Thames Water collapse could trigger Truss-style borrowing crisis, Whitehall officials fear

Senior Whitehall officials fear Thames Water’s financial collapse could trigger a rise in government borrowing costs not seen since the chaos of the Liz Truss mini-budget, the Guardian can reveal.

Such is their concern about the impact on wider borrowing costs for the UK, even beyond utilities and infrastructure, that they believe Thames should be renationalised before the general election.

Officials in the Treasury and the UK’s Debt Management Office fear that, unless the UK’s biggest water company is renationalised as soon as possible, “prolonged uncertainty” about its fate could “damage confidence in UK plc at a sensitive time”, with elections in the UK and the US later this year.

Earlier this month, the Guardian revealed details of government contingency plans, known as Project Timber, to renationalise Thames via a special administration. This could lead to the bulk of its £15bn of debt being moved on to the government’s balance sheet. Thames’ investors have refused to pump more money into the struggling company amid a standoff with the water regulator Ofwat.

Some lenders to its core operating company could lose up to 40% of their money under the plans, a move that officials believe marks a careful balance between managing public outrage at the water company’s many failures and the need to sustain investor confidence in the UK.

Those contingency plans also describe a risk of “contagion” from Thames’s plight that could trigger a loss of confidence that feeds through to wider state borrowing costs.

In the aftermath of the Truss mini-budget in September 2022, UK borrowing costs shot up as government debt markets went into freefall. Her chancellor Kwasi Kwarteng’s promise of £45bn of unfunded tax cuts, the sacking of the most senior civil servant at the Treasury and Truss’s refusal to have her sums checked by the independent Office for Budget Responsibility spooked investors and sent the value of UK debt instruments, known as gilts, plummeting.

The pound hit a low against the dollar not seen since 1985, and the whiplash effect on the bond market damaged some pension funds’ investment strategies so severely that the Bank of England had to stage an emergency market intervention to maintain market stability. That crisis added billions of pounds to the UK’s cost of borrowing, as investors demanded a higher price to lend to it. British households experienced big spikes in mortgage costs, as banks and building societies passed on higher borrowing costs. Many mortgage offers were pulled overnight.

While Kwarteng’s successor, Jeremy Hunt, reversed the tax plans and stabilised debt markets, the UK’s cost of borrowing has crept up again in recent months amid geopolitical shocks, including the Middle East conflict.

The UK’s growing debt pile and sluggish economic growth have added to investors’ wariness to lend to it. The UK’s £2.7tn of debt stands at about 98% of GDP, and will continue to swell as the government needs to borrow heavily to overhaul its ageing network of pipes, cables, water and power infrastructure.

The global lender of last resort, the International Monetary Fund, has warned that the UK is among economies where “debt vulnerabilities continue to grow” as inflation remains elevated. “Globally, borrowers would find it harder to service debt, given higher bond yields,” it said this month.

The British state relies on being lent money by investors, often foreign, to fund its spending. These loans take the form of gilts. Prices for these IOUs fall as yields rise. A higher yield is generally an indication of the risk associated with the loan.

Debt issued by regulated utilities such as water companies has traditionally been seen as a safe haven for investors, with a gold-plated risk profile similar to gilts.

There is increasing concern in Whitehall that the longer it takes to resolve the crisis at Thames, which has 16 million consumers, the greater the spillover effects will be. Thames has said it has enough money in its operating company to last for more than a year.

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“It’s coming at a time of significant domestic and global political uncertainty,” said one official. “This is not something that benefits from being left unresolved. Investors want clarity and certainty even if there is a short-term pain.”

“There is a real risk of contagion from Thames,” said a second official.

Whitehall officials expect any restructuring that involves investors losing money in Thames’ water operating company to trigger legal action against the government and Ofwat. Still, officials view a swift renationalisation that forces lenders to bear losses as preferable to a long, drawn out debate over the fate of Thames that weighs on the UK’s needs to raise capital for infrastructure projects and for its general debt issuance.

The Debt Management Office (DMO), an arm of the Treasury, is responsible for issuing new UK debt. In response to figures last week showing that Hunt will probably need to borrow more than originally hoped, the body announced it would increase sales of UK gilts this year by an extra £12.4bn. This takes the total expected sale of UK government debt this year to £277.7bn.

The government declined to comment on questions about the Treasury and DMO’s concerns.

A spokesperson for the Department for Environment, Food and Rural Affairs said: “Given water companies are commercial entities, it would be inappropriate for government to comment specifically on Thames Water.”

In a potential signal of the debt challenges the UK faces, a recent sale of new debt recorded the highest borrowing costs for a 30-year term bond sold via a syndication – a group of lenders – since 2005, when records began.


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