Public finances take hit from credit crisis

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An early indication of the impact on the public finances of the present credit market turmoil arrived yesterday, as the Office for National Statistics revealed that public sector net borrowing hit £9.1bn in August, the highest for the month since records began in 1993. It was much worse than City expectations of about £6bn.

"The financial services sector and corporations have been providing a lot of revenue, and if that slows the near-term outlook for public finances will look worse," said Nick Kounis, an economist at Fortis Bank who was formerly at HM Treasury. Corporation tax payments almost halved, while VAT returns fell by 1.6 per cent.

The slowdown in the housing market will depress stamp duty and lower City bonuses, and banking profits will also reduce the tax take. On the basis of recent research by Credit Suisse, the loss to the Exchequer from recent events could be as much as £10bn per year. Many economists have shaved their forecasts for UK economic growth in 2008 and 2009. Next month's Comprehensive Spending Review and pre-Budget Report statement by the Chancellor, Alistair Darling, promises to be especially tough, with renewed stress on limiting public sector pay awards and resisting industrial action.

In terms of the year to date, public sector net borrowing was £19.2bn, up £3.1bn on 2006. Total public sector net debt stands at £509.3bn (36.7 per cent of GDP), up from £476bn (36.2 per cent of GDP) 12 months ago.

Mr Darling has indicated he will retain the tighter public spending limits adopted by his long-serving predecessor.

However, given that public spending is growing twice as fast as tax revenues, the challenges will be even more daunting than those faced by Gordon Brown. In particular the "golden rules", that the Government raises enough tax revenue to cover current spending and borrows only for investment over the economic cycle, look increasingly threatened.