Vous êtes sur la page 1sur 8


In recent months, concerns have mounted over the possibility that UK government debt will be downgraded from its AAA rating. At the very outset and with a blunt stare, though one cannot completely rule out the risk of a downgrade, I believe it is unlikely in the SHORT TERM (at least, say, for the forthcoming few years) The following pages outline the UKs current fiscal and economic status and examine the prospects for UK government debt. The Impact on Gilts of Concerns over the UKs Debt Rating UK government debt has always been rated AAA by the three main rating agencies: Standard & Poors, Moodys and Fitch. However, the rating agencies outlook for the UK has taken a negative turn recently because of the UKs significant fiscal deficit and its ongoing economic difficulties. While all three agencies have voiced their concerns, S&P took its first action in May 2009 when it placed a negative outlook on the UK, based on concerns that government debt would be difficult to rein in, particularly in the uncertain policy environment in the run up to the general election. S&Ps negative outlook contributed to the rise in gilts yields towards the end of May 2009 as well as to a rise in the cost of insuring against a default by the UK government; the cost of this insurance was reflected in the increasing value of the five-year credit default swap (CDS) contract. Chart 1: UK Five-year Credit Default Swaps (basis points)

Disclaimer: We believe that information provided here is correct to the best of our knowledge but we do not guarantee its accuracy.
Opinions expressed herein are personal to the analysts & do not solicit any offer to buy or sell any security. All rights for these reports are reserved by Futures First and no part of this publication may be reproduced or distributed in any form or by any means or stored in any database without the written permission of Futures First.

By the end of October 2009, the CDS spread had fallen back to lower levels of around 45 basis points, as investors became more optimistic about the prospects for the UK and the global economy. Yet, six months later, concerns over sovereign risk have re-emerged as the market questions the sustainability of such large fiscal deficits. The recent jumps in the Sovereign Debt Concerns have forced the UK CDS to shoot up to what could be alarming levels yet again. And I am for one, sure, that the Tories do not want an Athens in the making!!! The Problem of Growing UK Debt Nearly 70-75% percent of the UKs GDP is derived from the services sector, of which financial services is a significant part. As such, the UK is more likely to be exposed than most nations to global financial restructuring and to the impact of any downturn in the global recovery. With six quarters of falling output between the second quarter of 2008 and the third quarter of 2009 unprecedented in post-war history the evidence that the UK has been particularly hard hit by the global downturn is compelling. Since 2007, as a result of several factors, the UK recorded the fastest rise in the government debt ratio among AAA rated sovereigns. First, the Labor government has spent excessively creating a deficit even before the credit crisis began. Second, bank bailouts have cost the government approx 69 billion, which equates to 4.9% of GDP for 2009. Third, the government has implemented a number of other measures to support the economy such as its car scrappage scheme and VAT reductions. Finally, increased government spending has coincided with an obvious (but more than estimated) declining tax revenues resulting from the economic downturn. The UK recession officially ended during the fourth quarter of 2009, when GDP showed a small increase of 0.3%. While this figure is better than the initial estimate, it is still minimal, suggesting that there is a real risk that UK growth forecasts have been too optimistic and adding to concerns over the countrys fiscal crisis.

Chart 2: GDP Growth

The Debt-to-GDP Menace UKs debt-to-GDP ratio and interest costs on the debt have risen in the past four decades. It also shows how these figures are forecast to only rise further. The UK is not the only major developed country experiencing such fiscal problems. US, Greece, Ireland and Spain all have similar fiscal deficits as the UK. But, with the exception of the US, none of these nations are triple-A rated by all three rating agencies. And despite its large deficit, the US is in a stronger position than the UK because of its position as the largest economy in the world, and the fact that the US dollar is the worlds main reserve currency. Despite its difficult fiscal situation, overall the UK economy is still arguably viewed somewhat favorably by the rating agencies. They point out that it is a large, wealthy, diversified economy. It has a high degree of fiscal and monetary policy flexibility, as well as relatively flexible product and labor markets. The catch lies here. The agencies also note, however, that whether the UK maintains its AAA rating relies on the assumption that the fiscal deficit will decline. S&P has forecast that the UK government debt-to-GDP ratio could approach 100% by 2013 and remain near that level thereafter. Unless fiscal consolidation is put in place to reduce this forecast, a longer-term debt-to-GDP ratio of near 100% is incompatible with a rating of AAA. But with a Hung Parliament, will fiscal consolidation be an easy path for the New Govie?? Chart 3: UK Debt as a % of GDP

The returning of the debt burden to normally acceptable levels would take considerable time and this is coupled with a high risk of Policy Error in such unprecedented times. To put the situation in perspective, cumulative net debt is forecast to rise sharply to 90% of GDP by 03/14 from the current 62%.

Chart 4: UK Govie Deficit as a %age of GDP

In the calendar year 2009 the UK recorded a general government deficit of 159.2 billion, which was equivalent to 11.4 per cent of gross domestic product (GDP). At the end of December 2009 general government debt was 950.4 billion, equivalent to 68.1 per cent of GDP. The Maastricht Treaty's Excessive Deficit Procedure sets deficit and debt targets of 3 per cent and 60 per cent respectively for all EU countries. Fiscal austerities are, therefore, a key determinant of the UKs rating outlook. The measures announced by Chancellor Alistair Darling in his pre-budget report in December 2009 were met with a lukewarm response from the market. The projections on growth were deemed too optimistic, and the proposed actions to tackle the deficit lacked details and clarity. As a result, gilt yields rose and CDS spreads widened. Uncertainty surrounding the UKs fiscal position has somewhat increased with the outcome of the general elections being a Hung Parliament the first since 1974. Though the Conservatives have promised more severe fiscal consolidation than Labor, and that too, sooner rather than late; I believe as Britain goes the India way (coalition Government), alliances are difficult to keep up with. There definitely needs to be a balance. Consolidation that is too aggressive could lead to a double dip scenario for economic growth, which would in turn precipitate a further deterioration in public finances. Coming back to our discussion on Budget Deficits and Government Debt, we must note that, in a historical context, high public sector debts are not uncommon. The ratio was some 156% of GDP in 1784 following wars. The Second World War resulted in the ratio reaching as high as 238% of GDP. It finally fell to 25% by 1992 owing to numerous factors, viz., rising inflation, string economic growth, reduction in obligations, privatizations. The major difference this time is that now governments have used national debt to not only finance wars but also to fund public services and mitigate economic troubles. Estimates reveal that such financial interventions have caused about 39% increase in Net Public debt over the past three years. The government has excluded these interventions on its forward-looking projections naming them as temporary. However, given their contingent nature of recovery (Bank Bailouts) the cost might further increase instead of a recovery on the taken-over financial institutions assets.

Another important point to be concerned about is that financial services, real estate and construction comprise a large portion of the UK economy, and are not expected to recover to their pre-recession levels anytime soon. This implies an increase in the structural deficit that might not be rectified directly through a return to growth. It is often assumed that indebted governments would inflate their way out of debt but inflation that becomes persistent would be priced into Bonds. This would force the government to pay more to raise more debt, thereby increasing the dangers. Inflation can easily get out of control and the cost of reducing it may turn out to be very high. As such, consolidation is the more preferred option currently available (the pros and cons of which have already been discussed) unless the economy starts explaining and the most preferred Tax Receipts methodology can be successfully adopted. On the rates front, the downside risk for yields is of interest rates rising more rapidly than expected. As things are panning out, this could occur (sadly though) if the government loses control of the deficit. In such scenarios, we could witness capital flight and a collapse of the Proud Pound currency, which would increase import prices substantially as well as have significant disruptive effects on the economy. From what it seems, a moderate decline in sterling that has recently happened shows that some Government leeway in its finances has already been factored into.

Chart 5: GBP/USD Currency Flow since the Credit Crisis 2007/08

Below are attached some charts that give an overview of some important economic sectors since the advent of the ongoing crisis:

Latest Figures from the Bloomberg:

Data Source Issuer Brazil China Denmark Dubai France Germany Greece Hungary Iceland Italy Japan Kazakhstan Portugal Qatar Romania Spain Switzerland USA United Kingdom Vietnam

TABLE SHOWING CDS Values as on May 10, 2010 CBIL 5Yr 130.95 68 42.99 459.91 62.64 49.17 576.25 293.93 N.A 145.83 79.08 195.27 260 91.64 270 160.58 54.8 41.61 80.54 246.67

CMAN 5Yr 151.72 86.06 50.57 464.79 77.9 57.3 938.69 287.2 342.7 229.59 89.39 242.4 440.16 103.16 310.59 251.16 61.5 42.61 99.75 270.93

Conclusion: Overall, the case for a severe ratings downgrade is one that could take some time and would be more of a process rather than a simple announcement as has been for many European counterparts.