The real challenges for Rishi Sunak lie ahead despite drop in public borrowing

There is good news for Rishi Sunak in the latest public borrowing figures. But there is trouble ahead for the chancellor as he considers how much money to give government departments in his three-year spending review.

This sense of foreboding, despite the improving financial picture, is going to gnaw away at Sunak’s Treasury team as October’s review approaches.

Dilemmas posed by the spending review have the potential to sour the relationship further between No 11 and the spendthrifts in Boris Johnson’s team next door, who are desperate for the public to be distracted by a volley of government initiatives taking them triumphantly through to the next election.

The good news is that in the first four months of the financial year, Britain’s debts climbed at a slower rate than was expected by the Treasury’s official forecaster, the Office for Budget Responsibility (OBR).

The OBR’s forecasts are crucial because the Treasury is duty-bound to accept its outlook for the public finances when drawing up a budget.

Officials at the OBR will produce a fresh forecast to coincide with October’s spending review, updating the last one in March, and drawing a circle around the cash available to spend. Go beyond this amount, and the Treasury will need to pencil in extra borrowing.

In the latest figures for July, public sector net borrowing was £10.4bn, which was £1.5bn below City analysts’ expectations and a whopping £5.2bn under the OBR forecast.

In addition, the estimate of borrowing over the previous three months was revised down to £67.7bn, from £69.5bn.

Sunak does not need to look far to see where he is winning. He spent less on the furlough scheme than the OBR thought he would back in March and tax receipts were higher, many of them from self-employed workers who survived the pandemic in better financial shape than they had expected.

Superficially, the improving economic situation, with job vacancy rates at record highs and unemployment falling, has put the chancellor on course to dramatically undershoot the OBR’s borrowing forecast over the rest of the financial year. In the first four months he has borrowed about £26bn less than forecast.

In No 10, this will be seen as a windfall to be spent, pronto. However, dark clouds are gathering.

Samuel Tombs, the chief UK economist at Pantheon Macroeconomics, gives several reasons to be less than cheerful. First, the furlough scheme disappears in September and it will stop being a benefit to the public finances from October.

Second, the large proportion of government borrowing linked to inflation is becoming an increasing burden as prices rise. Tombs said paying the extra interest on index-linked government bonds was likely to add £12bn to the borrowing bill over the financial year.

In line with analysis by the Institute for Fiscal Studies, Tombs said Sunak failed to make proper allowance in the last budget for extra health spending that will be needed in the winter to combat Covid-19, and much other spending delayed over the last 18 months.

Overall, the bill will be £25bn more than is implied by the trajectory from the first four months of the financial year, he said.

This still gives the chancellor about £30bn more to play with than the OBR forecast.

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Yet, there is worse news for the chancellor from the OBR’s calculation of the long-term damage to the economy from the pandemic. It expects the hit from the coronavirus to be 3% over the longer term, meaning there will be lower tax receipts for him to spend permanently.

For the OBR to significantly improve its forecast in October, it must adjust this loss downwards.

If it followed the Bank of England, the figure would fall from 3% to 1%. This would be a recognition that the economy not only performed better this year than expected but will recover its previous strength, or almost, giving Sunak a windfall not only in 2021-22 but for the rest of the parliament.

Sadly for Sunak and the prime minister, this is unlikely to happen.

The OBR’s gloomy forecasts were based on higher GDP growth than we haveenjoyed to date. Britain might have a buoyant labour market but there is much else wrong with the UK economy that has vexed, and will continue to vex, the OBR, not least the growing bill for an ageing population and the long-term damage to trade from Brexit.

Maybe the OBR boss Richard Hughes will smile on the chancellor and simply adopt the central bank’s sunnier outlook. No one should bet on that.


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