Month: October 2021

The key chart

The key message

The OBR’s forecasts of a rapid improvement in UK government finances (the good news) assume unusual behaviour on the part of the UK private sector and the RoW and imply a “return to the abnormality” of sustained domestic UK deficits counterbalanced by significant and persistent current account deficits (the bad news). Viewed from a sector balances perspective, the risks appear tilted to the downside ie, government finances may not recover as quickly as forecast.

The OBR published its latest “Economic and fiscal outlook” on Wednesday, 27 October 2021. The Office recognised the positive impact of the UK government’s fiscal response in protecting household and corporate incomes during the pandemic and through 2021. Looking further forward, the OBR forecasts a rapid improvement in the government’s finances, with borrowing falling back below £100bn next year and stabilising around £44bn (<2% of GDP) in the medium term.

The forecasts assume certain behaviours from the other economic sectors, namely the domestic private sector (households and corporates) and the RoW. Under the latest forecasts, the UK household sector, which is typically a net saver, shifts (unusually) to a net deficit position over the forecast period. Given the high level of existing debt, this requires HHs to sustain historically low savings ratios of c.5%. The NFC sector, which is typically a net borrower, returns to a deficit position in 2Q22 and then runs relatively high deficits of c.3% of GDP over the rest of the period. To offset these twin domestic deficits, the RoW runs equal and historically high counterbalancing surpluses vis-à-vis the UK.

In short, the forecast improvements in UK government finances rely on dynamic adjustments by other economic sectors and unusual patterns of behaviour beyond that. This suggests obvious risks that the forecasts will not be met. Furthermore, the assumed end-result is one where sustained, twin domestic deficits are counterbalanced by “significant and persistent current account deficits. The OBR describes this as a “return to more normal levels”. CMMP analysis suggests it is anything but.

“Returning to abnormality”

The OBR published its latest “Economic and fiscal outlook” on Wednesday, 27 October 2021. The outlook sets out the Office’s forecasts for the economy and public finances to 2026-27 and provides an assessment of whether the Government is likely to achieve its fiscal targets.

The OBR recognised the positive impact of the UK government’s fiscal response in ensuring that household (HH) and corporate (NFC) incomes did not fall “nearly as much as this expenditure or output” during the pandemic.

Government net borrowing rose to 12.5% of GDP in 2020, to pay for the fiscal support (see chart above). The HH net surplus rose to 7.8% of GDP, versus a 1Q04-1Q21 average of 2.5%. The NFC deficit moved into balance versus a 1Q04-1Q21 average deficit of -0.8% of GDP. Hence, the private sector’s net surplus rose to 7.8% of GDP versus a 1Q04-1Q21 average of 1.7% of GDP. These imbalances have persisted into 2021 as restrictions and support remained in place, albeit to a lesser degree.

Looking forward, the OBR forecasts a rapid improvement in the UK government’s financial position (see chart above, which compares the latest forecasts with the previous version), with borrowing falling “back below £100bn next year, declining more slowly thereafter to stabilise at around £44bn (1.5% of GDP) in the medium term.” Such and improvement would be sufficient for Rishi Sunak, the Chancellor of the Exchequer, to meet his fiscal target of getting “underlying debt falling as a share of GDP by the third year of our forecast (2024-25)”.

Domestic government balance + domestic private balance + foreign balance (must) = zero

These forecasts assume certain behaviours from the other economic sectors, namely the domestic private sector and the RoW. Recall that, from national accounting principles (see identity above), we know that the deficits run by one or more economic sectors must equal surpluses run by other sector(s).

Over the forecast period, the UK household sector, which is typically a net saver, shifts (unusually) to a net borrowing position. The OBR expects the HH net surplus to peak at 10% GDP in 1Q21, fall to 5.7% of GDP by 4Q21 and then (unusually) move into deficit by 4Q22 and for much of the forecast period out to 1Q27. Note that for any sector to run a deficit it must either increase its borrowing and/or reduce its accumulation of net financial assets.

Given the high level of HH debt, this requires HHs to sustain historically low savings ratios. At the end of 1Q21, the UK HH debt ratio was 91% of GDP, 6ppt above the BIS threshold limit and only 5ppt below its all-time high (see chart above). This suggests that HH are unlikely to increase borrowing levels significantly over the period.

Unsurprisingly, therefore, the OBR forecasts place a greater emphasis on HH savings. First, they assume that HHs will spend c.5% of the excess savings built up during the pandemic, a reasonable assumption. Second, and following on from this, they assume that the HH savings ratio will fall rapidly and stabilise at or around historic lows of c.5%, a more aggressive assumption (see chart below). History suggests that the risks to these assumptions lie clearly to the downside.

The NFC sector, which is typically a net borrower, returns to a deficit position in 2Q22 and then runs relatively high deficits of c.3% of GDP over the rest of the period (see chart below). This compares with a 1Q04-1Q21 average deficit of just under 1% of GDP. Again, given the current level of NFC borrowings the risks to these forecasts and to the level of NFC investment appear tilted to the downside.

To offset these twin domestic deficits, the RoW runs equal and historically high counterbalancing surpluses vis-à-vis the UK. The net surplus of the RoW is forecast to increase fro 3.3% of GDP currently (in-line with historic average) to 5.3% in early 2023 and then stabilise at c.4.5% for the rest of the forecast period. In other words, the UK is assumed to be increasingly reliant on the RoW as a net lender.

Conclusion

The forecast improvements in UK government finances rely on dynamic adjustments by other economic sectors and unusual patterns of behaviour beyond that. This suggests obvious risks that the forecasts will not be met.

Furthermore, the assumed end-result is one where sustained, twin domestic deficits are counterbalanced by “significant and persistent current account deficits. The OBR describes this as a “return to more normal levels”. CMMP analysis suggests it is anything but.

Please note that summary comments and charts above are extracts from more detailed analysis that is available separately.

The key chart

The key message

On Wednesday this week (27 October 2021), the OBR will publish its latest “Economic and fiscal outlook”. Among the 200+ pages of detailed analysis and forecasts, one page and one chart are key – “sectoral net lending” (typically around page 70!). This examines the impact of expected income and expenditure of the three economic sectors (private, public and RoW) for the path of each sector’s net lending to, or borrowing from, the others. A core element of CMMP analysis.

The previous outlook (March 2021) assumed that the two domestic sectors would return to running simultaneous net financial deficits in 2022 and described this situation as “more usual.” Of course, this is only possible if the RoW runs a compensating net financial surplus at the same time (ie current account surplus vis-à-vis the UK).

In short, existing official forecasts assume persistent and significant fiscal and current account deficits between 2022 and 2026. From a CMMP perspective, this is neither usual nor sustainable. Hence our attention will naturally focus on any revisions to these assumptions. Watch this space…

Neither usual, not sustainable

The OBR will publish its “Economic and fiscal outlook” (EFO) for the UK on Wednesday October 2021. The EFO sets out the Office’s forecasts for the economy and the public finances and provides an assessment of whether the Government is likely to achieve its fiscal targets. From a CMMP perspective, the key section is the one page summary of sectoral net lending. Specifically, the impact of expected income and expenditure of different economic sectors for the path of each sector’s net lending to, or borrowing from, the others.

• For background, see “Everyone has one”

In the previous EFO (March 2021), the OBR argued that, “Over the medium term, sectoral lending positions return to more usual levels. As can be seen from the key chart above, this assumed that the two domestic sectors would both be running simultaneous net financial deficits (ie, both spending more than they earn). Note that, in the case of a simple two-sector economy, it would be impossible for the private and public sectors to be running deficits at the same time.

• For background, see “Imbalances and dependencies”

Of course, in practice the two domestic sectors are linked economically to foreign FIs, NFCs, HHs and governments, collectively termed the rest-of-the-world (RoW). From this, we can see that the previous OBR forecasts assume that the RoW would run compensating net financial surpluses (current account surpluses) vis-à-vis the UK domestic sectors.

• For background, see “Where is the value…?”

In short, existing forecasts assume significant and persistent fiscal and current account deficits from 2022-2026. From a CMMP perspective, this is neither usual nor sustainable. Hence, our attention will naturally turn to the revised assumptions this week…

Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.