BRITAIN’S CREDIBILITY

Alistair Darling’s budget figures dominated the agenda of the week. There is pretty much agreement that he is too optimistic in growth forecasts of 2009, 2010 and 2011 with 3.5 per cent contraction, 1.25 per cent expansion, and 3.5 per cent expansion respectively. IMF forecasts contraction for both 2009 and 2010.

With current government spending plans, Britain needs £175bn in 2009 and another £173bn in 2010. Alistair Darling needs pretty much the same amount of government spending in 2010 unless the government spending causes an increase in household consumption and/or business investment. Considering the extent of unemployment, consumption is not the right candidate. Can the doubled capital allowance or £750m technology investment fund fill the gap through increased investment spending? We can’t tell under current uncertainty.

The challenge is the funding of the government spending. Gilts will be the major mechanism; there is a huge competition to sell government bonds from USA, European countries, Japan. US is planning to issue $2,000bn in the fiscal year from last October onwards, Euro zone governments $1,035bn for this financial year, Japan $449bn, and UK $262bn. Needless to mention the multinational companies selling corporate bonds to the same market segment.

Globally investors have a huge choice and little confidence! They are showing this through higher yields on gilts and higher basis point on credit default swaps. Former being the investors’ premium for higher risk and latter being cost of insuring against default on UK gilt.

If both yields and basis points keep on upward slope, the first risk is that; UK’s AAA credit rating may come under threat, secondly if unable to raise the target funds from gilt sales it may be likely to knock IMF’s door for bailout funds as in 1976. Ratings Agency Moody’s confirmed on Friday, the 24th April that it is not considering UK government’s credit rating for a possible downgrade. It looks like the next two years will be determinant.