- We now expect the United Kingdom’s net general government debt as a percentage of GDP to continue to rise in 2015, before declining again.
- Future employment or growth shocks could pressure government finances further.
- We are therefore revising our outlook on the unsolicited long-term ratings on the U.K. to negative, from stable, reflecting our view of a one-in-three chance that we could lower the ratings if the U.K.’s economic and fiscal performances weaken beyond our current expectations.
- We are affirming our ‘AAA/A-1+’ long- and short-term unsolicited sovereign credit ratings on the U.K.
- We have also revised to negative from stable the outlook on our ‘AAA’ ratings on the Bank of England and the debt program of Network Rail Infrastructure Finance PLC.
On Dec. 13, 2012, Standard & Poor’s Ratings Services revised its outlook on the unsolicited long-term ratings on the United Kingdom to negative from stable. At the same time, we affirmed our ‘AAA/A-1+’ long- and short-term unsolicited sovereign credit ratings. The transfer & convertibility (T&C) assessment on the U.K. remains ‘AAA’.
We have also revised to negative from stable our outlooks on the ‘AAA’ long-term issuer credit ratings of the Bank of England and the debt program of Network Rail Infrastructure Finance PLC.
The outlook revision reflects our view that we could lower the ratings on the U.K. within the next two years if fiscal performance weakens beyond our current expectations. We believe this could occur in particular as a result of a delayed and uneven economic recovery, or a weakening of political commitment to consolidation. We expect economic growth to rise slowly in the medium term, with net general government debt as a percentage of GDP continuing to rise in 2015, instead of stabilizing in 2014 as previously expected. If economic growth recovers more slowly than we currently forecast–due to domestic factors or waning economic performance by the U.K.’s main trading partners–such slow recovery could result in net general government debt approaching 100% of GDP, by our calculations, from its current estimated level of 85% of GDP in 2012.
In our opinion, many of the factors that have restrained growth in recent years will likely continue to do so in the near term. We continue to believe the government’s efforts over the next few years to engineer the planned correction in the U.K.’s fiscal accounts will likely drag on economic growth, although we note that the expected pace of consolidation is to ease in the short term.
We also believe that household spending will be restrained by sluggish nominal wage growth, a becalmed housing market, and a high, albeit falling, private-sector debt burden. With weak private-sector domestic demand, corporate investment is likely to recover only as the external environment improves (the eurozone accounts for nearly half of the U.K.’s overall trade).
An associated risk is that if economic growth fails to revive, companies may respond by cutting jobs at a time when the public sector is also retrenching. Job cuts would likely further constrain household spending, which contributes roughly two-thirds to GDP, with knock-on effects on economic growth and government finances. We note that the labor market has so far held up better than in previous recessions, which has supported social welfare contributions, and maintained personal income tax receipts. All things considered, we expect real per capita GDP growth to average just over 1% per year in 2013-2015, after a 0.8% contraction in 2012 (we expect real GDP growth to average 1.6% in 2013-2015, following a contraction of 0.3% in 2012).
U.K. banks are currently focused on building capital buffers, generally by their shedding relatively risky assets and constraining new lending. This deleveraging will continue to create headwinds for the economy, in our view. The authorities are taking measures to support and stimulate credit growth, but we do not expect these steps will have a significant impact. Nevertheless, we note that the Bank of England’s (BoE’s) highly accommodative policy stance should help to keep private-sector debt-servicing costs moderate, keep the currency at competitive levels, and provide a cushion in the event of further volatility in the international capital markets.
The government’s self-imposed fiscal mandate is to balance the cyclically-adjusted current budget (which excludes the cyclical deficit and investment spending) by the end of a rolling five-year time horizon, currently fiscal-year 2017/2018 (ending March 31, 2018). The Office for Budgetary Responsibility (OBR) anticipates that the government remains on course to meet this fiscal mandate. A supplementary target is to have public-sector net debt as a percentage of GDP falling by fiscal 2015/2016, but the OBR now expects this target to be missed by one year. Performance in the current fiscal year has been affected by weaker economic growth than the OBR had predicted in March 2012, with the result that tax receipts have stagnated. That said, we note that government expenditure performance between April and October 2012 has been just below target, and that the OBR expects spending to be lower than it originally forecast in March.
We forecast a general government deficit of 4.6% of GDP in calendar year 2015, using the accruals-based European (ESA 95) accounting standard, compared with the OBR’s 4.2% projection for fiscal year 2015/2016. Our higher deficit estimates are largely based on our view that economic growth will likely be lower than that forecast by the OBR. We anticipate the general government net debt burden will peak in 2015, at just over 92% of GDP on an ESA 95 basis, before stabilizing and then gradually declining. This level is similar to our July forecast because of the transfer of the Asset Purchase Facility’s (the BoE’s quantitative easing facility) excess cash from the BoE to the Exchequer, which will help reduce debt levels in the short term.
We believe that the U.K. ratings will continue to be supported by what we view as its wealthy and diversified economy, reserve currency advantages, fiscal and monetary policy flexibility, and adaptable product and labor markets. In our opinion, the U.K. government maintains a strong commitment to implementing its fiscal mandate, and has the ability and willingness to respond rapidly to economic challenges. We also view the U.K. as having deep capital markets with strong demand for long-dated gilts by resident and nonresident institutional investors alike. These markets, along with the U.K.’s good inflation record, proven countercyclical monetary policy flexibility, and floating exchange rate regime, provide more economic policy flexibility than typically exists in the U.K.’s eurozone peers.
The negative outlook reflects our view of a one-in-three chance that we could lower the ratings in the next two years if the U.K.’s economic and fiscal performances weaken beyond our current expectations. We expect economic growth to accelerate slowly, but the risks to our growth assumptions are weighted to the downside, however, with associated risks to government finances. This weaker growth scenario could result in net general government debt approaching 100% of GDP, by our calculations, from its estimated current level of 85% of GDP.
We could lower the ratings if we conclude that the pace and extent of fiscal consolidation has slowed beyond what we currently expect. This could stem from a reappraisal of our view of the government’s willingness and ability to implement its ambitious fiscal strategy.
The ratings could stabilize at the current level if the economy recovers more quickly and strongly than we currently anticipate, enabling net general government debt as a percentage of GDP to stabilize in 2014-2015.