very close to the plans of the previous government outlined in its budget – within about £5bn a year from next year onwards to 2014/15. One consequence of this may be that public-sector job losses will be somewhat smaller than forecast, but – because of the lower welfare payments – consumption may also be lower too.

We will see. The key thing will be to distinguish between the cyclical and the structural. The cyclical position may be a bit better than expected but the structural deficit is as bad as ever. It seems hard to remember it, but we are only seven months into this parliament and the slog of correcting the deficit has barely begun.

Lloyds-HBOS demerger: creating two effective banks from one monster

So will the Lloyds/HBOS merger be unscrambled? Yes, of course it will in the end, because it should never have gone though in the first place. It "did pose clear risks to competition" and "the full nationalisation of HBOS [as opposed to a rescue by Lloyds] ... would have had important economic advantages".

It's not me saying that, though I completely agree. The quotes come from a paper by Sir John Vickers to the Bank for International Settlements in May, before Sir John was appointed head of the Independent Commission on Banking by George Osborne. Of course he wouldn't have known he was going to get that job, so his action was quite proper as well as wise.

It was certainly a dreadful deal for Lloyds because it pushed it into partial nationalisation, but it is a bad principle for the country that you waive competition considerations to avoid potential political embarrassment. Poor old Lloyds is still discovering yet more nasties in its Irish closet, for HBOS went potty in its lending on property there and it is still not clear quite how much will every be repaid.

But there are two points of principle here and Lloyds would be right to put up as strong a defence as it can. The first is that if a sovereign government gives its word on something, then to some extent at least its successor should be bound by that. So on that I would incline with Lloyds.

The second is more problematic. It is whether it was within the authority of the PM to give assurances that normal competition rules would not apply. There, it seems to me, Mr Brown exceeded his authority – governments have to act within a wider legal framework – and I'm afraid on that one the deal should fall. But it should be unwound to give the country two effective banks rather than one monster. Lloyds' shareholders, including HMG, deserve some consideration, too.

Comments