With Brexit negotiations in full swing, we’re finally starting to see what impact leaving the EU could have on the UK as a whole. With debt and deficit levels at risk of increasing, understanding just what this could mean for the UK and whether this has anything to do with Brexit is a hot topic within the finance industry today. We’re taking a look at just what debt and deficit are and how the UK could see these levels change.
The words ‘debt’ and ‘deficit’ are both thrown around in the news seemingly freely, but did you know that they’re both very different? By definition, the UK’s debt is the amount of money that is owed by the public sector to UK private sector businesses, foreign institutions and other outside sources. This debt has been built up over the years; there is no single government to blame and our overall net debt has gradually grown to the figure it sits at today. The UK’s debt is actually not the total debt at all – it’s the debt, minus the government’s current liquid assets.
The UK’s deficit, however, is the difference between what the government is spending every day, and what they’re taking in. In recent years in particular, spending has been a lot higher than the revenue, which is why the word ‘deficit’ is often so widely used in political terms as of late. While every government promises to move out of deficit and into a surplus, Brexit could prove to make this difficult in the coming year simply due to the charge we’re facing to leave.
According to the UK’s government website, the European Union is the economic and political union of 28 countries. As it stands, these 28 member states have access to and operate on a single market for easy movement of goods, capital, services and people, and negotiations as to how much of this the UK will have access to once Brexit has come to completion have proven to be a hot topic in recent news.
The EU member states are as follows: Austria, Belgium, Bulgaria, Croatia, Republic of Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and, at least for the now, the UK. Iceland, Liechtenstein and Norway aren’t a part of the EU, but as members of the European Economic Area (EEA), they do have access to the single market, while Switzerland is a member of neither but has access regardless.
In order to join the EU, countries need to meet a certain set of criteria when it comes to their economic state and the UK need to continue to meet these criteria until their departure from the EU in March 2019. Agreed in Maastricht in 1991, the Treaty on the Functioning of the European Union is essentially a set of guidelines that ensure that the EU functions properly and prosperously. Article 126 in particular states that members of the EU oblige to avoid any excessive budgetary deficits.
The Protocol on the Excessive Deficit Procedure lists two criteria that all member states must adhere to where possible, and they are as follows: a deficit (net borrowing) to gross domestic product (GDP) ratio of only 3%, and a debt to GDP ratio of 60%. All countries in the EU must provide quarterly reports on any of their debt and deficit ratios.
The financial year of 2017 saw the UK government gross debt at £1,720 billion, which was a whopping 86.7% of the total GDP. With an increase of £68.1 billion since 2016’s financial year, this can seem eye watering, but it’s important to note that debt as a percentage of the GDP actually fell by 0.1%. This was incredible as we haven’t seen a decrease since March 2002!
Since 2010, the debt has risen from £1,075.6 billion to £1,720.0 billion, with the biggest jump in debt being in the 2011/12 year with a rise of around £180 billion. As a percentage, we can see that Government Gross Debt as a Percentage of GDP since 2015 has seemed to fall in the 1998/1999 financial year, and continued to do so until 2002/2003 where it began to gradually grow once more.
The financial year ending March 2017 saw the UK government deficit of £46.9 billion, the equivalent of 2.4% of GDP which was a notable decrease of £29 billion since March 2016. The deficit of this year was actually one of the lowest we’ve seen since March 2003 (also 2.4%) and the first time that the UK has actually been within the 3% criteria since March 2008.
Of course, a deficit at all is never something to proud of, however this fall was certainly welcome after the high of £154.8 billion that the country faced in 2009. The deficit has been gradually decreasing since this crash, though there was a brief rise in 2014 that thankfully dropped back down the following financial year. Whether Brexit will cause another crash is yet to be seen, however with any luck, we’ll maintain a low deficit or potentially reach a surplus in coming years.
The Office for Budget Responsibility is the UK’s fiscal watchdog and has made recent claims that it is inevitable that another recession will hit the country soon. While they claimed that Brexit itself may only have a small impact on public finances, just a small fall in the growth rate could see the debt skyrocket.
A stress test conducted on the government’s plans to manage public finances has seen annual deficit rocketing to 8.1%, and debt could even rise over 100% with the potential of reaching as high as $114 like fellow European country Italy. There is a substantial risk of a rise of £66.2 billion to the deficit in the current financial year alone, so experts are practically quaking in their boots at the fact a further £158.5 billion could be added on top in 2021-22. Extra government spending is likely to be the cause of this, though the true levels of the deficit and debt will be easier to predict the further into negotiations we get and just how the final exit from the EU progresses.
The true impact of Brexit on the public finances will ultimately come down to growth rates and incoming revenue. During 2017, forecasters were keen to state that the UK will likely only have a growth of 1% as opposed to the usual 2.2% all thanks to uncertainty of UK direction, a falling pound worth, decline in FDI as firms wait to see the outcome of negotiations, and a fall in net migration affecting GDP and tax revenues.
According to The Resolution Foundation, Brexit could lead to a deterioration of a whopping £80 billion by the end of parliament, which could lead to either lower spending or higher borrowing, both of which could have an adverse effect on public finances as a whole. With borrowing figures already failing to get very high, the chances of low spending are much higher which could bring the economy to a standstill. In fact, economists are already predicting a fall of 2% GDP. While this isn’t a recession, it certainly means that growth will slow which could result in higher debt and larger deficits.
Brexit voters were led to believe that a vote to leave the EU would result in better public services, however with the potential monetary hurdles that the UK could be facing, it could be quite some time before we truly see any improvements in these areas. If the government follow through on their promises of an improved NHS, public services and more, it can be difficult to see just how the UK might ever recover from their debts and deficits especially without the support of the EU in place. The future of the UK economy could truly rest in future politicians and chancellors and just how they choose to deal with the issue at hand.