IMF spells out risk of cutting rates or taxes

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The International Monetary Fund yesterday warned Kenneth Clarke, Chancellor of the Exchequer, that he had no scope to make pre-election cuts in taxes or interest rates.

The concluding thoughts of an internal report by the IMF's annual economic mission to the UK, published for the first time by the Treasury, left the Chancellor in no doubt about the risks of relaxing policy in an attempt to enhance the Government's flagging electoral prospects.

Though the IMF applauded Britain's recent performance on growth, jobs and inflation, the statement, which Mr Clarke described as "glowing", criticised the fragile state of the public finances. It said the positive picture was marred by slippages in borrowing forecasts, which "although unintended, were casting doubt on the medium-term financial strategy."

In the first three months of the financial year, government borrowing, excluding privatisation proceeds, has totalled pounds 12bn, up from pounds 11.3bn in 1995-96. The Treasury Summer Forecast, published earlier this month, raised its borrowing prediction for this year from pounds 22.5bn to pounds 27bn.

According to the IMF, the next Budget should include "credibility enhancing" measures to put the PSBR back on the course set in the last Budget. But it warned against doing this by cutting spending on capital projects. It gave Mr Clarke a stark warning.

"Current outlays, which represent over 90 per cent of total spending, should therefore bear the brunt of additional reductions. Given the limited scope for major progress in this area in the short term and the importance of strengthening the fiscal position, there appears to be no scope for tax cuts in the upcoming Budget."

The conclusions were welcomed by businesses who fear the "golden scenario" of a manufacturing-led recovery has already been jeopardised in the quest to win over voters. Paul Lester, who chairs the economic policy committee of the Engineering Employers Federation and is chief executive of the electronic instruments group Graseby, said: "The report is right to say Kenneth Clarke should not cut taxes. From our point of view it doesn't make sense, but of course he's still highly likely to do it for political reasons."

The IMF did not make a direct call for increases in taxes, but instead argued that one route to close the fiscal gap might be through changes to the tax system. Tax revenues have consistently failed to match Treasury expectations in recent months.

According to the IMF, "exemptions and preferences have tended to proliferate and have turned out much more expensive than anticipated. Moves toward greater uniformity of tax treatment would help generate revenues and foster greater economic efficiency."

The IMF statement came as figures from the Office of National Statistics showed output growth in the second quarter of the year was below expectations. Between April and June gross domestic product increased by 0.4 per cent, the same rate as the previous two quarters. Economists had forecast growth of around 0.5 per cent. The annual rate of increase fell from 1.9 to 1.8 per cent. In its forecast the Treasury revised its growth estimate for this yeardown from 3 to 2.5 per cent.

Jonathan Loynes, a UK economist with HSBC Markets said: "That 2.5 per cent forecast looks too optimistic. Growth this year is likely to be more like 2 per cent. But we still expect the pace to pick up markedly."

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