Public finances: Darling's impossible battle to climb a mountain of debt

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The Independent Online

Although Alistair Darling's projections for public borrowing are not quite as horrifying as some City economists had been predicting a few months ago, the Government's plans remain the largest peacetime programme of deficit financing in British history, and the most ambitious in the Western world. They also seem inadequate to the task of allaying market fears about the safety of the UK's international credit ratings.

Only a few months ago many analysts were warning that borrowing this year could exceed £200bn, by far the most serious shortfall among the advanced economies, but in the event Mr Darling has only had to nudge his estimates for borrowing this year marginally higher – up by only £3bn to £178bn, the smallest revision in many years. More hopefully still, the structural deficit, previously put by the Treasury at £90bn, seems to have shrunk a little of its own accord, thanks to slightly better economic performance, down to £75bn, still a formidable obstacle to fiscal stability.

As Mr Darling said in his statement, the reason why his borrowing will be lower than feared this year even though the economy has fared worse is because unemployment has not risen as rapidly as expected, and nor have company insolvencies and repossessions.

Still, at around 13 per cent of GDP, the 2009-10 deficit is still way higher than anything seen in the grimmest hours of previous recessions. It means that £1 in every £4 spent by Government is borrowed. In the 2008 pre-Budget report Mr Darling thought borrowing would be £118bn this year.

To the disappointment of some Mr Darling also broadly reiterated plans set out in the Budget, and now to be enshrined in the Fiscal Stability Bill, to halve the budget deficit as a proportion of national income, to 5.5 per cent by 2013-14, before returning to balance by the end of the next decade. Yet the Governor of the Bank of England, Mervyn King, called last month for the plan "to be something where a really significant reduction in the deficit, the elimination of a large part of the structural deficit, takes place over the lifetime of a parliament, which is the period for which a government is elected. Beyond that is a statement of intent and hope rather than a plan for which someone can be held accountable."

Reaction to the Chancellor's plans was mixed at a time when concerns over government borrowings and sovereign debt have been heightened by the Dubai debt crisis, this week's downgrading of Greece, yesterday's downgrade of Spain and warnings from Moody's about the UK itself. The National Institute of Economic and Social Research (NIESR) said: "The Chancellor has announced plans to raise an additional £5bn by 2012-13, mainly through a further increase in National Insurance contributions. These increases do nothing to address the structural budget deficit. We were hoping for a credible plan."

Alan Clarke, UK Economist for BNP Paribas, was more colourful: "The measures that were announced, not least the bankers' bonus tax, were a smokescreen and deflected attention from the number one issue – fixing the hole in the public finances. It was a missed opportunity to take steps to prevent a downgrade in the UK's credit rating."

In terms of the Chancellor's ambitions to tackle the structural deficit longer term, comparatively little seems to have altered since the Budget. At that point the Chancellor foresaw a demanding £90bn total cumulative tightening, around 6.4 per cent of GDP, but spread over almost a decade; now the figure is closer to £75bn, or 5.6 per cent, to be found over a similarly long time-frame. The total national debt, excluding the cost of bank bailouts, will peak at almost 78 per cent of GDP by 2014, but could run much higher if the economy fails to grow as rapidly as Mr Darling says.

And, in the absence of the Comprehensive Spending Review, due last year but canned, there was little official detail on how the Treasury plans to bridge the gap. Robert Chote, director of the Institute for Fiscal Studies, points out that, even in the case of "ring-fenced" areas such as the police, schools and hospitals, the spending plans are only available for two of the next three years. The pre-Budget report repeats the lines stated in the Budget: there will be a cumulative cut of £45bn, or 3.2 per cent of GDP, in public borrowing by 2013-14. Of that tightening, the bulk will derive from spending cuts. A further £30bn of spending cuts and tax rises are now due to by 2017-18, or 2.3 per cent GDP, by which time the deficit ought to be down to around 1 per cent of GDP, on the Treasury's figures. The pre-Budget report reinforces those goals, with about £130bn of spending "ring-fenced" in education, the NHS and the police.

The Chancellor's decision to "ring-fence" substantial areas of public spending has meant that the squeeze on other plans is even more severe. Schools, hospitals and the police join certain infrastructure projects such as Crossrail on the Treasury's protected list, and that could mean cuts of around 4.5 per cent a year in other areas, the tightest squeeze since the Second World War – a 14 per cent real-terms reduction in many budgets by 2013-14.