IMF Warns UK Treasury Needs £30 Billion More to Stabilize Debt

(Bloomberg) -- The International Monetary Fund warned that the UK Treasury needs to find £30 billion ($38.2 billion) of savings to stabilize its debt burden, undercutting Prime Minister Rishi Sunak’s ambition to reduce taxes before the next election.

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The estimate released with the institution’s annual health check into the economy also upgraded the outlook for growth and predicted a “soft landing.” Even so, advice on the scale of the UK’s budget gap highlighted the strain on the public finances already struggling to cope with demands on health, defense and social care.

The figures point to a bleak inheritance for the government that will rule after the election, which must be held by the end of January. With the ruling Conservative Party trailing in polls and the tax burden near its highest since World War II, Chancellor of the Exchequer Jeremy Hunt is looking for a “feel-good factor” that would make voters more confident in their own prospects.

“Difficult choices will need to be made to stabilize the debt,” the IMF said Tuesday in its Article IV report released in Washington.

The IMF forecasts don’t tie Hunt’s hands. Any fiscal statement Hunt delivers would be judged against his own debt rules by the Office for Budget Responsibility, which has to take government policy as given. But the fund’s figures suggest a fiscal consolidation of about 1% of gross domestic product — roughly £30 billion — will be needed in a post-election budget to put debt on a downward trajectory within five years.

Hunt has made it clear he would like to cut taxes one more time before the election that is expected in the second half of the year in a bid to boost the ruling Conservative Party’s chances after the drubbing it received in this month’s local elections. He has cut payroll taxes by £20 billion since November but has been accused of paying for the giveaway with “fictional” plans to cap departmental spending at 1% above inflation and freeze capital spending beyond April 2025.

The Chancellor drew attention to the IMF’s growth forecasts, which now anticipate a 0.7% expansion this year, up from the previous estimate of 0.5%. Growth will then pick up to 1.5% in 2025 and perform better than Germany and France over the medium term. That assumes the Bank of England cuts interest rates by half a point this year to 4.75% and by a further percentage point in 2025.

“Today’s report shows that independent international economists agree that the UK economy has turned a corner and is on course for a soft landing,” Hunt said. “The IMF have upgraded our growth for this year and forecast we will grow faster than any other large European country over the next six years — so it is time to shake off some of the unjustified pessimism about our prospects.”

Rather than tax cuts, the IMF said tax rises would be needed to get the national debt, which is close to 100% of GDP, under control. It said the Treasury’s spending plans “do not appear to sufficiently account for known pressures, especially in health and social care, and growth-enhancing investment needs, including the green transition.”

It urged officials to consider higher carbon taxes, broadening the VAT and inheritance tax base to capture more goods and people, and increasing capital gains and property taxes. Property tax reforms could allow the chancellor to reduce stamp duty, it added, which Hunt almost did in the March budget.

The fund also proposed scrapping the state pension triple-lock and instead indexing it solely against inflation. That policy commits the government to increasing pension payments at a pace that many economists say can’t be sustained. Other suggestions included user charges for public services and road tolls.

Interest Rates

On monetary policy, the IMF said the question the BOE now faces is “when and how fast to cut rates.” The IMF urged policymakers to wait for “clearer signs of receding inflation persistence” but not delay too long and “stall or even reverse the recovery.” It believes interest rates will eventually settle at a neutral rate of around 3%.

The BOE also needs to be clarify its plans for “quantitative tightening,” through which it is unwinding the £895 billion of assets bought to support the economy during the financial crisis and the pandemic. “Articulating a clear rationale for future QT will be important,” it said.

It warned that parliament’s proposal that the BOE focus on “a narrow value-for-money test” given the fiscal losses caused by QT would “potentially affect the BOE’s ability to carry out its mandate.” However, it said in future government “the size and frequency of transfers between the Treasury and the BOE should be reduced to insulate the BOE from political pressure.”

Members of Parliament have raised concerns about the losses that the taxpayer must currently bear as a result of the program, which are partly caused by the government seizing profits the program made between 2009 and 2021 and spending all the money. Losses are covered under a state indemnity, and around £50 billion has been transferred to the bank from the Treasury since 2022.

The fund also called for a change to the fiscal rules, as the current rule that debt must be falling in the fifth year of the forecast could potentially allow the debt to rise forever. Instead, it suggested the debt rule should be measure against the probability of the debt falling in the fifth year with a 75% probability rather than the 50% probability currently used.

--With assistance from Andrew Atkinson.

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