Tag: #sectorbalances

The key chart

Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)

The key message

Viewed from a sectoral balances perspective, the Office of Budget Responsibility’s (OBR’s) latest “Economic and Fiscal Outlook” for the UK appears “too dull to be true”.

Too dull to be true?

Sectoral balances illustrate the financial relationship between different economic sectors. Between the UK private sector (households and corporates), the UK public sector and the rest-of-the-world (RoW), for example, in the key chart above.

The approach builds on the key accounting identity pioneered by the late Wynne Godley that states that:

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

Pre-COVID, the UK was characterised by unsustainable macro imbalances. Both domestic sectors were running net borrowing (or deficit) positions at the same time. This left the UK increasingly reliant on net lending from the rest-of-the world – the ultimate irony for “post-Brexit Britain”.

The pandemic changed everything. The private sector shifted to unprecedented levels of net lending/surpluses. At its peak in 2Q20, private sector surpluses/disinvestment totalled almost 25% GDP. Fortunately, the UK government’s response was timely, rapid and appropriate with an offsetting deficit/investment of 25% GDP (see key chart above).

Recent (post-pandemic) OBR outlooks forecast a return to the pre-COVID world of unsustainable macro imbalances. The latest version is more optimistic, thanks in part to improved household dynamics.

In short, the OBR forecasts a balanced UK private sector – a net lending position for the household sector of 1.3% GDP in 1Q29 down from 2.6% GDP in 2Q23, but close to average levels, and a return to investment or net borrowing by UK corporates equivalent to -0.9% GDP. The OBR also expects net borrowing by the government to fall from -7.3% GDP to only -0.7% GDP over the same period.

The OBR concludes that, “Following large swings during the pandemic and energy crisis, sectoral balances are expected to return to historically more normal levels over the forecast period.”

A more cynical observer may conclude that the forecasts are simply too dull and/or too smooth to be true…

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

The key chart

The key message

The OBR’s latest “Economic and fiscal outlook” (published 15 March 2023) presents a brighter outlook for the UK economic and fiscal outlook – a shorter and shallower downturn, higher medium term output and lower budget deficits and public debt.

Viewed from our preferred sector balances perspective, however, the forecasts indicate that fundamental challenges and economic imbalances remain.

According to the OBR….

While the Chancellor and other fiscal hawks celebrate lower deficits, the UK’s household (HH) sector will move from a large surplus to a balance as savings are drawn down to support consumption during the squeeze on real disposable incomes. (This means no net HH saving or borrowing over a sustained period – really??). Private consumption will still fall in 2023, however (by 0.8%), as lower savings will only partially offset the decline in incomes.

Corporate (NFC) investment will disappoint too. The NFC sector moves from a modest surplus (ie, disinvestment) to balance as investment picks up, but only gradually.

With the private sector running small surpluses (as opposed to the small deficits forecast in November 2022), borrowing from the rest of the world remains sizeable and persistent.

In short, the OBR expects a return to the pre-pandemic world of economic imbalances. The good news, for what it’s worth, is that the private sector is forecast to run a small surplus rather than a deficit as before (and as predicted in November 2022). The bad news is that the UK economy is forecast to remain heavily dependent on net borrowing from abroad. A familiar story…

Six charts that matter

Don’t forget the context (see chart above)!

The counterpart to the large government debt built up during the pandemic (-26% GDP, June 2020) was large financial surpluses for UK households (+18% GDP, June 2020) and, to a lesser extent, UK corporations (+7% GDP).

From here, and according to the OBR….

In short, the OBR expects a return to the pre-pandemic world of economic imbalances (see chart below).

The good news, for what it’s worth, is that the private sector is forecast to run a small surplus rather than a deficit as before (and as predicted in the previous OBR forecasts).

The bad news is that the UK economy is forecast to remain heavily dependent on net borrowing from abroad. A familiar story…

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

The key chart

The key message

The context for the (now) eagerly anticipated OBR forecasts for the UK economy and its fiscal outlook remains very challenging. To re-use an old gag, if I was the OBR, I would not start from here!

The UK has already returned to the unsustainable world of pre-COVID economics with twin domestic sector deficits counterbalanced by significant current account deficits (ie, RoW surpluses).

Falling real disposable incomes in the face of the largest growth in household (HH) inflation since 4Q81 cloud the outlook for household consumption. In response, the HH savings ratio has fallen sharply from its 2Q20 peak already, but remains above its pre-pandemic level and previous OBR forecasts. A pressure release valve, of sorts, remains here.

Despite a period of sustained HH sector deleveraging since the GFC, the level of indebtedness remains high in absolute terms, and the prospect of high borrowing costs through to 2023 raise the risks of heightened debt vulnerability, however. A far more limited pressure release valve (ie, more HH borrowing) here.

Previous OBR forecasts have assumed dramatic role reversals in the position of the UK government vis-à-vis the HH sector combined with sustained and significant current account deficits. This unattractive and unsustainable scenario reflects the persistent flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing public debt as a problem rather than a solution.

The risk remains that “more-of-the same” forecasts will be interpreted as reverse engineering rather than reassurance for domestic and international investors and financial markets.

If I was the OBR

The UK has already returned to the unsustainable world of pre-COVID economics with twin domestic sector deficits (see chart above) counterbalanced by significant current account deficits. According to the latest ONS statistics for the 2Q22 (published 30 September 2022), the domestic private sector increased its net borrowing position to -0.7% GDP from -0.6% GDP in 1Q22 and a net lending position of 3.1% GDP in 4Q21. In other words, private sector investment in the first two quarters of 2022 has exceeded its income (minus consumption and taxes).

The domestic public sector reduced its net borrowing position to -4.9% GDP from -6.6% GDP in the 1Q22, reflecting a drop in health expenditure, but this was still above the 4Q21 net borrowing position of -3.7% GDP.

This left the UK economy dependent on the RoW running a net lending position of -5.6% GDP in 2Q22 (see key chart above).

Falling real disposable incomes in the face of the largest growth in HH inflation since 4Q81 cloud the outlook for household consumption. Nominal HH gross disposable income grew 1.8% QoQ in 2Q22, up from 1.4% in 1Q22 and 1.0% in 4Q21.

This was offset, however, by quarterly HH inflation of 3.1% up from 2.1% in 1Q22 and 1.3% in 4Q21 (see chart above).

Real HH disposable income fell -1.3% QoQ, from -0.7% in 1Q22 and -0.3% in 4Q21 (see chart below). On a YoY basis, real HH disposable income fell -2.5% in 2Q22, from -1.1% in 1Q22 and -0.6% in 4Q21.

In response, the HH savings ratio has fallen sharply from its 2Q20 peak but remains above pre-pandemic levels and previous OBR forecasts. During the COVID-19 pandemic the HH savings ratio increased from its 2018-19 average of 5.3% to 26.8%, reflecting the rise in forced and precautionary savings. It has now fallen to 7.6% in 2Q22 from 8.3% in the previous two quarters.

On a positive note, room remains for HH to support future consumption by running down their savings further (see chart above). For reference, the previous OBR forecasts assumed that the savings rate would fall faster that recent trends (to below 3%) and remain below 5% for the forecast period to 1Q27.

Despite a period of sustained HH sector deleveraging since the GFC, the level of indebtedness remains high in absolute terms and the prospect of high borrowing costs raise debt vulnerability risks.

The HH debt ratio (debt as a %age of GDP) has fallen from a peak of 97% GDP in 1Q10 to 85% in 1Q22 (see chart above). The BIS considers 85% GDP to be the “threshold level” above which debt becomes a constraint on future growth.

Perhaps more importantly, if the latest market forecasts and the Bank of England’s recent debt vulnerability forecast turn out to be correct, rates could reach the levels at which the share of HHs with high, adjusted debt service ratios – those who are typically likely to struggle with debt repayments – could return to pre-GFC highs in 2023.

Previous OBR forecasts have assumed dramatic role reversals in the position of the UK government vis-à-vis the HH sector combined with sustained and significant current account deficits (see chart above).

This is an unattractive and unsustainable scenario but one that reflects the persistent flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing public debt as a problem rather than a solution.

The risk remains that “more-of-the same” forecasts will be interpreted as reverse engineering rather than reassurance for domestic and international investors and financial markets.

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

The key chart

The key message

Two official UK data points released last week – the 1Q22 household (HHs) savings ratio and May 2022’s consumer credit growth – provide short-term comfort but may hide more serious medium-term concerns for the UK economic outlook.

The positive news: HHs have room to adjust to falling real incomes by running down savings and increasing borrowings further. The adjustment process here remains at an early stage (see “Don’t be surprised”).

The negative news: while the net lending position of the HH sector widened slightly in 1Q21 (0.9% GDP), the UK private sector, in aggregate, moved into a net borrowing position (-1.4% GDP). At the same time, the public sector increased its net borrowing position further (-6.7% GDP).

So what? The irony of post-Brexit Britain, is that the economy is currently more dependent than ever on the net lending of the RoW. The challenges of the pre-Covid period have returned already – twin domestic deficits counterbalanced by significant (and persistent?) current account deficits.

These trends are not unexpected but that does not mean that they are either welcome or sustainable.

Don’t be surprised – part 2

Two official UK data points released last week – the 1Q22 HHs savings ratio and May 2022’s consumer credit growth – provide short-term comfort but medium-term concerns for the UK economic outlook.

The context here is that real HH disposable income has fallen for four consecutive quarters (see chart above). Official forecasts suggest that this will continue for the rest of 2022 and in 2023.

In response, the same forecasts assume that HHs will reduce their savings ratio to a new low in 1Q23 by running down the excess savings built up during the pandemic (see chart below) and/or by increasing their borrowing. The positive news is that this process has hardly begun.

The 1Q22 HH savings ratio was 6.8%, unchanged from the 4Q21 and above the OBR’s forecast of 6.3% (see chart above). Of course, this represents a large decline from the 2Q20 peak of 23.9%, but the 1Q22 ratio is only slightly below the 20-year average of 7.1%. (Note that the OBR expects the savings ratio to fall further to 2.8% in 1Q23.)

Furthermore, while monthly HH money flows have moderated sharply, they remain slightly above pre-pandemic levels during 2Q22 (see chart above). The result? Rather than declining, the stock of excess savings is increasingly slightly still (see chart below). CMMP analysis estimated that excess savings currently total £167bn.

As an aside, the ONS also released the results of its modelling of the breakdown of the excess savings last week. The modelling suggests that so-called “forced savings” accounted for 75% of the increase in HH savings during the pandemic.

According to their calculation, this amounts to over £140bn, or around 10% of annual disposable income. This matters because forced savings are typically released relatively quickly to support economic activity (see “Forced versus precautionary”).

Consumer credit grew 5.7% YoY in May 2022, unchanged versus the previous month (see chart above). This is the fastest rate of growth since February 2020 (5.8%) due in part to base effects. The monthly flow of consumer credit in May 2022 fell, however, from £2.0bn in February, £1.3bn in March, and £1.4bn in April 2022 to £0.8bn. May’s monthly flow is also below the pre-pandemic average of £1.1bn.

In other words, the demand for consumer credit has recovered – a welcome trend – but is not increasing at a rate that would suggest significant levels of distressed borrowing. HH debt as a percentage of disposable income, while elevated in absolute terms, has remained relatively stable since 2015 and below the peaks seen in the built up to the GFC.

So far, so good. Recent trends reflect a return to normality and suggest that HHs still have room to adjust to falling real incomes. It is not all good news, however. In “Don’t be surprised”, I highlighted the negative implications of forecast trends for both financial equality and economic sustainability. Last week’s data also shines further light on question of economic sustainability.

The net lending of the UK HH sector, i.e. the surplus resources that the HH sector makes available to other sectors, rose from 0.6% GDP in 4Q21 to 0.9% GDP in 1Q22 (see chart above). However, the UK private sector in aggregate shifted from a net lending position of 4.3% GDP in 4Q21 to a net borrowing position of 1.4% of GDP.

When combined with the net borrowing of the UK public sector of 6.7% in 1Q22, the UK’s net borrowing position with the rest of the world increased to 8.4% GDP (see chart below).

The irony of post-Brexit Britain, is that the 1Q22 net borrowing position with the rest of the world exceeds the previous highest borrowing seen in 4Q201 (7.0% GDP).

With both domestic sectors currently running net borrowing positions, the UK is more dependent than ever on net lending from the RoW (see chart above).

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

The key chart

The key message

In its “Economic and fiscal outlook”, the Office of Budget Responsibility (OBR) delivered mixed messages for the UK economy and public finances.

The headlines are likely to focus on the forecast that the government’s borrowing will narrow to -1.1% GDP by 1Q27. This would be the lowest budget deficit for 25 years (£32bn) and music to the ears for a Chancellor who believes in his moral responsibility to balance the budget.

The forecasts assume (1) dramatic role reversals in the position of the UK government vis-à-vis the household (HH) sector and (2) sustained and significant current account deficits throughout the forecast period. They also present a more subdued outlook for business investment.

The key risks lie in the assumption that, in the face of falling real incomes, HHs will maintain consumption via reducing their savings ratio to a record low and/or increasing borrowing further (despite high HH debt ratios).

Beyond these risks, there are two further problems with these latest OBR forecasts:

• First, the assumed end-position envisages BOTH domestic sector sectors running persistent net deficits beyond 4Q22, leaving the UK reliant on the RoW as a net lender. Such a scenario appears neither attractive nor sustainable;
• Second, and more fundamentally, the implied shift away from public debt to private debt reflects the persistent flaw in conventional macro thinking that typically ignores the risk associates with private debt while seeing public debt as a problem rather than a solution.

Faced with these two problems, I believe that the greatest value in these forecasts lies in the insights they provide into the key drivers and assumptions that lie behind current policy and thinking. From there, we can all form our own views as to the likelihood of them being achieved in reality…

Good news for Rishi, but…

The OBR provided good news for Rishi Sunak, the UK Chancellor, in its latest “Economic and fiscal outlook” published on Wednesday 23 March 2022.

The UK government’s net borrowing position has already narrowed to -10.1% GDP (3Q21) versus previous expectations of -11.4%. More significantly, the OBR expects this to narrow to -1.1% by 1Q27 compared with previous forecasts of -1.5% (see chart above). This would represent the lowest budget deficit for 25 years (£31.6bn). Music to the ears for a Chancellor who believes in a moral responsibility to balance the budget.

Key OBR assumptions

The key assumption behind the OBR’s forecasts is that the HH sector moves from its traditional role as a net lender to the rest of the economy to being a sustained net borrower (see chart above).

Such a transition would involve remarkable role reversals from a period when the “Government took exceptional measures to protect HH incomes from the full effect of one crisis (the pandemic) to one in which imported cost rises force HHs to save less to cushion the blow to real spending” (OBR, March 2022).

In short, to move to a net lender position, HHs would need to either reduce their savings and/or increase their borrowings.

The OBR forecasts a more dramatic reduction in the HH savings ratio than previously, to a record low of 2.8% by the start of 2023 (see chart above). This would allow HHs to maintain their consumption levels in the face of the expected fall in real incomes.

To support this assumption, the OBR notes that HHs have, “saved around £230bn more than in the equivalent period before the pandemic, of which around £185 billion is held in highly liquid deposits.” This is true but much of these excess savings have accrued to HHs that already have sizable savings, have higher incomes, and are much older. Such HHs typically spend less from an extra savings they accumulate.

With the OBR also forecasting that the savings ratio will remain at around 5% through their forecast period, below the LT average of around 8%, the risks to this assumption lie to the downside, in my view.

The OBR argues that, “in practice the lower savings ratio will reflect some HHs running down excess savings while other take on more debt.” In that context, it is worth noting that the HH debt ratio has fallen from its peak of 97% GDP in 1Q10 to 88% GDP at the end of 3Q21. Nonetheless, it remains above the BIS maximum threshold level, above which debt becomes a drag in future growth (see chart above).

While the cost of servicing debt remains very low, the overall debt ratio suggests that HHs may be reluctant to increases borrowing levels dramatically from current levels.

In another example of assumed role reversals, the OBR expects the NFC sector to remain a net lender until 2Q25 (see chart above). Note that NFC sectors are typically net borrowers while HH sectors are typically net lenders.

The OBR notes that, “since the start of the pandemic, business investment has been weak and recovered more slowly than other elements of expenditure.” In the 4Q21, business investment remained over 10% below its pre-pandemic peak and almost 3% below the OBR’s previous forecast. In its downward revision, the OBR expects, “investment not to recover to its pre-pandemic peak until the end of 2022 – nearly a year later than GDP as a whole”.

With both UK domestic sectors forecast to run simultaneous net deficits, the OBR assumes (by definition) that the ROW’s net surplus (ie, the UK’s current account deficit) will remain significant and of a similar size to the years before the pandemic. In other words, the UK will remain reliant on the RoW as a net lender. No change from previous forecasts there.

Conclusion

The OBR’s forecast that the UK’s budget deficit will fall to just over 1% GDP (£32bn) in 2026-27 will be welcome news for Rishi Sunak. This would represent the smallest budget deficit (£32bn) for 25 years.

Viewed from a sector balances perspective, these forecasts assume dramatic role reversals in the position of the UK government vis-à-vis the HH sector (and to lesser extent between the HH and NFC sectors) and sustained and significant current account deficits. The key risks to these forecasts lie in the assumption that, in the face of falling real incomes, HH will maintain consumption via reducing their savings ratio to a record low and/or by increasing their borrowing further (despite HH debt ratios).

Beyond the risks to key assumptions, there are two further problems with the OBR forecasts.

First, the assumed end-game envisages BOTH domestic sector running net deficits from 4Q22 onwards leaving the UK increasing reliant on the RoW as a net lender. Such a scenario appears neither attractive nor sustainable (see chart above).

Second, and more fundamentally, the implied shift to replace public borrowing with more private borrowing reflects the flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing government debt as a problem rather than as a solution.

Faced with these two problems, I believe that the greatest value in these forecasts lies in the insights they provide into the key drivers and assumptions that lie behind current policy and thinking. From there, we can all form our own views as to the likelihood of them being achieved in reality…

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

The key chart

The key message

The Office of Budget Responsibility (OBR) will publish its latest “Economic and fiscal outlook” tomorrow (Wednesday 23 March 2022) following the Chancellor’s Spring Statement in Parliament.

The outlook will present the OBR’s latest forecasts for the economy and public finances. The context remains one in which the Chancellor, Rishi Sunak, has pledged to restore order to the government finances after borrowing increased during the pandemic.

“The ongoing uncertainty caused by global shocks means it’s more important than ever to take a responsible approach to the public finances.”

Rishi Sunak quoted by Bloomberg (22 March 2022)

There are three key things to bear in mind when analysing these latest forecasts tomorrow:

• First, the UK government’s response to the COVID-19 pandemic was both timely and appropriate (see “Extraordinary response to extraordinary times“)
• Second, responsible fiscal outcomes are those that deliver a balanced economy not a balanced budget (see “Note to Rishi“)
• Third, previous OBR forecasts for improvements in UK government finances (see key chart above) relied on unsustainable assumptions including sustained, twin domestic deficits counterbalanced by significant and persistent current account deficits (see “A return to abnormality“)

Rather than sending a message of fiscal responsibility, such assumptions smell more of “reverse engineering.” As always, one chart among the 200+ pages, will tell us all we need to know tomorrow…

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.