Public finances face biggest 'black hole' since Second World War, Darling is told

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The Independent Online

Alistair Darling will have to plug a £20bn-plus "black hole" in Britain's public finances when he presents his pre-Budget report next month. Expert analysis of the latest figures shows that the public sector deficit could soon approach £100bn – the biggest since the Second World War.

Public sector net borrowing reached £10.4bn in June, the Office for National Statistics said yesterday, putting the deficit well on course to hit £60bn or more this year, against a forecast of £43bn in the Chancellor's last Budget. So far this fiscal year, public borrowing has been running at about 70 per cent, or £2.3bn a month, above last year's levels. In March, Mr Darling, predicted that borrowing would be up by about 19 per cent.

Philip Shaw, a UK economist at Investec, said: "Public finances are in awful shape and, with the economy falling into recession, the deficit will surely deteriorate further next year. At some point this will have to be addressed. No one is pretending taxes will rise or spending will be slashed at any time soon, at least not before the election, but the day of reckoning is waiting in the wings."

This reinforces the impression that the Chancellor will have to suspend or modify the fiscal rules. But in remarks to MPs last week the Bank of England Governor, Mervyn King, issued a thinly veiled threat to the Treasury that a devalued fiscal framework would push up interest rates.

Some City economists were even more gloomy. Michael Saunders, of Citi European Economics, said: " Our forecast is for the deficit to rise to about £95bn (6.0 per cent of GDP) in 2010/11. Such large deficits could well become a source of instability in coming years, and further undermine the credibility of the UK's commitment to economic stability. Any significant fiscal slippage could easily push the deficit back to the crisis levels reached in 1975/76 (7.0 per cent of GDP) and 1993/94 (7.8 per cent of GDP)."

The deteriorating situation, particularly in the finance and property markets, has seen tax revenues grow less strongly than expected, notably from stamp duties, while public spending continues to rise by more than was forecast. Recent tax concessions and the impact of the Northern Rock collapse have complicated matters further. General government spending over the first five months of 2008-09 was 6.4 per cent higher than in the same period a year earlier, against a Budget forecast of 5.3 per cent.

Carl Emmerson, deputy director of the Institute for Fiscal Studies, added: "Public sector net debt, even excluding the impact of Northern Rock, is likely to break decisively through the Government's ceiling of 40 per cent of national income. The more borrowing persists, the bigger the tax raising measures and cuts in public spending plans that would be required to get the public finances back into good shape."