City economists estimated that the Government might have to cut pounds 16bn from its promises for expenditure in 1994/95 and 1995/96 to meet its new targets, but doubted that it would have the political will to do so.
In addition, the Treasury's implicit forecast for inflation of 2.25 per cent in 1994/95 and 1995/96, which emerged with details of the new spending controls, confirmed that the Treasury has a much more pessimistic view of economic growth in the next few years than at the time of the Budget.
Market reaction was muted, with dealers unsure whether to welcome the Treasury's harder line on spending or to worry that it would further delay recovery.
The Cabinet agreed on Wednesday to set cast-iron targets for about 85 per cent of public spending three years in advance. Ministers will no longer be allowed to bid for extra money - extra spending by one department must be offset by cuts in another. The Cabinet also agreed to stick to the current spending total of pounds 244.5bn for 1993/94. Although this means that spending ministers have agreed to abandon their bids for pounds 14bn in extra spending, it is a 7.9 per cent increase on the previous year.
Targeted spending growth will be much lower than previously planned in succeeding years, hitting manifesto commitments.
'I think you can overestimate the amount of change the new system really involves', Gavyn Davies, economist at Goldman Sachs, said. 'At the end of the day control of public spending is a matter of politics in a particular year.'
'Who is to say the total won't be overrun in a given year?' said Roger Bootle of Midland Montagu. 'We have not had the wrong regime, we have just not had the political will.'
Peter Spencer of Kleinwort Benson said that if the Government made the implied spending cuts of pounds 16bn the economy could slide back into recession.
The Government could allow itself a get-out by setting a large contingency reserve from which extra spending could be funded, Andrew Britton of the National Institute of Economic and Social Research argued. 'Periodically the Treasury regains control of public spending, only to lose it again,' he said.
The Treasury is creating a new target for public spending - the New Control Total (NCT) - which excludes unemployment benefit and income support for people of working age from the existing planning total, set in the Autumn Statement. These categories of spending vary automatically with changes in unemployment, and hence the state of the economy.
The NCT will be allowed to grow by no more than 1.5 per cent a year on average over the three years of the spending plans, excluding the effect of inflation. In cash terms it will rise by up to 3 per cent in 1994/95 and 3.25 per cent in 1995/96. This is intended to ensure that total public spending, which also includes debt interest, grows by no more than 2 per cent a year in real terms over the next several years, reducing government spending as a proportion of national output.
Despite the exclusion of unemployment benefit, recession will still put upward pressure on the NCT because it includes items such as housing and invalidity benefits that tend to rise when the economy is weak. This suggests the Government may be forced to cut some benefits and moderate its manifesto promises. This is more restrictive than the previous system, where government spending was allowed to rise to offset weakness elsewhere in the economy.
Little moved by the Cabinet's spending decisions, the foreign exchanges had a quiet day with dealers wary of provoking the leading banks into a round of intervention. Sterling was given freedom to rise in the exchange rate mechanism when the peseta, the system's strongest currency, rose following a 0.6 per cent rise in the key Spanish interest rate. But it closed almost unchanged at DM2.8636, having topped DM2.84 during the day. The dollar weakened following disappointing US unemployment figures. The US currency closed 0.85 pfennigs lower at DM1.4850.
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